Fap Combined

BBA SEM VI FINANCIAL ANALYSIS AND PLANNING
MODULE 6 BUSINESS FORECASTING
MEANING
Business forecasting is an act of predicting the future economic conditions on the
basis of past & present information. It is a technique of having a prospective view of
things likely to shape the turn of things in the foreseeable future. Scientific
forecasting involves (i) analysis of the past economic conditions & (ii) analysis of the
present conditions; so as to predict the future events accurately.
“Business Forecasting is the calculation of probable events, to provide against the
future. It therefore, involves a ‘look ahead’ in business and an idea of pre -
determination of events and their financial implication as in the case of budgeting.”
PURPOSE / USES / IMPORTANCE OF BUSINESS FORECASTING

The following aspects highlight the importance of forecasting in today’s business
world:
1) Establishing a New Business : To set up a new business, one has to
forecast the demand for the product, capacity of competitors, expected market
share, amount & sources of finances, etc. The success of a new business will
depend on the accuracy of forecasts & minimise its chances of failure.
2) Formulating Plans : Forecasting provides a logical basis for preparing plans.

The future assessment of various factors is necessary to make plans.
Planning is an impossibility without forecasting. The entire plan of an
enterprise is made up of a series of plans called forecasts.
3) Estimating Financial Needs : Any business requires adequate capital to

function well. Absence of correct financial estimates, the business may suffer
either from inadequate capital or from excess capital. Forecasting of sales &
expenses helps to estimate future financial requirements. Plans of expansion,
diversification etc, also depends on forecasting. A proper financial planning
depends upon systematic forecasting.
4) Facilitating Managerial Decisions : Forecasting helps management to make

accurate decisions. By providing a logical basis for planning & determining in
advance the nature of future business operations, it facilitates correct
managerial decisions about material, personnel, sales & other requirements.
5) Quality of Management : The quality of managerial personnel improves as it

compels them to look into future & provide for the same. By concentrating on
future, forecasting helps the management to adopt a definite course of action
& a set purpose.
ONLY FOR PRIVATE CIRCULATION Page 1

6) Encourages Co – operation & Co – ordination : Forecasting is not a one

man’s or one department’s job. No department or person can make
predictions in isolation. For proper forecasts of a business as a whole
depends on co – ordination & co – operation of various departments.
7) Better Utilisation of Resources : Forecasting ensures effective utilisation of

resources reveals areas of weaknesses & provide information about future.
Management will be able to concentrate on critical areas & control more
effectively.
8) Success in Business : Successful business to a great extent depends upon

correct predictions about the future. Systematic forecasting ensures smooth &
continuous working of the business. By knowing future course of events, one
could always face the difficulties in a planned manner.
STEPS / ELEMENTS OF BUSINESS FORECASTING

The process of forecasting consists of the following steps:
1) Developing the basis : The first step is to develop the basis of systematic
investigation of economic situation, position of industry and products. The
future estimates of sales & general business operations have to be based
on the results of such investigation.
2) Estimating future business operations : The second step involves

estimating of conditions & course of future events within the industry. On
the basis of data collected through investigation, future business
operations are estimated. The quantitative estimates for future scale of
operations are made on certain assumptions.
3) Regulating forecasts : The forecasts are compared with actual results so

as to determine any deviations. The causes for variations are determined
so as to take corrective action in future.
4) Reviewing the forecasting process : Once the deviations in forecasts and

actual performance are found improvements are made in the process of
forecasting. The refining of forecasting process will improve forecasts in
future.
SOURCES OF DATA USED IN BUSINESS FORECASTING
The collection of data is required for statistical investigation & is the basis
of analysis & interpretations. Data can be collected from:
1) Primary Sources: It is first - hand information collected personally by

the investigator. It is expensive & time consuming. It is collected by
personal interviews, questionnaires & observations.

2) Secondary Sources: These sources of information refer to already

published data or data collected by other agencies. It is second - hand
data. The task is to compile the data. The sources of secondary data
are:
a) Official reports of the government.
b) Publications of RBI, financial institutions etc.
c) Annual reports of companies
d) Journals, Newspapers, Magazines, etc.
Such data is cheaper, quicker and easily available.
KINDS OF FINANCIAL FORECASTS

1) General Business Forecasts : It is a forecast made according to expected
future conditions. These forecasts are influenced by the government rules &
laws, prevailing economic conditions, consumer preferences, etc.
2) Sales Forecasts : This forecast is linked to the general business forecast.

Taking the future business expectations, the management forecasts its
expected future sales. It is the potential sales of the business in future.
Various managerial plans are based on sales forecast, like the volume of
production, the requirement of various inputs, labour required for that
production, etc. On this forecast other plans are made.
3) Capital Forecast: This forecast is related to the firm’s capital. Every business
has to determine its fixed capital & working capital needs. The firm has to
ascertain the amount required to purchase of fixed assets & the amount to
meet its day to day expenses. A business may take up expansion &
diversification plans; it has to forecast the capital needs. If the estimates are
not accurate the concern will suffer due to shortage of funds or excess of
capital.
METHODS OF FORECASTING
1) Direct / Bottom – Up Method : In this method various departments of an
enterprise collect their own data & prepare their own forecasts. On these
basis the firm’s whole forecast is undertaken. The responsibility of successful
forecasting lies directly with various departments & people in the organisation.
2) Indirect / Top – Down Method : Its reverse of direct method. In this method the
forecast for the industry / business as a whole is ascertained first & then the
particular forecasts for the various activities of the business are established.
The process of forecasting is indirect & the responsibility for success in
forecasting mainly lies with the top levels of management.
3) Historical Method : It refers to the projection of trends on basis of past events.

The historical sequence of events is analysed as a basis for understanding
the present situation and forecasting the future trends. The past recurring
trends are associated with corresponding cause & effect phenomenon in the

future. The advantages are that past data is easily obtained & present
information is also not ignored.
4) Deductive method : Under this method future trends are based on observation
& investigation. Alongwith critical analysis of past events to obtain future
inferences, it involves subjective evaluation for deducing discretion,
experience & intuition of the forecaster. This method is dynamic as it also
takes into account the latest developments. The main drawback is that it relies
on individual judgement than on actual record.
5) Joint Opinion Method : This method utilises collective opinion, judgement &
experience of various experts. A committee for business forecasting is
formulated to take the joint view of various members. A consensus is evolved
for predicting future events on the basis of their views. The advantages
included (i) it encourages co – operation & co – ordination & utilised the
services of various experts; (ii) there is no need of detailed statistical analysis;
(iii) it is simple & easy to operate. The main drawback is the joint responsibility
which may ultimately lead to nobody’s responsibility.
6) Scientific Business Forecasting : Under this method, forecasting is done on

scientific lines by making use of various statistical tools. Past statistical data
modified in the light of changed present conditions provides the basic raw
material for drawing more accurate conclusions for the future. The following
are some of the most important statistical tools used for business forecasting:
a) Business Index / Barometer : Business index refers to a series relating to

business conditions. It is also known as indicator or economic forecaster. The
index number may measure changes in business activity during the changes
of cyclical variations i.e boom, decline, depression & recovery.
The indices of production, wages, trade, finance, shares, etc are plotted on a
graph paper to obtain the curve showing trend of long – period & seasonal
movements. The various index numbers relating to different activities of
business may be combined into a general or composite index of business
activity. The following are some of the important series which are considered
by businessmen for forecasting:
(i) Index of Wholesale Prices
(ii) Index of Consumer Prices
(iii) Index of Industrial Product
(iv) Gross National product
(v) Employment
(vi) General Aggregate Consumption
These business barometers guide businessmen in taking decisions on many
problems like expansion of production activity, diversification, undertaking of a
new project, exploring new markets, etc.
b) Extrapolation / Mathematical Projection : Extrapolation is the process of
estimating a value for some future period, based on some assumptions. The
basic assumptions underlying this statistical tool of business forecasting
include : (i) there should not be sudden jumps in figures from one period to

another; (ii) the conditions in future will not change drastically. The
extrapolated values are only the estimates of the original values.
c) Regression : The regression equation, y = a + bx, can be used as an

instrument to predict the value of y for a given value of x. This equation is
highly used in physical sciences where the data are related functionally.
d) Econometric Models : Economic activities describe in terms of mathematical

equations are referred to as econometric models. These models show the
way of inter – relationships amongst the various aspects of the economy.
THEORIES OF BUSINESS FORECASTING

There are few theories which are usually followed to make business forecasting.
These are:
1) Theory of Economic Rhythm : This theory propounds that the economic
phenomena behave in a rhythmic manner & cycles of nearly the same
intensity & duration tend to recur. The available historical data have analysed
into their components i.e trend, seasonal, cyclical & irregular variations. The
secular trend obtained from the historical data is projected a number of years
into the future on a graph or with the help of mathematical trend equations. If
the phenomenon is cyclical in behaviour, the trend should be adjusted for
cyclical movements.
2) Action and Reaction Approach : This theory is based on Newton’s third law
of motion i .e for every action there is an equal and opposite reaction. In
business it implies that if there is depression in a particular field of business,
there is going to be boom sooner or later. It takes into account the 4 phases of
business cycle i.e boom, decline, depression & recovery. This theory supports
that a certain level of business activity as normal & the normal is carefully
estimated by the forecaster. According to the theory, if price of the commodity
goes up beyond the normal level, it will also come down below the normal
level due to increased production of the commodity.
3) Sequence / Time Lag Method : It is based on the behaviour of different

businesses which show similar movements occurring successively but not
simultaneously. This method takes into account time lag based on the theory
of lead – lag relationship which holds good in most cases. The series that
usually change earlier serve as forecast for other related series. However, the
accuracy of the forecast depends upon the accuracy with which time lag is
calculated.
4) Specific Historical Analogy : It based on the assumption that history repeats

itself. It implies that whatever happened in the past under certain conditions
will be repeated under the same conditions in future. A forecaster selects a
past period which is similar to the period of forecasting. At the same time
certain changes should be adjusted if a special situation prevails at the time of
making the forecasts.

5) Cross – Cut Analysis : In this theory, the effect of combined factors on

business is not studied. But the effect of each factor that has an impact on the
forecast is studied independently.
6) Model Building Approach : This approach makes use of mathematical

equations for drawing economic models. These models depict the inter –
relationships amongst the various factors impacting the business or economy.
The expected values for dependent variables are ascertained by putting the
values of known variables in the model. It is a highly mechanical approach
and is rarely employed in business conditions.
SALES FORECASTING
This forecast is the first step in financial forecasting. Accurate sales forecast
means accurate financial forecast because most of the projections are based on
sales. Sales forecast can be done on the basis of last year’s sales or the judgement
of the management of the future market conditions. The sales budget is prepared on
the basis sales forecast.
A sales budget is an estimate of expected sales during a budget period. A sales
budget is known as nerve centre or backbone of the enterprise. The degree of
accuracy with which sales are estimated will determine the practicability of operation
budgets. It is the starting point on which other budgets are based.
A sales budget lays down potential sales figures in value as well as in quantity. It
lays down a comprehensive plan & programme for sales department. The following
factors are taken into account while preparing a sales budget:
1) Past Sales Figures : The sales forecasts are based upon past sales figures.
The past sales figures enable in determination of trends of sales. The upward
& downward sales trends helps to determine the future sales. The past sales
figures are the reliable criteria on which the sales budget should be prepared.
The expected seasonal fluctuations, potential demand & trade cycles must
also be considered.
2) Assessment & Reports by Salesmen : The salesmen are the most appropriate
persons to rely on for estimating future demand. They are the people in close
contact with the market & consumers. Their experience enables the manager
to avail realistic figures about possible future sales. The sales manager
should wisely utilise these figures while preparing the sales budget.
3) Availability of Raw Materials : The availability of raw material is a key factor in

preparing the sales budget. The quantum of raw material available to the
enterprise enables the sales manager to anticipate the sales figures. And only
smooth supply of raw materials helps to achieve the sales target.

4) Seasonal Fluctuations : While preparing the sales budget the company should
take into account the seasonal variations. The demand for goods is more in
some periods while it is less in demand in another period. The company
should provide discounts & other offers to reduce the seasonal effect on
sales.
5) Availability of Finances : The financial aspect must be considered while

preparing a sales budget as the sales can be expanded only if all the inputs
are there, these inputs to be purchased require a capital outlay.
6) Plant Capacity : Goods can be sold only if they are produced, hence the
capacity to produce the goods should be taken into account. At the same time
sales effort should ensure full utilisation of plant capacity.
PROBLEMS
1) The following is the income statement of ABC Ltd for the year ending 31st
December, 2013. Prepare projected income statement for 2014
Particulars Amount (Rs)

Sales 4,00,000
Less: Cost of goods sold 3,00,000
Gross Profit 1,00,000
Less: Depreciation 20,000
Less: Operating Expenses 50,000
Profit before interest and tax 30,000
Less : Interest 5,000
Profit before tax 25,000
Less : Tax @ 50% 12,500
Profit after tax 12,500
Less : Dividend paid 2,500
Retained Earnings 10,000
Additional Information:
(1) Sales to increase by 20%
(2) Dividend to be distributed after retaining Rs 14,000 in the business.
2) Following is the income statement of SMY Ltd; for the year ending 31st
December 2009
Income Statement for 2009
Particulars Amount (Rs in thousands)

Sales 2,000
Less: Cost of goods sold 1,200
Gross Profit 800
Less: operating expenses 300
Profit before interest & tax 500
Less: Interest 100

Profit before tax 400

Less: Tax @ 40% 160
Profit after tax 240
Less: Dividend paid 120
Retained Earnings 120
a) Sales to increase by 20%
b) Interest increases by 5%
c) Tax rate increases to 50%.
d) Dividend is paid at 40% of profit after tax.
Prepare Projected Statement for 2010.
3) The following is the income statement of KP Ltd for the year ending 31st March
2011:
Particulars Amt (Rs in lakhs)

Sales 5,600
Less: Cost of goods sold 4200
Gross Profit 1400
Less: Depreciation 280
Operating Expenses 700 980
EBIT 420
Less: interest 70
EBT 350
Less: Tax @ 40% 140
EAT 210
Less: Dividend paid 60
Retained Earnings 150
a) Additional Borrowings of Rs 1,40,00,000 @ 10%.
b) Sales to increase by 30%
c) Tax rate - 40%
d) Dividend is 25% of profits.

FINANCIAL ANALYSIS AND PLANNING
RATIO ANALYSIS
RATIO
A ratio is a simple arithmetical expression of the relationship of one number to another.

“A ratio is an expression of the quantitative relationship between two numbers.”
A financial ratio is the relationship between two accounting figures expressed

mathematically. A ratio can be expressed as percentage by multiplying the ratio by 100. It
can also be represented as times.
RATIO ANALYSIS
Ratio analysis is one of the most powerful tools of financial analysis. It is the process of
establishing & interpreting various ratios for helping in making decisions. It means a
better understanding of financial strengths & weaknesses of a firm.
USES AND IMPORTANCE OF RATIO ANALYSIS
1) Utility to shareholders: Ratio Analysis helps in decision making as it provides

valuable information from inferences. It enables in planning and forecasting as
ratios are prepared for a number of years. It is far communicative to the users of
financial statements. It brings about control in organisation as it enables correcting
deviations.
2) Utility to investors: For the assessment of the viability of financial statements, an

investor can study the long term solvency and profitability ratios. These ratios help
to decide whether to invest in a particular company or not.
3) Utility to Creditors: creditors and suppliers are interested to know the firm’s
ability to meet short term obligations; hence they can study the liquidity ratios of
the firm before extending credit.
4) Utility to employees: the employees are interested in knowing about their fringe
benefits and job security. The profitability ratios related to sales to understand
about their wages and other benefits.
FOR PRIVATE CIRCULATION

VI SEMESTER BBA Page 1
5) Utility to government: various ratios calculated enable the government to

understand a company’s short term financial, long term solvency & profitability
position of a firm, to formulate the policies, acts, plans and procedures.
CLASSIFICATION OF RATIOS
A. Traditional Classification / Statement Ratios

(a) Balance Sheet Ratios: These ratios deal with the relationship between two
items appearing in the balance sheet; e.g. current ratio, debt equity ratio, etc.
(b) Profit & Loss Account Ratios: this type of ratios show the relationship between
two items which are in the profit and loss account only; e.g. gross profit ratio,
net profit ratio etc.
(c) Composite Ratios: These ratios show the relationship between items one of
which is taken from profit and loss account and the other from the balance
sheet; e.g. rate of return on capital employed, debtors turnover ratio, stock
turnover ratio, etc.
B. Functional Classification
(a) Profitability Ratios
(b) Turnover / Activity Ratios
(c) Financial Ratios
(i) Short – Term Financial / Liquidity Ratios
(ii) Long – Term Financial / Solvency Ratios
A. PROFITABILITY RATIOS
Profit is considered essential for the survival of the business. Profits are a useful
measure of overall efficiency of a business. Profits to the management are test of
efficiency and a measure of control; to owners a measure of worth of their
investors; to creditors a margin of safety; etc. Profitability ratios are calculated
either in relation to sales or investment.
The following are the profitability ratios:
1. GROSS PROFIT RATIO
2. OPERATING RATIO
3. OPERATING PROFIT RATIO
4. INDIVIDUAL EXPENSES RATIO

5. TOTAL OPERATING EXPENSES RATIO
6. NET PROFIT RATIO
7. INTEREST COVERAGE RATIO
8. FIXED DIVIDEND COVERAGE RATIO
9. EQUITY DIVIDEND COVERAGE RATIO
10. DEBT SERVICING COVERAGE RATIO
11. RETURN ON INVESTMENT (ROI) / RETURN ON CAPITAL EMPLOYED
/ OVERALL PROFITABILITY RATIO
12. RETURN ON EQUITY CAPITAL
13. RETURN ON AVERAGE CAPITAL EMPLOYED
14. EARNINGS PER SHARE
15. DIVIDEND YIELD RATIO
16. DIVIDEND PAY – OUT RATIO / PAY – OUT RATIO
17. RETAINED EARNINGS RATIO
18. PRICE EARNING RATIO OR P/E RATIO (EARNINGS YIELD RATIO)
1) GROSS PROFIT RATIO

This ratio measures the relationship of gross profit to net sales and is
represented as a percentage.
Gross Profit Ratio = Gross Profit X 100
Net Sales
Gross Profit = Net Sales – Cost of Goods Sold.
This ratio indicates the extent to which selling price of goods per unit can
be reduced without resulting in losses or the efficiency with which a firm
produces its products. Higher the ratio, the better is the result.
2) OPERATING RATIO
Operating ratio establishes the relationship between cost of goods sold and
operating expenses with sales of the firm.
Operating Ratio = Operating Cost x 100

Net Sales
Operating Cost = cost of goods sold + operating expenses.

It indicates the percentage of net sales that is consumed by operating cost.
Higher the ratio, the less favourable it is, it would leave a small operating
profit to cover interest, income tax, dividend and reserves.
3) OPERATING PROFIT RATIO

Operating Profit Ratio = Operating profit before interest & tax X 100
Net Sales
Operating Profit = Net Sales – Operating Cost.
4) EXPENSES RATIO
Expenses ratios indicate the relationship of various expenses to net sales.
The lower the ratio, the greater is the profitability and vice versa.
(i) Cost of Goods Sold Ratio = Cost of Goods Sold X 100

Net Sales
Cost of Goods sold = Opening stock + Purchases + Direct Expenses

– Closing Stock
OR
Cost of goods sold = Net Sales – Gross Profit
(ii) Administration & Office Expenses Ratio =

Administration & Office Expenses X 100
Net Sales
(iii) Selling & Distribution Expenses Ratio =

Selling & Distribution Expenses X 100
Net Sales
(iv) Non – Operating Expenses Ratio =

Non – Operating Expenses X100
Net Sales
5) TOTAL OPERATING EXPENSES RATIO

The total operating expenses ratio indicates the relationship between all the
expenses and the net sales. The lower the ratio, the greater will be the
profitability and vice versa.
Operating Expenses Ratio = Total Operating Expenses X 100

Net Sales
6) NET PROFIT RATIO

This ratio establishes a relationship between net profits (after taxes) and
indicates the efficiency of the management in manufacturing,
administrative, selling & other activities of the firm.
Net Profit Ratio = Net Profit after taxes X 100

Net Sales
Higher the ratio better is the profitability.
7) INTEREST COVERAGE RATIO

This ratio is used to test debt servicing capacity of a firm. This ratio is
also known as Coverage Ratio or Fixed Charges Cover or Times Interest
Earned.
Interest Coverage Ratio = Earnings before interest & tax
Total Fixed Interest Charges
This ratio indicates the number of times interest is covered by the

profits. The higher the ratios safer are the long term creditors. If the
ratio is 6 to 7 times then it is considered to be good.
If the ratio is 6 to 7 times then it is considered to be good.
8) FIXED DIVIDEND COVERAGE RATIO

This ratio is used to test dividend paying capacity of a firm.
Preference Dividend Coverage Ratio = Earnings after tax
Preference Dividend
This ratio indicates the number of times dividend is covered by the
profits. The higher the ratio the more satisfied are the shareholders.
If the ratio is 3 to 4 times then it is considered as a good ratio for the
company.
9) EQUITY DIVIDEND COVERAGE RATIO

This ratio is used to test dividend paying capacity of a firm.
Equity Dividend Coverage Ratio = EAT – Preference dividend
Equity Dividend
This ratio indicates the number of times dividend is covered by the
profits. The higher the ratio the more satisfied are the shareholders. If
the ratio is 3 to 4 times then it is considered as a good ratio for the
company.
10)DEBT SERVICING COVERAGE RATIO

This ratio is used to test the capacity of a firm in paying its annual interest
to long term creditors as well as its capacity to repay the instalment of the
Loan term borrowings in a financial year.
Debt Servicing Coverage Ratio = Earnings Before Interest & Tax

Interest + Principal Repayment
(1- T)
11)RETURN ON INVESTMENT (ROI) / RETURN ON CAPITAL

EMPLOYED / OVERALL PROFITABILITY RATIO
Return on Investment = OPBIT / EBIT

Capital Employed
OPBIT – Operating Profit before Interest & Tax

EBIT – Earnings before Interest & Tax
Capital employed is done in two ways:

A) Liabilities Approach B) Assets Approach
Liabilities Approach = Equity Share Capital + Preference Share Capital + Reserves &
Other Undistributed Profits + Long Term Loans & Debentures – Fictitious Assets – Non
– operating Assets.
Fictitious Assets are preliminary expenses; discount on issue of shares & debentures;
underwriting commission, etc.
Non – operating/ Non – Trading Assets = Long Term Investments
Assets Approach = Net Fixed Assets + Net working Capital
Net working Capital = Current Assets – Current Liabilities
12)RETURN ON SHAREHOLDERS’ INVESTMENT / NET WORTH

This ratio studies the relationship between net profits (after interest & tax)
and the proprietors’ funds.
Return on Shareholders’ Investment / Net Worth Ratio

= Earnings after tax X 100
Shareholders’ Funds
Shareholders’ funds consists of equity share capital, preference share

capital, capital reserves, revenue reserves, accumulated profits, reserves for
contingencies, sinking funds, etc. The accumulated losses and deferred
expenses should be deducted from shareholders’ funds.
As this ratio reveals how well the resources of a firm are being used, higher
the ratio better are the results.
13)RETURN ON EQUITY CAPITAL

Ordinary shareholders are the real owners as they assume the highest risk in
the company & the rate of dividend varies with the availability of profits.

Return on Equity Capital = Earnings after Tax–Preference Dividend X 100

Equity Shareholders’ Funds
Equity Shareholders’ funds consists of equity share capital, capital reserves,
revenue reserves, accumulated profits, reserves for contingencies, sinking
funds, etc. The accumulated losses and deferred expenses should be
deducted from shareholders’ funds
Higher the ratio, the better it is.
14)RETURN ON AVERAGE CAPITAL EMPLOYED
Return on Average Capital Employed= Earnings before Interest & Tax

Average Capital Employed
Average Capital Employed = Opening Capital Employed + Closing Capital Employed
OR
Average Capital Employed = Closing Capital Employed – ½ current year’s profits
OR
Average Capital Employed = Opening Capital Employed + ½ current year’s profits
15)EARNINGS PER SHARE

The earnings per share is a good measure of profitability and when
compared with other companies, it gives view of the comparative earnings
power of a firm.
Earnings Per Share (EPS) = Earnings after tax – preference dividend

No of Equity Shares
16)DIVIDEND YIELD RATIO

This ratio is calculated to evaluate the relationship between dividend per share
paid and the market value of the share.
Dividend Yield Ratio = Dividend Per Equity Share X 100
Market Price Per Share
Dividend Per Share = Dividend Paid to Shareholders

Number of shares
17)DIVIDEND PAY – OUT RATIO / PAY – OUT RATIO

It is calculated to find the extent to which earnings per share have been
retained in the business, because ploughing back of profits enables a company
to grow & pay more dividends in future.
Dividend Pay – Out Ratio = Dividend Per Equity Share

Earnings Per Share
OR
Dividend Pay – Out Ratio = Total Dividend Paid to Equity Shareholders X 100
Earnings Available to Equity Shareholders
OR
Dividend Pay – Out Ratio = 100 – Retained Earnings Ratio
18)RETAINED EARNINGS RATIO
Retained Earnings Ratio = Retained Earnings per share x 100

Earnings Per Share
OR
Retained Earnings Ratio = Total Retained Earnings x 100

Earnings Available to Equity Shareholders

19)PRICE EARNING RATIO OR P/E RATIO (EARNINGS YIELD RATIO)

It is calculated to make an estimate of appreciation in the value of a share of a
company and is used by investors to decide whether or not to buy shares in a
particular company.
Price Earnings Ratio (P/E Ratio) = Market Price per Equity Share
Earnings per Share
B. TURNOVER / EFFICIENCY / ACTIVITY RATIOS

Funds are invested in various assets in business to make sales & earn profits.
The efficiency with which assets are managed directly affects the volume of
sales. The better the management of assets higher will be the sales & profit.
Activity ratios measure the efficiency with which a firm manages its resources.
These are called as turnover ratios because they indicate the speed with which
assets are converted into sales.
To measure the efficiency of a firm the following ratios are calculated:
1) INVENTORY / STOCK TURNOVER RATIO

2) DEBTORS / RECEIVABLES TURNOVER RATIO
3) AVERAGE / DEBT COLLECTION PERIOD
4) CREDITORS / PAYABLES TURNOVER RATIO
5) AVERAGE / CREDIT PAYMENT PERIOD
6) WORKING CAPITAL TURNOVER RATIO
7) FIXED ASSETS TURNOVER RATIO
8) CAPITAL TURNOVER RATIO
a) INVENTORY / STOCK TURNOVER RATIO

This ratio indicates the number of times the stock has been turned over
during the period & evaluates the efficiency with which a firm is able to
manage its inventory. The purpose is to ensure only minimum funds are
tied up in inventory.
Inventory Turnover Ratio = Cost of Goods Sold
Average Inventory

Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses

– Closing Stock
OR
Cost of Goods Sold = Sales – Gross Profit
Average Inventory = Opening Stock + Closing Stock

2
NOTE: (i) In the absence of cost of goods sold, cost of sales or sales can be
used to calculate this ratio.
(ii) When only closing stock is given it is taken to be average stock.
A high inventory turnover or stock velocity indicates efficient management

of inventory because the stocks are sold frequently & the lesser amount of
money is required to finance the stock & vice versa.
b) DEBTORS / RECEIVABLES TURNOVER RATIO

A concern sells goods on credit which results in tying up substantial funds
of a firm in the form of debtors and bills receivables. Trade debtors are
expected to be converted into cash in a short period of time and hence
affect the liquidity position of a firm.
Debtors’ turnover ratio indicates the velocity of debt collection i.e. the
number of times debtors are turned over during a year.
Debtors Turnover Ratio = Net Credit Sales
Average Receivables
Net Credit Sales = Total Sales – (cash sales + returns inwards)
Receivables = Sundry Debtors + Bills Receivables
Average Receivables = Opening receivables + Closing receivables

2
Note: Debtors should always be taken at net value.

The higher the debtors’ turnover ratio the more efficient is the management
of debtors in the firm and vice versa.
c) AVERAGE / DEBT COLLECTION PERIOD

This ratio represents the average number of days for which a firm has to
wait before its receivables are converted into cash.
Average Collection Period = No of days / months in a year

Debtors Turnover Ratio
The shorter collection period the better is the collection performance and
lesser are the chances of bad debts and vice versa.
d) CREDITORS / PAYABLES TURNOVER RATIO

In course of business, a firm will have to make credit purchases which have
to be paid the firm after a short period. Hence, creditors would like to know
if the firm has a good liquidity position.
This ratio indicates the velocity of debt payment i.e. the number of times
creditors are turned over during a year in relation to purchases.
Creditors Turnover Ratio = Net Credit Purchases

Average Payables
Net Credit Purchases = Total Purchases – (cash purchases + returns

outwards)
Trade Payables = Sundry Creditors + Bills Payable
Average Payables = Opening Payables + Closing Payables

2
Higher the ratio better is the firm’s position in paying debts, maintaining
liquidity & procuring credit from the market and vice versa.

e) AVERAGE / CREDIT PAYMENT PERIOD

This ratio represents the average number of days it takes a firm to meet its
short term liabilities i.e. pay off its creditors.
Average Payment Period = No of days / months in a year
Creditors Turnover Ratio
Lower the ratio the better is the liquidity position of the firm & discount
earned will also be high and vice versa.
f) WORKING CAPITAL TURNOVER RATIO

This ratio indicates the velocity of utilisation of net working capital i .e the
number of times the working capital is turned over during a year.
Working Capital Turnover Ratio = Net Sales

Net Working Capital
Working Capital = Current Assets – Current Liabilities
This ratio measures the efficiency with which the working capital is being
used by a firm. A higher ratio indicates efficient utilisation of working
capital and vice versa.
g) FIXED ASSETS TURNOVER RATIO

This ratio studies the velocity of utilisation of net fixed assets i.e the
number of times the fixed assets are turned over during the year.
Fixed Assets Turnover Ratio = Net Sales
Net Fixed Assets
OR
Fixed Assets Turnover Ratio = Cost of Sales

Net Fixed Assets
Net Fixed Assets = Fixed Assets – Depreciation

NOTE: In the absence of cost of sales, sales or cost of goods sold can be
utilised to calculate this ratio.
h) CAPITAL TURNOVER RATIO
This ratio indicates the velocity of utilisation capital i .e the number of times the
capital is turned over during a year.
Capital Turnover Ratio = Net Sales
Capital Employed
OR
Capital Turnover Ratio = Cost of Sales

Capital Employed
C. FINANCIAL RATIOS
1) SHORT – TERM FINANCIAL / LIQUIDITY RATIOS

Liquidity refers to the ability of a concern to meet its current obligations as &
when they become due. If the current assets can pay off current liabilities, then
the liquidity position will be satisfactory. On the hand, if the current liabilities
are not met by current assets, then the liquidity position is not good.
The bankers, suppliers & short term creditors are interested in the liquidity
position of a firm, as they will extend credit only if the firm’s working capital
position is good.
To measure the liquidity of a firm the following ratios are calculated:
a) CURRENT / WORKING CAPITAL RATIO
b) LIQUID / ACID TEST / QUICK RATIO
c) ABSOLUTE LIQUID / CASH RATIO
a) CURRENT / WORKING CAPITAL RATIO

It is the relationship between current assets & current liabilities. It is also as
working capital ratio. This ratio is widely used as a measure short term
financial or liquidity position of a firm.
Current Ratio = Current assets

Current liabilities
Current assets include cash & bank balance, marketable securities, bills
receivables, sundry debtors, temporary investments, inventories, work – in
– progress & prepaid expenses.
Current liabilities include bills payable, sundry creditors, outstanding

expenses, short term advances, dividend payable, income tax payable, bank
overdraft.
An increase in current ratio indicates an improvement in the firm’s liquidity

position & vice versa. Rule of thumb for current ratio is 2 : 1.
b) LIQUID / ACID TEST / QUICK RATIO

This ratio is the relationship between quick or liquid assets & current
liabilities. This ratio is a more rigorous test of a firm’s liquidity position.
An asset is said to be liquid if it can be converted into cash within a short
period.
Liquid/Acid Test/Quick Ratio = Liquid or Quick Assets

Current Liabilities
Liquid Assets = current assets – (inventories + prepaid expenses)

OR
Liquid Assets include cash & bank balance, marketable securities,
temporary investments, bills receivables & sundry debtors.
A high acid test ratio indicates that the firm has sufficient liquidity to meet
its current obligations. Rule of thumb for liquid ratio is 1 : 1.
c) ABSOLUTE LIQUID / CASH RATIO

It is the relationship between absolute liquid assets & current liabilities. It is
called as cash ratio as these assets immediately realise cash.
Absolute Liquid/Cash Ratio = Absolute liquid assets
Current Liabilities
Absolute liquid assets include cash balance, bank balance & marketable
securities.
Rule of thumb of absolute liquid ratio is 0.5: 1 or 1: 2.
2) LONG – TERM FINANCIAL / SOLVENCY RATIOS

Solvency refers to the ability of a concern to meet its long term obligations.
The long term creditors of a firm are primarily interested in knowing the
firm’s ability to pay regular interest on borrowings, repayment of the
principal amount and security of their loans.
To measure the solvency of a firm the following ratios are calculated:
a) DEBT EQUITY RATIO

b) CAPITAL GEARING RATIO
c) PROPRIETORY / EQUITY / NET WORTH TO TOTAL ASSETS
RATIO
d) SOLVENCY RATIO / RATIO OF TOTAL LIABILITIES TO TOTAL
ASSETS
e) FIXED ASSETS TO NET WORTH/PROPRIETOR’S FUNDS RATIO
f) FIXED ASSETS TO TOTAL LONG TERM FUNDS / FIXED
ASSETS RATIO
a) DEBT EQUITY RATIO

This ratio, also known as External – Internal Equity ratio indicates the
relationship between outsiders’ funds and shareholders’ funds. This
ratio measures the relative claims of outsiders and the owners against
the firm’s assets.
Debt – Equity Ratio = Total Long Term Debt
Long term debt includes debentures, mortgages and long term

borrowings.

Shareholders’ funds consists of equity share capital, preference share

capital, capital reserves, revenue reserves, accumulated profits, reserves
for contingencies, sinking funds, etc. The accumulated losses and
deferred expenses should be deducted from shareholders’ funds.
The Debt – Equity ratio of a firm should be 2: 1. (Company is

aggressive in financing if it is 2:1 and conservative in financing if it is 1:
2).
b) CAPITAL GEARING RATIO

This ratio is used to describe the relationship between equity
shareholders funds and other fixed interest & dividend bearing funds.
Capital Gearing Ratio = Fixed Interest & Dividend bearing Funds

Equity Shareholders’ Funds
Fixed Interest Bearing Funds = Debentures + Long Term Loans
Fixed Dividend Bearing Fund = Preference Share Capital
The firm is said to be in low gear if preference share capital & other
fixed interest bearing loans are less than equity shareholders’ funds.
Low geared means less than 1; evenly geared means equal to 1 and
highly geared means more than 1.
c) PROPRIETORY / EQUITY / NET WORTH TO TOTAL

ASSETS RATIO
This ratio establishes the relationship between a firm’s shareholders’
funds and its total assets. The total assets denote total resources of the
concern.
Proprietary / Equity Ratio = Shareholders’ Funds
Total Assets (excluding goodwill)

Total Assets = Net Fixed Assets + Current Assets + Investments.

Higher the ratio better is the long term solvency position of the
company.
d) SOLVENCY RATIO / RATIO OF TOTAL LIABILITIES TO

TOTAL ASSETS
This ratio indicates the relationship between the total liabilities to
outsiders to total assets of a firm.
Solvency Ratio = Total Liabilities to Outsiders X 100

Total Assets
Total Liabilities to outsiders = Long Term Debt + Current Liabilities
Lower the ratio, more stable is the long term solvency position of a firm.
e) FIXED ASSETS TO NET WORTH/PROPRIETOR’S FUNDS

RATIO
This ratio establishes the relationship between fixed assets and
shareholders’ funds.
Fixed Assets to Net Worth Ratio =
Fixed Assets (after depreciation) X100
Fixed Assets include all intangible assets like goodwill, patents,

copyrights, trademarks, etc unless they are worthless.
This ratio indicates the extent to which shareholders’ funds are sunk into
the fixed assets. If the ratio is less than 100%, it implies that owners’
funds are more than total fixed assets and a part of the working capital is
provided by the shareholders; and vice versa.
f) FIXED ASSETS TO TOTAL LONG TERM FUNDS / FIXED

ASSETS RATIO
Fixed Assets Ratio = Fixed Assets (after depreciation)

Total Long Term Funds
Fixed Assets include all intangible assets like goodwill, patents,
copyrights, trademarks, etc unless they are worthless.
Total Long Term Funds = Equity Share Capital + Preference Share

Capital + Reserves & Surplus + Debentures + Long Term Borrowings –
Fictitious Assets
This ratio indicates the extent to which the total fixed assets are
financed by long term funds of the firm. In case the fixed assets exceed
the total of the long term funds it implies that the firm has financed a
part of fixed assets out of working capital which is not a good financial
policy and vice versa. If 75 – 80% of the long term funds are used to
finance the fixed assets the ratio is good. The remaining funds will be
used to finance the permanent working capital.
PROBLEMS:
1. Calculate gross profit and COGS if the sales are Rs.25,00,000 and profit on cost is
25%.
2. Calculate sales, gross profit, if COGS (cost of sales) is Rs.35,50,000 and rate of
profit on sales is 25%.
3. The total cost of sales is Rs 3,16,160; percentage of profit on sales is 20%. Find
out the profit and sales.
4. If the sales are Rs 12,50,000 and rate of gross profit on cost is 20%; then calculate
GP and COGS.
5. From the following comment on the company’s liquidity ;
Liabilities Amount Assets Amount
9% Preference Share
Capital 5,00,000 Goodwill 1,00,000
Equity Share Capital 10,00,000 Land & Building 6,50,000
8% Debentures 2,00,000 Plant 8,00,000
Long term Loan 1,00,000 Furniture & Fixture 1,50,000
Bills Payable 60,000 Bills Receivables 70,000
Sundry Creditors 70,000 Sundry Debtors 90,000
Outstanding Expenses 35,000 Bank Balance 45,000
Short term 25,000

Investments
Prepaid Expenses 5,000
Stock 30,000
19,65,000 19,65,000
6. From the following details prepare a Redrafted Income Statement and comment on
the profitability using ratios.
Particulars Amt (Rs)
Sales 15,00,000
Purchases 7,50,000
Opening stock 1,40,000
Closing stock 1,60,000
Salaries 74,000
Rent 24,000
Postage & Stationery 10,000
Provision for taxation 1,00,000
Salesman’s salaries 36,000
Advertising 12,000
Commission on sales 15,000
Discount 4,000
Interest 10,000
Loss on sale of assets 23,000
Profit on sale of investments 19,000
7. Proline Limited provides you the following Balance Sheet for the year ending 31st
March 2015
Liabilities Amt (Rs) Assets Amt (Rs)
Equity Capital: 30,000 Goodwill 75,000
shares of Rs 10 each 3,00,000
Preference capital: Plant & machinery 3,75,000
7,500 shares of Rs 20 each 1,50,000
Reserve fund 75,000 Furniture & fittings 1,05,000
Dividend equalization fund 90,000 Trade investments 2,25,000
Profit & Loss A/c 60,000 Cash 30,000
5% Debentures 2,25,000 Sundry debtors 1,87,500
7% mortgage loan 1,05,000 Bills receivable 97,500
Sundry creditors 75,000 Advance tax 30,000
Bank overdraft 45,000
11,25,000 11,25,000
Comment on the firm’s long term solvency position.
8. Vax Ltd provides you Profit & Loss Account and Balance Sheet for the year ended
31/3 /2015
Profit & Loss Account

Amt (Rs) Amt (Rs)
To opening stock 1,65,000 By sales 17,86,500
To purchases 9,00,000 By closing stock 2,55,000
To wages 2,10,000 By Profit on sale of land 97,500
To carriage inwards 1,35,000
To office & administration
expenses 1,50,000
To selling & distribution
expenses 60,000
To loss on sale of motor 67,500
car
To interest on loan &
debentures 76,500
To net profit 3,75,000
21,39,000 21,39,000
Balance Sheet
Liabilities Amt (Rs) Assets Amt (Rs)
7,500 equity shares of Rs
100 each 7,50,000 Land & Building 12,00,000
9% preference share capital 1,50,000 Plant & Machinery 6,60,000
Profit & Loss Account 1,87,500 Stock 2,55,000
Reserve fund 2,70,000 Debtors 1,12,500
12% Debentures 4,50,000 Bills Receivable 30,000
15% Loan 1,50,000 Bank balance 67,500
Creditors 1,20,000
Bills payable 60,000
Provision for tax 1,87,500
23,25,000 23,25,000
1) Rate of tax – 50%

2) Market price per equity share Rs 67
3) 8% dividend declared to equity shareholders.
Comment on the firm’s profitability position using ratios.
9. Maxwell Ltd provides you the following balance sheets for the year ending 31st
December 2014 and 31st December 2015
Particulars 2014 (Amt in Rs) 2015 (Amt in Rs)
Cash 5,00,000 4,00,000
Sundry debtors 8,00,000 10,00,000
Temporary investments 5,00,000 8,00,000
Stock 46,00,000 54,00,000
Prepaid expenses 70,000 30,000
Total current assets 64,70,000 76,30,000
Total assets 1,40,00,000 1,60,00,000
Current liabilities 16,00,000 20,00,000
Long Term Loans 40,00,000 40,00,000
Share Capital 50,00,000 50,00,000
Retained earnings 11,70,000 20,30,000
Statement of profit for the year ending 31 December 2015
st
Sales 1,00,00,000
Cost of goods sold 70,00,000
Interest 4,00,000
Tax rate 40%
Profit distributed 5,50,000
From the above, appraise the financial position of the company for the year 2015 from
point of view of: (i) Liquidity; (ii) Profitability; (iii) Activity.
Additional Problems:
1. From the following information comment on the firm’s profitability position using
ratios:
particulars 2014 2015

Sales 6,00,000 10,00,000
Less: cost of goods sold 2,40,000 4,00,000
Gross profit 3,60,000 6,00,000
Less: Depreciation 60,000 1,00,000
Operating Expenses 1,00,000 1,30,000
Operating Profit 2,00,000 3,70,000
Less: interest 10,000 20,000
EBT 1,90,000 3,50,000
Less: Tax @ 40% 76,000 1,40,000
EAT 1,14,000 2,10,000

Equity Share Capital 3,00,000 5,00,000

8% preference share
capital 2,00,000 2,00,000
Reserves & Surplus 1,25,000 1,50,000
Debentures 1,00,000 2,00,000
Current Liabilities 50,000 75,000
7,75,000 11,25,000
Fixed assets 5,00,000 7,50,000
Current assets 2,50,000 3,55,000
Preliminary expenses 25,000 20,000
7,75,000 11,25,000
2. The following is the balance sheet of M/s Ram & co. as on 31st March, 2013
Capital & Liabilities Amt (Rs) Assets Amt (Rs)

Equity Share Capital 20,00,000 Goodwill 5,40,000
Preference Share Capital 8,80,000 Machinery 13,00,000
Securities Premium 2,08,000 Building 14,08,000
P & L A/c 10,72,000 Land 1,44,000
Debentures 5,12,000 Cash 2,56,000
Creditors 3,68,000 Debtors 3,04,000
Bills payable 32,000 Bills receivable 4,96,000
Provision for taxation 96,000 Stock in hand 7,84,000
Dividend payable 64,000
52,32,000 52,32,000
Comment on the short term and long term solvency of the business using ratios.
3. The statement of a company for the past two years are given below:
Particulars 2014 2015

Assets
Cash ------------ 32,000
Trade debtors 11,00,000 8,00,000
Stock in hand 11,00,000 9,00,000
Net fixed assets 27,40,000 29,08,000
49,40,000 46,40,000
Liabilities
Trade creditors 6,40,000 5,00,000
Provision for taxation 2,20,000 1,80,000
Bank overdraft 2,40,000 ---------
Paid up capital 30,00,000 30,00,000

General reserve 6,00,000 7,00,000
Profit & Loss Appropriation A/c 2,40,000 2,60,000
49,40,000 46,40,000
Sales 80,00,000 75,00,000
Less: Cost of Goods Sold 49,00,000 45,00,000
Gross Profit 31,00,000 30,00,000
Less: Other expenses 26,00,000 26,40,000
Net profit 5,00,000 3,60,000
On 1 January 2014; the opening stock was Rs 6,00,000; creditors Rs 5,20,000; Debtors
st
Rs 10,00,000
Comment on the firm’s (a) Liquidity; (b) Profitability; (c) Solvency; (d) Turnover
position for the two financial years.

STRATEGIC COST MANAGEMENT/MARGINAL COSTING
Marginal Cost
According to ICMA, London, Marginal cost represents “the amount of any given volume
of output by which aggregate costs are changed if the volume of output is increased by
one unit.”
Marginal Costing
According to ICMA, London, Marginal costing is defined as “the ascertainment of

marginal costs and of the effect on profit of changes in the volume or the type of output
by differentiating between fixed costs and variable costs.”
Characteristics of Marginal Costing
1) It is a technique and presentation of costs which help management in taking many

managerial decisions and is not an independent system of costing such as process
costing.
2) All elements of cost – production, administration, selling and distribution are
classified into variable and fixed components. Even semi – variable costs are
analysed into fixed and variable.
3) The variable costs (marginal costs) are regarded as the cost of the products.
4) Fixed costs are treated as period costs and are charged to profit and loss account
for the period for which they are incurred.
5) The stock of finished goods and work – in – progress are valued at marginal costs
only.
6) Prices are determined on the basis of marginal cost by adding contribution which
is the excess of sales over cost of sales.
Distinction between Marginal Costing and Absorption Costing
Absorption Costing Marginal Costing

1. Treatment of costs Both variable and fixed Only variable cost is
costs are charged to cost of charged to cost of
FOR PRIVATE CIRCULATION Page 1

VI SEMESTER BBA
production. production.
2. Valuation of stocks Stock of finished goods and Stocks are valued at
work in progress are valued marginal or variable costs
at both fixed and variable only.
costs.
3. Under/Over Arbitrary apportionment of Excludes fixed costs and the
Absorption of fixed costs over the question of under or over
overheads products results in under or absorption of fixed costs
over absorption of such does not arise.
costs.
4. Measurement of Profitability is judged by Profitability is based on the
profitability profit figures which is also study of contribution which
a guiding factor for guides managerial
managerial decisions. decisions.
5. Application Useful for long term Useful for short term
decision making and pricing decision making and pricing
policy. policy.
6. Emphasis Is on Production Is on sales
Contribution
Contribution is the difference between sales and variable cost or marginal cost of
sales. Contribution per unit is defined as excess of selling price per unit over
variable cost per unit.
Contribution = Sales – Variable Cost
Advantages of Contribution
1) It helps the management in fixation of selling prices.

2) It assists in determining the break – even point.
3) It helps in the selection of a suitable product mix for profit maximization.
4) It helps in choosing from among alternative methods; the method which gives
highest contribution per limiting factor is adopted.
5) It helps the management in deciding whether to purchase or manufacture a product
or component.
6) It helps in taking a decision as regards to adding a new product in the market.
Break – even Analysis / Cost – Volume – Profit Analysis (CVP analysis)

VI SEMESTER BBA
Cost – volume – profit analysis is a technique for studying the relationship

between cost, volume and profit. It is also known as break even analysis.
Break – Even Point
The break-even point is defined as that point of sales volume at which total
revenue is equal to total cost. It is point of no profit, no loss, i.e; total sales are
equal to total costs.
Advantages of Marginal Costing
1) The technique of marginal costing is very simple to operate and easy to

understand.
2) It does away with allocation, apportionment and absorption of overheads of fixed
overheads and hence removes away complexities of under – absorption of
overheads.
3) Marginal cost remains the same per unit of output irrespective of the level of
activity. It helps the management in production planning.
4) Since fixed costs are not considered in valuation of closing stocks, there is no
possibility of fictitious profits by over valuing stocks.
5) It facilitates the calculation of various important factors such as break – even
point, expectations of profit at different levels of production, sales necessary to
earn a predetermined target of profit.
6) It is valuable aid to management for decision making and fixation of selling prices,
selection of a suitable product mix, make or buy decisions, etc.
7) It is complimentary to standard costing and budgetary control for better results.
8) It helps the management in profit planning by making a study of relationship
between cost, volume and profits.
Disadvantages of Marginal Costing
1) The technique of marginal costing is based upon a number of assumptions

which may not hold good for all circumstances.

VI SEMESTER BBA
2) All costs are not divisible into fixed and variable. There are certain costs which
are semi – variable in nature. It is very difficult and arbitrary to classify these
costs into fixed and variable elements.
3) Variable costs do not always remain constant and do not always vary in
proportion to the volume of output due to the laws of diminishing and
increasing returns.
4) Selling prices do not remain constant for ever and for all levels of output due to
competition, discount for bul;k orders, etc.
5) Fixed costs do not remain constant after a certain level of activity.
6) The exclusion of fixed costs from the stocks of finished goods and work – in –
progress is illogical since fixed costs are incurred on the manufacture of
products. Stocks are valued at marginal costing are under valued and the profit
and loss account does not reveal true profits.
7) Although the technique of marginal costing overcomes the problem of over or
under absorption of fixed overheads, the problem still exists in regard to over
or under absorption of variable overheads.
8) Marginal costing completely ignores the ‘time factor’. If two jobs give equal
contribution but one takes longer time to complete, the one which takes a
longer time is considered as costlier. This fact is ignored in marginal costing.
9) Fixation of selling prices in the long run cannot be done without fixed costs.
MARGINAL COSTING (MANAGERIAL DECISIONS)
MANAGERIAL APPLICATIONS (DECISIONS INVOLVING ALTERNATIVE

CHOICE)
This technique is a valuable aid to management in taking managerial decisions. It is a

useful tool for making policy decisions, profit planning & cost control. Marginal Costing
Technique is applied:
1) PRICING DECISIONS
Fixing of selling prices is the most important function of management. Although
prices are generally determined by market conditions & other economic factors,
marginal costing technique assists in fixing the prices under the following
circumstances:
a) Pricing under normal conditions
b) During stiff competition

VI SEMESTER BBA
c) During trade depression

d) For accepting special bulk orders
e) For accepting additional orders utilising idle capacity
f) For accepting export orders & exploring new markets
2) PROFIT PLANNING
Profit planning involves planning of future operations to achieve maximum profits
or to maintain a desired level of profits. The change in the sales price, variable
cost & product mix affect profitability of the firm. Absorption costing fails to
bring out the effect of changes on profit as it includes fixed expenses as part of
total cost. Thus, with the help of marginal costing; the required sales to maintain
profit can be ascertained as follows:
Desired sales = Fixed Cost + Profit
P / V Ratio
3) MAKE OR BUY DECISIONS

Sometimes a firm has to decide whether a certain product or a component should
be manufactured (using unused production facilities) or purchase from another
which specialises in it. Using marginal costing technique in such a case is
beneficial to the firm. As this technique differentiates between fixed cost &
variable cost. It is advisable to make than to buy if the variable cost of the product
is less than purchase price.
4) PROBLEM OF KEY OR LIMITING FACTOR

A limiting or key factor is a factor which restricts production or sales & thus
prevents the firm from making unlimited profits. The limiting factor may be any
factor of production like availability of raw material, labour, capital, plant capacity
and sales. If a concern has two or more product lines & there is a key factor, then
the concern has to decide which product should be produced more so that by using
the limiting factor the firm can earn maximise profit. Contribution per unit of
limiting factor should be the criterion to assess the profitability of a product.
5) SELECTION OF A SUITABLE PRODUCTION / SALES MIX

When a concern manufactures more than one product, a problem arises as to the
product mix or sales mix which yield the maximum profits. In determining the
optimum or profitable sales mix the products which will give the maximum
contribution should be retained & their production should be increased. The

VI SEMESTER BBA
production of the products which yield lesser contribution should be reduced. If

there is a limiting factor, the contribution per limiting factor should be considered
while judging the profitability of the product.
6) EFFECT OF CHANGES IN SALES PRICE

Management has to face the problem of analysing the effect of changes in selling
price with the profitability of the company. It may have to reduce prices due to
depression, competition, government regulations, etc. The contribution technique
enables the management to analyse & understand the effect of changes of the
selling price on the profits of the firm.
7) ALTERNATIVE METHOD OF PRODUCTION

Sometimes the management has to choose from among alternative methods of
production, eg; machine work or hand work. The same product may be produced
either by employing machine No. 1 or machine No. 2 and the management has to
make a choice. In such cases, the marginal costing technique is adopted. The
method which gives highest contribution per limiting factor is selected.
8) DETERMINATION OF OPTIMUM LEVEL OF ACTIVITY

Marginal costing technique helps management to decide the optimum level of
activity. Contribution at various levels of activity are calculated & the level of
activity gives the maximum contribution is the optimum level of activity. The
level of production can be increased upto till the point marginal cost does not
exceed the selling price.
9) EVALUATION OF PERFORMANCE
The performance efficiency should be evaluated of various departments, product
lines, etc by using marginal costing technique. Sometimes on the basis of P/V ratio
the management may have to discontinue of non – profitable products or
departments so as maximise profits. The lower the P/V ratio of the product or
department doesn’t contribute to the firm.
10)CAPITAL INVESTMENT DECISIONS

The technique of marginal costing also helps the management to take capital
investment decisions.

VI SEMESTER BBA
Proforma of Income Statement under Absorption Costing
Particulars Amount
Direct materials xxx
Direct labour xxx
Direct Expenses xxx
Prime Cost xxxx
Add: Variable Production Cost xxx
Fixed Production Cost xxx
Works Cost xxx
Add: Administration overhead xxx
Cost of Production xxxx
Add: Opening Stock xxxx
xxxx
Less: Closing Stock (xxx)
Cost of Goods Sold xxx
Add: Variable Selling & Distribution overhead xxx
Fixed Selling & Distribution overhead xxx
Cost of Sales / Total Cost xxx
Add: Profit xxx
Sales xxx
Proforma of Income Statement under Marginal Costing
Particulars Amount Amount

Sales (units sold X selling price) xxx
Less: Marginal / Variable Cost
Direct Material xxx
Direct Labour xxx
Direct Expenses xxx
Variable Production Cost xxx
Variable Cost xxx
Add: Opening Stock xxx
xxx

VI SEMESTER BBA
Less: Closing Stock (xxx)

xxxx
Add: Variable selling & distribution overhead xxxx
Fixed Selling & distribution overhead xxxx
Total Variable Cost xxxx
Contribution xxxx
Less: Fixed Cost
Production Cost xxxx
Administration Cost xxxx
Selling & Distribution Cost xxxx xxxx
Net Income xxxx
PROBLEMS
1) In a period a company produced 2,000 units of a particular commodity and sold

the same at Rs 50 per unit. The relevant cost data is as follows:
Direct Materials 25,000

Direct Labour 15,000
Direct Expenses 2,000
Production overhead
Variable 5,000
Fixed 2,000
Administration overhead
Variable 1,000
Fixed 2,500
Selling & Distribution overhead
Variable 5,000
Fixed 8,000
Assuming that there are no closing inventories, prepare statements under
Absorption Costing & Marginal Costing.

VI SEMESTER BBA
2) Prepare Income Statement under Absorption Costing and Marginal Costing from
information of 2014 – 2015.
Opening Stock : - 1,000 units at Rs 70,000 including variable cost of Rs
50 per unit.
Fixed cost : - Rs 1,20,000
Variable cost : - Rs 60 per unit
Production: - 10,000 units
Sales : - 7,000 units at Rs 100 per unit.
Stock is valued on the basis of FIFO.
3) A company has a production capacity of 12,500 units. Opening inventory of

finished goods on 1/1/2015 was 1,000 units. During the year ending 31/12/2015, it
produced 11,000 units while it sold only 10,000 units.
The variable cost per unit is Rs 6.50 and standard fixed factory cost is Rs 16,500.
Total fixed selling and administration overhead amounted to Rs 10,000. The
company sells its product at Rs 10 per unit. Prepare income statement under
absorption costing and marginal costing.
4) A company has production capacity of 2,00,000 units. Normal capacity utilized is

90% of the total capacity. Standard variable cost is Rs 11 per unit. The fixed cost
is Rs 3,60000 per year. Variable selling cost is Rs 3 per unit and fixed selling cost
is Rs 2,70,000. The per unit selling price is Rs 20 in the year ended 30th June 2015.
Production was 1,60,000 units and sales were 1,50,000 units. The closing
inventory on 30th June 2015 was 20,000 units. The actual variable production costs
were Rs 35,000 higher than the standard variable cost.
a) Calculate profit for the year by using Absorption Costing and Marginal costing
b) Explain the reasons for the difference in profits, if any.
5) The following is the information relating to a company which makes and sells
computers.
Particulars March April

Sales Rs 5,00,000 Rs 10,00,000
Production 10,000 units 5,000 units
Sales 5,000 units 10,000 units
Variable production cost per unit Rs 50 Rs 50
Selling Price per unit Rs 100 Rs 100
Fixed production cost Rs 1,00,000 Rs 1,00,000
VI SEMESTER BBA
Selling & administration cost (all fixed) Rs 50,000 Rs 50,000

You are required to present comparative profit statement for each month using (a)
Absorption costing; (b) Marginal Costing
6) General Corporation produces only one product which had the following costs
Variable manufacturing costs Rs 4 per unit
Fixed manufacturing costs Rs 2,00,000 per year
There are no work – in – progress inventories.
In 2014, the company produced 2,00,000 units and sold 90% of them at a price
of Rs 7 per unit. In 2015, the company produced 2,10,000 units and sold
2,15,000 units at the same price.
You are required to prepare income statements for 2014 and 2015 based on
absorption costing and marginal costing.
7) The following cost information relates to factory X for 2 years
Particulars 2014 2015

Installed capacity (units) 10,000 10,000
Opening stock (units) -------- 1,000
Closing stock (units) 1,000 ------
Output (units) 10,000 9,000
Selling Price per unit Rs 14 Rs 14
Fixed cost for the year Rs 85,000 Rs 85,000
Variable cost per unit Rs 2.90 Rs 2.90
Work out the profit under absorption costing and marginal costing for 2 years,
assuming FIFO basis.
8) Using the information below prepare profit statements for the months of June and
July using (i) marginal costing (ii) absorption costing.
Data per unit: Rs
Selling price 50
Direct material cost 18
Direct labour cost 4
Variable production overheads 3
Monthly costs:
Fixed production overheads 99,000
Fixed selling expenses 15,000
Fixed administration expenses 25,000

VI SEMESTER BBA
Variable selling costs are 10% of sales revenue.

Month Sales (units) Production (units)
June 10,000 12,000
July 12,000 10,000
9) From the following cost, production and sales data of a company, prepare
comparative income statement for 3 years under Absorption Costing and Marginal
Costing.
Particulars 2013 2014 2015

Production & Sales (units)
Opening stock -------- ------ 10,000
Production 50,000 70,000 60,000
Sales 50,000 60,000 66,000
Closing stock ---------- 10,000 4,000
Cost incurred (Rs)
Direct material 1,00,000 1,44,000 1,27,200
Direct labour 1,50,000 2,16,000 1,74,000
Direct expenses 48,000 72,000 56,000
Factory & administration overhead (fixed) 72,000 72,000 70,000
Variable selling cost 2,50,000 3,00,000 3,40,000
Fixed selling cost 50,000 50,000 50,000
Selling Price per unit is Rs 20.
10)ABC Motors assembles and sells motor vehicles. It uses an actual costing system,
in which unit cost are calculated on a monthly basis. Data relating to March and
April 2015 are:
March April
Unit data
Beginning inventory ------ 150
Production 500 400
Sales 350 520
Variable cost data
Manufacturing cost per unit Rs 10,000 Rs 10,000
Distribution costs per unit Rs 3,000 Rs 3,000
Fixed cost data:
Manufacturing costs Rs 20,00,000 Rs 20,00,000
VI SEMESTER BBA
Marketing costs Rs 6,00,000 Rs 6,00,000
The selling price per motor vehicle is Rs 24,000.

Prepare income statements for ABC Motors in March and April 2015 under (a)
absorption costing and (b) marginal costing.
11)The following details were taken from the past records of a company at two cost
levels. The company has 3 departments and all fixed costs have been apportioned
to the departments on the basis of sales turnover.
Level 1
Particulars Dept A Dept B Dept C Total

Sales 50,000 75,000 1,25,000 2,50,000
Less: Costs 45,000 60,000 1,06,250 2,11,250
Profit 5,000 15,000 18,750 38,750
Level 2
Particulars Dept A Dept B Dept C Total

Sales 60,000 90,000 1,50,000 3,00,000
Less: Costs 50,000 66,000 1,17,500 2,33,500
Profit 10,000 24,000 32,500 66,500
You are required to recast the above statement using marginal costing.
Decision Making
Make / Buy Decision

12)A manufacturing company finds that while the cost of making a component in its
own workshop is Rs 8 each, the same is available in market at Rs 6.50 with the
assurance of continuous supply. Give your suggestion whether to make or buy this
component. Also give your views in case the supplier reduces the price from Rs
6.50 to Rs 5.50.
The cost data is as follows:
Particulars Rs (per unit

cost)
Materials 3.00
Direct Labour 2.00
VI SEMESTER BBA
Other Variable Expenses 1.00

Depreciation & other Fixed 2.00
Expenses
Total cost 8.00
13)Annexe Ltd is manufacturing a part for one of its major product at a cost of Rs 22.
The cost is analysed as follows:
Cost per unit

Materials 6
Labour 8
Variable overheads 5
Fixed overheads 3
Total cost 22
The total requirement is 25,000 units p a. An outside supplier supplies the part
at Rs 20 per unit with no change in quality and guarantee of regular supply.
a) Should the company go for buying in the place of making the component?
b) If the foreman who is getting a salary of Rs 3,000 per month is retiring soon
and the premises can be let out at an annual rent of Rs 20,000 in case the
production is stopped, what would be your decision?
14)Expansion Ltd. manufactures automobile accessories & spare parts. The following
are the total cost of processing 1,00,000 units
Particulars Amount
(Rs)
Direct materials cost 5,00,000
Direct labour cost 8,00,000
Variable factory 6,00,000
overheads
Fixed factory overheads 5,00,000
The purchase price of the component is Rs 22 per unit. The fixed overhead
would continue to be incurred even when the component is bought from
outside, although there would have been reduction to the extent of Rs
2,00,000.
a) Should the component be made or bought considering present facility when
released following a buying decision would remain idle?
b) In case the released capacity can be rented out to another manufacturer for
Rs 1,50,000 having good demand, what should be the decision?

VI SEMESTER BBA
15)K.K. Ltd purchased 12,000 units p.a of a spare part from another manufacturer at
Rs 4 per unit. The production manager has put forward a proposal that the
production of this component may be undertaken for production in order to stop
the purchase of the above said spare part. He has submitted the following
information along with the proposal;
a) Material and labour would cost 60 paise and 50 paise per unit respectively.
b) Variable overheads will be 100% of labour.
c) A foreman will be paid Rs 1,000 per month.
d) The machine needed would cost Rs 50,000.It will have a production
capacity of 15,000 units and its economic life will be 5 years.
e) Funds needed for the above can be obtained at an interest rate of 10% p.a.
You are required to advise the management about the proposal of the
production manager.
16)Autoparts Ltd has an annual production of 90,000 units of Motor components. The
cost structure is as follows:
Particulars Cost per unit

Materials 270
Labour (25% fixed) 180
Expenses – variable 90
- fixed 135
Total 675
a) The production manager has an offer from a supplier to supply the part at
Rs 540 per unit. Should the component be purchased and production
stopped?
b) Assume the resources now used for the component, are to be used to
produce another new product for which selling price is Rs 485 per unit.
In the latter case materials cost Rs 200 per unit. 90,000 units of this product
can be produced at the same cost basis for labour and expenses.
Discuss whether it would be advisable to develop resources to manufacture
the new product, assuming the component now manufactured will be
bought from the supplier.
17)There are two components X and Y. It is considering to manufacture one of the

component and buy the other. The relative details are:
Particulars X Y
Materials 5,00,000 2,00,000

VI SEMESTER BBA
Labour 3,00,000 3,50,000

Variable overheads 2,00,000 2,50,000
Fixed overheads 5,00,000 5,00,000
Total output (units) 10,000 20,000
Buying price per unit 170 60
Machine tine per unit (units) 25 minutes 10 minutes
Materials per unit 500 grams 100 grams
Give your recommendations as to which to be bought and which to be
manufactured when
a) There is no key factor
b) Materials are a key factor
c) Machine time is key factor
18)K Ltd produces a variety of products, each having a number of component parts. B
takes 5 hours to process on a machine working to full capacity. B has a selling
price of Rs 50 and a marginal cost of Rs 30 per unit. ‘A- 10’ component part used
for Product A, could be made on the same machine in 2 hours for a marginal cost
of Rs 5 per unit. The supplier’s price is Rs 12.50. Should K Ltd make or buy ‘A –
10’? Assume that machine hour is the limiting factor.
Accept/ Reject
19)The cost sheet of a product is given as under:
Particulars Per unit (Rs)

Direct Materials 5.00
Direct Wages 3.00
Factory overheads
Fixed 0.50
Variable 0.50 1.00
Administrative expenses 0.75
Selling & Distribution overheads
Fixed 0.25
Variable 0.50 0.75
Total cost 10.50
The selling price per unit is Rs 12.
The above figures are for an output of 50,000 units; the capacity for the firm is
65,000 units. A foreign customer is desirous of buying 15,000 units at a price
of Rs 10 per unit. Advise the manufacturer whether the order should be
accepted. What will be your advice if the order were from a local merchant?

VI SEMESTER BBA
20)A manufacturer has planned his level of operation at 50% of his plant capacity of
30,000 units (at 100% capacity). His expenses are estimated as follows, if 50% of
the plant capacity is utilised.
Direct materials – Rs 8,280
Direct wages – Rs 11,160
Variable & other manufacturing expenses – Rs 3,960
Total fixed expenses irrespective of capacity utilisation – Rs 6,000
The expected selling price in the domestic market is Rs 2 per unit. Recently,
the manufacturer has received a trade enquiry from an overseas organisation
interested in purchasing 6,000 units at a price of Rs 1.45 per unit.
As a professional management accountant what would your suggestion be
regarding acceptance or rejection of the offer? Support your suggestion with
suitable quantitative information.
21)A mechanical toy factory presents the following information for the year 2012:
Particulars Rs
Material cost 1,20,000
Labour cost 2,40,000
Fixed overheads 1,20,000
Variable overheads 60,000
Units produced 15,000
Selling price per unit 40
The available capacity is a production of 20,000 units per year. The firm has an
offer for the purchase of 5,000 additional units at a price of Rs 30 per unit. It is
expected that by accepting this offer, there will be a saving of Re 1 per unit in
material cost on all units manufactured; the fixed overheads will increase by Rs
20,000 and the overall efficiency will drop by 3% on all production. Prepare a
statement showing the variation of net profits resulting from the acceptance of
the order.
22) Happiest Enterprises Ltd produces 3 lines of products namely A, B and C. the
details are as follows:
Particulars A B C
Capacity engaged 20% 40% 40%
Units produced 2,000 5,000 6,000
Cost per unit
Materials 20 32 36
Wages 10 12 16
Variable overheads 7 9 11
Fixed overheads 6 9 10
VI SEMESTER BBA
Total cost 43 62 73
Selling price 40 75 85
Profit (Loss) - 3 13 12
The management has already proposed to discontinue Line A and utilise the
unutilised capacity of A equally in Lines B and C. The expected rise in cost is
as follows:
B C
Materials increase by 10% 10%
Wages increase by 5% 5%
Selling price increase by 2% 5%
Fixed overhead remains unchanged. You are required to prepare a statement of
projected profit and advise the management whether the revised mix could be
adopted or not.
23)Sports Specialists Ltd; are famous for specialised manufacture of quality chess
board sets. Presently, the company is working below its normal capacity of 1,000
units per month. The company sells chess board sets in the national market at Rs
150 per unit. During April 2014, 600 units were sold which is regular sales volume
for each month all through the year.
The unit cost of production is:
Direct material Rs 60
Direct labour Rs 30
Factory overhead Rs 30
Selling and administration overhead Rs 15
The company has received an export order on 20th April, 2008 for the supply of
600 units to be dispatched by 30th June, 2014. However the offer stipulates the
price per unit as Rs 100. The cost analysis indicated that the cost of direct
material and labour that are to be incurred on the export order would be the
same per unit as the regular one of production. An amount of Rs 2,000 will
have to be incurred on special packing, labelling etc. No additional factory,
selling and administration overhead costs would be incurred in executing the
export order since the firm is operating below normal capacity.
Should the export offer be accepted?
24) A company manufactures 10,000 units of a product at a cost of Rs.4 per unit and
there is a domestic market for consuming entire volume of production at a sale
price of Rs.4.25 per unit. In the next year, it is expected that there will be a fall in

VI SEMESTER BBA
demand for domestic market, which can consume 10,000 units only but at a selling
price of Rs.3.72 per unit. The analysis of cost per 10,000 units is
Material Rs.15,000
Wages Rs.11,000
Fixed overheads Rs.8,000
Variable overheads Rs.6,000
The foreign market is explored and it is found that this market can consume
20,000 units of the product, if offered at a selling price of Rs.3.55 per unit.
However, the fixed cost would increase by Rs.1,600 if additional production is
undertaken. Is it worthwhile to try to capture the foreign market?
Addition/ Deletion of a product

25) The marginal cost of a product is Rs 11 per unit & fixed expenses amount to Rs
2,00,000. Selling price per unit is Rs12 and 1,00,000 units can be sold at this price.
Should the firm continue or discontinue the production?
26)The management of a company considers that product Y; one of the three products
of the company is not profitable as the other two with the result no other particular
efforts are made to push sales. The selling price and costs of the three products are
as follows:
Labour Department
Product Selling Direct A (Rs) B (Rs) C (Rs)

Price materials
X 68 10 8 2 2
Y 58 6 2 8 2
Z 64 8 2 2 8
Overhead rates for each Dept per Re of direct labour are as follows:
A B C
Variable overheads 1.20 0.40 1.00
Fixed overheads 1.20 2.00 1.40
What advice would you give to the management about the profitability of
product Y?
Profitability of products
27) In a factory producing two different kinds of articles, the limiting factor is the
availability of labour. From the following information, show which product is
more profitable:

VI SEMESTER BBA
Product A Cost per unit Product B Cost per unit

Materials 5.00 5.00
Labour
6 hours @ Re 0.50 3.00
3 hours @ Re 0.50 1.50
Overheads :
Fixed (50% of labour) 1.50 0.75
Variable 1.50 1.50
Total Cost 11.00 8.75
Selling Price 14.00 11.00
Profit 3.00 2.25
Total Production for the
month (units) 500 600
Maximum capacity per month is 4,800 hours.
28)A company manufactures and markets 3 products X, Y and Z. All the 3 products
are made from the same set of machines. Production is limited by machine
capacity. From the data given below, indicate priorities for products X, Y and Z
with a view to maximising profits.
Particulars X Y Z
Raw material cost per unit 11.25 16.25 21.25
Direct labour cost per unit 2.50 2.50 2.50
Other variable cost per unit 1.50 2.25 3.55
Selling Price per unit 25 30 35
Standard machine time
required per unit in minutes 39 20 28
29)A manufacturing business sells its product at Rs 20 per unit. It has a normal
capacity of 50,000 units p.a and budgeted costs at this level are:
Particulars Rs
Direct materials 3,00,000
Direct labour 2,00,000
Expenses:
Fixed 2,50,000
Variable 1,00,000
A sales budget has been prepared for the local market and orders are expected
for 35,000 units. The sales manager has established that an export order for an
additional 10,000 units could be negotiated at a special price of Rs 14 per unit.
He has also established that a second order of 4,000 modified units could be
obtained at a special price of Rs 13 per unit. The modifications would reduce

VI SEMESTER BBA
the cost of direct materials by Re 1 per unit but would increase the direct
labour cost by 25%.
Submit your recommendations, with facts and figures, as to whether the special
orders should be accepted or not.
30)Ram Lal and Company manufactures a component which is ordinarily sold to
other manufacturers. The plant has been operating at 50% capacity because of
reduced demand. A foreign manufacturer offers to buy 5,000 units at a total price
of Rs 25,000. The domestic selling price of the product is Rs 6.20 per unit. The
company hesitates to accept the order for fear of increasing its already large
operating losses. Overhead expenses of the company amount to Rs 6,000 per year.
The cost accounting records show an average cost of Rs 6 per unit for the product
during the last one year, as shown by the following figures:
Cost of production during the last one year:
Particulars Rs
Direct materials 10,000
Direct labour 10,000
Factory expenses 40,000
60,000
Production – 10,000 units.
The cost accountant of the company has set up the following schedule of the
estimated cost of producing 15,000 units, in case the order from the foreigner
is accepted:
Particulars Rs
Direct materials 15,000
Direct labour 15,000
Factory expenses 50,000
80,000
Should the company accept the offer? Justify your answer with appropriate
calculations.
31)The following particulars are extracted from the records of a company
Per Unit
Particulars A B
Selling price 100 110
Consumption of materials (kg) 5 4
Material cost 24 14
Direct wages 2 3
Machine hours used 2 3

VI SEMESTER BBA
Variable overheads 4 6
Comment on the profitability of each product (both use the same raw material)
when:
a) Total sales potential in units is limited
b) Total sales potential in value is limited
c) Raw material is in short supply
d) Production capacity (in terms of machine hours) is the limiting factor.
32)A wholesale company which sells 4 products; finds some of them unprofitable and
is considering elimination of one of them. The following information is available:
A B C D
Sales 30,000 50,000 25,000 45,000
Cost of production 20,000 45,000 21,000 22,500
Area of storage (sq mts) 5,000 4,000 8,000 3,000
No of parcels sent 10,000 15,000 7,500 17,500
No of invoices sent 8,000 14,000 6,000 12,000
Its overheads cost on the basis of allocation are as follows:
Fixed cost – Rent – Rs 3,000; basis – Sq mts
Insurance – Rs 100; basis – Sq mts
Depreciation – Rs 1,000; basis – No of parcels
Salesmen’s salaries & expenses – Rs 6,000; basis – sales volume
Administration expenses – Rs 5,000; basis – no. of invoices
Variable cost – Packing materials – 0.25 per parcel
Commission – 4% of sales
Clerical expenses – 0.05 per invoice
You are required to
a) Prepare an income statement showing profit or loss for each product.
b) Compare the profits if the company wants to (i) eliminate product B and (ii) if
product C is eliminated.
33)The management of a factory is considering the question of an unprofitable line
namely Z. The following data are available:
X Y Z
Sales 10,00,000 8,00,000 2,00,000
Direct materials 2,95,000 3,36,000 75,000
Direct labour 1,18,000 1,12,000 45,000
Variable expenses 1,77,000 1,12,000 30,000
Fixed expenses 3,30,000 1,80,000 90,000
Profit / Loss 80,000 60,000 - 40,000

VI SEMESTER BBA
In the event of discontinuance of product Z certain supervisory staff could be

discharged and their expenses like salary, benefits, etc could be reduced to the
extent of Rs 20,000 which are included in fixed expenses. The management
however proposes to drop Z but retain supervisory staff and increase product X
by 2,00,000 units at Re 1 each as selling price. Give your advice.
34)The following are the present cost and output data of a manufacturer:
Product Selling price per Variable cost per Percentage of

unit unit sales
Tables 120 80 40
Chairs 60 40 35
Book cases 80 60 25
Total fixed cost – Rs 40,000. Last year’s sales was Rs 2,00,000. The
manufacturer is considering to drop the line of book cases and replacing with
cabinets. His estimates for new scheme are as follows:
Product Selling price per Variable cost per Percentage of

unit unit sales
Tables 120 80 40
Chairs 60 40 40
Cabinets 150 100 20
Total fixed cost – Rs 40,000. Sales was Rs 2,50,000. Is the change worth
undertaking?
35)A Ltd manufactures three products and cost particulars for the year as follows:
X Y Z
Sales 2,00,000 4,00,000 2,50,000
Materials 1,00,000 1,50,000 1,25,000
Labour 30,000 50,000 40,000
Variable overheads 10,000 20,000 25,000
Fixed overheads 35,000 50,000 25,000
The company imports one of the raw material which is used in the manufacture
of all the products. The consumption of materials as follows:
X – 2,000 kgs; Y – 5,000 kgs; Z – 3,000 kgs.
There is restriction on import of raw material. The management is planning to
close down one product and utilise the raw material in the other two products.
Advise the management about the mix.
36)The cost per unit of the three products A, B, C of a concern is as follows:
A (Rs) B (Rs) C (Rs)

VI SEMESTER BBA
Direct Materials 10 8 9
Direct Labour 6 7 6
Variable
Expenses 4 5 3
Fixed expenses 3 3 2
Total Cost 23 23 20
Profit 9 7 6
Selling Price 32 30 26
Number of units
produced 10,000 5,000 8,000
Production arrangements are such that if one product is given up, the
production of others can be raised by 50%. The directors propose that C should
be given up because the contribution in that case is the lowest. Do you agree?
37)Product ‘A’ can be manufactured either by machine X or machine Y. Machine X
produces 50 units of ‘A’ per hour and Machine Y produces 100 units per hour.
Total machine hours available are 2000 hours per annum. Taking into account the
following cost data, determine the profitable method of manufacture:
Per Unit of Product ‘A’
Particulars Machine X (Rs) Machine Y (Rs)

Direct material 8 10
Direct wages 12 12
Variable overheads 4 4
Fixed overheads 5 5
29 31
Selling Price 30 30
38)Present the following information to the management to choose the appropriate
sales mix.
(i) The marginal product cost & the contribution per unit.
(ii) The total contribution & profits resulting from each of the following
mixtures.
(iii)The proposed sales mixes to earn a profit of Rs 250 and Rs 300 with total
sales of A and B being 300 units
Particulars Product A Product B

Direct materials (per unit) 10 9
Direct wages (per unit) 3 2
Sales price (per unit) 20 15
Fixed expenses – Rs 800.
Variable expenses are allotted to the products as 100% of direct wages.

VI SEMESTER BBA
Sales mixtures:
a) 100 units of product A and 200 of B
b) 150 units of product A and 150 of B
c) 200 units of product A and 100 of B.
Recommend which of the sales mixtures should be adopted.
39)Following information has been made available from the cost records of United
Automobile Ltd manufacturing spare parts
Materials – Product X : Rs 8 per unit
Product Y : Rs 6 per unit
Direct wages – X : 24 hours per unit at Rs 0.25 per hour
Y : 16 hours per unit at Rs 0.25 per hour
Fixed overheads – Rs 750
Variable overheads – 150% of wages
Selling Price per unit – Product X : Rs 25
Product Y : Rs 20
The directors want to adopt only one of the following sales mixes for the
forthcoming period.
a) 250 units of X and 250 units of Y
b) 400 units of Y only
c) 400 units of X and 100 units of Y
d) 150 units of X and 350 units of Y
State which mix would you recommend for production.
40)Parrys Confectioneries Ltd produces 3 products all of which require sugar. The
monthly average sales, cost of sales and sugar consumption are as follows:
Particulars X Y Z Total
Sales (Rs) 10,000 12,000 8,000 30,000
Cost of sales (Rs) 6,000 8,000 5,600 19,600
Sugar requirement 500 kgs 800 kgs 240 kgs 1540 kgs
Due to government restriction sugar quota has been reduced to 1,405 kgs for a
period. Suggest a suitable sales mix which would ensure maximum profit.
41)A manufacturer was producing three products in the mix of 15,000 units of
Product A, 10,000 units of Product B and C each. The total variable cost amounted
to Rs 2,10,000 and on experience the cost ratio among the products was estimated
to be 1: 1.2: 1.5 respectively in relation to products. The fixed cost was Rs 70,000.
At the selling price of Rs 6 for A, Rs 8 for B and Rs 10 for C he incurs loss.
In order to correct the situation the manufacturer desired to change the mix as
follows:

VI SEMESTER BBA
I II III
A 15,000 10,000 4,000
B 12,000 15,000 16,000
C 8,000 10,000 15,000
He seeks for advice as to which mix would give him highest return.
42)X Ltd manufactures three products A, B & C from common facilities. Production
was standardised for some months at a mix of 27000 units of Product A and
18,000 units of Product B and C each. The total fixed cost amounted to Rs
3,15,000. At the production volume per month the variable cost are of the order of
Rs 9,00,000. The cost ratio among the products was estimated (excluding fixed
cost) 2: 3: 4 for A, B and C respectively. The selling price of Rs 12 for A, Rs 15
for B and Rs 30 for C.
Three proposals as given below have been put up.
A B C
Mix 1 32,000 22,000 13,000
Mix 2 27,000 10,000 23,000
Mix 3 25,000 5,000 30,000
Which mix is the best?
43)Jupiter Ltd has manufactured and sold 3 products during the year 2010 as under:
Product X – 20,000 units
Product Y – 14,000 units
Product Z – 10,000 units
Cost analysis has disclosed as under:
Particulars X (Rs) Y (Rs) Z (Rs)

Marginal cost 10 18 16
List price 20 30 40
Time taken per unit 2.5 hours 3 hours 2.5 hours
Fixed cost – Rs 2,00,000
Discount – 10%
Due to shortage of labour the available working hours for the forthcoming year
are expected to be only 90,000 hours.
Suggest a suitable production mix for the forthcoming year:
a) When there is enough demand for all products
b) When potential demand for X – 18,000 units; Y – 10,000 units and Z –
12,000 units.
44)Bivin Udyog Ltd is engaged in 3 lines and has the following data for 2014 – 2015

VI SEMESTER BBA
Line A Line B Line C

Selling price per unit (Rs) 100 75 50
P/V Ratio (%) 10 20 40
Maximum sales potentials (units) 40,000 25,000 10,000
Raw materials as % of variable cost 50 50 50
Fixed expenses are estimated at Rs 6,80,000.
The company uses a single raw materials in all the three lines. Raw material
are in short supply and the company has a quota for raw material of the value
of Rs 18,00,000 for the year 2014 – 2015 to manufacture the three lines of
products.
You are required to:
a) Fix a product mix which gives maximum profit.
b) Calculate the amount of maximum profit.
c) Novelties Ltd seeks your advice on production mix of 3 products namely
Super, Bright and Fine. The following information is supplied:
Particulars Super Bright Fine

Direct materials 320 240 160
Variable overheads 16 40 24
Direct labour
Dept A at Rs 8 per hour 6 hours 10 hours 5 hours
Dept B at Rs 16 per hour 6 hours 15 hours 11 hours
From current budget you have future details as following:
Actual Production in units 5,000 6,000 10,000

Selling price per unit 624 800 480
Fixed overheads – Rs 16,00,000
Sales department’s estimate of maximum sales
Super – 6,000 units; Bright – 8,000 units; Fine – 12,000 units
You are also to note there is a constraint on supply of labour in Dept A and its
manpower can’t be increased beyond the present level.
Suggest the best production mix and also calculate the profits from the
suggested mix.
45)A Ltd produces 2 products A and B and the following details are available for a
period.
A B
Selling Price 6.00 3.75
Less: Marginal Costs

VI SEMESTER BBA
Direct Materials 3.00 2.00

Direct Labour 1 hour ½ hour
Standard labour hour rate 2.00 2.00
Variable overheads 0.50 0.50
Fixed overheads budgeted Rs 50,000. Total direct labour hours available is
1,00,000 hours.
The company do not want to produce Product A below 30,000 units and
Product B below 1,00,000 units. Assuming the materials and labour are freely
transferable within the products. Suggest a profitable mix.

VI SEMESTER BBA
MODULE 4- STANDARD COSTING

Cost accounting was initially developed to meet the informational requirements
about cost. The financial accounts could provide only a historical data. The
ascertainment of cost on the basis of historical information was considered useful
in the beginning.
HISTORICAL COSTING
Historical costing refers to the ascertainment and recording of actual costs after
these have been incurred. The amounts spent on material, labour and overheads are
recorded and these expenses totalled together give a figure of cost of providing a
particular product.
STANDARD COSTING
Standard costing defined as “a technique of cost accounting which compares the
standard cost of each product or service with actual cost to determine the efficiency
of the operation so that any remedial action may be taken immediately.”
STANDARD COST
Standard cost defined as “a predetermined cost which is calculated from
management standards of efficient operation and the relevant necessary
expenditure.”
STEPS IN STANDARD COSTING

The technique of standard costing involves the determination of cost before hand.
The cost is based on technical information after considering the impact of current
conditions. The standard costing involves the following steps:
1) The determination of standard cost.
2) The recording of actual cost.
3) The comparison between standard cost and actual cost.
4) The finding out of variance.
5) The reporting of variance so as to find out inefficiency.
6) To take necessary corrective measures.

VI SEMESTER BBAPage 1
TARGET COST
The target cost is the difference between target price which the potential customers
are willing to pay and the reasonable profit.
TARGET COSTING
Targeting costing is defined as “a cost management tool for reducing the overall
cost of a product over its entire life cycle with the help of the production,
engineering and R & D.”
BUDGETARY CONTROL
Budgetary control is a important technique of cost control where budgets are used
as a means of planning and control. The targets of various segments are set in
advance and actual performance is compared with pre – determined objects. In this
way management can assess the performance of different departments.
DIFFERENCES BETWEEN STANDARD COSTING & BUDGETARY

CONTROL
The points of distinction between the two systems are as follows:
1) Concept: In budgetary control the budgets are prepared for the concern as a
whole whereas in standard costing the standards are set for producing a
product or for providing a service. In standard costing, unit concept (i.e a
single product) is used while in budgetary control, total concept (i.e the
concern as a whole) is applied.
2) Basis: The budgets are fixed on the basis of past records and future
expectations. Standard costs are fixed on the basis of technical information.
3) Scope: The scope of budgetary control is much wider than the scope of
standard costing. Budgets are prepared for incomes, expenditures, etc.
Budgets are prepared for different functional departments such as purchase,
sale, production, finance, etc. On the other hand standards are set up for
expenditures only and standards are set for different elements of cost i.e
material, labour and overheads.
4) Emphasis: In budgetary control, the targets of expenditure are set and these
targets cannot be exceeded. In this system the emphasis is on keeping the
expenditures within the budgeted figures. In standard costing the standards

are set and an attempt is made to achieve these standards. The emphasis is
on achieving the standards.
5) Objective: Budgets are set on the basis of present level of efficiency of the
operations while standard costs are based on the basis of standards set by the
management.
6) Relationship: Budgetary Control is related to financial accounts while
standard costing is related to the cost accounts.
7) Variance Analysis: Budgetary control deals with total variances only. The
variances may be calculated for different departments or for the concern as a
whole. In standard costing variances are calculated for different elements of
cost i.e material, labour and overheads. In standard costing variances are
studied according to their causes.
8) Elements: The budgetary control system can be partly applied or wholly.
Budgets are prepared for some departments and may not be prepared for all
the departments. Standard costing cannot be used partially, it will have to be
used wholly. The standards will have to be set for all elements of cost.
ADVANTAGES OF STANDARD COSTING

The advantages of standard costing are as follows:
1) Measuring Efficiency: Standard costing is a yardstick for measuring

efficiency. The comparison of actual costs with standard costs enables
the management to evaluate performance of various cost centres. In the
absence of standard costing system actual costs of different periods may
be compared to measure efficiency.
2) Formulation of Production and Price Policy: Standard costing is helpful
in formulating production policies. The standards are set by studying all
existing conditions. It becomes easy to formulate production plans by
taking into account standard costs.
3) Determination of Variance: By comparing actual costs with standard
costs variances are determined. Management is able to spot out
inefficiencies. It can fix responsibility for deviation and is possible to
take corrective measures.

4) Reduction of Work: In historical costing, records are maintained for

determining the costs. Standard costing reduces clerical work to a
considerable extent and management is supplied with useful information.
In this system only necessary information will be recorded and
superfluous data are avoided.
5) Management by Exception: This means that everyone is given target to
be achieved and management need not supervise each and everything.
Standard costing enables the management to concentrate on important
things by determining the targets.
6) Facilitates Cost Control: Every costing system aims at cost control and
cost reduction. Standard costing helps in achieving these aims as
standards are being constantly analysed and an effort is made to improve
efficiency. When variance occurs the reasons are studied and immediate
corrective measures are undertaken.
7) Eliminating Inefficiencies: The standards are differently set for
manufacturing, administrative and selling expenses. The determination of
manufacturing expenses will require time and motion study for labour.
All these studies will make it possible to eliminate inefficiencies at
different steps.
8) Decision – Making: Standard costing provides useful information to the
management in taking important decisions. The problem created by
inflation, etc can be effectively tackled with standard costing.
LIMITATIONS OF STANDARD COSTING

1) Standard costing cannot be used in those concerns where non – standard
products are produced. If the production is undertaken according to the
customer’s specifications then the each job will involve different amount of
expenditures. Under such circumstances it is not possible to set up standards
for every job.
2) The process of setting up standards is a difficult task as it requires technical
skill. The time and motion study is required to be undertaken for this
purpose. These studies require a lot of time and money.
3) The conditions under which standards are fixed are not static. With the
change in circumstances the standards are also to be revised. The revision of

standard is a costly process. In case the standards are not revised the same
become impractical.
4) This system is expensive and small concerns may not afford to bear the cost.
5) The variances are to be classified into controllable and uncontrollable
variances. The responsibility can be fixed only for controllable variance.
6) The industries liable for frequent technological changes will not be suitable
for standard costing system. The change in production process will require a
revision of standard.
STANDARD HOUR
The production may be expressed in some convenient units of measurements

i.e kilos, tonnes, gallons, pounds, litres, etc. The ICWA, London defines
standard hour as “a hypothetical hour representing the amount of work
which should be performed in an hour under standard conditions.”
VARIANCES
The deviations between standard costs, profit or sales and actual costs,
profits or sales respectively will be known as variances. The variances may
be favourable and unfavourable.
If the actual cost is less than the standard cost then it is favourable variance.
If the actual cost is more than the standard cost then it is an unfavourable
variance.
CLASSIFICATION OF VARIANCES
A) Direct materials variances

B) Direct labour variances
C) Overheads cost variances
D) Sales or profit variances

A) DIRECT MATERIAL VARIANCE

Direct material variances are also known as material cost variances. The
material cost variance is the difference between the standard cost of
materials that should have been incurred for manufacturing the actual output
and the cost of materials actually incurred.
Material Cost Variance comprises of (i) Materials Price Variance and (ii)
Materials Usage Variance.
Materials Usage Variance can be further sub divided into (i) Material Mix
Variance and (ii) Material Yield Variance.
a) Material Cost Variance: Material cost variance is the difference

between standard materials cost and actual materials cost. Material cost
variance arises due to change in price of materials and variations in use
of quantity of materials.
b) Material Price Variance: Is that part of material cost variance which is

due to the standard price specified and actual price paid. Materials price
variances may arise due to the following reasons:
(i) Changes in basic prices of materials
(ii) Failure to purchase the quantities anticipated at the time when
standards were set.
(iii) Failure to secure discount on purchases.
(iv) Failure to make bulk purchases and incurring more freight, etc.
(v) Failure to purchase materials at proper time.
(vi) Not taking cash discount when setting standards.
c) Material Usage Variance: It is that part of material cost which arises

due to difference in standard quantity specified and actual quantity of
materials used. The variance may arise due to following reasons:
(i) Negligence in use of materials
(ii) More wastage of materials by untrained workers or defective
methods of production
(iii) Loss due to pilferage

(iv) Use of material mix other than the standard mix

(v) More or less yield from materials than the standard set.
(vi) Defective production necessitating the use of additional materials.
d) Material Mix Variance: Is that part of material variance which arises

due to changes in standard and actual composition of mix. It results from
a variation in the materials mix used in production.
Materials mix variance is the difference between standard price of
standard mix and standard price of actual mix.
e) Material Yield Variance: It results from the between actual yield and
standard yield. The sub variance may arise due to low quality of
materials, defective methods of production, etc
B) DIRECT LABOUR VARIANCES
a) Labour Cost Variance: It is the difference between the standard direct

wages specified for the activity and the actual wages paid. It is the
function of labour rate of pay and total labour efficiency or labour time
variance.
b) Labour Rate Variance: It is that part of labour cost variance which

arises due to change in specified wage rate. It arises due to following
reasons:
(i) Change in basic wage rate or piece work rate
(ii) Employing persons of different grades then specified.
(iii) Payment of more overtime than fixed earlier
(iv) New workers being paid different rates than the standard rates
(v) Different rates being paid to workers employed for seasonal work
c) Labour Efficiency Variance: It is that part of labour cost variance

which arises due to the difference between standard labour hours

specified and the actual labour hours paid for including idle time. This
variance helps in controlling efficiency of workers. The reasons for this
variance are:
(i) Lack of proper supervision
(ii) Defective machinery and equipment
(iii) Insufficient training and incorrect instructions
(iv) Increase in labour turnover
(v) Bad working conditions
(vi) Discontentment among workers due to unsatisfactory personnel
relations.
(vii) Use of non – standard material requiring more time to complete
work.
d) Labour Idle Time Variance: It is variance of labour efficiency. The

reasons for idle time may be power failure, defect in machinery, etc
e) Labour Mix Variance: The variance arises due to change in the actual
gang composition than the standard gang composition.
Problems
MATERIAL VARIANCES
1. Given that the standards for materials consumption are 40 kg at Rs.10 per
kg, compute a) Material cost variance (MCV); b) Material Price variance
(MPV); c) Material Quantity variance (MQV), when actual are
i) 48 kg at Rs.10 per kg
ii) 40 kg at Rs.12 per kg
iii) 48 kg at Rs.12 per kg
iv) 36 kg for a total cost of Rs.360
2. A manufacturing concern has furnished the following information:

Materials for 70 kg finished product are 100 kg.
Price of material is Re.1 per kg
Actual output is 2,10,000 kg
Actual material used is 2,80,000 kg
Cost of materials is Rs.2,52,000

Calculate a) Material Cost Variance; b) Material Price Variance; c)

Material Usage Variance.
3. From the following particulars, calculate (a) Material cost variance; (b)
Material price variance and (c) material usage variance
Standard Actual
Materials Units Price (Rs.) Units Price (Rs.)
A 2,020 2 2,160 2.40
B 820 3 760 3.60
C 700 4 760 3.80
4. Standard quantity of raw materials used is 25 kg for an output of 20 kg.

Actual quantity of raw material used is 5000 kg for an output of 4600 kg.
Standard price is Rs.5 per kg for 25 kg. Actual price is Rs.6.50 per kg for
5000 kg. Calculate:
a) Material Price Variance
b) Material Usage variance
c) Material Cost Variance
Hence verify your answer.
5. The standard material required to manufacture one unit of ‘X’ is 10 kg and

the standard price per kg of material is Rs 2.50. The cost account records
however revealed that 11,500 kg of materials costing Rs 27,600 were used
for manufacturing 1,000 units of ‘X’. Calculate
a) Material Cost variance
b) Material price variance
c) Material usage variance
Hence verify your answer.
6. The standard material for producing 100 units is 120 kg. A standard price of
50 paise per kg is fixed and 2,40,000 units were produced during the period.
Actual materials purchased was 3,00,000 kg at a cost of Rs 1,65,000.
Calculate (a) material cost variance; (b) material price variance; (c) material
usage variance. Hence verify your answer.

7. A furniture company uses sun mica tops for tables, calculate a) MCV; b)
MPV; c) MUV
Standard quantity of sun mica per table – 4 sq ft
Standard price per sq ft of sun mica – Rs 50
Actual production of tables – 1,000
Sun mica actually used – 4,300 sq ft
Actual price of sun mica per sq ft – Rs 55
8. From the following particulars, calculate a) MCV; b) MPV; c) MUV

Standard Actual
Material Price (Rs.) Quantity (Kg) Price (Rs.) Quantity (Kg)
A 23 2025 24 2360
B 43 920 38 1053
C 50 7000 48 7600
D 49.50 10500 52.50 11000
9. The standard cost of a certain chemical mixture is:

35% Material A @ Rs 25 per kg
65% Material B @ Rs 36 per kg
A standard loss of 5% is expected in production.
During a period the usage is as follows:
125 kg of Material A @ Rs 27 per kg
275 kg of Material B @ Rs 34 per kg
The actual output was 365 kg.
usage variance; (d) material mix variance; (e) material yield variance. Hence
verify your answer.
10.ABC Ltd manufactures a single product, the standard mix of which is:
Material A – 60 kg @ Rs. 20 per kg
Material B – 40 kg @ Rs. 10 per kg
Normal loss in production is 20% of input. Due to shortage of Material A,
the standard mix was changed. Actual results for March 2016 were:
Material A – 105 kg @ Rs. 20 per kg
Material B – 95 kg @ Rs. 9 per kg
Input – 200 kg
Loss – 35 kg
Output – 165 kg
usage variance; (d) material mix variance; (e) material yield variance.
11.Calculate Material cost variance, Material price variance, Material usage

variance and Material mix variance from the following information:
The standard material cost to produce a tonne of chemical X is:
300 kg of Material A @ Rs 10 per kg
400 kg of Material B @ Rs 5 per kg
500 kg of Material C @ Rs 6 per kg
During a certain year, 100 tonnes of mixture X was produced from the usage
of:
35 tonnes of Material A at a cost of Rs 9,000 per tonne
42 tonnes of Material B at a cost of Rs 6,000 per tonne
53 tonnes of Material C at a cost of Rs 7,000 per tonne
12.A company manufacturing ‘distempers’ operates a costing system. The

standard cost of one of the products of the company shows the following
standards:
Materials Quantity in kg Standard price Total (Rs)
per kg (Rs)
A 40 75 3,000
B 10 50 500
C 50 20 1,000
Total material cost 4,500
The standard input is 100 kg and the standard output of the finished product
is 90 kg. The actual results for the period are:
Materials used:
A = 2,40,000 kg at Rs 80 per kg
B = 40,000 kg at Rs 52 per kg
C = 2,20,000 kg at Rs 21 per kg
Actual output of the finished product = 4,20,000 kg.

You are required to calculate (a) material cost variance; (b) material price
variance; (c) material usage variance; (d) material mix variance; (e) material
yield variance.
13. XY Limited manufactures a product which increases engine efficiency and

improves mileage. The standard product and cost specification for 1000
litres of the product are as follows:
Chemical Quantity (litre) Price per litre (Rs.) Cost
ingredients
P 800 25 20,000
Q 200 40 8,000
R 200 10 2,000
Input 1,200 30,000
Output 1,000
The actual material records indicate the consumption in March 2015 as
follows:
P- 1,57,000 litres at Rs.24 per litre
Q- 38,000 litres at Rs.42 per litre
R- 36,000 litres at Rs.11 per litre
The actual finished production for the month of March 2015 is 2,00,000
litres.
Compute a) MCV; b) MPV; c) MUV; d) MMV; e) MYV.
14. Mikes Limited is engaged in producing ‘standard mix’ using 60 kg of

Chemical X and 40 kg of Chemical Y.
The standard loss of production is 30%.
The standard price of X is Rs.5 per kg and Y is Rs.10 per kg.
The actual mixture and yield were as follows:
X- 80 kg at Rs.4.50 per kg
Y- 70 kg at Rs.8 per kg
Actual yield is 115 kg.
Calculate different material variances. Reconcile the variances.
15.The standard material inputs required for 1,000 kgs of a finished product are
given below:
Material Quantity (in kg) Standard Rate per kg (in Rs)
P 450 20
Q 400 40
R 250 60
1,100
Standard Loss 100
Standard output 1,000
Actual production in a period was 20,000 kgs of the finished product for
which actual quantities used and the prices paid thereof are:
Material Quantity used (in kg) Actual price per kg (in Rs)
P 10,000 19
Q 8,500 42
R 4,500 65
Calculate (a) Material Cost Variance; (b) Material Price Variance; (c)
Material Usage Variance; (d) Material Mix Variance; (e) Material Yield
Variance.
16.The following standard and actual data is given about a product:

Material Standard Actual
Qty Rate Amt Qty Rate Amt
(units) (Rs) (units) (Rs)
A 500 6 3,000 400 6 2,400
B 400 3.75 1,500 500 3.60 1,800
C 300 3 900 400 2.80 1,120
Input 1,200 5,400 1,300 5,320
Less:
Standard 120 220
Loss
1,080 1,080
Calculate all the material variances.
17.A company manufactures a product A by mixing three raw materials. For

every 100 kg of output, 125 kg of raw material are used. In April 2016, there
was an output of 5,600 kg. The standard and actual particulars of April 2016
are as follows:
Standard Actual
Raw Material Mix Price per kg Mix Price per kg
I 50% Rs 40 60% Rs 42
II 30% Rs 20 20% Rs 16
III 20% Rs 10 20% Rs 12
Calculate all material variances. The actual quantity of material used was
7,000 kgs.
18.Vinayak Ltd produces an article by blending two materials. It operates a

standard costing system and the following standards have been set for raw
materials:
Material Standard mix Standard price per kg
A 40% Rs 4
B 60% Rs 3
The standard loss in processing is 15%.
During April 2015 the company produced 1,700 kgs of finished output. The
position of stocks and purchases for the month of April 2015 is as under:
Purchases during April 2015
Materials Stock as on Stock as on Kg Cost (Rs)
1/4/2015 30/4/2015
A 35 5 800 3,400
B 40 50 1,200 3,000
usage variance; (d) material mix variance; (e) material yield variance.
Labour Variances
19. Data relating to a job is:

Standard rate of wages per hour Rs 10
Standard hours (standard time) 300
Actual rate of wages per hour Rs 12
Actual hours 200
You are required to calculate:
(a) Labour Cost Variance; (b) Labour Rate Variance; (c) Labour Efficiency
Variance.

20. From the data given below; calculate LCV, LRV and LEV for the two
departments:
Dept A Dept B
Gross wages (direct) Rs 2,00,000 Rs 1,80,000
Standard hours produced 8,000 6,000
Standard rate per hour Rs 30 Rs 35
Actual hours worked 8,200 5,800
21.Calculate (a) labour cost variance; (b) labour rate variance; (c) labour
efficiency variance.
Particulars Standard Actual
Output in units 2,000 2,500
No of workers employed 50 60
No of working days in a month 20 22
Average wage per month Rs. 280 Rs. 330
22.The standard cost card reveals the following information:

Labour rate – Re 0.50 per hour
Hours set per unit of production – 10 hours
Actual data are given below:
Units produced – 500
Hours worked – 6,000
Actual labour cost – Rs 2,400
Calculate (a) Labour Rate Variance; (b) Labour Efficiency Variance; (c)
Labour Cost Variance.
23.The standard and actual labour force required for completing a job taking
one week period is given as follows:
Standard Actual
Category of No of Weekly Rate No of Weekly Rate
workers workers (Rs) workers (Rs)
Skilled 45 50 48 55
Semi – 50 40 45 40
skilled

Calculate (a) Labour Rate Variance; (b) Labour Efficiency Variance; (c)
Labour Cost Variance.
24.Standard hours for manufacturing two products M and N are 15 hours per
unit and 20 hours per unit respectively. Both products require identical kind
of labour and the standard wage rates per hour is Rs 5. In the year 2015,
10,000 units of M and 15,000 units of N were manufactured. The total of
labour hours actually worked were 4,50,500 and the actual wage bill came to
Rs 23,00,000. This includes 12,000 hours paid for @ Rs 7 per hour and
9,400 hours paid for @ Rs 7.50 per hour, the balance having been paid @ Rs
5 per hour. You are required to compute the labour variances.
25.Calculate (a) labour cost variance; (b) labour rate variance; (c) labour
efficiency variance.
Particulars Standard Actual
Output in units 2,000 2,500
No of workers employed 50 60
No of working days in a month 20 22
Average wage per man per month Rs. 280 Rs. 330
26.Using the following calculate (a) labour cost variance; (b) labour rate
variance; (c) labour efficiency variance; (d) labour idle time variance.
Standard hours – 5,000
Standard wage rate – Rs 4 per hour
Actual hours – 6,000
Actual wage rate – Rs 3.5 per hour.
Time loss due to machinery break down – 300 hours.
27.In a manufacturing concern the standard time fixed for a month is 8,000
hours. The standard wage rate is Rs 2.25 per hour. During one month, 50
workers were employed and average working days in a month are 25 days.
A worker works for 7 hours a day. Total wage bill of the factory amounts to
Rs 21,875. There was stoppage of work due to power failure for 100 hours.
Calculate (a) labour cost variance; (b) labour rate variance; (c) labour
efficiency variance; (d) labour idle time variance.
28.From the following data, calculate the labour variances:

The standard wage rate per employee per day is Rs.6
Actual output is 9,00,000 units
Actual wage rate per employee per day is Rs.6.50
Standard daily output per employee is 100 units
Total number of days worked is 50
Idle time paid for and included above is ½ day
Number of employees is 200.
29.The standard output of production ‘EXE’ is 25 units per hour in

manufacturing department of a company employing 100 workers.
The standard wage rate per labour hour is Rs 6.
In a 42 hour week, the department produced 1,040 units of ‘EXE’, despite
5% of the time paid being lost due to an abnormal reason. The hourly wage
rate actually paid were Rs 6.20; Rs 6 and Rs 5.70 respectively to 10, 30 and
60 of the workers.
Calculate (a) labour cost variance; (b) labour rate variance; (c) labour
efficiency variance; (d) labour idle time variance.
30.From the following data of a manufacturing concern, calculate (a) labour

cost variance; (b) labour rate variance; (c) labour efficiency variance; (d)
labour mix variance.
Budgeted labour composition for producing 100 articles:
20 men at Rs 125 per hour for 25 hours
30 women at Rs 110 per hour for 30 hours
Actual labour composition for producing 100 articles:
25 men at Rs 150 per hour for 24 hours
25 women at Rs 120 per hour for 25 hours
31.The details regarding composition and the weekly wage rates of labour force
engaged on a job scheduled to be completed in 30 hours as follows:
Category of Number of Standard Actual Actual
workers labourers hourly wage number of hourly wage
rate (Rs.) workers rate (Rs.)
Skilled 75 60 70 70
Semi–skilled 45 40 30 50
Unskilled 60 30 80 20
The work is actually completed in 32 hours. Calculate the various labour
variances.
32.A gang of workers normally consists of 30 men, 15 women and 10 boys.

They are paid at standard hourly rates as under:
Men – Rs.80; Women – Rs.60; Boys – Rs.40.
In a normal working week of 40 hours, the gang is expected to produce
2,000 units of output.
During the week ended 31st December 2016, the gang consisted of 40 men,
10 women and 5 boys. The actual wages paid were Rs.70, Rs.65 and Rs.30
respectively. 4 hours per worker were lost due to abnormal idle time. 1,600
units were produced. Calculate all labour variances.


Fap Combined

Uploaded by

Copyright:

Available Formats

You might also like

Fap Combined

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Fap Combined

Uploaded by

Copyright:

Available Formats

BBA SEM VI FINANCIAL ANALYSIS AND PLANNING

MODULE 6 BUSINESS FORECASTING

PURPOSE / USES / IMPORTANCE OF BUSINESS FORECASTING

2) Formulating Plans : Forecasting provides a logical basis for preparing plans.

3) Estimating Financial Needs : Any business requires adequate capital to

4) Facilitating Managerial Decisions : Forecasting helps management to make

5) Quality of Management : The quality of managerial personnel improves as it

ONLY FOR PRIVATE CIRCULATION Page 1

6) Encourages Co – operation & Co – ordination : Forecasting is not a one

7) Better Utilisation of Resources : Forecasting ensures effective utilisation of

8) Success in Business : Successful business to a great extent depends upon

STEPS / ELEMENTS OF BUSINESS FORECASTING

2) Estimating future business operations : The second step involves

3) Regulating forecasts : The forecasts are compared with actual results so

4) Reviewing the forecasting process : Once the deviations in forecasts and

SOURCES OF DATA USED IN BUSINESS FORECASTING

1) Primary Sources: It is first - hand information collected personally by

ONLY FOR PRIVATE CIRCULATION Page 2

2) Secondary Sources: These sources of information refer to already

KINDS OF FINANCIAL FORECASTS

2) Sales Forecasts : This forecast is linked to the general business forecast.

3) Historical Method : It refers to the projection of trends on basis of past events.

ONLY FOR PRIVATE CIRCULATION Page 3

6) Scientific Business Forecasting : Under this method, forecasting is done on

a) Business Index / Barometer : Business index refers to a series relating to

ONLY FOR PRIVATE CIRCULATION Page 4

c) Regression : The regression equation, y = a + bx, can be used as an

d) Econometric Models : Economic activities describe in terms of mathematical

THEORIES OF BUSINESS FORECASTING

3) Sequence / Time Lag Method : It is based on the behaviour of different

4) Specific Historical Analogy : It based on the assumption that history repeats

ONLY FOR PRIVATE CIRCULATION Page 5

5) Cross – Cut Analysis : In this theory, the effect of combined factors on

6) Model Building Approach : This approach makes use of mathematical

3) Availability of Raw Materials : The availability of raw material is a key factor in

ONLY FOR PRIVATE CIRCULATION Page 6

5) Availability of Finances : The financial aspect must be considered while

Particulars Amount (Rs)

Particulars Amount (Rs in thousands)

ONLY FOR PRIVATE CIRCULATION Page 7

Profit before tax 400

Particulars Amt (Rs in lakhs)

ONLY FOR PRIVATE CIRCULATION Page 8

A ratio is a simple arithmetical expression of the relationship of one number to another.

A financial ratio is the relationship between two accounting figures expressed

USES AND IMPORTANCE OF RATIO ANALYSIS

1) Utility to shareholders: Ratio Analysis helps in decision making as it provides

2) Utility to investors: For the assessment of the viability of financial statements, an

FOR PRIVATE CIRCULATION

5) Utility to government: various ratios calculated enable the government to

A. Traditional Classification / Statement Ratios

4. INDIVIDUAL EXPENSES RATIO

1) GROSS PROFIT RATIO

Gross Profit = Net Sales – Cost of Goods Sold.

Operating Ratio = Operating Cost x 100

Operating Cost = cost of goods sold + operating expenses.

3) OPERATING PROFIT RATIO

Operating Profit = Net Sales – Operating Cost.