MANAGERIAL

ACCOUNITNG
For B.Com. Third Year, Semester-VI

(as per latest Semester wise CBCS Syllabus

applicable to all Universities of Telangana State)

R.P. TRIVEDI
M.Com, LL.B.,

MANOJ TRIVEDI
B.Com. GradCWA, ACA
ADF, PGDM (IIM Bangalore)

PANKAJ PUBLICATIONS
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 |PREFACE
We are very happy to place this book in your hands. The book is
written strictly according to the latest Semester wise CBCS Syllabus
applicable to all Universities of Telangana State. The Chapter
“Importance and Estimation of Working Capital” has been
included exclusively for the benefit of students of Kakatiya
University

The book contains adequate theoretical explanation, short answer

questions, illustrations and problems of B.Com. standard. The newly
introduced chapter on “Decision making” has been covered in detail
with different type of problems covering all types of decisions.
Problems that were asked in the examinations of various Universities
of Telangana state have been included. The content of the book is
identical in English and Telugu versions. An effort has been made to
eliminate printing errors. We sincerely believe that students will find
this book most useful for their examination preparation and no other
reference material may be required.

In spite of the increase in content, the book continues to be handy

and convenient. The book has been very reasonably priced. We sincerely
hope that the teachers and students will derive greater satisfaction from
it.

Our sincere thanks to Dr. Krishna Rao, Sri N. Srinivas and all
lecturers who provided us with their valuable suggestions. We gratefully
acknowledge the contribution of Sri Vijay Kumar Savanna towards
the publishing of this book. We also thank Sri M. Ram Reddy, Proprietor
Om Sai Graphics and his dedicated team for the efficient and timely
work done by them.

We look forward to your feedback and constructive criticism in

our efforts to improve the book and make it more useful for the students
and the faculty.
Z
Authors
 ------- i^NAGeRIAL ACCOUNTING
B.Com., Third Year - VI Semester
SYLLABUS
Applicable to all universities olTelangana Stnte^

UNIT-I
Ch -1
Advantages and Limitations
Management and Financial Accounting.
Unit-I
UNIT-II
Ch-1
Ch-2 : MARGINAL COST Equation - Diffference
Meaning - Importance - tion Costing - Application of
between Marginal Costing an Analysis : Meaning Unit-II
Marginal Costing- CVP Analysis - Break bven Ch-2
Assumptions-importance-Limitations.

U nit-III
UN IT-III
Ch-3 : decision making ot Process Further. Ch-3
Make or Buy - Add or Drop rc> uu^ _ Replace or Retain
Operate or Shut-down-Special Order Pricing
Unit-I V
Ch-4
UNIT-IV
budgets and budgetary control
Ch-4 :
Unit-V
- Preparation of Budgets. Ch-5

UNIT-V : STANDARD COSTING AND ^^^^^ng and

Ch-5 : Ch-6
Standard Costing : ^"^JXn Standard Costing. Variance
ZZ-— vX^bourvartance - Overhead variance -

Sales variance.
WORK.NG CAPITAL

(Only for Kakatiya University)

 CONTENTS

Chapters Page No.

Unit-I
Ch-1 Inroduction A-l toA-9

Unit-II
Ch-2 Marginal Costing B-l toB-25

Unit-Ill
Ch-3 Decision Making C-l toC-19

Unit-IV
Ch-4 Budgets and Budgetary Control D-l toD-35

Unit-V
Ch-5 Standard Costing and Variance
Analysis E-l to E-34

Ch-6 Importance & Estimation of Working F-l to F-12

Capital
(only for Kakatiya University)

Objective type Questions 1 to 12

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 Chapter 1
INTRODUCTION

According to Smith and Asbume, "Accounting is the science of recording

and classifying transactions and events, primarily of financial nature and the
art of making significant summaries, analyses and interpretations of those
transactions and events and communicating the results to persons who must
make decisions or form judgements"
Accounting may be classified into Financial Accounting, Cost Accounting
and Management Accounting. Financial Accounting deals with preparation
of Profit & Loss A/c and Balance Sheet, catering to the requirement of owners,
and other users. Cost Accounting deals with classification, computation and
analysis of costs of different basis, providing useful information to managers,
employees, Government and other users. The third discipline of Accounting,
namely Management Accounting, deals with processing of data generated in
Financial and Cost Accounting for managerial decision making.
Limitations of Financial Accounting : While Financial Accounting is very
useful and significant, it has certain limitations and inadequacies, which have
resulted in adoption of supplementary accounting disciplines such as Cost
Accounting and Management Accounting. Some of the limitations are stated
below :
1. Historical Information : Financial statements are prepared only at the
close of the accounting period. Thus, only historical information is
available from financial records. They do not provide day-to-day cost
information for evaluating the efficiency of the organisation and for pre­
determining costs.
2. No Classification of Information : Financial Accounts are concerned
with the ascertainment of profit or loss of the business 'as a whole'. They
reveal the overall trading results for a period and financial position of
the business as on a particular date. They merely show the result of the
collective activities of the business. No detailed information is provided
of the exact manner in which the net profit or loss has been made. In a
business, the total turnover may comprise many activities and
departments, processes, jobs, contracts etc., some of which may be
profitable, while others may be at a loss. As separate information for an
activity is not revealed, profit or loss on each activity cannot be known.
3. No Standards : There are no standards or norms against which different
cost items can be compared in financial accounts. Incomes and expenses
can be compared with the corresponding figures of previous years, but
this does not provide a satisfactory basis for evaluating the progress or
efficiency of the activities.
 A-2

4. No Idea of Efficiency: Profit is not a measure of efficiency, as inefficient

firms can make profits in conditions of boom and efficient firms may
lose money during difficult economic conditions. Financial Accounting
fails to inform whether the profits are due to efficiency in operations or
due to external factors such as inflation, trade depression, war, famine,
etc. Material losses due to pilferage, wastage, labour and machine hours
lost due to idle time etc cannot be found out with the help of Financial
Accounting.
5. No Aid to Decision-Making : Managers need to think of and evaluate
alternative courses of action. Situations such as extent of capacity
utilisation, product mix, mix of factors of production, price negotiations
for new markets, internal production of parts against outsourcing etc
require information for effective decision making. Financial Accounting
does not provide such information. They meet the requirement of external
parties such as investors, banks, creditors etc.
6. No Classification of Expenses : Expenses are not classified into direct
and indirect expenses or fixed and variable expenses. They are not
assigned to products at each stage or production so as to reveal the
controllable and uncontrollable items.
7. Does not Aid Price Fixation : In the absence of cost data by products,
division, processes, etc; neither price fixation is possible nor is it possible
to prepare tenders and estimates.
8. Inadequate Data for Detailed Reports : Detailed information is not
available from financial records to supply reports of operations. It gives
only results, but does not explain the cause of such a result.
9. No Scope for Performation Appraisal : Since the Profit & Loss a/c
reveals the result of operations for the entire business as a whole, a system
of incentives based on performance appraisal of different individual
departments is not possible.
10. No Emphasis on Cost Control and Cost Reduction : In Financial
Accounting, there are revenues and expenses, no costs. There is no
accounting for wastage or for overtime. If profits are to increase, sales
will have to increase. With no emphasis on costs, cutting expenses will
be arbitrary.
11. Opportunity Costs are Ignored : Financial Accounting records only
such expenses that are actually incurred by the business. They do not
take into account notional expenses such as rent of own premises, or
opportunity cost of choosing one alternative over the other.
12. Qualitative Information is ignored : Financial Accounting ignores
qualitative aspects of the business. Even in case of quantitative aspects,
only such information that can measured in monetary terms is recorded.
Definition of Management Accounting : Management accounting is that
branch of Accounting that provides information to Management according to
its needs. While management is definitely interested in the usual figures of
Profit / Loss, positions of assets and liabilities etc., it is more concerned with
information which helps it in its basic functions of planning, organizing and
control. Management has to set goals for the organization, evaluate various
 A-3

means by which they can be achieved and select the best alternative. It has to
employ its scarce resources in the best possible manner and ensure that there
are no significant deviations from the plans. It will require information that is
mostly internal to the organization. It may want to know how the organization
has been faring, compared to its past performance, whether the business has
enough cash resources to meet its immediate needs, how the funds required
have been raised and deployed, how the various departments, branches or
products are faring and is it beneficial to continue them, a detailed break up of
each element of cost and whether it is conforming to the original budget etc.
Management Accounting takes care of all these issues.
Definition : A number of authorities have defined Management Accountancy
in different terms. A couple of standard definitions are given below, followed
by a very broad working definition of Management Accounting.
'Management Accounting is the process of identification, measurement,
accumulation, analysis, preparation, interpretation and communication of
information that assist executives in fulfilling organizational objectives"-
Charles T. Horngren.
" Management Accounting includes the methods and concepts necessary
for effective planning, for choosing among alternative business action and for
control through the evaluation and interpretation of performances" - American
Accounting Association.
Thus, in a very broad sense, Management Accounting is accounting
information in any form, which is useful to Managers in making intelligent
decisions and attain its objectives.
Features of Management Accounting
1. Management Accounting is future oriented. It does not confine itself to
collection of data. It uses the data for making projections for various
situations which may occur in future.
2. Management Accounting lays greater emphasis on the nature of
various elements of costs. Costs are classified as fixed costs, variable
costs and semi-variable costs. An understanding of the nature of various
costs involved helps in making accurate forecasts of the future.
3. Management Accounting is both a science and an art. It is based on
facts, and hence, can be regarded as Science. However, any forecast
will involve subjective judgement of the forecaster, and hence, it can be
termed as an art.
4. It concerns itself with the 'Problem of Choice'. It is an aid to decision
making, which necessarily involves evaluation of alternatives and choice
of the. best alternative.
5. i Decision making cannot restrict itself to monetary and financial
considerations. As such Management Accountancy takes into account
non-monetary variables also.
6. While Financial Accounting restricts itself to finding out the ultimate
result of operations of the organization, Management Accounting goes
 A-4

further and finds out the reasons for such result. The focus is on 'Cause
and Effect' relationship. .
Management Accounting is not bound by any specific rules. The user
7. being the management itself, the analyst is free to use his discretion and
present the required information in a way which can be most useful.
Management Accounting supplies information, and not decisions. Based
8.
on the information supplied, management has to take decisions.
Objectives of Management Accounting: The important objectives o
Management Accounting are :
ToTuppty necessary data to the management for formulatiing future plans.
1.
The data inculdes statements pertaining to past results and estimates or

To6 present financial information to the management in a way that is

2.
easily understandable. • j i„
To establish a strong, working relationship amongst different individua ,
3. pertaining to different departments, of the same organization
To help in keeping the actual performance as per the plans made by
4.
management. . .
To motivate the employees, by fixing targets and providing incentives.
5.
To keep the management fully informed about the latest position o e
6.
organization. . .
7. To keep the tax burden of the organization to the minimum.
8 To maximize the wealth of the organization.
Scope of Management Accounting: The scope of Management Accounting
covers all information that can be used by managers in decision-makmg. The
decisions with which managers are concerned can be classified as Planm g
decisions, Organizing decisions and Control decisions. Planning decisions are
concerned with the establishment of goals for the organization and choice
plans to accomplish these goals. Examples of decisions for which Management
Accounting information is needed include decisions like whether to purchase
or produce a component, whether a particular department should be earned

°n OT Organizing decisions involve optimization of available human and non

human resources to achieve organizational objectives.
is useful in decisions regarding number of units of each product that can be
used budgeting of specific amounts to be spent on sales promotion, etc.
Control decisions result from implementing the plans and monitonn
the actual results to see if goals are being achieved. If there is a significant
deviation from the plan, corrective action will have to be initiated. Examples
of decisions where Management Accounting information is esse^1^C^
manipulation of price to adjust the difference between actua and planned
sales, review of the economic order quantity and re-order levels so that
production process runs smoothly, analysis of Variances, etc.
 A-5

Management Accounting touches upon a number of areas and as such,

the following aspects also fall within its scope.
1. Financial Accounting: Historical data presented in Financial Accounting
is the basis for planning the future course of action.
2. Cost Accounting: Cost Accounting provides various techniques such
as Marginal Costing, Standard costing, etc which help the management
in a number of ways.
3. Tax Accounting: Tax planning, filing of returns with different
departments and keeping the management informed of its tax burden
falls within the scope of Managment Accounting.
4. Internal Audit: Internal audit, undertaken for performance appraisal,
strengthening of internal control procedures and as aid to the final
statutory audit, also comes within the purview of Management
Accounting.
5. Budgetary Control: Formulation of budgets, their comparision with
actuals and analysis of variances is a part of Management Accounting.
6. Forecasting: Managmenet Accounting covers forecasting the future, in
all possible states of nature and evaluation of alternatives in that backdrop.
7. Reporting: Reporting to Management of the various activities of the
organization in an integral part of Management Accounting. Reports are
made in uniform intervals of time, the length of the time interval being
dependent on the nature of information.
8. Office Services: Management Accounting might also be expected to
deal with data processing, filing, copying, duplication, communication
etc. and report about the utility of different office machines.
Functions of Management Accounting: The basic function of Management
Accounting is to assist the management in making intelligent decisions. This
is accomplished in the following ways.
1. Planning and Forecasing: Planning and forecasting is done by
Management Accountants for short term and long term periods. Various
techniques such as budgeting, standard costing, marginal costing, etc
are used for the purpose.
2. Modifications of Data: Management Accounting helps in modification
of data presented in financial statements in a way which is more suitable
to the management. For example, information on sales can be presented,
product-wise, territory-wise, season-wise, dealer-wise etc.
3. Financial Analysis and Interpretation: Management Accountant
ana|yses and interprets financial data in a simple way and presents it in
a non-technical manner. He gives facts and figures about various policies
and evaluates them in monetary terms, supplementing it with his opinion
on various alternatives. The management has to only take a decision.
 A-6
5. Maximum Profitability
Managerial Control: Management Accounting covers fixing of
4. cost reduction, but also a
standards, recording of actuals and analysis of Variances for all
that provide the maximui
departments, individuals, and all elements of cost. This helps in
is ensured.
performance evaluation and managerial control. 6. Industrial Relations: U
Communication: Management Accounting establishes communication
5. with the organization and with the outside world. Reports are prepared are often responsible
management and labour c
for the benefit of different levels of management. Relevant information
on activities of the organization are communicated to interested outside Accounting. Industrial R
7. Control: The tools and tec
parties such as shareholders and creditors. to the management in pla
Use of Non-Monetary Information: While evaluating alternatives, non­
6. monetary information is also considered. For example, if the industry is of the concern. Timely re
in recession and a company wants to retrench the workers, the 8. Contribution to Society
Management Accountant not only thinks of the cost involved, but also development of nation’s
the nature of the work force and the difficulty in getting back similar Management Accounting
Limitations of Management .4
labour force, once the industry is out of recession.
1. Dependent on Accounting
Co-ordination : Management Accountant acts as a coordinator among
7. different financial departmentts through budgeting and financial reports. records form the source
The targets and performances of different departments are communicated effectiveness of Managem
to them from time to time. It helps to increase the efficiency of various accuracy of the accountin
2. Subjectivity: The informa
sections thereby increasing profitability of the concern.
Strategic Decision Making: Management Accounting supplies is always prone to some si
8. analytical information regarding various alternatives and choice of uncertain. Similarly, inteq
management in making strategic decisions is made easy. personal judgement of the
Information: The information requirement of various levels of 3. Inter-dependency of disc
9. Management is met by Management Accounting. The supply of adequate only if the Management /
information at the proper time leads to increase in efficiency of the and understanding of othei
Economics, Engineering.
management. 4. Not a substitute to Mana
Advantages of Management Accounting
1. Management's need for information: Various levels of management tool, not a substitute to n
are concerned with different issues. Each issue requires unique solution, but a solution h
information. Complete and detailed information of every aspect of management.
business has to be collected and analyzed, which is possible only with 5. Dependent on Level of
Accounting will get dilutee
Management Accounting.
Efficient Planning and Effective Organization: Management are not properly executed.
2. Accounting leads to efficient planning and an effective organization. 6. Evolutionary Stage: Manas
Policies, Programmes and Strategies are formulated with the help of is a wide scope for further i
available information. A sound and effective internal control and audit obtained by applying differ
7. Expensive: Installtion of 1
system can be developed.
Service to Customers: Management Accounting helps in cost reduction elaborate organizational
/ 3. and production of better quality goods, thereby resulting in better services organizations, which can af
to customers of the organization. 8. Non-Quantitative Factors
Increae in Efficiency: Management Accounting encourages efficiency consider all the non-quantita
4. in business operations. For example, standards are fixed for production decision.
by workers. Incentives are based on performance in relation to standards.
 A-7

5. Maximum Profitability: Management Accounting not only helps in

cost reduction, but also assists management in choosing the alternatives
that provide the maximum yield. Maximum return on capital employed
is ensured.
6. Industrial Relations: Unacceptable standards or sub standards, which
are often responsible for unhealthy and bad relations between
management and labour class, can be removed by the use of Management
Accounting. Industrial Relations can thus be improved.
7. Control: The tools and techniques of management accounting are helpful
to the management in planning, coordinating and controlling activities
of the concern. Timely remedial actions can be taken.
8. Contribution to Society: The economic uplift of the community and
development of nation's economy can be achieved by the use of
Management Accounting.
Limitations of Management Accounting
1. Dependent on Accounting Information: Financial and Cost Accounting
records form the source of Management Accounting. Therefore, the
effectiveness of Management Accounting depends upon the fairness and
accuracy of the accounting information.
2. Subjectivity: The information provided by the Management Accountant
is always prone to some subjectivity, as it is future oriented and hence,
uncertain. Similarly, interpretation of information also depends on the
personal judgement of the interpreter.
3. Inter-dependency of disciplines : Management Accounting is helpful
only if the Management Accountant has a comprehensive knowledge
and understanding of other disciplines such as Accountancy, Statistics,
Economics, Engineering, Management etc.
4. Not a substitute to Management: Management Accounting is only a
tool, not a substitute to management. It provides all the means to a
solution, but a solution has to be chosen and implemented by the
management.
5. Dependent on Level of Execution: The impact of Management
Accounting will get diluted if the decisions taken by the management
are not properly executed.
6. Evolutionary Stage: Management Accounting is still in its infancy. There
is a wide scope for further improvement. Therefore, varying results are
obtained by applying different tools.
7. Expensive: Installtion of Management Accounting system needs an
elahforate organizational system. It's use is limited to only large
organizations, which can afford it.
8. Non-Quantitative Factors: Management Accounting does not totally
consider all the non-quantitative factors which may pertain to a particular
decision.
 A-8

Financial Accounting and Management Accounting:Financial Accounting

and Management Accounting are two different branches of Accounting, each
having its own objective and relevance. They also share some similarities.
1. Common Accounting System: Management Accounting sourcesits data
entirely from Financial and Cost Accounting records. Thus, data base
from which the two branches of Accounting derive their information is
the same.
2. Responsibility Accounting: Both Financial and Management Acconting
rely heavily on the concept of responsibility. Financial Accounting is
concerned with the concept of responsibility over the company as a whole,
where as Management Accounting is concerned with responsibility over
its parts.
Distinction :
1. Objective and Usage: The objective of Financial Accounting is to record
all transactions and finally reveal the operational result for the year along
with the position of assets and liabilities at the end of the year. This
information is mainly useful to share holders, creditors and other
outsiders. The objective of Management Accounting is to help the
management in the formulation of plans and policies.
2. Nature: Financial Accounting is 'objective' in nature where as
Management Accounting is prone to a little subjectivity.
3. Orientation: Financial Accounting concerns itself with the record of
financial history of an organization and is past oriented. Management
Accounting involves analysis of data and estimates of the future. It is
future oriented.
4. Flexibility: In Financial Accounting, records are maintained and accounts
are prepared in accordance with some Generally Accepted Accounting
Principles (GAAP). Such Accounting Principles are not binding on
Management Accounting.
5. Statutory Obligation: Preparation of Financial Accounts and their
presentation in a prescribed manner are a statutory obligation.
Management Accounting is not mandatory.
6. Periodicity: Financial Accounting is done as and when transactions
occur, but final accounts are prepared usually for a period of one year.
However, in case of Management Accounting, there is no specified time
period, but information has to be kept up to date as it may be required
any time.
7. Precision: While Financial Accounting lays emphasis on 'precision',
Management Accounting stresses on 'Speed' with which information can
be obtained. It relies more on estimates and approximations, rather than
wait for more accurate data.
8. Scope: While Financial Accounting covers only that information which
can be measured in terms of money, Management Accounting considers
non-quantifiable factors also.
 A-9

9. Audit: Financial Accounts need to be audited. Management Accounts

need not, and in many cases, cannot be audited.
10. Focus: Financial Accounting focuses on company as a whole.
Management Accounting focuses more on segments of the company.
11. Difference in Approach: Financial Accounting ignores notional costs
and revenues. Management Accounting may consider even notional costs.
12. Use of other Disciplines: Management Accounting draws heavily from
other disciplines such as Economics, Statistics, Engineering, etc.
Financial Accounting is bound by conventional accounting systems and
practices.
Cost Accounting and Management Accounting: Management Accounting
and Cost Accounting are normally understood as one. However, there are a
few differences between them.
1. Objective: The main objective of Cost Accounting is to determine and
record the cost per unit of output. The objective of Management
Accounting is to provide information to Management to formulate plans
and policies.
2. Orientation: Cost Accouting is based on past and present figures.
Management Accounting is future oriented.
3. Scope: The Scope of Management Accounting is wider. Cost Accounting
is only a part of Management Accounting.
4. Focus: The focus of Cost Accounting is on costs, where as Management
Accounting focuses on revenues also.
5. Principles: Cost Accounting has certain principles and procedures for
recording and analyzing data. Management accounting prepares and
presents information as per requirement of the management.
6. Evolution: Cost Accounting has been in use since industrial revolution.
Management Accounting is relatively new concept.
7. Usage: Information provided by Cost Accounting is useful to external
and internal parties, where as information provided by Management
Accounting is useful only to Management.
8. Factors Considered: In Cost Accounting, only those transactions are
taken which can be expressed in terms of money. Management
Accounting considers non-monetary, quantitative information also.

f-
 Variable Costs: Vari
production. No vari;
production increases,
will not change. For
required to produce 1
to increase as the num
Chapter -2
cost of materials will I
marginal costing costs. Commission o
basis of number of ui
Semi-Variable Costs
AM.n.gem.mAueouhtam.atodiehelpof^— —*
of production, but the
to assist the management in taking an tn orm, Ratio Analysis are semi variable costs ai
Statements, Funds flow Analysis, C he help costs normally have
some of the popular tools emp> oyeP Marginal Cost Analysis, Break irrespective of num
increases as the nun
example of semi vari
XX—”=^mfmZt.InLc11a,er.«e„11 component of Rent, t
The charge for every
Semi Variable
learn about Marginal Costing. Management Accountants
Concept of Cost: The ^““"XX^edon a given thing. A study Semi variable costs c
graphs method, two p
defines ‘Cost’ as the amount o “p t controllability, relevance etc. is
of the various costs involved, the . t costs consjst of all such method. The two-po
Two Point Method:
divided into two categones-direct an 1 tQ the products. Indirect
items of expenditure that can be conve y rticular product. Indirect compared with corre
costs are those expenseMhat cannot e a further classified into costs remain fixed th
costs, which change:
costs are also called Overheads . and Distribunon
divided by the chang
°‘to Cta8K 'he of units at a given le-
get the variable prop
Direct Costs. , . • of thejr relationship with the The difference betw
--^.px^la-edinBFi"C08,s' in the semi-variable
Illustration -1: Frc
you are required to i
amount spent towards such an expense — me ™ p js Production
5,000
volume of produciton They “ buMng has to be paid irrespective 6,000
production. For example, rent 7 Quantity of goods produced 7,000
of whether or not production is taking place The qu ntny duced
8,000
does no. matter. Ren. will “XZmd “ven” no ™rk is assigned to a
Solution: The prob
increases. Similarly, salanaa n ,. fees Godown rent etc. are all any two output lev,
person. Depreciation of Machine scale, as the number semi-variable exper
XXXXXed does no. result in any addition.! cost. Thus, the Variable cost
= Change in s
cost per unit comes down. = (24,000 - 2(
 B-2

Variable Costs: Variable costs vary in direct proportion to the volume of

production. No variable costs are incurred if production is stopped. As
production increases, variable costs increase. However, variable cost per unit
will not change. For example, if it is estimated that 2 units of material are
required to produce 1 unit of finished product, then material costs will continue
to increase as the number of units of finished stock desired increases. Similarly,
cost of materials will be nil, if production is stopped. All direct costs are variable
costs. Commission of sales persons, certain taxes and duties payable on the
basis of number of units produced, etc are examples of variable expenses.
Semi-Variable Costs: Semi variable costs change with the changes in output
of production, but the change is not proportionate. For the purpose of analysis,
semi variable costs are spilt into fixed costs and variable costs. Semi variable
costs normally have a fixed cost component, which needs to be incurred
irrespective of number of units produced. The variable cost component
increases as the number of units increases. Telephone expenses are a good
example of semi variable costs. Telephone expenses can be split into a fixed
component of Rent, that needs to be paid whether or not the telephone is used.
The charge for every call made constitutes the variable component.
Semi Variable costs are also called ‘semi fixed costs’. Segregation of
Semi variable costs can be done by any of the popular methods such as scatter
graphs method, two point method, degree of variability method, or least squares
method. The two-point method is explained below.
Two Point Method: Under this method, the output at two different levels is
compared with corresponding amount of semi variable expenses. Since fixed
costs remain fixed the change in amount of expenses is on account of variable
costs, which change in proportion to change in output. The change in expenses,
divided by the change in output, gives the variable cost per unit. If the number
of units at a given level of output are multiplied with variable cost per unit we
get the variable proportion in the total amount of expenses at the given level.
The difference between the two amounts gives us the ‘fixed cost’ component
in the semi-variable costs.
Illustration -1 : From the following figures pertaining to M/s Design House,
you are required to calculate the fixed component in the semi variable costs
Production (units) Semi -Variable costs (?)
5,000 18,000
6,000 20,000
7,000 22,000
8,000 24,000
Solution : The problem can be solved with the help of two point method. Take
any two^output levels, say 6,000 units and 8,000 units. The corresponding
semi-variable expenses are ? 20,000 and ? 24,000 respectively
Variable cost per unit
= Change in semi variable costs/Change in number of units
= (24,000 - 20,000) / (8,000 - 6,000) = 4,000 / 2,000 = ? 2 per unit
 B-3

At any given level of output, we can find the variable conmponent of Absor
semi - variable costs by multiplying the output with variable cost per unit. At of cha
production = 5,000 units, variable component of semi-variable costs = produc
5,000 x ? 2 = ?10,000 enterpr
Total semi -variable costs at 5.000 units of output = ? 18,000 also at
Therefore, Fixed component = ? 18,000 - ? 10,000 = ? 8,000 Margii
Step Costs : Step costs remain fixed, as long as the output remains within a amount
certain level. If output has to be increased beyond the said level, step costs rise if the vc
sharply. They remain fixed until the next such level is reached. Godown Rent broadh
is a good example of step costs. If a godown has capacity to store 100 units of decisioi
a material, the rent payable shall be the same irrespective of number of units M
stored, as long as the number is less than 100. To store the 101st unit, a new • artable
godown may have to be rented, which will increase the rent. If the capacity of costs ot
new godown is also 100 units, then godown rent will remain fixed till the time period. (
there is requirement of storing more than 200 units. Thus, the concept of step ’.he inve
costs is vital to fix the optimum level of activity. used to <
Cost Behavior: Understanding ‘Cost Behavior’ implies classifying the various >r shut d
expenses into ‘fixed cost’ and ‘variable cost’. Semi variable costs will have to . ’Sting t
be segregated into fixed and variable components with the help of a suitable Margin;
method devised for the purpose. Step costs will be treated as fixed costs, but 'ales anc
amount will differ depending upon the level of activity. c> ’sts. Th

=>

The
.lustrat
.■"‘articular

Solution
The Marg
Fixed Cot
C ontribu
Since sale
Marginal Costing vs Absorption Costing : The ICMA (London) defines - mtributic
costing as the technique and process of ascertaining costs. Techniques of costing C ontribut
refer to the specialized procedures adopted for ascertaining the cost of products f ontributi
or services for certain special purposes under special conditions, and for Total Cont
providing relevant cost data to the management for purpose of cost control, Total Cont
management policy and managerial decision making. Absorption Costing and P V Ratio
Management Costing are some of the various techniques of Costing. : f contribt
.. nsidered
 B-4

Absorption Costing: According to ICMA, Absorption costing is the practice

of charging all costs, both variable and fixed, to operations, processes, or
products.” It is a technique that takes into account the total cost of running an
enterprise. It is also knows as Total costing or full costing. It values inventory
also at total cost. It is useful in preparing job estimates or quotations.
Marginal Costing : According to ICMA, London, “Marginal Cost is the
amount for any given volume of output by which aggregate costs are changed,
if the volume of output is increased or decreased by one unit.” Marginal Costing,
broadly speaking, is the technique of applying the concept of Marginal cost in
decision making process.
Marginal Costing is a technique that distinguishes between fixed and
variable costs. The ‘marginal’ cost of product is its variable cost. The fixed
costs of the period are written off against total contribution earned in that
period. Contribution is the excess of Sales over marginal (variable) cost. Even
the inventory is valued only at marginal cost. Marginal Costing technique is
used to determine the impact of changes in volume or change in product mix
or shut down of a production unit on current profits. In simple terms, marginal
costing focuses on variable costs as a criteria for decision making.
Marginal Costing Equation : We know that profit is the difference between
sales and total cost. Total cost can be bifurcated into fixed costs and variable
costs. Thus
Profit = Sales - (Fixed cost + Variable Costs)
>=> Profit = Sales - Fixed cost- Variable Costs
■=> Fixed Cost + Profit = Sales - Variable costs
The above equation is termed as Marginal cost Equation
Illustration-2 : Determine the amount of fixed costs from the following
Particulars.
Sales ? 2,00,000
Variable cost ? 40,000
Profit ? 30,000
Solution
The Marginal cost Equation is fixed cost + Profit = Sales-Variable cost
Fixed Cost = 2,00,000 -40,000,-30,000 = 1,60,000-30,000 = ? 1,30,000
Contribution: Contribution is the difference between sales and variable costs.
Since sales and variable costs can both be expressed in ‘per unit’ terms,
contribution is usually expressed in per unit terms.
Contribution p.u = Selling Price p.u.- Variable costs p.u
Contribution can also be expressed in absolute terms.
Total Contribution = Contribution p.u x Number of units. Alternatively
Total Contribution = Total Sales - Total Variable Expenses;
P/V Ratio : P/V ratio stands for Profit / Volume Ratio. However, it is the ratio
of contribution to sales. (The term ‘Profit’ is used as fixed costs are not
considered in marginal costing technique and profit is same as Contribution)
 B-5

PA/ Ratio has wide application in Marginal costing. PIN ratio can be calculated In Abso
with the help of any of the following formulae. under oi
PIN Ratio = Contribution/ Sales = Sales - Variable costs/ Sales fixed cc
= Fixed Costs + Profit/ Sales = 1- Variable costs I Sales does no
<= Change in contribution/Change in Sales InAbsoi
Illustration-3 : From the following particulars, find i) Contribution^ P/V Ratio which is
Variable cost per unit the ma
Selling Price per unit ? 80
? 2,00,000 excess c
Fixed Expenses Justration-5 :
Output 10,000 (unit)
Variable n
Solution :
Fixed mar
i) Contribution p.u = Selling Price p.u -Variable cost p.u
= ? 80 - ?40 = 7" 40 The norms
Total contribution = Contribution p.u x Output entories. F
= 40 x 10,000 units = ? 4,00,000 In 1998, tl
ii) P /V Ratio = Contribution I Sales = ? 40 / ? 80 = 0.5 = 50% price of ? 8 pt
Let us now understand as to how information is presented tn Marginal Costing ..15,000 units
Illustration-4 : From the following information, find out the amount of profit
You are re>
earned during the year using marginal costing technique ibsorption co;
Fixed Cost * 5’UU’UUU
Variable Cost ? 10 per unit Solution
Selling price ? 15 per unit Income
Output level 1’5O;2°/2 Unl‘ „ } Pa
(B.Com Calcutta) Manufactu
Statement Showing Calculation of Profit Variable :
Particulars Fixed: 1,0
Selling price per unit Recovery i
Less : Variable cost per unit Cost of Pre
Contribution per unit Add Openi
No. Of Units produced (units) Ven non
Total contribution = (contribution p.u x No. of units produced) 7,50,000 .
Less : Clos
ProfitRXedCOSt SOOO Cost of Go
Difference between Marginal Costing and Absorption Costing: The basic Sales : 90,(
difference between absorption costing and marginal costing are as follows. Profit (B-4
Absorption costing is the total cost technique. Thus, under absorption Add / Less
1.
costing, all costs weather variable or fixed, are treated as product costs Net Profit
In marginal costing technique, only variable costs are treated as product
Income St
costs. Fixed cost are treated as period costs and are charged to profit and
Pa
loss account for that period. Manufactu:
2.
In Absorption Costing, the stock of finished goods and work in- process
Variable : 1
is valued at total cost which includes both variable and fixed cost, n
Fixed : l,0<
marginal costing, such stocks are valued only at marginal cost. Hence
Recovery r
absorption costing results in higher valuation of inventories as compared
Cost of Pre
to marginal costing.
 B-6

3. In Absorption costing, arbitrary apportionment of fixed costs results in

under or over- absorption of such fixed costs. Marginal costing excludes
fixed costs and the question of under or over absorption of fixed costs
does not arise.
4. In Absorption Costing, managerial decision making is based upon ‘profit’
which is the excess of sales value over total cost. In marginal costing,
the managerial decisions are guided by ‘Contribution’, which is the
excess of sales value over variable cost.
Illustration-5 : A company produces only one product which had the following costs :
Variable manufacturing costs ? 4 per unit
Fixed manufacturing costs ? 1,00,000 per annum
The normal capacity is set at 1,00,000 units. There are no work -in- process
inventories. Fixed overhead rate is Re.l per unit
In 1998, the company produced 1,00,000 units and sold 90,000 units at a
price of ? 8 per unit. In 1999, the company produced 1,10,000 units and sold
1,15,000 units at the same price.
You are required to prepare income statement for 1998 and 1999 based on
absorption costing and marginal costing
Solution
Income Statement under Absorption costing for the year 1998
Particulars Amount(f)
Manufacturing Costs
Variable : 1,00,000 units @ ? 4 per unit 4,00,000
Fixed : 1,00,000 units @ Fixed overhead
Recovery rate of Re. 1 p.u 1.00.000
Cost of Production 5,00,000
Add Opening Stock -
5,00,000
Less : Closing Stock : 10,000 units @ ? 5 p.u 50.000
Cost of Goods sold (A) 4.50.000
Sales : 90,000 units @ ? 8 p.u (B) 7.20.000
Profit (B-A) 2,70,000
Add / Less Over / Under absorption of Fixed overheads -
Net Profit 2.70.000
Income Statement under Absorption costing for the year 1998
Particulars Amount (f)
Manufacturing Costs
Variable : 1,00,000 units @ ? 4 per unit 4,40,000
Fixed : 1,00,000 units @ Fixed overhead
Recovery rate of Re. 1 p.u 1.10.000
Cost of Production 5,50,000
 B-7

Add Opening Stock 50.000 dividing Standar

6,00,000 Recovery rate is
Less : Closing Stock : 5,000 units @ ? 5 p.u 25.000 arrived at is adjti
Cost of Goods Sold (A) 5.75.000 than fixed overhc
Sales : 1,15,000 units @ ? 8 p.u (B) 9.20.000 more than fixed
Profit (B-A) 3,45,000 case of Marginal
Add over absorption of Fixed Overheads (1,10,000 - 10,000) 10,000 Break Even Ana
Net Profit 3,35,000 Accountant. In a'
Income Statement under Marginal costing for the year 1998 is understood as a
Paticulars Amount cost is equal to
? determination of
Variable Manufacturing costs 1,00,000 units @ ? 4 per unit 4,00,000 relationship betw
Add Opening Stock Break Even Poin
4,00,000 equal to its total c
Less : Closing Stock: 10,000 units @ ? 4 p.u 40,000 can be calculated
Cost of Goods, Sold (A) 3.60.000 of units required t
Sales : 90,000 units @ ? 8 p.u (B) 7,20.000 to be attained in n
Contribution Margin (B-A) 3,60,000 can be calculated
Less Fixed Costs 1,00,000 Break even I
Net Profit 2,60,000 = Fixed Cost
Income Statement under Absorption costing for the year 1998 Break Even point i
Paticulars Amount (?) = (Fixed cost
Variable Manufacturing Costs : = Fixed costs
1,10,000 units @ ? 4 per unit 4,40,000 Break Even An
Add Opening Stock 40.000 earn desired profit!
4,80,000 Uuits for desired p
Less : Closing Stock : 5,000 units @ ? 4 p.u 20,000 Sales for desired Pt
Cost of Goods Sold (A) 4,60.000 = units for a
Sales: 1,15,000 units @ ? 8 p.u (B) 9,20.000 Illustration-6: Yoi
Contribution Margin (B-A) 4,60,000
following case. Th<
Less Fixed Costs 1,00,000
unit for the single p
Net profit 3,60.000
Estimated salt
In 1998, Number of units produced is 1,10,000 units, while number of
units involved coini
units, sold is 90,000 units. Thus, there is closing stock of 10,000 units. Similarly,
at ?20
in 1999, Number of units produced is 1,10,000 units, while number of units
Solution :
sold is 1,15,000 units. This is possible on account of opening stock of 10,000
units. The closing stock in 1999 will be opening Stock + number of units Break Even Pi
produced -number of units sold = 10,000 +1,10,000 -1,15,000 = 5,000 units. Contribution p
In absorption costing this stock will be valued at total cost of production. = 120- ? 4 = 3
However, in Marginal costing it will be valued at marginal (variable) cost Therefore
only. Break Even po
In absorption costing, Fixed costs will be recovered by multiplying actual Break Even Point (ii
production with the fixed Overhead Recovery rate. This rate is arrived at by
 B-8

dividing Standard fixed costs by Normal capacity. However, Fixed Overhead

Recovery rate is already given in the problem as Re.l per unit. The profit
arrived at is adjusted for under absorption (if Actual fixed overhead is more
than fixed overhead recovered), or over absorption (if actual fixed overhead is
more than fixed overhead recovered). No such adjustments are required in
case of Marginal costing.
Break Even Analysis: Break Even Analysis is a vital tool for the Management
Accountant. In a very ‘narrow’ interpretation of the term, Break Even Analysis
is understood as a system of determination of that level of activity where total
cost is equal to total sales. However, Break Even Analysis also involves
determination of probable profit at any given level of activity. It portrays the
relationship between cost of production, volume of production and Sales.
Break Even Point: A business is said to ‘Break even’ when its total sales are
equal to its total costs. It is a point of ‘No Profit No Loss’. Break Event point
can be calculated ‘in units’ or ‘in value’ i.e. it can be expressed as the number
of units required to be produced and sold to ‘break-even’ or the sales required
to be attained in rupees, so that there is a situation of ‘no profit - no loss’. It
can be calculated with the help of any of the following formulae.
Break even Point (BEP) (in units) = Fixed Costs / Contribution p.u
= Fixed Costs / Selling Price p.u - Variablae Costs’
Break Even point (BEP) (sales in value) = BEP in units x Selling price p.u
= (Fixed costs x Total Sales) / (Total sales - Total variable costs)
= Fixed costs / P/V Ratio = (Fixed costs x Total Sales) / Total contribution
Break Even Analysis also enables us to plan our production and sales to
earn desired profits.
Uuits for desired profits = (Fixed costs + Desired Profit) / Contribution p.u
Sales for desired Profits = (Fixed costs + Desired Profits) / P/V Ratio
= units for a desired profit x Selling price p.u
Illustration-6: You are required to calculate the break even point in the
following case. The fixed costs for the year are ? 80,000. Variable cost per
unit for the single product being made is T 4
Estimated sales for the period are valued at ? 2,00,000. The number of
units involved coincides with the expected volume or output. Each unit sells
at ? 20 (C.A. Final)
Solution :
Break Even Point (in units) = Fixed Expenses / Contribution p.u
Contribution p.u = Selling price p.u (-) Variable costs p.u
20- ? 4 = ? 16
Therefore
Break Even point = ? 80,000 / ? 16 = 5,000 units
Break Even Point (in value) = Break even point (in units) x selling price p.u
- 5,000 units x ? 20 = ? 1,00,000
 B-9

Illustration-7 : Calculate Break Even Point from the following figures :

Sales ? 2,00,000
Fixed Expenses ? 50,000
Variable Expenses ? 1,00,000
Solution : Since no information about number of units produced and costs
per unit is given, only break Even Point in value can be ascertained.
Break even point (in value)
= (Fixed costs x Total Sales) / (Total Sales - Variable Costs)
= (50,000 x 2,00,000) / (2,00,000 -1,00,000) = ? 1,00,000
Illustration-8 : Calculate P/V Ratio and Break Even Point from the following
particulars.
Sales ? 5,00,000
Fixed Expenses ? 1,00,000
Profit ? 1,50,000
(B.Com, Madurai)
Solution :
P/V Ratio = Contribution/ Sales
Contribution = Fixed Costs + Profit
= ? 1,00,000 + ? 1,50,000 = ? 2,50,000
P.V Ratio = ? 2,50,000 / ? 5,00,000 = 0.5 = 0.5%
Break Even Point = Fixed Costs / P/V Ratio
= ? 1,00,000 / 0.5 = ? 2,00,000
Illustration-9 : Form the following data, calculate :
a) BEP Expressed in amount of sales in rupees
b) No. of units that must be sold to earn a profit of ? 60,000 per year
Sales Price ? 20 per unit
Variable Manufacturing cost ? 11 per unit
Variable Selling cost ? 3 per unit
Fixed Factory Overhead ? 5,40,000 per year
Fixed selling cost ? 2,52,000 per year
(B.Com, Madras, B.Com (Hons) Delhi, MCA Osmania,
M.Com, Pune, ICWA Final)
Solution
(a) :BEP (in rupees) = Fixed Costs / P/V Ratio
Fixed costs = Fixed factory overhead + Fixed Selling Cost
= ? 5,40,000 + 2,52,000 = ? 7,92,000
P/V Ratio = Contribution p.u / Selling Price p.u
= 1-Variable cost p.u / Selling price p.u
Variable costs p.u =
Variable Manufacturing cost p.u + Variable Selling cost p.u
= ? 11+?3 = ?14
there fore,
P/V Ratio = 1- 14 /20 = 1.07 = 0.3 = 30%
Thus, BEP (in Rupees) = 7,92,000 / 0.3 - ? 26,40,000
(b) No. of units to be sold to earn desired profit
 B-10

= Fixed cots + Desired Profits / Contribution p.u

= Contribution p.u = Selling Price p.u - Variable cost p.u
= ? 20 - ? 14 = 6.
Therefore,
Unit required to be sold = ? 7,92,000 + ? 60,000 / 6 = ? 1,42,000 units.
Cash Break Even point: It is the point where cash receipts on account of
sales are equal to cash expenses incurred. While calculating the cask break
even point, non-cash items are excluded.
Cash BEP (in units) =
= Fixed costs- (depreciation + other Non Cash Fixed Expenses)/
CashContribution per unit
Composite Break Even Point : If an organization deals in more than one
product, a composite Break Even point can be computed for the entire
organization. It refers to the total sales required to be achieved by the
organization by sales of its different products, so that it neither incurs any loss
nor earns any profit. In the process, some products may yield profit while
some products may result in loss.
Composite BEP (in value) = Total Fixed Cost x Total Sales I Total Contribution
= Total Fixed costs P/V ratio
Cost Break Even Point: In the event of an organization facing the problem of
choosing between two different options with varying costs. Cost Break Even
point helps in identifying the level of output at which both the options result
in equal cost. At any other point, a particular option may be more cost effective
than the other. The choice of the option can be made depending upon the level
of activity. Cost Break Even Point can be calculated with the help of algebraic
equations, which have to be framed depending upon the particular option.
Margin of Safety: ‘Margin of Safety’ sales is the sales over and above the
‘break even’ sales. Margin of safety ratio is the ratio of margin of safety sales
to total sales.
Margin of Safety Sales = Total Sales - Break even Sales - Profit / P/V Ratio
Margin of Safety Ratio = Margin of Safety Sales / Total Sales
‘Margin of Safety’ reflects the inherent strength of the business. A
business with a large margin of safety will be able to withstand a substantial
fall in sales without incurring any loss, but a business with low margin of
safety will be adversely affected even if there is a relatively small fall in sales.
Illustration-10 : Calculate Margin of safety from the fallowing data
Sales ? 1,00,000
Fixed costs ? 30,000
Variable Costs ? 50,000
£ (C.A. Final -adapted)
Solution
Margin of Safety = Total Sales - Break Even Sales
Break even Sales = Fixed Costs x Total Sales / Total Sales - Variable Cost
= (30,000 x 1,00,000) / (1,00,000 - 50,000) = ? 60,000
 B-ll

Ss -X - ratio. Bre.k

Even Sales and fixed costs. Profit ? 2.200 represents 10%

safety is ? 10,000.
Solution:
Profit = 10% of Sales = 10% x Sales -J2.000
Sales = ? 2,000 / 10% = 2,000 / 0.1 = ? 20,000 .
Margin of Safety Sales = Total Sales - Break Even Sa es = ? 10,000
Break Even Sales = Total Sales - Margin of: Safety Sales
= ? 20,000 - ? 10,000 = ? 10,000
Margin of Safety Sales = Profit I P/V Ratio
P/V ratio = Profit I Margin of Safety Sales
= 2,0001 10,000 =1/5 = 0.2 = 20%
Break Even Point = Fixed Cost/ P/V ratio
There fore fixed costs = Break Even Point xP/Vratio
= T 10,000 x 2% = ? 2,000
Illustration -12 : Sales of product amount to 200 units per month at ? 10 per
Fixed Overhead is ? 400 per month and variable cos. ? 6 per umf There
is a proposal io reduce price by 10%. Calculate present and ™ '
How many units must be sold to maintain total profit. (ICWAfi

Present P/V ratio = Present Contribution p.u / Present Selling price p.u
Present contribution p.u = present selling price p.u - Present variable cost p.u
= ? 10 -^6 = ^4
Therefore,
Present P/V ratio = 4/10 — 0.4 — 40%
Future P/V ratio = Future Contribution p.u / Future Selling Price pat
Future contribution p.u = Future Selling price p.u - Future vanble cost p.u
X Price = Present Selling price -10% of present Selfing price
- ? 10 - Re.l = ? 9 p.u
There fore,
Future contribution p.u = ? 9, ? 6 = t 3 p.u
Therefore,
Future P/V ratio = 3/9 = 1/9 = 0.33 .t
Present Profit earned = Present Contribution - Fixed Costs
Present contribution = ,
Present contribution p.u x No. of units presently produced
= ? 4 x 200 units = ? 800
Therefore, Present Profit = ?800 - ? 400 = ? 400
Present profit is to be maintained in the future
Future profit = Future contribution - Fixed Costs
Therefore, Future contribution = Future profit + Fixed Costs
= ? 400 + ? 400 = ? 800
 B-12

Future Contribution = Future contribution p.u x No. Of units required to be

produced
= Future contribution / Future contribution p.u
= ? 800 / ?3 = 267 units
Illustration -13 : The following figures relate to a company manufacturing a
varied range of products.
Total Sales Total Cost
(V (V
Year ending 31st Dec 1980 22,23,000 19,83,600
Year ending 31st Dec. 1981 24,51,000 21,43,200
Assuming stability in prices, with variable costs carefully controlled to reflect
predetermined relationships, and an unvarying figure for fixed costs calculate,
(a) The Profit / Volume ratio (b) Fixed cost (c) Fixed cost % to sales (d) Break
Even Point (e) Margin of Safety for the year 1980 and year 1981
(CA. Inter, CA. Final)
Solution
Profit in 1980 = ? 22,23,000 - ? 19,83,600 = ? 2,39,400
Profit in 1981 = ? 24,51,000 - ? 21,43,200 = ? 3,07,800
Profit is due to increase in contribution
P/V ratio = Change in contribution / Change in Sales
= (? 3,07,800 - ? 2,39,400) / (?24,51,000 - ? 22,23,000)
= 68,400 /2,28,000 = 0.3 = 30%
In the year 1980, sales = ? 22,23,000, p/v ratio = 0.3
Therefore,
Contribution in 1980 = ? 22,23,000 x 0.3 = ? 6,66,900
Fixed costs = Contribution - Profit
= 6,66,900 - 2.39,400 = ? 4,27,500
Fixed cost % to sales
1980 = 4, 27,500 / 22,23,000 x 100 = 19.23%
1981 = 4,27,500 / 24,51,000 x 100 = 17.44%
Break Even Point = Fixed cost /P/V ratio
= 4,27,500 /0.3 = ?14,25,000
Margin of safety = Total Sales - Break Even Sales
1980 = ? 22,23,000 - 14,25,000 = ? 7,98,000
1981 = ? 24,51,000 - 14, 25,000 = ?10,26,000
Break Even Chart: The Break Even Chart is a graphic representation of cost
and revenue data which brings out their inter relationship at different levels of
activity
Steps to construct the Break Even Chart
1. Let the X axis represent the volume or level of activity and the Y axis
represent the costs and revenues in rupees.
2. Draw the fixed cost line parallel to X axis, from the point in Y axis
which represents the amount of fixed cost.
 B-13

3. With the help of data given, construct the total cost line. The total cost is
the total of variable costs at any given level of activity and the fixed cost.
The total cost line will intersect the Y axis at the point representative of
fixed cost, as total cost is equal to fixed cost at ‘Zero’ level of activity.
4. With the help of data given, construct the ‘total revenue’ chart. The total
revenue cost will pass through the origin as the revenues at zero level of
activity is nil.
5. The Break Even Point is the point of intersection of the total cost line
and the total revenue line. Drop a perpendicular line from the Break
Even Point on both the axis. The point of intersection of X- axis and the
perpendicular represents Break Even point in units and the point of
intersection of Y-axis and the perpendicular drawn on it represents the
Break Even point in value.
6. The angle between the two lines of total cost and total revenue is called
‘angle of incidence’. The area between the two lines, at any given level
of activity, represents the loss or profit at that level of activity. The area
between the Y-axis and the Break Even Point of X- axis represents Break
Even Sales in Units and area between the BEP on X axis and a given
level of activity represents the ‘Margin of Safety’ Sales.
Note: There are alternative methods constructing the Break Even Chart, Charts
with specific representation such as Cash Break Even Chart, Composite Break
Even Chart, Contribution Break Even Chart etc, can also be constructed.
Illustration-14 : The following figures relate to one year’s working at 100%
capacity level in a manufacturing business.
Fixed overheads ? 30,000, Variable overheads ? 50,000 ; Direct Wages
? 40,000; Direct materials ?1,00,0000; Sales ? 2,50,000
Represent the above figures on a Break Even Chart and determine from
the chart, the break even point. Verity your result by calculation
(B.Com, Meerut, B.Com, (Hons) Delhi)
Solution
Step-1: Let the X axis denote level of activity and the Y axis denote the
expenses and revenue in Rupees.
Sales X axis = 1 cm = 10% level of Activity
Y axis - 1 cm - ? 25,000
Step-2 : Draw the line representing the Fixed costs parallel to x axis from the
point representing ? 30,000 on the Y axis.
Step-3 : Total cost at 100% level of activity is ? 2,20,000. Mark the point on
the graph and join it the point from where the fixed cost line has been drawn,
as total cost at ‘0’ level of activity will be equal to fixed cost. This line is the
total cost line.
Step-4 : Mark the point representing sales at 100% level of activity on the
graph. Join the point to the origin. This line is the total sales line.
Step-5: The point of intersection of the total cost line and the total sales line is
the break Even point. Drop perpendiculars on both the axes from the break
Even point. The point of intersection of the axes and the perpendiculars give
the break even point in terms of level of activity and in value.
 B-14

:is
st.
of
y-
tai
of

ine
:ak
the
of
the
Verification:
led
BEP = (Fixed costs x Total Sales) / (Total Sales - Variable Costs)
:vel
= (30,000 x 2,50,000) / (2,50,000 - 1,90,000)
irea
eak = ? 1.25,000 = 50% Level of Activity
ven Analysis of Break Even Chart: A break even chart gives us a clear picture
about the break even point, Angle of Incidence and Margin of safety for a
arts particular product or a business. These factors help in forming an opinion on
eak the state of affairs for the product or business. The following points must be
noted.
10% 1. The lower the Break Even point, the better it is : A low break even
point implies that the organization can survive even if it is operating at a
iges
lower level of activity. Since Fixed Expenses are relatively lower, the
rom loss on account of stoppage of production due to adverse circumstances
is also little.
<lhi) 2. The Larger the angle of incidence, the greater is the benefit: Angle
of incidence represents the difference between total sales and total cost.
the The larger the angle, the greater is the spread. The profits increase in a
great proportion with the increase in production. However, a fall in
number of units produced will also have an adverse impact in greater
proportion.
ithe
3. The larger the margin of safety the better it is : Margin of safety
it on reflects the cushion the organization has against a possible fall in sales.
awn, The greater the margin of safety, the more comfortable the organization
s the will be. It has a greater capacity to withstand recessionary phases.
A high margin of safety, large angle of incidence and low break even
n the point is the most favourable situation, whereas a low margin of safety, low
angle of incidence and high break even point is the most unfavorable situation.
ine is A high margin of safety with a small angle of incidence indicates that the firm
ireak is making reasonable profits over a large volume, while low margin of safety
give
with a large angle of incidence and high break even point makes a firm highly
ulnerable to even a small drop in volume of production.
 B-15

P/V Chart : The profit volume chart is the graphic representation of the
relationship between profit and volumes. The following are the steps in the
construction of P/V chart.
1. Let the X-axis represent the sales value in rupees and the Y axis represent
the profit in rupees.
2. Mark two points on the graph, which are representative of profits for a
given amount of sales.
3. Join the two points and extend the line until it cuts both the X-axis and
the Y-axis.
4. The point where the line meets the X axis is the break even point. The
point where the line meets the Y axis is the amount of fixed costs.
The area between the line drawn and the X-axis, above the X-axis, is
the margin of safety and represents profits. The area between the line
drawn and the X-axis, below the X-axis, is indicative of loss
Illustration -15 : X Ltd represents the following results for one year
Sales ? 2,00,000
Variable Costs <1 1,20,000
Fixed costs ? 50,000
Net profit 30,000
Draw up a profit Volume Graph
Solution
Steps:
1. Let X axis represent sales with scale 1 cm = ? 20,000 and Y axis represent
profit with a scale of 1cm = ? 10,000
2. Mark the point (0,50,000) on the graph as the point representative of
profit when sales are nil.
3. Mark the point (2,00,000,30,000) on the graph as the point representative
of profit when sales are ? 2,00,000
4. Join the two lines. The point where the line intersects the X axis is the
 B-16

Break Even point. Sales less than that represented as the Break Even
Point result in a loss. Whereas sales higher than the break even point
yield profit.
Cost - Volume Profit Analysis : Cost Volume profit (CVP) Analysis is often
misunderstood to be the same as Break even Analysis. However, Break Even
Analysis is only a part of CVP Analysis. CVP Analysis studies the relationship
between cost, number of units produced and sold, Selling price and profit,
individually and collectively taken. The scope of CVP Analysis covers the
study of behavior of cost in relation to volume, sensitivity of profits to variation
in output, Break Even Analysis, price formulation etc and provides valuable
insight into effects on profit on account of various management decisions. We
will be using the concepts of CVP Analysis is the next chapter on decision
making.
Advantages of Marginal costing
The following are the advantages of marginal costing:
1. It is very simple to operate and easy to understand. Since fixed costs are
kept outside the unit cost, the cost statements prepared on the basis of
marginal cost are much less complicated.
2. There is no need for allocation, appointment and absorption of fixed
overheads. The complexities of under-absorption or over-absorption of
overheads are eliminated.
3. It helps the management in profit planning by making a study of
relationship between cost, volume and profits. It facilitates calculation
of various important factors such as break-even point, expectation of
profits at different levels of production, sales necessary to earn a
predetermined target of profit, effect on profit due to change of raw
material prices, increased wages, change in sale mixture, etc.
4. Marginal costing values closing stock at variable costs only. Thus, the
value of stock arrived at is conservative.
5. It is a valuable aid to management for decision-making. It helps
management in fixation of selling price, selection of profitable product/
sales mix, make or buy decision, problem of key or limiting factor,
determination of optimum level of activity, continue or shut down
decisions, evaluation of performance and capital investment decisions,
etc.
6. It facilitates the study of relative profitability of different product line
departments, production facilities, sale divisions, etc.
7. It is complimentary to standard costing and budgetary control and can
bemused along with them to yield better results.
8. Marginal costing aids in cost control by dividing costs into fixed costs
and Variable costs. This helps in better understanding of controllability
of such costs. It helps in cost control by focussing on Controllable costs.
9. Marginal costing facilitates ‘management by exception’.
 10. The use of break-even charts and profit graphs in Marginal Costing makes
it easily understandable even to a layman.
Limitations or Disadvantages of Marginal Costing
The technique of marginal costing suffers from the following limitations:
■ It is based upon a number of assumptions that may not hold good under
all circumstances.
2. All costs cannot be classified into fixed costs and variable costs. The
increase in semi-variable costs and step costs may not be proportional
Analysis based on any arbitrary or faulty classification of costs can be
misleading.
3. Vanable costs do not always remain constant and do not always vary in
direct proportion to volume of output. Fixed costs do not remain constant
tor all levels of activity.
4. Selling prices do not remain constant forever and for all levels of output
due to competition, discounts on bulk orders, changes in the general
pnce level etc,
5. It may not be always preferable to ignore fixed costs. Management may
lose control on fixed costs as Marginal costing ignores such fixed costs
tor the purpose of analysis.
6. In the business scenario where the proportion of fixed costs in relation
to variable costs is very high Managerial decisions such as fixation of
se ling price cannot be done with out considering fixed costs.
7. Stocks valued on marginal costing are undervalued as fixed costs are
excluded in valuation. This may not be right as fixed costs are also
incurred on the manufacture of products. The financial position of the
organization is not properly reflected if fixed costs are ignored for the
purpose of stock valuation.
8. Although the technique of marginal costing overcomes the problems of
under or over-absorption of fixed overheads, the problem still exists in
regard to under or over- absorption of varible overheads.
9. Marginal costing completely ignores the ‘time factor’. Thus if two jobs
give equal contribution but one takes longer time to complete, the one
that takes longer time should be regarded as costlier.
10. The technique of marginal costing may not be applicable across all
industries. For example, it cannot be applied in contract or ship building
industries because in such cases, normally the value of work -in- progress
is very high and the exclusion of fixed overheads may result into losses
every year and huge profit in the year of completion of job.
Despite the above limitations. Marginal costing technique is a very useful
tool in the hands of management and is extensively used for cost control
decision-making and profit planning.
 B-18

PROBLEMS
1. Find the amount of variable cost from the following information
Sales ? 2,85,000
Fixed Cost ? 50,000
Profit ? 60,000
(Ans ? 1,75,000)
2. Determine the fixed component in the semi-varible cost of M/s Model
House Ltd. Semi-fixed costs on producing 5,000 units T 24,000 semi­
variable expenses and producing on additional 1,000 units ? 1,800.
(Ans 115,000)
3. A plant produces a product in the quantity of 10,000 units at a cost of
? 3 per unit. If 20,000 units are produced, the cost per unit is ? 2.50.
What is the variable cost per unit?
(B.Com, Punjab) (Ans. Fixed cost^ 10,000 Variable Costp.u ? 2)
4. Given that fixed cost is ? 7,000, profit ? 3,000 and Sales ? 50,000, find
p/v ratio. (B.Com, Punjab) (Ans. 20%)
5. The following figures are extracted from the books of Vijay Irons Ltd.
for the year 1989 and 1990, whose capacity is 10,000 irons per year.
Direct Materials ? 3.50 per unit
=
Direct Labour ? 0.50 per unit
Fixed Overhead ? 2.00 per unit
Selling Price per unit
1989 1990
Production in units 10,000 10,000
Sales in units 8,000 12,000
Prepare cost statements assuming that the company uses marginal costing.
(B.Com, Osmania) (Ans. Profit for 1989 ? 12,000, for 1990 ? 28,000)
6. In a period a concern produced 2,000 units of particular commodity.
The selling price is ? 50 per unit. The relevant costs were
Direct material ? 25,000
Direct labour t 15,000
Direct expenses ? 2,000
Production overhead :
Variable 5,000
Fixed 2,000
Administration :
Variable 1,000
Fixed 2,500
Selling & Distribution :
Variable 5,000
.Fixed 8,000
Assuming closing stock of 500 units, prepare operating statements under
absorption costing and Marginal costing techniques.
(Ans : Net profit as per absorption costing ? 22,625, Value of closing Stock
? 13,125. Net profit as per Marginal costing t 21,500. Value of closing Stock
? 12,000)
 B-19

7. Calculate Break Even Point from the following figures.

Sales ? 3,00,000
Fixed Expenses ? 75,000
Direct Material ? 1,00,000
Direct Labour ? 60,000
Direct Expenses ? 40,000
(B.Com, Kerala) (Ans. ? 2,25,000)
8. A compay’s turnover in a year was ? 50 lakhs, and its profit ? 5 lakhs.
It’s p/v ratio was 40%. What was the BEP?
(B.Com, Punjab) (Ans. ? 37.50 Lakhs)
9. Calculate Break Even point from the following particulars
Fixed Expenses 3,00,000
Variable Cost per unit ? 16
Selling price per unit ? 21
(Ans. BEP in units 60,000; BEP Sales ? 12,60,000)
10. From the following figure, calculate the sales required to earn a profit of
? 1,20,000.
Sales ?6,00,000
Variable Cost ?3,75,000
Fixed cost ?1,80,000
(B.Com, Calicut) (Ans. ? 8,00,000)
11. What would be the volume of sales to derive a profit of ? 20,000 if the
p/v ratio is 66 2/3% and fixed overhead for the period is ? 40,000
(B.Com, Punjab) (Ans. ? 90,000)
12. The following data is given:
Fixed Expenses ? 10,00.000
Varible Expenses ^10 per unit
Selling price ?15 per unit
Indicate the number of units to be manufactured and sold (i) to break
even (ii) to earn a profit of ?10,000 (iii) What additional units would be
necessary to increase the above profit by ? 5,000?
(M.Com, Calcutta) (Ans. (i) 2,00,000 units (ii) 2,02,000 units
(iii) 1,000 units)
13. From the following data calculate the break even point:
Selling price per unit ? 20
Direct Material cost per unit ?8
Direct Labour cost per unit ?2
Direct Expenses per unit 2
Variable Overhead per unit ?3
Fixed overhead (total) ? 20,000
If sales are 20% above break even point, determine net profit
(M.Com, Calcutta) (Ans. BEP 4,000 units. Net profit ? 4,000)
 B-20

14. (a) A company makes T 5,000 profit from ? 60,000 sales. Fixed cost are
? 15,000. What is the Break Even Point?
(b) A company’s sales are ? 1,00,000. Fixed costs are ? 20,000 and the
break even point is ? 80,000. What profit has it made ?
A company has a profit of ? 5,000 and fixed cost of ? 10,000 and
(c)
break even point of ? 20,000. What are it s sales?
(CAIIB) (Ans. (a) ? 48,000 (b) ? 5,000 (c) t 30,000)
15. From the following information, calculate the break even point and the
turnover required to earn a profit of ? 36,000.
Fixed overheads ^ 1,80,000
Variable cost per unit
Selling price 20
If the company is earning a profit of ? 36,000, express the margin of
safety available to it.
(C.A Inter) (Ans. BEP 10,000 units, turnover to earn desired profit
? 2,40,000. Margin of Safety ? 40,000)
16. You are given the following data for the year 1978 of ‘X’ company
Variable Costs 6,00,000 60%
Fixed costs 3,00,000 30%
Net profit 1,00,000 10%
1,00,000V 100%
Find out (a) Break Even point (b) P/v ratio and (c) Margin of safety ratio.
(B.Com, Karnataka) (Ans. ? 7,50,000 (b) 40% (c) 25%
17. Suppose the break even sale is ?10 lakhs. Fixed costs are ? 4 lakhs,
compute
(a) Contribution - Sales ratio
(b) Sales price per unit if variable cost are ? 12 per unit
(c) Margin of safety if 80,000 units are sold
(MBA, Osmania) (Ans.(a) 40% (b)f 20 (c) ? 6,00,0000)
18. The contribution sales ratio of A Ltd. is 50% and margin of safety is
40%. You are required to calculate the net profit if sales volume is ?10
lakhs. (MBA, Osmania) (Ans. Profit ? 2,00,000)
19. Find P/V ratio and margin of safety when Sales, Variable Costs and Fixed
Costs are ? Ten lakhs, Four lakhs and four lakhs respectively?
(MBA, Osmania) (Ans (i) 60% (ii) 3,33,333)
20. Given Margin of safety ? 20,000 (which represents 20% of sales) and
p/v ratio= 50%, find out the break even sales, fixed cost and profit?
(B.Com, Osmania) (Ans (i) f 80,000 (ii) ? 40,000 (iii) ? 10,000
21. From the following particulars, find (a) fixed costs (b) break even sales
(c) total sales and (d) profit. Margin of safety T10.000 (which represents
40% of sales) P/v ratio 50% .
(B.Com Osmania) (Ans. (a) ? 7,500 (b) ? 15,000 (c) t 25,000 (d) ? 5,000)
 B-21

2. Fran die following, calculate (i) P/V ratio (ii) Profit when sales are
? 2 •> fixed expenses ? 4,000 and Break Even sales ?10,000
(B.Com. Hons. Osmania) (Ans (i) 40% (ii) ? 4,000)
3. ~- z following information is related to Kakatiya Cements Ltd.

Sales (10,000 tones) 5,00,000

Cost: Material 1,00,000
Labour 50,000
Direct Expenses 10,000 1,60,000
Fixed cost 3,00,000
Profit 40,000
You are required to find out (a) Break even point, (b) PIN ratio (c) Margin
of safety. (D) Sales required to earn a profit of ? 50,000 (e) Profit at a sales
level of ? 9,00,000
(B.Com, Kakatiya) (Ans: (a) ? 4,41,176 (b) 68% (c) ? 58,824
(d) ? 5,14,706 (e) 3,12,000)
24. In a recent period, Zack company had the following experience

Sales (10,000 units @ ? 200 20.00.000

Costs Fixed ? Variable ?
Direct Material 2,00,000
Direct Labour 4,00,000
Factory overhead 1,60,000 6,00,0000
Administrative expenses 1,80,000 80,000
Other Expenses 2,00,000 1,20,000
Total costs 5,40,000 1,40,000 19,40,000
Net earnings 60,000
Required
(a) Calculate break even point for zack in units and in rupees. Show your
calculations and use the contribution margin ratio to find the rupee break
even.
(b) What sales rupees would be required to generate a net income of ? 96,000
(c) What will be the break-even point in units if fixed costs are increased by
?18,000
(M. Com, Delhi) (Ans: (a) 9,000 units ? 18 lakhs (b) ? 21,20,000
(c) 9,300 units)
25. An analysis of Sultan Manufacturing Co Ltd led to the following
information.
Variable Cost (% of sales) Fixed cost (?)
Direct materials 32.8
Direct labour 28.4
Factory overheads 12.6 1,89,900
Distribution overheads 4.1 58,400
General Administration overheads 1.1 66,700
 B-22

Budgeted sales are ? 18,50,000. You are required to determine

(i) Break even sales value (ii) Profit at the budgeted sales value (iii) Profit
if actual sales (a) drop by 10% (b) increase by 5% from budgeted sales.
(B.Com, Delhi) (Ans: (i)^ 15 lakhs (ii) 73,500 (iii) (a) ? 34,650
(b)
l 92,925)
26. From the following data, ascertain break even point
Selling Price per unit ? 10
Trade Discount 5%
Direct Material Cost per unit ? 3
Direct Labour Cost per unit 2
Fixed overheads ? 10,000
Variable overheads 100% on direct labour cost
If sales are 10% and 15% above break even volume, determine the net
profits.
(M. Com, Bombay) (Ans: Break even point 4,000 units, Profit
(i) ? 1,000 (ii) ? 1,500)
27. The following data are available from the records of a company.
Sales ? 1,00,000
Variable cost 60,000
Fixed Cost 20,000
You are required to calculate P/V ratio, Break even point and Margin of
safety. Also study the impact of change in the following variables on P/V
ratio. BEP and Margin of safety.
(a) Increase in selling price by 10%
(b) Decrease in Fixed cost by ? 5,000
(MCA, Osmania) (Ans: P/V ratio 40% BEP T 50,000 Margin of safety f 50,000.
Increase in selling price and reduction in fixed cost will lower the BEP, raise the
p/v ratio and increase the margin of safety)
28. A company’s turnover in 1989 was ? 3.20 crores. It’s contribution margin
ratio is 0.4 and fixed costs were ? 80 lakhs. What will be the company’s
profit in 1990 if sales were ? 3.80 crores, assuming that fixed costs will
rise by 10% (MBA Osmania) (Ans: ? 64 lakhs)
29. From the following data, calculate (i) P/V ratio (ii) Profit when sales are
? 20,000 and (iii) New Break Even Profit if selling price reduced by
10% .
Fixed Expense ? 4,000
Break Even Point ? 10,000
(B.Com, Hons, Delhi) (Ans: (i) 40% (ii) ? 4,000 (iii) ? 12,000)
30. ^Company X and Company Y sell the same line of product at a unit price
of ? 40. The variable costs per unit for each company are ? 24 and the
fixed costs are ? 4,00,000. Company X reduces its price by 10% and
company Y increases its variable costs by 10%.
(a) Compute the break even point before the change in price and costs
 B-23

(b) Compute the break even point after the change in price and costs
(c) Which company must sell a greater volume to break even?
(MBA, Delhi) (Ans: (a) 25,000 units or ? 10 lakhs, (b) Co x 33,334 units or ? 12
lakhs Co. Y29,412 units or ? 11, 76,470 (c) Co. X)
31. Two competing companies P Ltd and Q Ltd produce and sell the same
product in same market. For the year ended March 1991, their forecasted
profit and loss accounts are as follows
PLtd QLtd
? ? ? ?
Sales 3,00,000 3,00,000
Less : Variable cost of Sales 2,00,000 2,25,000
Fixed cost 50,000 2,50,000 25,000 2,50,000
50,000 50,000
Profit
You are required to calculate (a) P/V ratio, BEP and Margin of safety of
each business (b) sales value at which each business will earn a profit of Rs.
30,000. Explain which company is likely to earn greater profits in the conditions
of (i) heavy demand for the product (ii) low demand for the products.
(B.Com, Nagarjuna, adapted) (B.Com, Punjab) (Ans : (a) P. Ltd33 1/3%
11,50,000, ? 1,50,000 Q. Ltd, ? 25%. ? 1,00,000, ? 2,00,000
(b) P.Ltd ? 2,40,000 Q. Ltd ? 2,20,000 (c) (i) P.Ltd (ii) Q. Ltd)
32. The sales turn over and profit of a company during two years was as
follows:
Sales (?) Profit (?)
1991 1,50,000 20,000
1992 1,70,000 25,000
You are required to calculate (a) P/V ratio (b) break even point (c) Sales
required to earn a profit of ? 40,000 (d) the profit made when sales are
? 2,50,000 (e) Margin of safety at a profit of ? 50,000 (f) Variable costs of the
two periods.
(MCA, Osmania) (Ans: (a) 255 (b) 70,000 (c) ? 2,30,000 (d) ? 45,000
(e) 2,00,000 (J) 1991 ? 1,12,500,1992 ? 1,27,500)
33. The sales and profits during two periods are as under:
Period I sales ? 20 lakhs profits ? 2 lakhs
Period II sales ? 30 lakhs profit ? 4 lakhs
Calculate (i) P/v ratio (ii) Break even point (iii) Sales required to earn a
profit of ? 5 lakhs (iv) Profit when sales are ? 50 lakhs (v) Margin of safety at
a profit of ? 2,50 lakhs.
(ICWA Inter, B.Com, Osmania) (Ans: (i) 20% (ii) ?10 lakhs
(iii) ? 35 lakhs (iv) ? 8 lakhs (v) ? 12.5 lakhs)
34. The following figures related to a company manufacturing a varied range
of Products.
 B-24

Total Sales Total Cost

Year ended 31s'Dec. 1980 ? 2,22,300 1,98,360
Year ended 31st Dec. 1981 ? 2,45,100 2,14,320
Assuming stability in price, with variable costs carefully controlled to
reflect predetermined relationships, and an unvarying figure for fixed costs.
Calculate.
(a) The profit / Volume ratio (b) fixed cost (c) Fixed cost % to sales (d)
Break even point (e) Margin of safety for the year 1980 and year 1981.
(Ans: (a) 30% (b) f 42,750 (c) 1980 19.23% 1981 17.44%
(d) ? 1,42,500 (e) 1980 ? 79,800, 1981 f 1,02,600)
35. Ram Agencies sold during 1990-91 and 1991-1992 7,000 units and 9,000
units at ? 100 each. In 1990-91 they incurred a loss of? 10,000 whereas
in 1991-1992, they earned a profit of ? 10,000. Calcutate (i) P/V ratio
(ii) Fixed Expense (iii) Number of units to be sold where there is neither
profit nor loss (iv) Number of units to be sold to earn a profit of? 40,000
(B.Com. Osmania) (Ans: (i) 10% (ii) ? 80,000 (iii) ? 8,000 units
(iv) 12,000units)
36. Hyderabad Industries Ltd’s sale amounted to ? 45,000 and total cost
? 40,000 during the half year ended 30th September, 1991. During the
half year ended 31st March, 1992 sales were ? 50,000 and total cost
? 43,000. Calculate for the year ended 31st March 1992, (a) P/V ratio
(b) Break Even Sales in value (c) Fixed Expenses (d) Margin of Safety.
(ICWA, Inter, B.Com (Hons) Delhi. B.Com, Osmania) (Ans: (a) 40%
(b) ? 65,000 (c) ? 26,000 (d) ? 30,000
37. A Company making and selling a product has made the following
estimates. Selling price ? 20 per unit, fixed cost ? 15 lakhs a year, Variable
cost ? 16 per unit. Sales volume 5 lakhs units.
Suppose a selling price decrease of 10% results in a 15% increase in
sales volume, what will be its profit?
(B.Com, Punjab) (Ans: Loss off 3.50 lakhs)
38. From the following figures, find the break even volume:
Selling price per ton ? 69.50
Variable cost per ton ? 33.50
Fixed Expenses ? 18.02 lakhs
If this volume represents 40% capacity, what is the additional profit for
an added production of 40% capacity, the selling price of which is 10% lower
for 20% Capacity production and 15% lower, than the existing price, for another
20% capacity.
(ICWA, Inter) (Ans: BEP 53,000 tons or ? 36,83,500,
Additional Profit ? 13,41,562)
39. From the following particulars pertaining to ABC Ltd, which
manufactures three products, find break even point.
 B-25

Product Sales (?) Variable

Expenses (?)
X 10,000 6,000
Y 5,000 2,500
Z 5,000 2,000
20,000 10,500
Total Fixed Costs 15,700.
(B.Com, SKU) (Ans: BEP ( 12,000)
40. From the following particulars, find the minimum number of units
required to be sold so that no cash loss is incurred.
Selling Price ? 20
Variable cost per unit ? 10
Administration Expenses t 10,000
Depreciation ? 6,000
(ICWA, Inter -a adapted) (Ans: 1,000 units)
41. Find the cost break even points between each pair of plants whose cost
functions are:
Plant A ? 6,00,000 + 12 x
Plant B 9,00,000 + ? 10 x
Plant C ? 15,00,000 + ? 8 x
where x is the number of units produced.
(CA, Final) (Ans: A & B 1,50,000 units; B & C 3,00,000 units;
A & C 2,25,000 units)
42. The following figures relate to one year’s working at 100% capacity
level of a manufacturing company.
Fixed overheads ? 1,20,000, Variable overheads ? 1,00,000, Direct wages
T 1,50,000, Direct Materials ? 4,10,000, Sales ?10,00.000. Represent
the above figures on a break even chart and determine the break even
point- (B.Com, Meerut) (Ans: 3,52,941)
43. From the following information, draw break even chart and a P/V graph.
Fixed expenses ? 6,00,000. Variable expenses per unit ? 10. Selling price
per unit T 15. Output 4,00,000 units.
(ICWA- adapted) (Ans: BEP 1,20,000 units)
44. Draw a Break even chart from the following figures
Sales Profits
(t’000) (T -000)
Year 1 160 4
Year 2 175 10
 Chapter -3
DECISION MAKING

The concepts of Marginal Costing learnt in the Previous chapter are widely
used by Management in decision making. In this chapter, we will see some
specific application of those concepts with respect to some key decisions.
Decision making is about choosing among alternative courses of action,
based on quantitative as well as qualitative factors. In this chapter, we will
focus on quantitative factors.
Students must note that decision making is NOT based simply on the
concept of variable and fixed costs. Decision making involves evaluation of
alternatives. The concept of fixed and variable costs plays a very important
role in the evaluation of alternatives. However, we need to understand a few
more concepts of cost, before we start our discussion on various types of
decisions.
1. Differential cost: When two alternatives are being evaluated, the
difference in costs incurred is respect of the two alternatives is called
differential cost. For example, if the decision to be made is to buy a
small car vs. a big car, the mileage of the car and hence, the monthly
final bill, is a differential cost. Irrespective of the car purchased we
need a garage to park it and the rent of the garage does not change
irrespective of the car bought. Garage rent is not a differential cost often,
differential costs are considered as identical to variable costs. This is
not true. While variable costs differ with number of units, some of the
fixed costs may also vary. In our earlier example, if the big car is so big
that it requires a bigger garage, for which higher rent is to be paid, then
garage rent, even if it is a fixed cost, is considered as differential.
2. Sunk Costs: In simple terms, sunk costs, are costs have already been
incurred and no amount can be recovered on that front, irrespective of
the decision made. For example, if a factory premises has been taken
on rent by paying 6 months of rent in advance, which is non-refundable,
then what is being done in the factory will not be based on this cost. A
Sunk cost is thus a cost that has already been incurred and it is irrelevant
to the decision being taken.
3. Shut-Down Costs: Shut down costs are costs that will continue to be
incurred even if there is a temporary closure or shut-down of the
production facilities.
 C-2

4. Avoidable Costs: Fixed costs that can be saved by suspending activities

are called ‘Avoidable’ costs, or Escapable Costs’. These expenses should
be evaluated against the costs that need to be incurred to restart the
operations.
5. Notional Costs : Notional cost is ‘hypothetical’ cost. It is not an actual
expense incurred. Interest on capital, rent of owned premises are
examples of Notional Cost.
6. Opportunity cost: Opportunity cost is the value of a benefit sacrificed
in favour of an alternative course of action. The concept of notional
cost is closely linked to the concept of opportunity cost. For example,
if a business owns the factory premises, the opportunity cost of doing
the business from factory premises is the rent it would have earned if
the premises had been let out to some other business.
Having understood the above concepts, let us discuss some specific
decisions.
‘Make or Buy Decision’: Let us imagine a company X Ltd which produces
a number of components, assembles them into a product and sells the product
in the market. Suppose there is another company Y Ltd, which is engaged in
the production of a particular component C, which is used by X Ltd. If the
sales manager of Y Ltd offers to sell the component C to X Ltd at a price
which is lower than the total cost a production per unit of C of X Ltd, the
manager of X Ltd is faced with a ‘Make or Buy' Make or Buy' Decision. He
has the option of choosing from two alternatives (i) To continue producing
the component in his factory or (ii) To purchase the product from Y Ltd and
use the spare capacity generated to alternative uses.
In such circumstances, the manager of X Ltd has to carefully evaluate
the effect of purchasing the component from Y Ltd. Purchase of component
from Y Ltd may not result in reduction of any fixed expense, and as such, the
offer price should be compared with variable cost only. Alternative uses of
spare capacity should also be considered. Apart from the above factors, various
non monetary factors such as quality of materials supplied, regularity of
delivery, track record of the supplier etc, will have to be looked into. In so far
as monetary factors are concerned, the technique of marginal costing would
be found largely beneficial. Let us understand the same with the help of an
illustration.
Illustration -1: Part No. X 293 used in an assembly of a product manufactured
by your company has, during the past three years, been a bought out item.
The current price of this part is ?120. Transportation and other delivery costs
account for ? 15 per piece. Sales tax @ 10% is added to the invoice price.
Your company had been manufacturing this part earlier but decided
subsequently to discontinue its own manufacture. There is sufficient unutilized
capacity which can be used, if it is decided to manufacture this part again in
its own plant. Annual requirement of this part is 6,000 units.
 C-3

Prepare a study to enable the management to come to a decision on a

proposal to manufacture the part within its own plant. The following details
are available.
Part No. X 293
Estimated cost (per unit')
Raw Material 96
Direct Wages 8
Overheads 80% of Direct wages 64
168
Mark up for return on investment 12
In addition, special tools, jigs and fixtures required to manufacture this
part are needed to be acquired at a cost of Tl ,50,000. These are to be amortized
over 5 years. The overhead rate is the budgeted recovery rate for products
manufactured by the company. The variable portion of this amounts to 100%
of direct wages. Make you recommendations. (C.A. Final)
Solution
Statement showing comparison of the two alternatives (Amount in ?)
Particulars ‘Buy’ ‘Make’
Purchase price 120.00
Add Sales Tax @ 10% 12.00
132.00
Add Transportation and other charges 15.00
147.00
Direct Material 96.00
Direct Wages 8.00
Variable Overhead - 100% of direct wages 8.00
Special Tools
(? 1,50,000 / 5 years divided by 6,000 units 5.00
147.00 117.00
Add Mark up for Return on Investment
@ 7.14% of total cost 10.50 8.35
(12*100/168)
Total cost 157.50 125.35
It is recommended that the component be manufactured using the spare
capacity.
Add / Drop Products : The concept remains the same. We use differential
costing as the basis to decide the right product mix. If an existing product is
dropped, it will lead to reduction in sales as well as reduction in variable
cost./there can be some savings in fixed costs. However, it will free up capacity
that can be used to increase the production of other products. Thus, we need
to decide if the benefits of producing other products exceed the fall in
contribution from the product being dropped.
 C-4

Key Factor or Limiting Factor: In a simple scenario where a business has

unlimited resources, whether to drop or continue with an existing product
will bril down to whether the product is generating positive contribution in
excess of fixed costs incurred solely when the product is being made.
Normally, all products will earn some contribution which is likely to be more
than the fixed costs incurred specifically for the product. In such a case,
continuing with the product will be an obvious decision.
However, busineses usually face challenges in terms of limited
availability of resources. Such challenge could be limited availability of
material, labour, production capacity, capital or any other resource. In such a
case, it is beneficial to the business to maximise the contribution earned per
unit of scarce resource. Let us understand this with the help of an example.
Let us say there are 3 products A, B and C which use the same raw-material
X which is in short supply. The following details are available.
ABC
Selling Price p.u 20 25 45
Less Variable cost p.u
Material X @ Rs.5 p.u 10 15 30
Other Variable cost p.u 40 5 5
14 20 35
Contribution p.u 6 5 10
Only 10,000 units of X are available.
In the above example, contribution per unit is maximum in case of C.
However, it consumes 6 units of X. Thus even if all 12,000 units of X are
used to produce C, only 2000 units of C can be produced. Thus, contribution
earned will be 2000 units x tlO pu = ? 20,000
Let us now look at product A. It used only 2 units of X. Thus, if all
10,000 units of X are used to produce A, 5,000 units of A can be produced.
Since contribution p.u of A is ? 6, total contribution earned = 5,000 units x
? 6 - T 30,000. Thus, it makes sense to discontinue ‘C’ and produce A.
To arrive at this decision, we can use the figure of contribution per unit
of scarce resource. Let us calculate it below.
A B C
Contribution p.u 4.00 5.00 10.00
Material X @ ? 5 p.u 10.00 15.00 30.00
No.of units of X 2.00 3.00 6.00
Contribution p.u.of X 2 1.67 1.67
Since contribution p.u of X is hightest in case of A. A should be
continued.
The concept of limiting factor is widely used in deciding the optimum
product mix.
Illustration-2 : Pravek Ltd manufactures 3 products X, Y and Z. Following
are the budgets prepared for the 3 products for the year 2019.
 C-5

Particulars X(?) Y(?) Z(?) Total (?)

Sales 90,000 4,50,000 60,000 6,00,000
Production cost
Variable 48,000 2,88,000 24,000 3,60,000
Fixed 6,000 96,000 18,000 1,20,000
54,000 3,84,000 42,000 4,80,000
Selling Administration
Variables 16,200 16,200 15,600 48,000
Fixed 4,200 3,600 4,200 12,000
Total Cost 74,400 4,03,800 61,800 5,40,000
Profit 15,600 46,200 (1800) 60,000
The Board is of the view that product Z should be dropped, as it is
making losses. State your views with reasons.
Solution : Statement of Budgeted Profit
X(?) Y(?) Z(?) Total (?)
Sales (A) 90,000 4,50,000 60,000 6,00,000
Less : Variable Costs (B)
Production 48,000 2,88,000 24,000 3,60,000
Sales 16,200 16,200 15,600 48,000
64,200 3,04,200 39,600 4,08,000
Contribution (A-B)= C 25,800 1,45,800 20,400 1,92,000
Less Fixed costs
Productions 1,20,000
Sales 12,000
1,32,000
Profit 60,000
Product Z is making a contribution of ? 20,400. Unless dropping Z results in
reduction of fixed costs of at least ? 20,400, Product Z should not be dropped.
Illustration-3 : Preksha Ltd produces 3 products - X, Y and Z, the details of
which are given below :
X(?) Y(?) Z(?)
Selling Price p.u 630.00 780.00 1100.00
Costs p.u
Direct Material 330.00 240.00 330.00
Direct Labour 120.00 240.00 300.00
Overheads 120.00 210.00 300.00
570.00 690.00 930.00
Profit p.u 60.00 90.00 1070.00
'The factory has only 100 workers who work for 8 hours a day after
accounting for idle time. ? 480 per day is paid to each one of them. The
management wants to maximise profit by dis continuing product X and
focussing on only Y and Z. The Maximum number of units that can be sold
of each Product are as under :
 C-6

X-200 units, Y-300 units, Z-100 units. Assume that 50% of overheads
are variable. There will be no change in fixed overheads irrespective of the
product mix.
What is your advise of the management?
Solution : Statement of Contribution and Profit
X(?) Y(?) Z(?)
Selling Price p.u (A) 630 780 1100
Variable Cost p.u (B)
Direct Material 330 240 330
Direct Labour 120 240 300
Variables overhead 60 105 150
510 585 780
Contribution p.u C=A-B 120 195 320
No. of units of labour per
unit (working note 1) 2 4 5
Contribution per hour of
Direct Labour 60 48.75 156
Ranks II III I
Since labour is in short supply we will produce the product that gives
us maximum contribution per unit of labour, which is product Z. However, Z
can be produced only to the extent of 100 units. We will then produce product
X. If required, we will drop Product Y.
Total labour hours available (W.N.2) 800
Labour hours required for X, 100 units x 5 500
Remaining Labour hours 300
No. of units of X that can be produced = 300 hrs / 2 = 150 units.
Since X has maximum demand of 200 units, Product Y should be
dropped. Optimal Product mix is :
X : 150 units, Z : 100 units.
Working Note-1
A Worker who works for 8 hours / day is paid ? 480. Thus, wage rate /
hour = ? 4801 8 hours = ? 60/hr
Direct Labour Cost of Product X = 120
Since wage rate is ? 60/hr, no. of hours taken to
Produce 1 unit of X= ? 120/ ? 60 = 2 hours I unit
Similarly, for Y = ? 240/ ? 60 = 4 hours I Unit
For Z - ? 300 / ? 60 = 5 hours / unit
Working Note-2
There are 100 workers in the factory. Each person works for 8 hours.
Thus, maximum labour hours available for production=100 workers x 8
hours=800 hours.
Sell I Further Process : The decision to sell a product at a given stage or
process it further depends on the concept of ‘Incremental cost’. Incremental
 C-7

costs are the additional costs that need to be incurred to process the product
further. If further processing results in extra benefits (greater revenues), which
are more than the additional processing costs, than we can process the product
further. For example, in petroleum refining industry, the initial process
produces Crude Oil and Natural Gas. Crude Oil can be further refined into
Petrol. The decision to be made is to whether to sell the Crude oil as is, or
should it be refined into petrol and sold.
Illustration-4: Manik Ltd. produces a product that can be further broken
down into 3 parts namely A, B and C. Every month, it produces 50,000 units
of A : 20,000 units of B and 30,000 units of C at a cost of ? 15,00,000. These
costs are apportioned to the three products in the ratio of number of units
produced i.e. 5:2:3
Each of the three parts can be further processed, the details of which
are as under:
A B C
Selling price p.u. at Split 15.00 8.00 10.00
Further processing cost p.u 5.00 3.00 4.00
Selling price p.u. after
further processing 23.00 15.00 13.00
Should Manik Ltd process the 3 Products further?
Solution : Statement of Contribution and Profit
A(?) B(?) C(^)
Selling Price after processing 23.00 15.00 13.00
Selling Price before proceeding 15.00 8.00 10.00
Incremental revenue on - - -
Processing further 8.00 7.00 3.00
Processing cost p.u 5.00 3.00 4.00
Additional Contribution p.u - - -
on further processing 3.00 4.00 (1.00)
No.of units 50,000 80,000 (30,000)
Thus Manik Ltd., should process A and B further, but sell ‘C’ at split-
off point
Note : Joint Costs or Pre-Split costs are not relevant and hence, ignored.
Operate / Shut Down : sometimes, when the economy or the industry is in
recession, demand for products of a company may fall significantly.
Sometimes, the demand is so low that the company has to operate below
normal capacity. This results in losses as the company is not able to recover
its costs in full. In such circumstances the company may consider a
s. tempofating shut down of operations. The decision to shut down must be
8 taken carefully as there are many expenses that will continue to be incurred
even if the operations are temporarily shut down.
or Shut Down Point = (Avoidable Costs - Restart cost)/ Contribution p.u
tai
 C-8
T stories - one each at Bangalore,
LChennai
Uustrat^and Hyderabad. All the
same pr°duct’WhiCh
The following details are available.
is sold at ? 750 p.u.------- Chennai Hyderabad
Bangalore
24,00,000 12,00,000
6,00,000
Sales 7,00,000 2,90,000
1,50,000
Direct Material 5,60,000 2,80,000
1,50,000 1,10,000
Direct Labour 2,20,000
Variable Factory overhead 40,000 1,20,000
80,000 2,40,000
Fixed Factory overhead 1,80,000 80,000
40,000
Administration overhead 1,40,000 80,000
46,000
Variable Sales overhead 1,00,000 60,000
30,000
Fixed Sales overhead 1,00,000 60,000
H.O Expenses (allocated) 24,000
A’.re for renewal but the new contract
The lease of Bangalore factory ts due torre
galore factory^ youI
of -rental
will result in increase c. — by. t 24 f
advise on whether
advise on whether ioto renew the lease or increased
can be incre ased in either
the Bangalore factory is s if production is increased in Chennai, t e
Chennai or Hyderabad. Howe , . 50 u t0 meet the additional
variable cost of additional uni s; wi1 mere y inclusive of allocation of
freight costs. Fixed costs will increase by
Head office costs. Hvderabad factory, variable costs for
If production is increased ? Fixed costs, including H.O
additional output will increase by j?™ P »-
allocated costs, will increase by x 65,UW.
of Profit (before decision on renewa )
Solution : Statement Total
Bangalore Chennai Hyderabad
12,00,000 42,00,000
6,00,000 24,00,000 5,600
Sales 3,200 1,600
800 27,66,000
No.of units 16,20,000 7,60,000
3,86,000
Variable Costs 7,80,000 4,40,000 14,34,000
Contribution 2,14,000 9,30,000
5,20,000 2,60,000
Less: Fixed costs 1,50,000 5,04,000
2,60,000 1,80,000
64,000 1,84,000
Less: H.O Exp 3,20,000
Profit will increase
If Bangalore, lease is reviewed allocated
will reduce profit from Ba g , 3.20.000 -
bypenses)
? 24,000. t 40,000.
toThis .. Overall profit will reduce to 2,96,000 (
exi
ion is
^ ^B^angaloreFactory is shutdown and production — increased
— in Chennai.

Additional Variable Costs 000/800 = 486.50

Variable cost p.u j" X^iwOoZ 3,200 = 506.25
Increase is°variablecostsSOOunits X <506.25-482.501= 19,000
 C-9

Additional Variable Costs = 800 units x ? 50 40,000

59,000
Additional fixed Costs 50,000
- Allocated cost of H.O. 24,000 26,000
Total Increase in costs 85,000
Savings in fixed costs 1,50,000
Increase in profit (Incremental Profit) 65,000
If Bangalore Factory is shut down and production is increased in
Hyderabad.
Additional variable costs
Variable cost p.u in Hyderabad 475.00
Variable cost p.u in Bangalore 482.50
Saving in Variable costs = 800 units x 7.50 = 6,000
Additional Variable costs = 800 units x ? 70 p.u 56,000
Net Increase in variable costs 50,000
Additional fixed costs 65,000
(-) Allocated H.O. Costs 24,000 41,000
91,000
Saving in fixed costs at Bangalore 1,50,000
Incremental Profit 59,000
Summary Incremental Profit
Continue with Bangalore Factory (24,000)
Shut down Bangalore factory and
increase production in Chennai 65,000
Increase Production in Hyderabad 59,000
Thus, Decision should be to shut-down Bangalore factory and increase
production in Chennai factory.
Special Order Pricing : Fixing the selling price of a product, particularly
when a special order is received, is a very critical function of Management
Accountant. This is because a special order requires a special price. If the
price is not acceptable to the customer giving the special order, then the entire
order is cost. Hence, managements are willing to quote a lower price for such
orders.
However, there are 2 things that must be kept is mind before quoting a
‘Special’ price for a special order :
1. The price must still result in some ‘incremental’ profit for the business
2. The ‘Special’ price should not impact the regular price at which the
product is being sold in the market.
Illustraf ion-6 : Ramakanth Ltd manufactures a product, whose cost structure
is as follows.
Material ? 34
Labour ? 13
Services (? 2 Fixed) 6
 C-10

Factory Overhead (fixed) 7

Office Overhead (fixed) 2
62
Add Profit 6
Selling Price 68
Vijay Ltd., a subsidiary of a Hong Kong based company, has approached
Ramakanth Ltd to buy 10,000 units of the product at ? 55 per unit for sale in
Hong Kong. The management of Ramakanth Ltd., wants to reject the offer as
it is below cost price. There is spare capacity to manufacture the 10,000 units.
What is your advise?
Solution : Statement of Contribution and Profit

Selling Price offered p.u 55

Less : Variable costs p.u
Material 34
Labour 13
Services ? (6-2) 4
51
Contribution p.u 4
No. of units 10,000
Additional Contribution earned 40,000
Additional Fixed costs to be increased) -
Additional Profit 40,000
Ramakanth Ltd., should accept the offer
Replace / Retain : Decisions on Replace / Retain usually pertain to assets,
which are old but still have a useful life. There are a lot of factors that go into
this decision. Some of the factors that are considered for taking this decision
are:(l) Remaining life of existing equipment (2) Cost of Repairs &
Maintenance (3) Equipment downtime (4) Health, Safety and Environment
concerns (5) Cost of new equipment (6) Cost of disposing old equipment and
installing new equipment. (7) Cost of capital (8) Cost of training the employees
on new equipment (9) Regulatory Requirements.
However, from a management Accountants point of view, we need to
compare the costs and benefits associated with replacing the old asset with
new asset. Kindly note that the cost of acquisition, depreciation and book
value of the old asset is not relevant for this decision.
Illustration-7: Preksha Ltd manufactures plastic containers using a machine,
which they have been using for the last 2 years. Although the machine has a
remaining useful life of another 3 years, it is frequently breaking down and
requires a lot of repairs. The management is considering purchase of a new
machine and seeks your opinion. Your study reveals the following information.
 C-ll

Old Machine New machine

Remaining life 3 years 3 years
Operative costs 50,000 10,000
Purchase Price 2,00,00 1,20,000
Current Disposal Value 60,000 Not applicable
Terminal Disposal Value 10,000 0
(after 3 years)
Should Preksha Ltd retains the old machine or replace it with new machine
Ignore time value of money.
Solution : Statement of Cost (3 years)
Retains Old Machine Replace with new machine
T
Cash Operating Costs 1,50,000 30,000
Current Disposal Value - (60,000)
Terminal Disposal Value (10,000) -
Cost of New Machine 1,40,000 90,000
Replacing the old machine with new Machine will result in additional cost of
? 50,000 if we do not consider time value of money.
PROBLEMS
Make or Buy
1. Following information relates to Coromandel Co. Ltd. which produces
washing machines.
Cost (per unit) Material ? 50, Labour ? 25, Direct Expenses 115, Fixed
Expenses ?10, Profit t 20, Selling price ? 120.
The production capacity of the factory is 10,000 units. At present, a
supplier has offered to sell the same item for ? 95. Should the company
produce the item or buy it from the supplier? Give reasons
(B.Com, Kakatiya) (Ans: The company should the make the product)
2. An automobile manufacturing company finds that while the cost of
making in its own workshop part No. 0028 is ? 6.00 each, the same is
available in the market at 15.60 with an assurance of continuous supply.
Write a report to the Managing Director giving your views whether to
make or buy this part. Give also your views in case the suppliers reduce
the price from ? 5.60 to ? 4.60. The cost data is as follows:
Materials ? 2.00, Direct Labour ? 2.50 other variable overheads ? 0.50.
Depreciation and other fixed costs ?1.00
(ICWA, Final) (Ans: Make ifprice is ? 5.60, Buy ifprice is ? 4.60)
3. i Auto part Ltd has an annual production of 90,000 units for a motor
component. The component's cost structure per unit is given below:
Materials ?270, Labour (25% fixed) ? 180, Variable Expenses ? 90 Fixed
Expenses ? 135, total ? 675.
The purchases manager has an offer from a supplier who is willing to
 C-12

supply the component at ? 540. Should the component be purchased?

Assuming that the resources now used for the purpose of this
component’s manufacture can be used to produce a new product for which
the selling price is ? 485, is it advisable to divert the resources for producing
the new product, if it used material of ? 200 per unit and has the same cost
for labour and expenses.
(ALMA, ACS, Intermediate) (Ans: (a) The company should continue to make the
product (b) If new product can be produced, it must purchase the component
from the market)
4. The Managing director of your company seeks your advise in arriving
at a decision whether to continue manufacturing a component or to buy
it from outside. The component is used in several of company’s products.
The following information is available.
(i) The annual requirement is 40,000 units.
(ii) The lowest price quotation from a supplier was T 27.50 per unit.
(iii) The costs incurred last year when 40,000 components were
produced is as under. Material ? 12,00,000, Labour (Direct)
? 15,00,000. Indirect Labour ? 4,00,000 Light and Heat ? 80,000
Power ?1,20,000. Depreciation ? 7,00,000 Property taxes and
Insurance ? 70,000. Miscellaneous ? 1,50,000.
(iv) The following proportion of the variable costs could be avoided if
production of the component is discontinued. Materials 35% direct
labour 40% Power 25%
(v) If the component is purchased from an outside supplier, average
freight cost will be Re.0.50/unit. Also Indirect Labour would
increase by ? 30,000 on account of receiving, handling and
inspecting the purchased parts. Advise the management.
(B.Com. Punjab) (Ans: The company should continue to make the product)
5. The cost of manufacturing of 8,000 units of ‘X’ product is given below:
Direct materials ? 8,000; Direct labour ? 64,000; Variable overheads
? 32,000. Fixed overheads T 40,000; Fixed overhead is inclusive of
? 24,000 that continues regardless of the decision. The same product is
available in the market for ? 16 per unit. Should the company make or
buy the product?
(B.Com, Osmania) (Ans: The company should make the product)
6. A radio manufacturing company finds that while it costs ? 6.25 each to
make component X, the same is available in the market at ? 5.57 each,
with an assurance of continued supply. The Break-down of costs is as
follows:
Materials ? 2.75 each
Labour T 1.75 each
Other variable cost ? 0.50 each
Depreciation and other Fixed cost ? 1.25 each
? 6.25 each
 C-13

(a) Should the company Make or Buy?

(b) What would be your decision if the supplier offered the component at
? 4.85 each? (B.Com, Osmania, Kakatiya) (Ans: a) Make (b) Buy)
7. A Company produces variety of products and components. Following
components with relevant manufacturing costs are under consideration
for purchase outside:
Component Direct Direct Variable Fixed Bought out
No Material Labour Overheads Costs Price
?
XY 600 200 100 300 800
PR 200 800 200 1,000 2,300
MN 100 300 200 500 1,200
Select the components which should be bought from outside, indicating
reason for choice
(B.Com, Nagarjuna) (Ans: XY should be bought from outside)
8. A part used in the assembly of a final product is manufactured by Vijay
& Co. in two operations. Originally 1,50,000 parts are manufactured
each year with total manufacturing costs as follows:
Operation I Operation II
Direct Materials 84,000 Total of Operation I b/d 2,16,000
Direct labour 78,000 Direct labour 23,000
Variable costs of Variable costs of supplies
Supplies and indirect and indirect materials 11,000
Material 18,000
Allocated costs of plant Allocated cost of plant
Occupancy 36,000 Occupancy 27,000
2,16,000 2,77,000
Operation I can be eliminated if these parts are purchased from outside
supplier at a price of ^1.10 per unit. The space used for operation I can be
rented for ? 6,000 a year. The parts purchased from outside supplier will still
have to be put through operation II.
Should the parts be manufactured or should they be purchased? Give
computations to support your conclusion.
(B.Com, Kakatiya) (Ans: Purchasing will result in saving of ?21,000)
9. Component ‘X’ is manufactured in the machine shop. The annual
requirement of component ‘X’ is 10,000 units. If it is bought out, the
lowest quotation from an outside supplier is ? 8.00 per unit.
The following expenses of the Machine shop apply to manufacturing
ofcomponent ‘X’, Materials ? 35,000; Labour T 56,000; Indirect labour
T 12,000; Power and fuel ? 600, repairs and Maintenance: ? 1,000
The sale of Machinery used for manufacture of Component X would
reduce. Depreciation by ? 4,000 and Insurance by ? 2,000.
If component X is bought out, the following additional expenses are
incurred.
 C-14

Freight Re. 1.00 per unit, Inspection ? 10,000 per annum.

You are required to prepare a report to the Managing Director showing
the comparison of expenses to Machine shop when (i) component X is made
and (ii) when bought out. (AIMA adapted) (Ans: (i) ? 11.06 (ii) ? 10.00)
10. Product ‘A’ takes 8 hours to produce on a machine which is used to full
capacity. Its selling price is ? 84 and marginal cost ? 52. A component
part ‘B’ used in the production of ‘A’ can be made on the same machine
in 12 hours. The marginal cost of producing B is ? 40. It can be bought
at a net price of ? 80. from the market. Should the company make or
buy the component? (Ans: The company should buy the component)
Add or Drop
11. Mamta Ltd manufactures 3 products, namely Heavy, Medium and Light
the details of which are given below.
Heavy Medium Light
Selling Price p.u 80 50 40
Direct Materials p.u 30 25 20
Other variable costs p.u 14 11 8
Fixed overheads p.u 10 8 7
54 44 35
Material consumed p.u 10kg 6kg 4kg
The company is thinking of discontinuing one product and focus on the
other two.
1. If there are no limitations on either material, labour or sales, which
products should be discontinued?
2. Assuming that material is in short supply, which product should
be discontinued?
Fixed overheads will remains constant irrespective of product mix.
(Ans : (i) Light (ii) Medium)
12. Pankaj Industries produces 3 types of Detergents, Light, Strong and
White, the details of which are as under :
Light Strong White
Material 300 480 180
Labour 220 300 80
Variables Overhead 240 360 160
Fixed Overhead 240 360 240
Selling Price 1360 1800 760
No. of units 1,000 1,500 2,000
The Management wishes to focus only on 2 Products. The Sales manager
states that if a product is discontinued, the other two products can be increased
by 50%.What is your advise to the management?
(Ans : ‘Light’ should be discontinued)
 C-15

13. Gulab Ltd manufactures 3 types of products, namely Popular, Executive

and Supreme. There is a proposal to close down the production of
Popular. Following details are available.
Popular Executive Supreme
Sales (in Units) 60,000 3,00,000 90,000
Price p.u (is ?) 35 65 95
Material (p.u) 15 25 35
Labour (p.u) 10 18 22
Variable Overhead 3 7 13
Fixed overheads ? 9,00,000 27,00,000 18,00,000
What is your recommendation to the management if production of
‘Popular’ is stopped assuming that (i) no part of fixed overhead can be saved
(ii) fixed overhead can be completely saved (iii) raw material prices go up by
20% and fixed overhends can be saved.
(Ans: (i) Continue with all3products (ii) Drop ‘Popular’ (iii) Drop ‘Popular’
It does not make any difference whether ‘Supreme’is continued or dropped).
14. Ravindra Ltd., produces 20,000 units of a product ‘SHINE’. It has spare
capacity to produce another 10,000 units. The current break up of costs
of SHINE is as under.

Material 2,00,000
Labour 1,00,000
Variable Overheads 20,000
Fixed Overheads 1,50,000
Fixed Overheads include ? 40,000 for depreciation. ‘SHINE’ is sold at
? 30 per unit. It is proposed to manufacture ‘BRIGHT’ along with ‘SHINE’.
The installed capacity of ‘BRIGHT’ will be 15,000 units. This will require
? 2,50,000 additional investments over and above existing ? 5,00,000
investments. To begin with, 10,000 units of BRIGHT are to be manufactured
and sold. These can be sold at ? 20 each. ? 15,000 overheads (as fixed) apart
from 10%. depreciation on machinery will be needed. Out of the new
investment, ? 50,000 will be required for working capital. The cost estimates
for BRIGHT are :
Material : ? 10 per unit
Labour : ? 3 per unit
Variables overheads : ? 1 per unit
Is it advisable to introduce ‘BRIGHT’? (Ans: BRIGHT can be
introduced as it results is additional profit of ? 25,000. However, ROI is
very low)
15. In an oil mill, four products emerge from a refining process. The total
cost of input during the quarter ending March 1983 is ? 1,48,000. The
output, sales and additional processing costs are as under :
 C-16

Product Output Additional processing cost Sales value

litres) after split-off point ?
AOXE 8,000 43,000 1,72,500
BOXE 4,000 9,000 15,000
COXE 2,000 - 6,000
DOXE 4,000 1,500 45,000
In case these products were disposed of at the split off point, that is
before further processing, the selling price would have been :
AOXE ? 15.00; BOXE : ? 6.00; COXE : ? 3.00; DOXE : ? 7.50
Prepare a statement of profitability based on the following facts :
(i) If the products are sold after further processing is carried out in the
mills.
(ii) If they are sold at the split off point.
(C.A. Inter, I.C. W.A. Inter-Adapted) (Ans : I AOXE (30,833’ BOXE (13,733
(loss) COXE (1,067; DOXE (18,833. IIAOXE (21,333; BOXE (4,267; COXE
(1,067; DOXE (5,333)
16. Jwala Ltd sells 2 Products, namely ‘Stone’ and Fire. The product ‘Fire’
is obtained after ‘Stone’ is processed further. The cost of producing 1
unit of ‘Stone’ is ? 25, and it is sold for ? 30 p.u.
To produce ‘Fire’, the company has to spend ? 25 p.u on material and
? 20 per unit on labour. ‘Fire’ can be sold at ? 80 per unit.
Currently the company produces 600 units of ‘Stone’ and 600 units of
‘Fire’.
It is proposed to process the entire quantity of ‘Stone’ into ‘Fire’. This
will result in an increase is factory overhead to the extent of ? 1,000.
State your views.
(Ans : It is advisable to process further, resulting in incremental
profit of (2,000)
17. Anand Ltd., Produces 2,00,000 units of a Product ‘Jay’ at a total cost of
? 25,00,000 including ?10 p.u. of variable cost. The selling price is
? 15 p.u. On account of recession, demand has fallen and Anand Ltd
has to cut the selling price by 20%. The management wants to know if
the factory should be shut-down till the demand picks up again?
(Ans : Company must continue operations loss : (1,00,000)
18. Abhishek Ltd., can produce 1,00,000 units of a product, by incurring a
fixed cost of ? 6.00,000 and a variable cost of ? 20 p.u. Due to severe
recession, the company is now operating at only 50% of capacity. The
selling price per unit is ? 30. Anand Ltd seeks your advise if it should
temporarily shut down operations. The company will have to incur
? 2,00,000 of fixed costs even in case of temporary shut-down. Please
advise.
(Ans : Company must continue operations loss (1,00,000.
Shut-down point: 40,000 units)
 C-17

19. Aruna Ltd has a factory in Hyderabad. It distributes its product through
3 sales dopots situated in Hyderabad, Pune and Vijayawada. It plans to
sell 1,00,000 units at ? 100 p.u of which 70% of the units would be sold
from Hyderabad. Pune and Vijayawada will sell 20,000 and 10,000
units respectively. The details of cost are as under
Direct Material T 25 p.u
Direct Wages ? 15 p.u
Variable Factory overheads: 140% of Direct wages
Fixed Factory overheads : ? 20,00,000
The details of selling overhead are as under
Hyderabad Pune Vijayawada
Variable Sales Costs 5% 8% 10%
(as % of sales Value)
Fixed sales overhead 4,00,000 2,50,000 3,50,000
Management is evaluating a proposal to shut-down the sales depot at
Pune and Vijayawada. If this is done, all sales done through these depots
will be lost. However, sales from Hyderabad depot will remain the same.
You are requested to evaluate the proposal and state your views.
(Ans : Continue Pune depot shut down Vijayawada depot)
20. Sanjay Ltd., manufactures a product whose cost details are given below.

Material 35.00
Labour 12.50
Factory overhead (50% fixed) 62.50
Sales overhead (25% variable) 8.00
60,000 units of 118.00
The company sells, 60,000 units of the product at ? 143 p.u. in the
domestic market. It receives an order to supply 20,000 units of the
product at T 98 per unit, which will be sold in the foreign market. Their
is sufficient spare capacity available with the company. Should the
company accept or reject the offer?
(Ans : Accept the order as it is generating additional profit of ? 3,45,000)
21. Anshul Ltd., manufactures a component that is used in the production
of ‘Smart’ meters. It receives an invitation from the state Government
to bid for the supply of the component. Anshul Ltd is keen to win this
order even if it does not make any profit on the same. However, it finds
that its competitor, Nikhil Ltd., had quoted a price of ? 1,700 in the
. previous bidding, which is lower then its cost of production. The cost
structure of the component is as under.

Materials 800
Direct Wages 200
Factory overheads (50% fixed) 500
 C-18

Office overheads (100% fixed) 150

Sales overheads (? 50 Variable) 350
Profit 200
Selling Price 2,200
Anushul Ltd currently operates at 60% Capacity, selling 30,000 units
of the component. 15,000 units are to be supplied to the state
Government. Management does not want to lose this opportunity but
does not wish to incur a loss. What is your advise?
(Ans : Bid Price ? 1,300)
22. Bhavana Ltd produces 10,000 units of a product at a cost of sales of
? 80 p.u. The entire production is sold in the domestic market at ? 85
p.u. However, the company is facing the problem of recession and is
forced to reduce the price to ? 75 p.u to sell the entire 10,000 units. The
break down of cost is as under.

Materials 3,00,000
Wages 2,20,000
Fixed overheads 1,60,000
Variable overheads 1,20,000
The company is also looking at foreign markets. A buyer is willing to
buy 20,000 units of the product at ? 71 p.u. Fixed overheads will increase by
10% if additional 10,000 units are produced.
Management has 2 alternatives
1. Sell 10,000 units is domestic market at ? 75 p.u
2. Sell 20,000 units in foreign market at ? 71 p.u. with no sales in domestic
market.
Please advise. (Ans : Alternative 2 should be chosen)
23. Deepak Ltd. makes an average profit of ? 30 p.u by selling a product at
? 450 p.u. whose cost breakup is as under.
Material: ?105
Wages 40
Factory overhead 180 (at 60% Capacity, 50% fixed)
Sales overhead 49 (25% Variable)
The company currently produces 6,000 units. For the coming year it
receives an order from a large retail chain for supply of 2,000 units. It
anticipates that material and wages will increase by 6% and 8% respectively
while fixed overheads will go up by 10%. The company wants to earn a
profit of ? 6 lakhs in the coming year but it cannot increase its selling price in
the normal market. What price can it accept the order for 20,000 units?
(Ans: ? 364)
24. Ram Ltd., is interested to bid for a special order, which needs 4,000 kg
of Material X, which is regularly used by the company. Currently, the
company has 10,000 kg of X in stock, which was purchased recently
 C-19

by paying ? 2 lakhs. The price of X has increased by 10% since then.

The special order requires 800 hours of labour, which is currently
engaged in the production of another product ‘P’. ? 30,000 of additional
factory overheads will have to be incurred if Ram Ltd has to meet
requirements of this special order.
The details of Product ‘P’ are as below:
Selling Price p.u ? 500
Less : Material ? 80
Wages (2 hrs @ ? 50/hr) ? 100
Variable overheads ? 20
Ram Ltd also incurs ? 1,50,000 towards fixed factory overhead. What
is the minimum price that Ram Ltd should quote for the special order,
if no extra profits are desired by the company? (Ans: ? 2,78,000)
25. Satish Ltd. uses a machine which is 3 years old. Although the machine
has a life of another 3 years, it is frequently breaking down, resulting in
high operating costs. The management is considering replacing the
machine with a new one, which will significantly reduce operating
expenses.
The details of the 2 assets are as under :
Old Machine New Machine
Purchases Price 5,00,000 6,00,000
Remaining Life 3 years 3 years
Operating costs p.u 1,25,000 25,000
Current Disposal Value 1,00,000 N/A
Terminal Disposal Value 30,000 10,000
Advise the management. Ignore time value of money
(Ans : Retain the old machine)
26. Ashish Ltd., operates bus services within Hyderabad city. The bus was
purchased for ? 8 lakhs and has a life of 8 years. Its current book value
is ? 3 lakhs. The management is considering to replace this bus with a
brand new bus, which can be purchased for ? 12 lakhs. It will get a
value of ? 4 lakhs in exchange scheme for the old bus.
Currently the company earns Revenues of ? 4 lakhs per annum and
incurs ? 2 Lakhs towards various operating expenses. The new bus will
increase Revenues by 25% and reduce operating costs by 30%. It will also
have life of 3 years, after which it can be sold for ? 2 lakhs. State your views.
Ignore taxation and time value.
(Ans : Old bus should be retained)
 Chapter -4
BUDGETS & BUDGETARY CONTROL

Introduction to Budget, Budgeting and Budgetary Control: A Budget is a

very commonly used term. It is a widely practiced technique and most of us
use budgets in some way or the other. For example, a student receiving pocket
money of T 500 per month knows that he has limited money. He understands
that he needs to spend the money cautiously so that he derives maximum
satisfaction from the available money. He may for example, decide to spend
?100 in the college canteen, ? 100 on movies, ?150 for surfing the net and
?100 on miscellaneous activities. He may wish to save ? 50 every month in
order to buy a gift for a friend on his/her birthday.
The spending pattern of the student need not be same every month.
Moreover, he may decide in the middle of a month that he will reduce the
spending on Internet and spend the money on a picnic. It is quite possible that
this student may monitor his spending in the middle of the month to check if
it in line with his original plan. He may also initiate corrective action. For
example, if he finds that he has already spent ? 75 on movies on 15th day of a
given month, he will have to control his spend on movies in the next 15 days.
It is also possible that the student may end up saving more additional money
to meet certain unforeseen requirements. It is important to note that parents
may want to monitor the plan of their children. They may grant additional
money if the student is able to convince them of the need for such money.
This is a classic case of Budget and Budgetary control touching our daily
lives. The act of planning as to how the money should be spent is nothing but
Budgetting. If the student keeps a careful record of the plan and prepares a
statement giving a break-up of spending, such a statement is a 'Budget'. The
act of continuous monitoring and taking timely corrective action is 'Budgetary
control'.
Definition of Budget: According to the Institute of Cost and Management
Accountants (ICMA), England, a Budget is "a financial and/or quantitative
statement, prepared and approved prior to a definite period of time, of the
policy to be pursued during that period for the purpose of attaining a given
objective. It may include income, expenditure and the employment of capital"
"A budget is a written plan covering projected activities of a firm for a
defined period" - Dickey.
 D-2

"A budget is a plan of action to achieve stated objectives based on

pre-determined series of related assumptions: - Keller and Ferrara
According to Gordon and Shilling Law, a budget is "a pre-determined
detailed plan of action developed and distributed as a guide to current operations
and as a partial basis for the subsequent evaluation of performance.
Essentials of Budget : From the above definitions, we can understand that
the following are the essentials of a budget.
(i) It is a Statement
(ii) It pertains to a future period
(iii) It states action points that need to be followed to attain the objectives of
the organization.
(iv) It may be expressed in monetary units (i.e. in value) or in physical units
(quantity) or both
(v) It forms the basis for monitoring and control.
Definition of Budgeting : The National Association of Accounts (U.S.A.)
defines Budgeting as "the process of planning all flows of financial resources
into, within and from an entity during some specified future period. It includes
providing for the detailed allocation of expected available future resources to
projects, functions, responsibilities and time periods".
According to G.R. Crowningshield. "Budgeting is the formulation of
plans for future activity that seek to substitute carefully constructed objectives
for hit and miss performance and provide yard sticks by which deviations
from planned achievements can be measured."
From the above definitions, it is clear that Budgeting is the actual act of
preparing the budget. It is the process of evolving the final statement. Budget
is the end product of Budgeting.
Definition of Budgetary Control: According to ICMA England, Budgetary
control is "the establishment of budget relating to the responsibilities of
executives to the requirements of a policy, and the continuous comparision of
actual with budgeted results, either to secure by individual action, the objective
of the policy or to provide a basis for its revision".
In the words of J.Batty, "Budgetary control is a system which uses budgets
as means of planning and controlling all aspects of producing and I or selling
commodities and services".
To quote J.A.Scott "Budgetary control is the system of management
control and accounting in which all operations are forecast and as far as possible
planned ahead, and the actual results compared with the forecasted and the
planned ones".
Essentials of Budgetary Control: From the above definitions, the following
can be stated as essentials of Budgetary Control:
1. Budgeting, or the process of preparing the budget, is the starting point
for Budgetary Control.
2. Distribution of Budgets pertaining to each function to all the relevant
sections within the organization.
 D-3

3. Collection of actual data pertaining to all budgeted activities.

4. Continuous comparision of actual performance and budgeted
performance.
5. Analysis of variances in actual performance and budgeted performance.
6. Initiation of corrective action to ensure that actual performance is in line
with budgeted performance.
7. Revision of budget if it is felt that the budgets prepared are no longer
relevant on account of unforeseen developments.
Objectives of Budgeting Control: The primary objective of Budgetary Control
is to help the management in systematic planning and in controlling the
operations of the enterprise. The primary objective can be met only if there is
proper communication and co-ordination amongst different departments within
the organization. Thus the objectives can be stated as :
1. Planning: Businesses require planning to ensure efficient and maximum
use of their scarce resources. The first step in planning is to define the
broad aims and objectives of the business. Then, strategies to achieve
the desired goals are formulated and tentative schedules are set up. The
budget is a detailed schedule of the proposed combinations of the various
factors of production, which is most profitable for the defined period.
Budget influences strategies that need to be followed by the organizations.
It cultivates forced planning among managers. For example, software
development companies had to think of innovative ways to cut costs as
management reduced budgeted expenditure.
2. Co-ordination: Co-ordination is a managerial function under which all
factors of production and all departmental activities are balanced and
intergrated to achieve the objectives of the organization. For example,
the activities of production and sales department may need to be
coordinated. The sales department may went to sell more quantity at
lower price, but the production department may not have the capacity to
produce such large quantity. Budgeting provides the basis for individuals
in all departments to exchange ideas on how best the organization’s
objectives can be realized. Executives are forced to think of the
relationship between their department and the company as a whole. This
removes unconscious biases against other departments. It also helps to
identify weaknesses in organizational structure.
3. Communication: All people in the organization must know the
objectives, policies, programs and performances of the organization. They
must have a clear understanding of their part in attainment of
organization's goals. This is made possible by ensuring their participation
in the budgeting process.
4. Control and Performance Evaluation: Budgetary control ensures
control by continuous comparison of actual performance with budgeted
performance. Variances are highlighted and corrective action can be
initiated. Budgets also form the basis of performance evaluation in an
 D-4

organization as they reflect realistic estimates of acceptable and expected

performance.
Advantages of Budgetary Control: Budgetary control has become an
essential tool of management for controlling costs and to maximize profits.
Some of the advantages of budgetary control are :
1. It defines the objectives and policies of the undertaking as a whole.
2. It helps in estimating the final needs of the concern and there by reduces
the possibility of over or under-capitalization.
3. It secures planned allocation of productive facilities and resouces for
their best utilization.
4. It facilitates 'Management by Exception'. Attention of Management is
attracted only to areas requiring remedial action.
5. It facilitates decentralization of authority and responsibilities in definite
departmental as well as individual authority and responsibilities in definite
terms. This prevents tendencies of passing the blame or responsibility
on some one else, when the budgeted results are not achieved.
6. It results in effectinve co-ordination of activities of different departments
and develops sound communication system through meetings and
discussions. It promotes better understanding of each other’s problems
and develops team spirit within the undertaking.
7. It helps in measuring the efficiency of departments and individualts, as
budgets provide the yardsticks against which actual results can be
compared.
8. It instills into the managers the habit of carefully evaluating their problems
before making any decision.
9. It helps in promoting a feeling of cost-consciousness. Wasteful
expenditure is avoided and expenditure beyond the budgeted figure is
not incurred without the prior approval of higher authority.
10. It increases the morale and the productivity of employees by seeking
their effective participation in the formulation of plans and policies. It
brings about a harmony between individual goals and the goals of the
enterprise.
11. Budgets create the necessary conditions for the setting up of standard
costing.
12. Budgetary control reduces delays as budgets, once adopted, operate as a
sanction to proceed. There is no need to wait for further clearances.
13. Budgetary control provides the basis for the introduction of incentive
remuneration plans based on performance.
14. ft' serves as a basis for future policy and also for reviewing current policy
in the light of experience. It is helpful in reviewing current trends in the
business and in determining future policy of the business.
15. It serves as internal audit by continuous scrutiny of departmental results
and costs.
 D-5

16. When there is budgetary control, seasonal and cyclical fluctuations in

the business can be anticipated in advance and new product lines may
be taken up to maintain the level of production. Thus, budgeting assists
in the stabilization of industry.
Limitations of Budgetary Control: Budgetary control has several advantages,
but it also has certain limitations. It main limitations are
1. Budgets are essentially based on forecasts and estimates whose accuracy
depends upon the correctness of facts and good judgement. Thus, budgets
are a matter of opinion rather than a scientific tool. This reduces the
reliability of Budgets.
2. There is a danger of over-budgeting, spelling out major expenses in detail.
This deprives the managers of freedom of action in managing their
departments.
3. Under the fast changing business conditions and Government policies,
budgeting becomes a difficult task. Budgets may become outdated even
before they are approved.
4. For the success of budgetary program, all level of management should
take active interest in its execution. This is usually not the case.
5. Budgeting may result in every executive just trying to achieve the
budgeted targets. Thus, budgets serve as constraints on managerial
initiative.
6. Preparation and operation of budgetary program is expensive. Hence,
small organisations may not be able to afford having a system of
budgetary control.
7. Budgetary control may lead to conflicts among functional executives,
because every executive may try to get a larger share of budgetary
allocation, shirk responsibility and blame others for pit-falls.
8. Budgeting tends to bring about rigidity in control. Budgets, once made,
become irrevocable.
9. Budgeting may lower the morale and productivity of the personnel, if
unrealistic targets are set and if Budget is used as a pressure tool.
10. Budgeting may hide inefficiencies instead of exposing them, if there is
no evaluation system. Unless there is continuous evaluation of the actual
performance, budgeting cannot be a success.
11. Budgets will become a mere routine and lose their dynamism unless the
budget program is revised from time to time, in tune with the changes in
business condition and management policies. However, frequent revisions
may be a costly affairl.
Classification of Budgets: Budgets can be classified into different types from
different points of view. Classification of budgets is commonly done on the
basis of the following.
1. Classification of budgets according to Condition : According to their
condition, budgets can be classified into two types, viz., (A) Basic budget
and (b) Current budget.
 D-6

a. Basic budgets : A basic budget has been defined as a budget which

is prepared for use over a long period of time without any alteration.
This does not take current conditions into account and can be
attainable under standard conditions.
b. Current budgets : A Current budget can be defined as a budget that
is related to current conditions. It is prepared for use over a short
period of time. This budget is more useful than a basic budget as it
is more reealistic and there is proper monitoring of stated targets.
2. Classification of budgets according to period of time: From the point
of view of period of time, budgets may be classified into four types.
They are : (a) Long-term budgets (b) Short-term budgets (c) Current
budgets (d) Interim budgets
a. Long term budgets : Long-term budgets are budgets prepared for a
long period of 5 to 10 years. They are concerned with planning the
operations of a firm over a considerably long period of time. Long­
term budgets are usually prepared by the Financial Controller
exclusively for the top management. These budgets are very useful
in case of industries having a long gestation period. They are
sometimes prepared in terms of physical units (i.e., quantities) or
percentages, since accurate values may be difficult to forecast over
such long period. Capital expenditure budgets, research and
development budgets, etc. are examples of long-term budgets.
b. Short-term budgets : Short-term budgets are budgets prepared for
a short period of 1 to 2 years. They are prepared for those activities
the trend in which cannot be foreseen easily over long periods. These
budgets are very useful in case of consumer goods industries such
as sugar, cotton, textiles, etc. They are, generally, prepared in terms
of physical units (i.e., quantities) as well as monetary inits (i.e.,
values). Materials budget, Cash budget, etc. are examples of short­
term budgets. They are very useful to lower level of management
for control purpose.
c. Current budgets : According to ICWA, London, "Current Budget
is a budget which is established for use over a short period of time
and is related to current conditions." Thus, Current budgets are
essentially short-term budgets adjusted to current (i.e., present or
prevailing) conditions or circumstances. They are prepared for a
very short period, say, a quarter or a month. They relate to Current
activities of the business.
d. Interim budgets : Interim budgets are budgets, which are prepared
in between two budget periods. These budgets may get integrated
with the budget of the following period. For example, let us say that
an organization, X Ltd, follows the Calendar year for budgeting.
The latest budget has been prepared for the period from 1st January
 D-7

2015 to 31st December, 2015. However, there is a change in

management in X Ltd from 1st April 2016. In such a case, the present
management may not want to prepare the budget for the full calendar
year. It prepares an interim budget for the period 1st January 2015to
31st March 2016. The new management taking over may prepare a
fresh budget either for the 9-month period from 1st April 2016 to
31st December, 2016 or start following the financial year for the
purposes of Budgeting.
3. Classification of budgets according to content: From the point of view
of content, budget may be classified into Budgets in physical terms and
into Budgets in monetary terms.
a. Budgets in physical terms: Budgets in physical terms are budgets
that budget in terms of Quantities only. They do not include
corresponding rupee value. Long term budgets are usually prepared
in physical terms. Examples of such budgets are Production budget,
Materials budget, etc.,
b. Budgets in monetary terms: Budgets in monetary terms are budgets
that budget in terms of Quantities as well as their corresponding
rupee value. Sales budget, Purchase budget, etc are examples of
such budgets. Budgets such as Cash budget, Capital Expenditure
budget, etc that may not have physical quantities also form part of
Budgets in monetary terms.
4. Classification of budgets according to function: On the basis of
Functions, Budgets can be classified into a) Operating Budgets, b)
Financial Budgets and c) Master Budget
a. Operating budgets: Operating budgets relate to the different
operations or activities of a firm. The number of such budgets
depends upon the size and nature of business. Sales budget,
Production Budget, Production Cost Budget, Purchase budget, Raw
Material Budget, Labor Budget, Plant Utilization Budget, etc are
some of the commonly used operating budgets in any organization.
These budgets are also termed as "Functional" budgets as they relate
to a given function of the organization.
b. Financial Budgets: Financial budgets are concerned with cash
receipts and disbursements, working capital, capital expenditure,
financial position and result of business operations. The commonly
used financial budgets include Cash budget, Working Capital Budget,
Capital Expenditure Budget, Income Statement Budget, Statement
of Retained Earnings Budget, Budgeted Balance Sheet or Position
Statement Budget, etc
c. Master Budget: According to ICWA London, "the Master Budget
is the summary budget incorporating its functional budgets". All the
operational and financial budgets are integrated into the Master
 D-8

budget. This budget is prepared by the Budget officer for the benefit
of the top-level management. This budget is used to co-ordinate the
activities of various functional departments. It is also used as an
effective control device.
5. Classification of budgets according to flexibility: According to
flexibility, level of activity or capacity, budgets can be classified into a)
Fixed or Static budgets and b) Flexible, Variable or Sliding scale budgets.
a. Fixed or Static budgets : According to ICMA, London "a fixed
budget is a budget which is designed to remain unchanged
irrespective of the level of activity actually attained". It is based on
a fixed volume of activity and shows only one volume of output and
related cost. It is not adjusted according to the actual level of activity
attained. Thus, if it is forecast that the organization will operate at
60% capacity, there is no provision to adjust the budget if the actual
operations are at 75% or 50% of capacity.
A fixed budget is useful only when the actual level of activity
corresponds with the budgeted level of activity. But this, generally,
does not happen, As such, a fixed budget is not useful for managerial
purposes.
b. Flexible, Variable, sliding scale or control type budgets:
According to ICMA, London, "a flexible budget is a budget which
is designed to change in accordance with the level of activity actually
attained". Thus, a flexible budget changes according to the change
in the level of activity. In other words, it provides the budgeted costs
at any level of activity. For example, let us say that it is forecast that
the organization will operate at 60% of its capacity and a budget is
drawn that reflects the cost at 60% capacity. However, the
organization actually operates at 90% capacity due to favourable
market conditions. If Flexible Budgeting is followed, then there is a
provision to adjust the budget to 90% capacity. A series of budgets
for different levels of activity can be prepared.
Business activities cannot be accurately predicted on account of
uncertainties of business environment. A flexible budget contains several
estimates for different assumed circumstance instead of just one estimate. It
provides for automatic adjustments with changes in the volume of activity.
Hence, a flexible budget is useful tool in controlling operations in real business
situations in an unpredictable environment.
A flexible budget is prepared where it is not possible to forecast sales
and costs for any level of activity with great degree of accuracy. A flexible
budget is considered most desirable or suitable in the following cases :
1. The sales are unpredictable on account of the typical nature of business,
g., in luxury and semi-luxury trades.
e.
2. The level of activity during the year varies from period to period, either
due to seasonal nature of the industry or due to variation in demand.
3. The production or business is governed by some key factor or limiting
factor (material, labour, plant capacity, etc.) whose availability is not
assured for the entire budget period.
4. The business is new and it is difficult to foresee the demand.
5. The business keeps introducing new models, designs, product
enhanements, etc (e.g. fashion designing)
6. The business is engaged in "make to order” activities.
7. The business is subject to vagaries of nature.
In short, a flexible budget is essential in cases of uncertainty.
Difference between Fixed Budget and Flexible Budget: Following are the
difference betweens a Fixed budget and a Flexible budget:
1. Rigidity: A fixed budget is rigid. It remains the same even if volume of
business is changed. A flexible budget can be recast to suit the changed
circumstances. It provides for automatic adjustments for any change in
the volume of activity. It can be adapted to reflect the increase / decrease
in level of activity.
2. Cost Classification: For the purpose of preparing Flexible budgets, costs
are classified as per their nature into fixed, variable and semi-variable
costs. No such classification is done for preparation of fixed budgets.
3. Cost Ascertainment: If flexible budgets are prepared, costs can be easily
ascertained under different levels of activity. This helps in fixing prices.
Costs cannot be easily ascertained under changed circumstances if Fixed
budgets are prepared.
4. Comparison of Budget with Actuals: If Fixed budgets are prepared,
then budgeted and actual results cannot be compared if there is a change
in the level of activity. If Flexible Budgets are prepared, then such budgets
are redrafted as per the changed volume. A comparasion between
budgeted and actual figures will be possible.
5. Forecasting: Forecasting of accurate results is difficult in case of Fixed
Budgets. Flexible budgets clearly show the impact of expenses on
operations and it helps in making accurate forecasts.
6. Assumptions : A fixed budget assumes that conditions will remain
constant. Flexible budget is free of such assumptions.
Preparation of Various budgets
Sales Budget: A sales budget is an estimate of expected sales during a budget
period. It is the starting point on which other budgets are also based. It lays
down a comprehensive plan and program for the sales department. The sales
manager is made responsible for preparing sales budget. He uses all possible
information available from internal and external sources.
A sales budget lays down potential sales figures in quantity as well as in
value. To the extent possible, the Sales budget must be prepared territory wise
(area wise) for each product. The budgeting must be done in terms of Sales
figure for each month or atleast a quarter, so that all other operating Budgets
 D-10

can also be meaningfully prepared. It may ideally include an estimate of Selling

and distribution costs. However, it is preferable to have a separate budget for
the Selling and distribution expenses. A format of Sales budget is given below
Sales Budget
Product I Product II Product III Total Sales
Month Qty Vai Qty Vai Qty Vai Qty Vai
Jan
Feb
Mar
April
May
June
July
Aug
Sep
Oct
Nov
Dec
Total
The degree of accuracy with which sales are estimated determines the
success of budgeting exercise. Hence, all possible care must be taken to ensure
that the figures pertaining to Sales budget are as accurate as possible. Sales
budget is not a guess, but a serious exercise that takes into considereation
several factors. The following factors must be taken into account while
preparing a sales budget.
1. Past Sales Figures: Past data on sales enables determination of the trend
in sales. The sales trends can be relied upon to a great extent in forecasting
future sales. Such trend will reflect the expected seasonal fluctuations,
cyclicality and potential demand which will be of help in preparing sales
budgets. Quantitative Techniques for trend analysis and forecasing
techniques can be used for making the sales estimate for the budget
period.
2. Assesment by Sale Force: The Salesmen are the most appropriate
persons for estimating future demand. They are in touch with the market
and the customers. Their experience will enable them to forecast sales
figures more realistically. However, they may have a positive or negative
bias on account of their attitude and personal thinking. The sales manager
should cautiously scrutinize the figures provided by the sales force to
eliminate their bias. The scrutized estimates can be incorporated into
the sales budget.
3. Availability of Key Factor: The forecast for any future period must be
based on ground realities. There are numerous instances where in a
 D-l 1

business could not realize its full sales potential due to non availability
of material, skilled labour, plant capacity, etc. Availability of such key
factor is an important factor in preparing the sales budget.
4. Seasonal Fluctuations: The effect of seasonal fluctuations should also
be considered while preparing a sales budget. The demand for goods
may be more in some periods while they may be in less demand at other
times. An effort should be made to reduce the seasonal effect by giving
discounts or other concessions during off seasons.
5. Avilability of Finances: The availability of finance sometimes becomes
a limiting factor. The finances will be required for purchasing various
Parts. The sales budget is prepared along with-the financial budget. The
expansion of sales effort will need additional capital outlay. Financial
aspects should be taken into consideration while preparing a sales budget.
6. General Trade Prospects: The possibility of increase or decrease in
sales can be forecast by a study of the prevailing general trade prospects;
This can be done by looking at Consumer confidence Index, interpretation
of information provided in newspapers, etc.
7. Order Book Position: The number of orders in hand will provide a lot
of insight for preparing the sales budget. Similarly, Business "in the
pipeline" must also be factored in while preparing the Sales budget.
8. Market Intelligence: The Sales manager must be continuously
attempting to anticipate the steps being taken by competitors. Similarly,
Government policy must be closely watched. The nature and degree of
competition has tremendous influence in deciding on the sales targets
for any organization.
9. External Environment: Without considering the external environment,
the sales targets may not be realistic.
10. Policy Implications: The Sales manager must study the possibility of
influencing Sales by way of Advertisement, Publicity, Price reduction,
Volume discounts, Lobbying with the Government, etc. The organization
should be capable of absorbing the impact of such policy decisions as
and when it happens.
Illustration -1 : Beta Manufacturing Ltd manufactures two products X and Y
and sells them through three Divisions Viz North, South and West.
Sales Budget for the current year based on the estimates of the Sales
Division managers were :
Product North South West
X 15,220 12,500 17,560
Y 12,500 7,000 6,000
Sales price are 2 and ? 8 for X and Y respectively in all regions.
A market research was conducted by the management of the company.
It was found that Product X has a favour among customers, but is under-
priced. It is expected that if the price is increasee by Re.l, its sale will not be
 D-12

effected. The price of Product Y is proposed to be reduced by Re. 1 as it is

over-priced.
One the basis of above information provided by salesman, it is estimated
by the Divisional Manager that percentage increase in sales will be: X-North
10%; South-5% and west 5%; Y-North 10%; South 5% and West 10%.
It is also expected that there will be further 'push up' in sales if intensive
advertisement is resorted to. The increase will be X-North 1,500; South 240;
West 55; Y-North 600; South 1,000.
Prepare a Sales Budget on the basis of above information.
Solution
Budgeted Sales for X
Particulars North South West Total
Budgeted 15,220 12,500 17,560 45,280
Add Increase of 10%, 5% and 5% 1,522 625 878 3,025
16,742 13,125 18,438 48,305
Add Increase on Advertisement 1,500 240 55 1795
18242 13365 18493 50195
Budgeted Sales for Y
Particulars North South West Total
Budgeted 12500 7000 6000 25500
Add Increase of 10%, 5% and 10% 1250 350 600 2200
13750 7350 6600 27700
Add Increase on Advertisement 600 1000 0 1600
14350 8350 6600 29300
Sales Budget for 1992
Budget Period....
Area X y Total
20’ SP Value SP Value
?
North 18242 13 237146 14350 7 100450 337596
South 13363 13 173745 8350 7 58450 232195
West 18493 13 240409 6600 7 46200 286609
Total 50100 651300 29300 205100 856400
Production Budget: The production budget is a forecast of the number of
units to be produced during the budget period. It answers the question as to
what is. to be produced and when should it be produced. It is prepared in
relatiofi to the sales budget. Just like the Sales budget, Production budget is
prepared for each product for each month / quarter or the period for which the
Sales budget is prepared.
The Production budget is prepared in terms of the number of units to be
produced during a given period. The number of units to be produced is arrived
 D-13

at after taking into account the existing Opening stock for the period, estimated
Sales and the desired closing stock. The Production Budget is the responsibility
of the Production in Charge or the Factory Manager. If a Factory has more
than one production department, the produciton budget may be split and a
production budget for each department can be prepard.
The Production budget is prepared in the following format:
Production budget
for the period ending 31st December, 2000
Month Units Closing Total Opening Units
(1) Required Stock of Units Stock of To be
For sales Finished Required Finished Produced
(2) goods (3) 4 = 2+3 Goods (5) 6 = 4-5
Quarter 1
Quarter 2
Quarter 3
Quarter 4
Total
Note: In case of problems having details pertaining to work in progress,
the percentage of work completed should be considered to convert the work
in progress into Equivalent Completed work. For example, if work in progress
is 100 units and percentage of completion is 75%, then Equivalent completed
units will be 100 *75% = 75 units.
The following factors must be considered in preparing the production
budget:
1. Sales Budget: The sales budget will provide a guideline for production
planning. In case the sales are not undertaken as per schedule, then
production should be reduced or vice-versa.
2. Plant Capacity: The number of units of different products to be produced
should be determined and the capacity, which the plant will be able to
work throughout the budgeted period, should be decided. Capacity
utilization should be planned in such a way that Sales program is
satisfactorily met and there are no huge spikes in capacity utilization.
3. Lag Time: The time lag between production in factory and sales to
Customer must be built into the Production budget.
4. Stock Quanity to be Held: The quantity of finished goods to be carried
forward shold be decided. It will depend upon a number of factors like
sales potential, storage facilities available and cost of the stock.
5. Availability of Key Factors: Production must be planned keeping in
mind the availability of Key factors such as material, skilled labour,
power, etc.
6. Production Planning: An understanding of the production-planning
schedule is essential for preparing production budget. The number of
 D-14

physical units to be produced is determined. The utilization of optimum

plant capacity and avoidance of bottlenecks due to shortage of materials
and labour, etc., is considered while preparing a production plan.
Production planning will ensure a smooth production schedule.
Cost of Production Budget: The production budget determines the number
of units to be produced. When costing is done for the budgeted production,
we state the units to be produced in terms of their cost. This statement, where
production plan is stated in monetary terms, is termed as Cost of Production
budget.
The Cost of Production budget is the total amount to be spent on
producing the units stipulated in the production budget. The physical units are
broken into the various elements of cost and the cost to be incurred on materials,
labour and factory overheads is determined. All the costs required for
manufacturing are totaled together to make it a cost of production budget.
Illustration-2 : The following information has been made available from the
records of Atul Tools Ltd., for the last six months of 1994 (and of only the
sales of January 1995) in respect of Product X.
i) The Units to be sold in different months are :
July 1,100 September 1,711 November 2,500
August 1,100 October 1,900 December 2,300
January 2,000
ii) There will be no work-in-progress at the end of any month.
iii) Finished units equal to half of sales for the next month will be in stock
at the end of every month (including June).
iv) Budgeted Produciton and Production cost for the year ending 31.12.94
are as thus :
Production (Units) 22,000
Direct material per unit ? 10.00
Direct Wages per unit ? 4.00
Total factory overheads apportioned to product ? 88,000
Prepare :
(a) A produciton budget for each of the last six months of 1994.
(b) A summarized production cost budget for the same period.
(B.Com Pune, B.Com(Hons) Delhi, M.Com Bombay, ICWA Inter)
Solution :
(a) Production Budget for six months
Particulars Jw/r Aug. Sept. Oct. Nov. Dec.
Sales (in Units) 1100 1100 1700 1900 2500 2300
Add: Closing stock half of
sales for the next month 550 850 950 1250 1150 1000
1650 1950 2650 3150 3650 3300
Less : Opening Stock last
month's closing stock 550 550 850 950 1250 1150
Production in units 1100 1400 1800 2200 2400 2150
 D-15

(b) Production Cost Budget for six months

Production for six months (July to December)
(1100 + 1400 + 1800 + 2200 + 2400 + 2150 Units) = 11050 Units ?
Direct Material @ ?10 per. Unit 1,10,500
Direct Wages @ ? 4 per. Unit 44,200
Factory Overheads (88,000 x 16) 44,000
Total Production Cost 1,98,700
Direct Materials Budget: A Materials budget is prepared as a follow up to
the Production budget. It will enable the Purchase Department to plan the
purchase of raw materials at different times. It will also help in the fixation of
minimum stock level, maximum stock level and re-ordering level.
The material budget is concerned with determinig the quantity of direct
materials required for produciton. Indirect materials are budgeted as part of
Factory overhead. The period for Materials budget is relatively shorter than
that of the Sales and Produciton budgets. The budget is prepared for each
material separately and then consolidated.
Materials budget is prepared in accordance with the Production budget.
The requirement of materials is determined product-wise. The rates of
consumption of raw materials (raw materials required for producing one unit
of the product) is determined. The number of units to be produced is multiplied
by the rate of consumption to find the quantity of materials required. The
quantity of materials required for each product is then added to determine the
total requirement of the material for the budget period. The budgeting exercise
upto this stage is also referred to as 'Material Requirement budget'.
The stock of materials required in hand at any time is added to the
materials required for production. The opening stock of materials is deducted
from the figures determined as above. In this way, the requirement of materials
in units will be determined. The time lag between placing the order for purchase
and the actual receipt of material, availability of material due to seasonality,
price trend in the market, etc should be cosidered in estimating the desired
stock to be held at any point of time. The final result is termed as 'Material
Procurement budget'.
Illustration-3: A company manufactures products A and B. During the year
ending 31st December 1993, it is expected to sell 15,000 kg. of product A and
75,000 kg. of product B at ? 30 and ?16 per Kg. respectively. The direct
materials P,Q and R are mixed in the producdtion of 3:5:2 in the manufacture
of product A. Materials Q and R are mixed in the proportion of 1:2 in the
manufacture of product B. The actual and budgeted inventories for the year
are given below :
Opening Stock Expected Closing Anticipated Cost per
Kg- Stock Kg. Kg. (in f)
Material P 4,500 3,000 12
Q 3,000 6,000 10
 D-16

R 30,000 9,000 8
Product A 3,000 1,500 --
B 4,000 4,500 -
Prepare a Production and the Materials Budget showing the expenditure
on purchase of materials for the year ending 31st December, 1993.
(I.C. W.A. Final)
Solution
Production Budget
For the year ending 31st December, 1993
Product A Product B
(Kg.) (Kg.)
Sales 15,000 75,000
Add : Closing Stock 1,500 4,500
16,500 79,500
Less: Opening Stock 3,000 4,000
Production 13,500 75,500
Material budget
For the year ending 31s' December, 1993
Particulars P (Kg.) Q (Kg.) R (Kg.)
For Product A
13,500 Kg i 3:5:2 4,050 6,750 2,700
For Product B
75,500 kg in 1:2 (Q&R) - 25,167 50,333
Material Consumption 4,050 31,917 53,033
Add : Closing Stock 3,000 6,000 9,000
7,050 37,917 62,033
Less : Opening Stock 4,500 3,000 30,000
Material Purchase Budget 2,550 34,917 32,033
Cost per kt. ?12 ? 10 ?8
Expenditure on Purchase of materials for 30,600 3,49,170 2,56,264
1993 (?)
Direct Labour Budget: The labour budget is concerned with determining the
effort of direct labour required for production. Indirect labour is budgeted as
part of Factory overhead.
The labour content is determined in terms of grades of workers required
at various stages of the production process. The number of hours of each type
of labour for each job, process and operation is determined with the help of
time and motion study. The rates of pay, including all allowances, are multiplied
by labour time for calculating labour cost. If labour incentive schemes are in
operation, then labour rates should be suitably increased.
Preparation of Labour budget is very critical as labour has a human
element that involves lot of uncertainty. Unlike materials and machines, labour
has the ability to disagree with the management. Hence, a proper understanding
 D-17

of labour is very essential. Labour budget helps the organization to understand

the requirement of skills that are needed to meet the production budget. It can
plan its training and recruitment according to the skills required and build
sufficient buffer or reserve as a protection against unplanned termination of
services of one or more employees.
Plant Utilization Budget: This budget lays down the requirements of plant
capacity to meet the targets as per production budget. Preparation of a Plant
utilization takes into account available machine capacity. Machine capacity
should be sufficient to produce the number of units stated in the production
budget. If not, either the production budget is revised or additional plant
capacity will have to be created. Plant capacity can be productively used by
application of PERT / CPM techniques.
Manufacturing Overheads Budget: Manufacturing overheads comprise of
manufacturing costs on account of indirect labour, indirect materials and other
factory expenses. Manufacturing overheads cost are classified into fixed cost,
variable cost and semi-variable cost.
The fixed works overheads cost remains constant irrespective of output
and it is estimated on the basis of past experience. The variable works overhead
cost is determined per unit of cost and it is calculated by multiplying the rate
per unit by the budgeted output. Semi-variable costs can be determined by
segregating them into their Fixed and variable components.The level of activity
that is budgeted as per produciton budget is the key factor in budgeting for
manufacturing overheads. The manufacturing overheads budget can be broken
down into departmental overhead budget for the purpose of having greater
control.
Selling and Distribution Overhead Budget: This budget includes all expenses
relating to selling and distribution of goods. These expenses may be analyzed
according to products, territories, salesmen, etc. The fixed expenses under
this category may be estimated on the basis of past experience and anticipated
changes. Variable selling and distribution overheads will vary with the
executives of sales departments. The volume of these expenses should be in
direct proportion to expected sales figures. The future expectations estimated
by the management, advertising policies, research programs and nature of
these expenses will influence the preparation of selling and distribution
overhead budget.
Illustration-4: A department of Company X attains sales of ? 6,00,000 at
80% of the normal capacity and its expenses are given below :
Administration Cost ?
Office salaries 90,000
General Expenses 2% of the sales
Depreciation 7,500
Rates and taxes 8,750
 D-18

Selling Costs
Salaries 8% of the sales
Traveling expenses 2% of the sales
Sales Office 1% of the sales
General Expenses 1% of the sales
Distribution Costs
Wages 15,000
Rent 1% of the sales
Other expenses 4% of the sales
Draw up a flexible administration, selling and distribution costs budget,
operating at 90%, 100% and 110% of normal capacity. (C.A.Inter)
Solution
Flexible Selling & Distribution budget of department......of Company X
Level of activity
Items Basis 80%(f) 90%(f) 100%ft)
Sales 6,00,000 6,75,000 7,50,000 8,25,000
Administration Cost
Office salary Fixed 90,000 90,000 90,000 90,000
General Exp 2% of sales 12,000 13,500 15,000 16,500
Depreciation Fixed 7,500 7,500 7,500 7,500
Rates and taxes Fixed 8,750 8,750 8,750 8,750
Total Administration Cost 1,18,250 1,19,750 1,21,250 1,22,750
Selling Cost
Salary 8% of sales 48,000 54,0000 60,000 66,000
Sales Offce 1 % of sales 6,000 6,750 7,500 8,250
General Experses 1% of sales 6,000 6,750 7,500 8,250
Total selling cost 72,000 81,000 90,000 99,000
Distribution cost
wages Fixed 15,000 15,000 15,000 15,000
Rent 1% of sales 6,000 6,750 7,50 8,250
Other expenses 4% of sales 24,000 27,000 30,000 33,000
Total distribution costs 45,000 48,750 52,500 56,250
Total administration,
Selling and distribution costs 2,35,250 2,49,500 2,63,750 2,78,000
Note : In the absence of information it has been assumed that office salaries,
Depreciation, rates and taxes and wages remain the same at 110% level of
activity also. However, in practice some of these costs may change if present
capacity is exceeded.
Capital Expenditure Budget: The Capital Expenditure Budget lays down
the amount of estimated expenditure to be incurred on fixed assets during the
budget period. The budget highlights the fixed assets that are required to achieve
the produciton targets stated in the production budget. As the amount involved
in capital expenditure is usually high, this requires careful attention of the top
management. The budget is based upon the annual forecasts of capital
 D-19

expenditure of various divisions or departments. Each division or department

of an organization sends the annual forecast of capital expenditure of its own
department to Capital Expenditure Sanction Committee. The Committee,
considers the existing production capacity, need for replacement of assets,
planned capacity expansion, need for modernization and justification for the
capital expenditure in terms of cost saving or greater revenues, etc. It then
sanctions the expenditure and the required amount is incorporated in the budget.
The following is an illustrative sheet used for analysis of Capital Expenditure:
Capital Expenditure Analysis Sheet
Particulars Project 1 Project 2 Project 3
Division / Department
Description of Asset
------- :---- --------
External Costs
Purchase Price
Delivery & Installation
Total
Internal Costs
Material
Labour
Overheads
Total
Total External and Internal Costs
Estimated Life of Asset
Benefits Expected
Rate of return
Cost Savings or Cash Inflow
Asset to be replaced
Description
Cost
Remarks
Cash Budget: A Cash budget is a forecast of expected cash inflow and outflow.
It is an estimate of cash receipts and disbursements during a future period of
time. It translates all the operational planning of the organizations in terms of
flow of cash. It is prepared by the Management Accountant himself.
The Cash budget essentially has two parts, namely Receipts and
Disbursements. The excess of Receipts over Disbursements is called Cash
surplus. The excess of Disbursements over Receipts is called Cash Deficit.
The surplus or deficit is adjusted for the cash balance at the beginning of the
period. The deficit for any period is met by short-term borrowing or by making
use of Overdraft facility with the company's bankers. The management
accountant would ideally want to have a minimum amount of cash always
 D-20

available to the management to meet the day to day expenses and to take care
of any unforeseen circumstances. Thus, an organization may use the overdraft
facility even if it has a surplus, if the closing cash balance is less than the
required minimum balance. At the same time, any idle cash can be more
profitably invested in short-term investments.
Preparation of Cash budget involves forecasting all possible sources from
which cash will be received and the channels in which payments are to be
made so that a consolidated cash position is determined. The cash receipts
from various sources include cash sales, estimated cash collection for credit
sales, debts, bills receivable, miscellaneous receipts such as interest, dividends,
etc. Any inflow from anticipated sale of investments or other assets is also
considered. The amounts to be spent on purchase of materials, payment to
creditors, meeting various other revenue expenditure such as wages, electricity
costs, advertisement expenses, etc are listed under disbursements or Payments.
Payment towards Capital expenditure, income tax payments, dividend payable,
etc also form part of disbursements.
Illustration-5: From the following information of Moon Ltd., prepare a Cash
Budget for the three months commencing on 1st June 1990, when the Bank
balance was ? 10,000.
Month Sales Purchases Wages Selling Exp. Overheads
(V (9 (?) (?) (?)
April 1,00,000 70,000 8,500 3,500 4,000
May 1,20,000 80,000 9,500 3,500 4,500
June 1,40,000 90,000 9,500 3,500 6,000
July 1,60,000 1,00,000 12,000 3,500 6,500
August 1,80,000 1,10,000 14,000 3,500 7,000
A sales commission of 5% on sales due 2 months after sales is payable
in addition to the selling expenses. Credit terms of Sale are - payment by the
end of the month following the month of supply. On average, one half of the
sales is paid on the due date while the other half is paid during the next month.
Creditors are paid during the month followng the month of supply. Plant
purchases in June for ? 78,000; payable on delivery ? 48,000 and balance in
two equal monthly installments, in July and in August. A dividend of ? 30,000
will be paid in September. Wages are paid %th on due date while *4th during the
next month. Lag in payment of selling expenses and overheads is one month.
{B.Com., (H.Nos) Calcutta}
Solution :
Cash Budget
for the three months ending 31st August.........
June(^) July(^) August(^)
Receipts
Balance b/d 10,000
Cash Receipt from debtors 1,10,000 1,30,000 1,50,000
 D-21

Bank Overdraft to fund Dificit 30,500 32,375 27,875

(balancing figure)
1,50,500 1,62,375 1,77,875
Payments :
Repayment of Bank overdraft (b.f.) 30,500 32,375
Payments to creditiors 80,000 90,000 1,00,000
Plant Purchased 48,000 15,000 15,000
Wages Paid 9,500 11,375 13,500
Selling Commission 5,000 6,000 7,000
Selling Expenses 3,500 3,500 3,500
Overheads 4,500 6,000 6,500
1,50,500 1,62,375 1,77,875
Working Notes :
1. Cash Received from Credit Sales : Amount is received at the end of
the month following the month of supply. Thus, due date for April sales
is May 31s1. However, only 50% of the amount is received on due date.
Remaining 50% is received in the next month (i.e. June). Similarly, for
all other months. Thus, the amounts received can be tabuated as under :
Amount Collected in the Month of
Month Amount ? June August
April 1,00,000 50%* 1,00,000
= 50,000
May 1,20,000 50%* 1,20,000 50%* 1,20,000
= 60,000 = 60,000
June 1,40,000 50%* 1,40,000 50%* 1,40,000
= 70,000 = 70,000
July 1,60,000 50% * 1,60,000
= 80,000
Total 1,10,000 1,30,000 1,50,000
2. Selling Commission : A sales commission of 5% on sales is payable 2
months after sales. Thus, commission on Sales pertaining to April are
payable in June. Similarly, commission on Sales pertaining to May and
June are payable in July and August respectively. The amount is calculated
as under :
on April Sales : ? 1,00,000 *5% = ? 5,000 (payable in June)
on May Sales : ? 1,20,000 *5% = ? 6,000 (payable in July)
on June Sales : ? 1,40,000 * 5% = ? 7,000 (payable in August)
3. Wages : % Wages are payable in the same month. (4 is payable in the
next month. Thus, cash outflow on account of wages will be equal to
75% of wages of the same month + 25% of wages of the previous month.
For example, wages payable in June will be 14 of May + % the June =
25% * 9500 + 75% *9500 = 2,375 + 7,125 = 9,500. Similarly, other
months.
 D-22

Flexible Budget: As stated earlier, "a flexible budget is a budget which is

designed to change in accordance with the level of activity actually attained".
It provides the budgeted costs at any level of activity. In order to prepare such
a budget, all the costs need to be classified into Fixed costs and Variable Costs.
All Semi Variable costs should also be split into their fixed and variable
components so that it becomes easy to estimate such costs at any given level
of activity.
Sales can be assumed to vary proportionately to level of activity, unless
volume discounts or a differential pricing policy is specifically mentioned.
Fixed costs will remain fixed at any given level of activity. They will not
change except in special circumstances, which will be stated in the problem.
Variable expenses will change in proportion to the level of acdtivity.
Illustration-6: The monthly budgets for manufacturing overhead of a concern
for two levels of activity were as follows :
Capacity 605 100%
Budgeted Production (Units) 600 1,000

Wages 1,200 2,000

Consumable Stores 900 1,500
Maintenance 1,100 1,500
Power and Fuel 1,600 2,000
Depreciation 4,000 4,000
Insurance 1,000 1,000
9,800 12,000
You are required to
i. Indicate which of the items are fixed, variable and semi-variable
ii. Prepare a budget for 80% capacity and
iii. Find the total cost, both fixed and variable, per unit of output at 60%,
80% and 100% capacity. (ICS-Inter)
Solution: Of the above expenses, Depreciation and insurance are Fixed
Expenses. There is no change in these expenses at 60% and at 100% capacity.
The other four expenses vary at the two levels. Let us calculate their cost per
unit.
60% 100%
Wages 1,200/600=2.00 2,000/1000=2.00
Consumable Stores 900/600 = 1.50 1,500/1000= 1.50
Maintenance 1,100/600= 1.83 1,500/1000=1.50
Power and Fuel 1,600/600 = 2.67 2,000/1000 = 2.00
Wages at ? 2.00 per unit and Consumables stores at ^1.50 per unit are
Variable expenses. Maintenance and Fuel exepenses are semi variable.
We need to break the semi variable expenses into their Fixed and Variable
components.
 D-23

Maintenance expenses have increased from ? 1,100 to ? 1,500 when

number of units increased from 600 to 1000. Thus, the additional increase of
? 400 is on account of increase in number of units by 400. Thus, the per unit
increase in maintenance expenses will be
? 400/400 - Re.l per unit
Thus, the Variable component is Re. 1 per unit.
At 60% capacity, variable component of Maintenance cost = 600 units * Re. 1
per unit - ? 600. Thus, Fixed component = ? 1,100 - ? 600 = ? 500.
Similarly, Power and Fuel.
Variable component =
2,000 - 1,600 / 400 = 400 MOO = Re. 1 per Unit
Fixed Component = ? 1,600 - (600 *Re. 1 per unit) = ? 1,000.
i) Budget for 80% capacity (output 800 Units)

Wages @ ? 2 per unit (800 *2) 1,600

Consumable stores @ ^1.50 per unit (800 *1.50) 1,200
Maintenance : T 500 + Re.l per unit (500 + 800 *1) 1,300
Power and Fuel ? 1,000 + Re.l per unit (1000+800*1) 1,800
Depreciation 4,000
Insurance 1,000
10,900
Total Cost
(iii) Capacity 60% 80% 100%
Units 600 800 1,000

Fixed Costs Total Per Unit Total Per Unit Total Per Unit
a
Depreciation 4,000 4,000 4,000
Insurance 1,000 1,000 1,000
Maintenance 500 500 500
Power and fuel 1,000 1,000 1,000
6,500 10.83 6,500 8.125 6,500 6.50
Variable Costs
Wages 1,200 2.00 1,600 2.00 2,000 2.00
Consumables 900 1.50 1,200 1.50 1,500 1.50
Maintenance 600 1.00 800 1.00 1,000 1.00
Power and 600 1.50 800 1.50 1,000 1.50
Fuel
3,300 5.50 4,400 5.50 5,500 5.50
Total cost 9,800 16.33 10,900 13.625 12,000 12.00
Sales Budget:
 D-24

PROBLEMS
1. The HP Ltd, manufactures which two Brands A and B, gives the following
particulars. The Sales Department of the company has three departments
in different areas of country.
The sales Budget for the year ending 31st December 1992 were :
A Department I 6,00,000
Department II 11,25,000
Department III 3,60,000
B Department I 8,00,000
Department II 12,00,000
Department III 40,000
Sales price are ? 3,000 and 4,000 in all departments.
It is estimated that with rigorous sales promotion, the sale of "B" in
Department I will increase by 3,50,000. It is also expected that by increasing
production and arranging extensive advertisement, Department III will be able
to increase the sales of B to 1,00,000. It is recognized that the estimated sales
by Department II represents an unsatisfactory target. It is agreed to increase
both estimates by 20%.
Prepare a Sales Budget for the year to 31SI December 1992.
(B. Com Bangalore) {Ans : (Rupees in '000s) A ? 6930; B % 10760}
2. Chandram Bros sells two products, which are manufactured in one plant.
During the year 1982, it plans to sell the following quantities of each
product:
Sales Estimates (Units)
I Quarter II Quarter
Product I 90,000 2,30,000
Product II 85,000 75,000
III Quarter IV Quarter Total
Product I 3,00,000 80,000 7,00,000
Product II 55,000 85,000 3,00,000
Each of these two products is sold on a seasonal basis. Product I tends to
sell better in summer months, while Product II sells better in winter months.
Chandram B ros plan to sell Product I throughout the year at a price of ? 10 and
Product II at a price of 20 per unit. A study of the past experience reveals
Chandram Bros have lost about three per cent of its billed revenue because of
returns (constituting a two per cent loss of revenue), allowances and bad debts
(one per cent loss)
Prepare a Budget incorporating the above given information.
(B.Com., Bharathidasan) (Ans : ? 1,26,10,000)
Production Budget
3. From the following particulars, prepare a production budget of Arun
Sales Corporation for the year ended June 30, 1987.
 D-25

Product Sales (units) Estimated stock (units)

(as per sales July 1,1986 June 30,1987
Budget)
A 1,50,000 14,000 15,000
B 1,00,000 5,000 4,500
C 70,000 8,000 8,000
(B.Sc., Bharathidasan) (Ans:■A 1,51,000; B 99,500; C 70,000 units)
4. From the following data, prepare a production budget for the ABC Co.,
Ltd.,
Stocks for the budgeted period :
Product As.on 1st January As on JO"1 June
A 8,000 10,000
B 9,000 8,000
C 12,000 14,000
Requirements to fulfill sales program
A 60,000
B 50,000
C 80,000
Normal Loss in production :
A 4%
B 2%
C 6%
5. Gama Engineering Company Limited manufactures two products X and
Y. An estimate of the number of units expected to be sold in the first
seven months of 1975 is given below :
Product X Product Y
January 500 1,400
February 600 1,400
March 800 1,200
April 1,000 1,000
May 1,200 800
June 1,200 800
July 1,000 900
It is anticipated that
1. There will be no work-in-progress at the end of any month; and
2. Finished units equal to half the anticipated sales for the next month will
be in stock at the end of each month (including December 1974).
The budgeted production costs for the year ending 31st December, 1975
are as follows :
Product X Product Y
Production (Units) 11,000 12,000
Direct materials per unit (?) 12 19
Direct wages per unit (?) 5 7
 D-26

Other manufacturing charges apportionable to 33,000 48,000

each type of product (?)
You are required to prepare
(a) A production budget showing the number of units to be manufactured
each month.
(b) A summarized production cost budget for the six-month period January
to June 1975.
(B.Com Pune, B.Com (Hons) Delhi, C.A. Final) (Ans : Cost of Production :
XI 1,11,000; K? 1,90,500)
(Hint: Assume manufacturing expenses as variable)
6. U.P. Agro Industries Ltd. manufactures pickles and juices. The sales
department has prepared the following forecasts for the six months of
1990 :
Pickles: No. ofBottles
Mango 1,00,000
Mixed 75,000
Juices:
Apple 25,000
Mango 15,000
Pineapple 35,000
The inventory levels have been determined as under
Work in progress Finished goods
Products Units % Completed
Opening Closing Opening Closing Opening Closing
Pickles:
Mango 25,000 40,000 80 60 7,500 6,000
Mixed 15,000 25,000 60 80 3,000 2,000
Juices:
Apple 5,000 4,000 80 75 1,500 2,000
Mango 3,000 3,000 70 80 800 500
Pineapple 4,000 5,000 75 80 2,000 2,000
The production in each month is expected to be uniform. Prepare producftion
budget for six months.
(Ans : Mango 1,02,500; Mixed 85,000; Apple 24,500; Mango Juice 15,000;
Pineapple 36,000 bottles)
Materials Budget
7. From the following figures, prepare the Raw Materials Purchase budget
for January, 1987 :
Material (Units)
A B c D E F
Estimated Stock
on January 1 16,000 6,000 24,000 2,000 14,000 28,000
Estimated Stock
 D-27

January, 31 20,000 8,000 28,000 4,000 16,000 32,000

Estimated
Consumption 1,20,000 44,000 1,32,000 36,000 88,000 1,72,000
Standard Price
Per unit 25p. 5p. 15 p. 10 p. 20 p. 30 p.
(B.Com., Madras 1980) (Ans : Total Estimated Purchases ? 1,28,300)
8. The sales director of a manufacturing company reports that next year he
expects to sell 54,000 units of a certain product.
The production manager consults the store-keeper and casts his figures
as follows:
Two kinds of raw materials, A and B, are required for manufacturing the
product. Each unit of the product required 2 units of A and 3 units of B. The
estimated opening balances at the commencement of the next year are :
Finished product—10,000 units, A-—12,000 units, B-—15,000 units.
The desirable closing balances at the end of the next year are :
Finished Product—14,000 units, A—13,000 units, B—16,000 units.
Draw up a quantitative chart showing the Materials Purchases Budget
for the next year.
(M.Com., Calcutta) (Ans ; A T 1,17,000 units; B f 1,75,000 units)
9. From the given particulars presented by P.Ltd., you are asked to prepare
a Materials Budget. Estimated Sales 50,000 units. (Each unit of the
production requires 2 units of material X and 4 units of material Y).
Estimated Opening Balance
Finished goods 10,000 Units
Material - X 15,000 Units
Material - Y 25,000 Units
Materials on Order (Opening)
Material - X 8,000 Units
Material - Y 12,000 Units
Estimated Closing Balance
Finished goods 6,000 Units
Material - X 16,000 Units
Material - Y 30,000 Units
Materials on Order (Closing)
Material - X 6,000 Units
Material - Y 8,000 Units
(B.Com., Madurai) (Ans : X ? 91,000; Y ? 1,85,000 Units)
(Hint: The treatment ofMaterials on order is same as that ofstock ofmaterials)
10. The following details apply to an annual budget for a manufacturing
company :
Quarter Is* 2nd 3rd 4<h
Working days 65 60 55 60
Production (units per working day) 100 110 120 105
 D-28

Raw Material Purchases (% by weight of

annual total) 30% 50% 20%
Budgeted Purchases price (per kg.) ? 1 1.05 1.125
Quantity of Raw Material per unit of production : 2 Kg
Budgeted opening stock of raw material - 4,000 kg. (Cost ? 4,000)
Budgeted closing stock of raw material: 2,000 kg.
Issues are priced on FIFO basis
Calculate the following budgeted figures :-
(a) Quarterly and annual purchases of raw material, by weight and value.
(b) Closing quarterly stocks by weight and value.
(I.C. W.A. Inter) (Ans : a) Annual Purchases Q 115,000 kg; ? 15,000 Q II 25,000
kg; T 26,250 Q III 10,000 kg; T 11,250 b) Closing Stock Q16,000 kg. ? 6,000
0. II17,800 kg; T 18,690 £11114,666 kg-, 16,686; £ IV 1,000 Kg; } 1,150)
11. Sangrila Food Products Limited has prepared the following Sales Budget
for the first five-months of 1993 :
Sales Budget
(in Units)
January 10,800
February 15,600
March 12,200
April 10,400
May 9,800
The inventory of finished products at the end of evey month is to be
equal to 25 percent of the sales estimate for the next month. On January 1,
1993, there were 2,700 units of product in hand. There is no Work-in-process
at the end of any month.
Every unit of product requires two types of materials in the following quantities
Material A 4 Units
Material B 5 Units
Materials equal to one-half of the next month's production are to be in
hand at the end of every month. This requirement was met on 1st January,
1993.
Prepare a Materials Budget for the first quarter of 1993 in a logical form
showing the quantities of each type of material to be purchased.
(B.Com., Hons., Delhi) (Ans : Material requirementfor the first quarter of1993 :
Material A = 1,50,500 units; Material B= 1,88,125 units)
12 . From the information given below, prepare a manufacturing overhead
(budget for the quarter ending December 31, 2000 :
Budget output during the quarter 5,000
Fixed overheads ? 30,000
Variable Overheads (varying at the rate of ? 5 per unit) ? 15,000
Semi-variable Overheads (40% fixed and 60% varying @? 3 per unit)
(Ans : Total Overheads Cost ? .76,000)
 D-29

13. Prepare a manufacturing overhead budget and ascertain the

manufacturing overhead rates at 50% and 70% capacities. The following
particulars are given at 60% capacity.
5=
Variable Overheads
Indirect Material 6,000
Indirect Labour 18,000
Semi-Variable Overheads
Electricity (40% fixed) 30,000
Repairs and Maintenance (20% variable) 3,000
Fixed Overheads
Depreciation 16,500
Insurance 4,500
Salaries 15,000
Total overheads 93,000
Estimated Direct Labour hours 1,86,000 hrs
(B.Com., Punjab, Calicut) (Ans : Total overheads : 50% T 85,900; 60% T 93,000;
70 % T 1,00,100)
14. You are requested to prepare a sales overhead budget from the forecasts
given below :
5=\
Advertisement 5,000
Salaries of sales department 10,000
Expenses of sales department 3,000
Counter salesmen salary allowances 12,000
Commission at 10% on their sales and expenses at 5% on their sales.
Sales have been budgeted as under :
Period Conter sales T Travelling sales men sales %
A 1,60,000 20,000
B 2,40,000 30,000
C 2,80,000 40,000
(Ans : Period A ? 34,600; Period B T36,900 Period C T38,800)
15. Following information is given about a Ltd. concern. You are required
to prepare a Selling Overheads Budget:
3=\
Advertisement 2,000
Salaries of sales department 2,000
Expenses of Sales department - Fixed 950
Salesmen remuneration :
Salaries 6,000
Commission @ 1 % on sales affected
Carriage Outwards : Estimate @ 5% on Sales
Agent's Commission 6% on sales.
Sales during the period were estimated as follows :
 D-30

? 1,00,000 including Agent's sales ?10,000.

? 1,50,000 including Agent's sales ? .20,000
? 2,00,000 including Agent's sales ? 20,000.
(Ans : ? 17,450, ? 20,950,723,950)
Cash Budget:
16. The following expenses are incurred in a factory for the months of January
and February in a particular year.
January (?) February (?)
Wages 16,000 20,000
Salaries 10,000 12,000
Factory Expenses 14,000 16,000
Calculate the budgeted cash outflow for the month of February taking
into account that:
(a) Wages are paid at the beginning of next week;
(b) Salaries are paid at the beginning of next month and
(c) Time lag in case of factory expenses is half month.
(B.Com., Calicut University) (Ans : Budgeted Cash outflow = 744,000)
17. A firm expects to have ? 30,000 in the bank on 1 May 1980, and requires
you to prepare an estimate of the cash position during the three months
May to July 1980. The following information is supplied to you
Month Sales Purchases Wages Factory Office Selling
Exp. Exp. Exp.
(V (V (9 (?) (?) (?)
March 40,000 24,000 6,000 3,000 4,000 3,000
April 46,000 28,000 6,500 3,500 4,000 3,500
May 50,000 32,000 6,500 4,000 4,000 4,000
June 72,000 36,000 7,000 4,400 4,000 4,000
July 84,000 40,000 7,250 4,250 4,000 4,000
Other information
i. 25% of the sales is for cash, remaining amount is collected in the month
following that of sales.
ii. Suppliers supply goods at two months credit
iii. Delay in payment of wages and all other expenses - one month
iv. Income tax of ?10,000 is due to be paid in July and
v. Preference share dividend of 10% on ? 1,00,000 to be paid in May.
(B.Com., Punjab University, 1982) (Ans : Cash balance : May ? 25,500;
June ? 35,000; July ? 48,600)
18. From the following forecasts of income and expenditure, prepare a cash
budget for the months January to April, 2000 :
Months Sales Purchases Waes Mnfg Admn Selling
(Credit) ? (Credit)? ? Exp? Expenses? Exp?
1999 Nov 30000 15,000 3,000 1,150 1,060 500
Dec 35,000 20,000 3,200 1,225 1,040 550
 D-31

2000 Jan 25,000 15,000 2,500 990 1,100 600

Feb 30,000 20,000 3,000 1,050 1,150 620
Mar 35,000 22,500 2,400 1,100 1,220 570
April 40,000 25,000 2,600 1,200 1,180 710
Additional information is as follows
1. The customers are allowed a credit period of 2 months.
2. A dividend of ? 10,000 is payable in April.
3. Capital expenditure to be incurred : Plant purchased on 15th of January
for ? 5,000; a Building has been purchased on Is' March and the payments
are to be made in monthly installments of ? 2,000 each.
4. The creditors are allowing a credit of 2 months.
5. Wages are paid on the Is'of the next month.
6. Lag in payment of other expenses is one month.
7. Balance of cash in hand on 1st January, 2000 is ? 15,000.
(B.Com., Delhi) (Ans : Closing Balance : Jan ? 18,985; Feb : ?28,795;
Mar K 30,975; Apr : f 23,685)
19. National products Limited wants to approach its bankers for temporary
overdraft facility for the quarter beginning Is' October, 1996. During the
period of these three months, the company will be manufacturing mostly
for stock. You are required to prepare cash budget for the above period
from the following data indicating the overdraft facility required by the
company at the end of each month.
Sales(f) Pruchases(^) Wages (?)
August, 1996 3,60,000 2,49,600 24,000
September, 1996 3,84,000 2,88,000 28,000
October, 1996 2,16,000 4,86,000 22,000
November, 1996 3,48,000 4,92,000 20,000
December, 1996 2,52,000 5,36,000 30,000
(a) 50% of credit sales are realized in the month following sales and the
remaining 50% in the second month following.
(b) Creditors are paid in the month following the month of purchase.
(c) Estimated cash at bank as on 1st October, 1996 ? 50,000
(M.Com., Madras) (Ans : Overdraft at the end ofNovember f 94,000;
December ? 3,34,000)
20. Sundaram & Co. wishes to arrange overdraft facilities with its bankers
during the period April to June of a particular year, when it will be
manufacturing mostly for stock. Prapre a cash budget for the above period
from the following data indicating the extent of the bank's facility the
company will require at the end of the eah month.
(i) Month Sales (?) Purchases (?) Wages (?)
February 1,80,000 1,24,800 12,000
March 1,92,000 1,44,000 14,000
April 1,08,000 2,43,000 11,000
 D-32

May 1,74,000 2,46,000 10,000

June 1,25,000 2,68,000 15,000
(ii) 50% of the credit sales are realized in the month following the sales and
the remaining sales in the following second month. Creditors are paid in
the following month of purchases.
(iii) Cash at bank on 151 April (estimated ? 25,000).
(M.Com., Madras; ICWA) (Ans : Overdraft at the end of May f 47,000;
June 11,67,000)
21. Based on the following information, prepare a Cash Budget for ABC
Ltd.
J* 2'"' 3rd
Quarter(1) Quarter(l) Quarter(l) Quarter(l)
Opening Cash balance 10,000
Collection from customers. 1,25,000 1,50,000 1,60,000 2,21,000
Payments
Purchase of Materials 20,000 35,000 35,000 54,200
Other expenses 25,000 20,0000 20,000 17,000
Salary & Wages 90,000 95,000 95,000 1,09,200
Income tax 5,000 - - -
Purchase of Machinery - - - 20,000
The company desires to maintain a cash balance of ? 15,000 at the end
of each qurter. Cash can be borrowed or repaid in multiples of ? 500 at an
interest of 10% per annum. Management does not want to borrow cash more
than what is necessary and wants to repay as early as possible. In any event,
loans cannot be extended beyond four quarters. Interest is computed and paid
when the principal is repaid. Assume that borrowings take place at the beginning
and repayements are made at the end of the quarters.
(I.C. W.A - Inter, Dec. 1991) Ans : Closing Balance : QI ? 15,000, Q2 1 15,000,
Q3 ? 15,325, Q4 1 23,825)
(Hint: Principal Repayment Q3 19,000, Q4 111,000 Interest payment, Q3 1 675,
Q4 11,100)
Flexible Budget:
22. The expenses budgeted for production of 10,000 units in a factory are
furnished below :
Per. Unit (1)
Materials 70
Labour 25
Variable Overheads 20
Fixed overheads (? 1,00,000) 10
Variable expenses (direct) 5
Selling expenses (10% fixed) 13
Distribution expenses (20% fixed) 7
Administration expenses (? 50,000) 5
155
 D-33

Prepare a budget for 6,000 units and 8,000 units. (Administration

expenses are fixed for all levels of production)
(Bangalore University, B.Com.) (Ans : Total Cost: 6,000 units f 10,00,800;
8,000 units f 12,75,400; 10,000 units f 15,50,000)
23. Johnson & Co. produces an article, the estimated cost per unit are given
below :

Materials go
Labour 43
Expenses 12
Semi-Variable overheads at 100% activity level (10,000) are estimated
to be ? 2,40,000 and these overheads vary in steps of 12,000 for each change
in output of 1,000 units.
Fixed overheads are estimated at ? 3,00,000. The selling price per unit is
also estimated at ? 240.
Prepare a flexible budget at 50%, 70% and 90% levels of capacity.
(B.Com., Bangalore) (Ans : Budgeted Profit: 50% fl,20,000, 70%
f 3,36,000 90% f 5,52,000)
24. A factory is currently working to 50% capacity and produces 10,000
units. Estimate the profits of the company when it works to 60% and
80% capacity.
At 60% working, raw material cost increases by 2% and selling price
falls by 2%. At 80% raw material cost increases by 5% and selling price falls
by 5%. At 50% capacity working, the product cost ?180 per unit and sold at
? 200 per unit. The cost of T180 is made up as follows.

Materials 100
Labour 39
Factory overhead (40% fixed) 30
Administration overhead (50% fixed) 20
(B.Com., Bangalore) (Ans : Profit: 60% f 2,12,000; 80% ? 2,12,000)
25. The cost of an article at the capacity level of 5,000 units is given below.
For variation of 25% in capacity above or below this level, the individual
expenses vary as per details given against each cost.

Material Cost 25,000 100% Variable

Labour Cost 15,000 100% Variable
Power 1,250 100% Variable
Repairs 2,000 75% Variable
Stores 1,000 100% Variable
Inspection 500 20% Variable
Depreciation 10,000 20% Fixed
 D-34

Administration overheads 5,000 25% Variable

Selling overheads 3,000 50% Variable
Total 62,750
Cost per unit 12.55
Prepare the produciton budget at 4,000 and 6,000 units.
(M.Com., Bangalore; M.Com, SKU) (Ans ; Taotal Cost; 4,000 units ?53,480;
6,000 units 72,020)
26. A company produces a product. The estimated costs per unit are as follows

Raw Materials 5.00

Direct Labour 3.00
Variable overheads 6.00
The Semi Variable costs are

Indirect Materials 2,000

Indirect Labour 1,500
Maintenance and repairs 2,800
The variable cost per unit included in semi-variables are :
Re.
Indirect Materials 0.50
Indirect Labour 0.12
Maintenance and repairs 0.15
The Fixed costs are :

Factory 5,000
Administration 4,000
Selling and distribution 3,000
The above costs are at 70% normal capacity producing 700 units. The
selling price is ? 50 per unit.
Prepare flexible budget for 60%, 80% and 100% normal capacities from
the above particulars.
(B.Com., Bangalore) (Ans ; Profit 60% ? 3,332; 80% ? 10,468; 100% ? 17,604)
27. Excellent Engineering Works had prepared its budget for 1989, based
on the production of one-lakh units of their only product as follows :
? ('000')
(a) Raw Material 252
0?) Direct Labour 75
fc) Direct Expenses 10
(d) Works overheads (60% fixed) 225
(e) Administration overheads 40
(f) Selling overheads (50% fixed) 20
 D-35

For want of demand, the actual production for that period was only 60,000
units. Calculate the budgeted cost per unit under both the original plan and
under actual performance
(M.Com., Madras) (Ans : Total Cost Original Plan T 6,22,000;
Revised Plan ? 4,47,200)
28. The following data are available in a manufacturing company for a year
Fixed Expenses (Lakhs)
Wages and Salaries 95
Rent, rates and taxes 6.6
Depreciation 74
Sundry administrative expenses 6.5
Semi-Variable Expenses (at 50% capacity)
Maintenance and Repairs 35
Indirect labour 79
Sales department salaries etc. 33
Sundry administrative expenses 2.8
Variable Expenses (at 50% of capacity)
Materials 217
Labour 20 4
Other Expenses 79
98.0
Assume that the fixed expenses remain constant for all levels of
production, semi variable expenses remain constant between 45% and 65% of
capacity increasing by 10% between 65% and 80% capacity and by 20%
between 80% and 100% capacity.
Sales at various levels
? (lakhs)
50% capacity jqo

60% capacity 120

75% capacity 159
90% capacity |g()
100% capacity 200
Prepare a flexible budget for the year and forecast the profits at 60%,
75%, 90% and 100% of capacity.
(ICWA - Inter) (Ans : Profit (t In Lakhs) 50% f 2.00; 60% ? 12.00; 75% T 25.20;
90% ? 38.40; 100% ? 48.40)
 Chapter -5
STANDARD COSTING
& VARIANCE ANALYSIS

Introduction : We have so far learnt about Historical Costing and Marginal

Costing. The emphasis was mainly on ‘what a product or service has cost’.
Historical Costing helps us in finding out the costs incurred and Marginal
costing helped us in adopting appropriate pricing strategies by differentiating
between Fixed and Variable cost. Yet, neither Historical costing nor Marginal
costing stressed on Cost Control. The deficiencies of historical costing and
the shift in emphasis from cost ascertainment to cost control have led to the
development of the technique of standard costing.
Standard Cost and Standard Costing : When a businessman is planning to
start a production unit, he will try to estimate the probable cost of production.
This can be done with the help of some basic rule of thumb calculations. For
example, he may state that production overheads will be roughly 100% of
Direct labour. While his basic of estimation may be correct, it results from
past experience and contains all the inefficiencies that were present earlier.
However, if the businessman chalks out a clear plan in terms of the technology
to be used and incorporates the various concepts of production engineering
into his plan, he is likely to have more clarity in respect of how the costs are
likely to be. When he actually sets out to start production, the actual costs may
or may not be equal to what he had forecast, but he knows what the costs
ideally ought to be. Such pre-determined costs are called Standard Costs and
the technique of ascertaining the standard costs is called Standard Costing.
According to ICMA, England, the term ‘Standard Cost’ can be defined
as “a pre-determined cost which is calculated from management’s standards
of efficient operations and relevant necessary expenditure”. Kohler defines
Standard cost as “a forecast or pre-determination of what actual cost should
be under projected conditions, serving as a cost control and as a measure of
production efficiency or standard of comparison when ultimately aligned
against actual cost”.
Thus, Standard Cost can be understood as a pre-determined cost
calculated in relation to a prescribed set of working conditions, correlating
technical specifications and scientific measurements of various elements of
cost. Standard cost is a target cost that must be attained. It is a planned cost
 E-2

estimated in advance of production, based on technical and engineering studies,

production methods, material specifications, and material and labour price
projections. It cannot be computed until a technical specification has been
written up for the manufacture of the product. It is on this document that the
cost estimates are based.
Standard costing is defined by the ICMA, England as “the preparation
and use of standard costs, their comparison with actual costs and the analysis
of variances to their causes and points of incidence.” Standard costing is a
technique of cost ascertainment and cost control. It establishes pre-determined
estimates of the costs of products and services. The pre-determined estimates
are based on management’s standards of efficient operationa. Thus, the
emphasis is on ‘what the costs should be’. These costs are then compared with
the actual costs and the Variances are analyzed. Management is made aware
of the adverse variance and given an opportunity to take corrective action
without delay.
Standard Costing and Historical Costing : Standard Costing has evolved
out of the limitations of Historical costing. As such, it differs from Historical
Costing in the following aspects:
1. Historical Costing is concerned with calculation of costs after they are
incurred. Standard Costing is concerned with determination of costs
before they are incurred.
2. Standard Costing has a much wider scope. Historical Costing records
only past operations. Standard Costing sets standards before
commencement of production, compares actual results with Standards
set up and analyses the variances between the two.
3. Historical Costing is concerned with ascertainment of costs, while
Standard Costing is concerned with measurement of efficiency
operations.
4. Standard Closing is very useful in controlling the cost of current
production. Since cost data from Historical Costing is not immediately
available, it is more of a post-mortem rather than a measure for controlling
current costs.
5. Historical Costing is valid for only one accounting period for which
cost has been ascertained. Standard costing is valid for multiple number
of years. Standard costs determined once are applicable as long as the
basis of their calculation does not change. However, there may be periodic
revisions in standard costs.
6. Recording of historical costs keeps changing depending on volume of
production (due to recovery of overheads). Standard costing is not
concerned with actual volume as it records costs for normal production
at normal efficiency standards and normal costs.
Standard Cost and Estimated Cost: Standard costs can be often confused
as estimated costs. Estimated costs focus on ‘what the product or service is
 E-3

likely to cost’. Standard costing is concerned with ‘what a product or service

should cost’. Estimated costs differ from standard costs in the following respects
1. Difference in derivation. Estimated costs are best estimates arrived at
by using statistical devices. They are based on lot of assumptions and
involve some extent of guesswork. They are far from being scientific.
Standard costs are scientifically set since they are based on technical
and engineering estimates.
2. Difference in use. Estimate cost is used for cost ascertainment. Such
estimated costs are used for fixing sales prices. Estimated costs do not
emphasize cost control. Standard costing stresses on cost control.
3. Difference in records. Estimated costs are statistical in nature. As such,
they are not a part of the accounting system. They are only posted in the
cost sheet for the purpose of comparison. Standard costs, on the other
hand, are a part of the accounting system, and find a place in the
accounting records.
4. Applicability. Standard costing is most suitable to industries engaged in
mass production. Estimated costs are applicable to concerns engaged in
construction work such as buildings, factories, bridges, ships, and other
types of concerns such as bakeries, bottling companies, medicines and
dairy works.
Budgertary Control and Standard Costing: The techniques of Budgetary
Control and Standard Costing are similar in principle. They are concerned
with setting performance and cost levels for the purposes of control. However,
the two are not a substitute to each other but are complementary to each other.
Many concerns operate a comprehensive budgetary control system
without combining the technique of standard costing. Similarly, standard
costing can be operated without having a system of budgetary control. Although
each has a distinctive object of its own and one can be worked without the
other, they function much better in conjuction with each other than in isolation.
According to Bigg, “a logical development of Budgetary Control is
Standard Costing”. According to Batty, Blocker and Weltmer, some form of
budgeting is necessary for setting standards and the use of standard costs is
necessary for developing budgets. It is relatively easy to prepare budgets for
production costs and sales when standard costs are determined. On the other
hand, in determining standard costs, it is necessary to ascertain the level of
output for the period, and this is much easier when budgeted levels are set.
Thus, Budgetary Control and Standard Costing are inseparably linked together.
Each is an adjunct to managerial planning and control.
Similarities between Budgetary Control and Standard Costing
(a) Pre-determined standards are fixed for both.
(b) Both attempt at determining costs in advance.
(c) Both assume that costs are controllable along fixed lines of supervision
and responsibility.
 E-4

(d) Actuals are compared with the standard set in the case of both.
(e) Both aim at corrective action to be taken without delay, in the case of
adverse variances.
Difference between Budgetary Control and Standard Costing :
(i) Budgeted costs, based on past experience, are expected costs. However,
standard costs are planned costs, indicating the level of coSts that should
be attained.
(ii) While budgets are constructed on the basis of existing levels of efficiency,
standards are set on the basis of management’s standard of efficient
operation.
(iii) Budgets include both incomes, expenditure and the consequent impact
on profit/loss, whereas standards are essentially for expenditure. Although
Sales variances are calculated, they cannot be strictly termed as standard.
(iv) Budgets lay down the level of costs, which should not be exceeded.
Standards, on the other hand, emphasize the levels to which costs should
be reduced.
(v) Standards apply to particular products, individual operations or
processes. Budgetary control, on the other hand, is concerned with totals.
It lays down cost limits for functions and departments and for the firm
as a whole.
(vi) Budgets project financial accounts, while standaid costs project cost
accounts.
(vii) While budgeting is concerned with the origin of expenditure at functional
levels, standard costing is concerned with the requirement of each element
of cost for each cost unit.
(viii) Budgeting may either be partial or comprehensive but standard costing
cannot be applied in part.
(ix) Under the technique of budgetary control, deviations are found out by
putting the budgeted expenses and the actual expenses side by side and
not through accounts. In the case of standard costing, however, variances
are made to reflect themselves through different accounts.
(x) Budgetary control of expenses is more broad in nature, whereas in the
case of standard costing. Variances are analyzed to the minutest details.
Advantages of Standard Costing: The specific advantages of standard costing
are :
(a) Yardstick of performance : Standard costing serves as an effective
measure of performance. Actual performance is measured against pre­
determined standards to assess current performance. Areas where
attainable efficiency is not being achieved are brought to light.
(b) Facilitates Management by Exception : Attention of management is
drawn to adverse variances that are significant and also those that appear
to be suspicious. Analysis and investigation of variances pinpointing
inefficiency facilitates Management by Exception.
 E-5

(c) Simplification and Standardization of Production Methods: Fixation

of standards for every elefnent necessary involves analysis of operations.
A study of the standard time required for these operations is also
necessary. This automatically leads to simplification of operations,
products and methods. Further, investigation into the reasons for adverse
variances may reveal inefficiency and improve the methods of working.
(d) Assists the preparation of budget and forecasts: When standard costing
is in operation, the production would be valued at standard cost and
even the estimated revenue would be based upon standard prices.
Consequently, not only profit and loss account can be prepared at the
end of the period, but it is also possible to prepare forecast of profits for
the remaining period of the financial year based on the orders received.
(e) Simplifies Inventory Valuation: Standard costing simplifies the work
of valuing inventory. If inventories are valued at standard cost, stores
ledger can be maintained in terms of quantities only. This saves
considerable time and effort involved in pricing the inventory. Standard
cost of inventory on hand at the close of the period may easily be found
out by multiplying the quantity by the standard price. The difference
between standard cost and actual price is then transferred to a variance
account.
(f) Guide to fixation on selling price: Standard costs form a basis for future
planning, estimates, tenders, price fixing, etc. In the absence of standard
costing, selling price should be based on actual costs. But actual costs
vary from time to time due to change in price of input factors. It is,
therefore, necessary to have a fixed cost structure based on normal
standards of efficiency. Standard costs provide such a cost structure.
(g) Saves Clerical Costs: Installation of Standard Costing saves clerical
labour and expenses involved in the work of Cost Accounting. Costing
procedure is simplified and the number of forms and records is reduced.
Further, the time to be devoted to collect cost data for budget preparation
or for pricing the product becomes considerably reduced.
(h) Facilitates timely reporting: Standard costing facilitates timely
presentation of cost reports to management. Timely reporting facilitates
corrective action.
Limitations of Standard Costing : The technique of Standard Costing also
suffers from certain limitations outlined below:
(a) Setting standards is difficult task as it involves technical skills.
(b) Revision of standards, in the light of the changed circumstances, becomes
Expensive. If the standards are not revised, they become rigid and
outmoded. Such standards become unreliable.
(c) Fixation of inaccurate standards, especially those that are incapable of
achievement, adversely affects the morale of employees and acts as
hindrance to increased efficiency.
 E-6

(d) It becomes necessary to distinguish between controllable and

uncontrollable variances for localizing deviations and fixing
responsibilities. Such a distinction may not always be possible.
(e) Standard Costing is not suitable to jobbing type of industries. Fixation
of standards for each job becomes difficult and expensive.
(f) Constant revision of standards is necessary in the case of industries liable
to frequent technological changes.
(g) Standard costs can form a basis of production and price policies only if
the materials and labour valuations used to fix the standards reflect
anticipated trends in cost during the following period.
(h) Standards may cause resentment among workers and supervisors. Such
psychological factors at work may negate the benefits of the technique,
(i) It is expensive from the point of view of small concerns.
Applicability of Standard Costing : Standand Costing can be implemented
in any industry but its benefits are strongly felt in case of industries where the
products and their components are standardized and the methods of production
are repetitive in nature. Standard Costing is of maximum value in
1. Process industries where the methods of production and the nature of
the output are the same, e.g., chemical industries, fertilizer industry, paper
industry, distilleries, sugar, dyes, etc.
2. Industries where the methods of manufacture are repetitive and products
are more or less same. e.g. agricultural products, food products, etc.
3. Foundries.
4. Textile industries
5. Service industries like transport, gas, water, electricity, etc.
6. Extraction industries like coal, oil, timber, etc.
7. Engineering goods industries.
8. Automobiles
It is not of much use in Contract and Job order type of industries carrying
out special jobs or work orders. Here, standard costing cannot be applied
profitably, as the work is dissimilar and non- repetitive in character. This does
not mean that standard costing cannot be applied to job order type of industries.
Standard costing can be adapted to job industries provided separate standards
are established for each individual job. However, it may not be worth while to
set up standards for each individual job. That means, there is not much scope
for Standard Costing in job order type of industries.
It should be noted that the standards to be used should never be too high
nor too low. Too high standards dampen the morale of the employees, as they
cannot be attained. Too low standards do not tone up efficiency, because it can
be achieved very easily. So, the standard to be used must be proper or correct.
Step involved in Standard Costing: Several preliminaries are required to be
gone through before the establishment of standard costing system. The
following are the steps involved in standard costing:
 E-7
i

(i) Sound organization structure with well defined authority relationships.

(ii) Sound technical and engineering studies, known production methods,
work study and work measurement, material specifications and wage
and material price projections.
(iii) Standardization of functions and all activities.
(iv) Establishment of cost centers and assignment of responsibilities.
(v) Classification of accounts, and codling of incomes and expenses to
facilitate speedy collection and analysis.
(vi) Determination of the period for which standards are to be used
(vii) Estimate of the level of activity or volume of output.
(viii) Determination of the type of standard to be used.
(ix) Fixation of standards for each element of cost.
(x) Determination of standard costs for each product.
(xi) Recording of actual costs incurred.
(xii) Comparison of actual cost with predetermined standards to ascertain the
deviations.
(xiii) Investigation into the reasons and analyzing of variances.
(xiv) Reporting of significant adverse variances.
(xv) Action by management to ensure that adverse variances are not repeated.
(xvi) Revision of the standards, if necessary.
Types of Standard: One of the fundamental requisites to set up standard
costs is to determine the type of standard to be used. There are alternative
bases for setting standards.
Basic Standard and Current Standard:
Basic Standard: Basic Standard is “an underlying standard from which a
current standard can be developed.” When a basic standard is established, the
intention is that it shall remain unchanged for a number of years. Its use is to
show long-term trends and it operates in a way similar to index numbers.
Basic standard is not revised when material prices and labour rates vary.
It is maintained at its original level in order to show the trend revealed by the
computed variances. It is thus a long-term and static’ standard. It is revised
only when new products are introduced or the existing ones are modified to
the extent that they can be considered to be practically new ones.
Although there is a saving in clerical cost of setting the standards, the
basic standard cannot be used to highlight current levels of efficiency. They
are not useful for cost control. However, basic standards are used as a base for
preparing current standards. They also help in knowing the long-term trend in
Variances.
Current Standard: A Current Standard is “a standard established for use
over a short period of time, related to current conditions.” The period covered
by the standard is normally one year. The, current conditions’ take into account
 E-8

:L2XX“d«x«^

Ideal Standard, Expected Standardand Normal Standar

Itol Standard : hVE'Erable condttions possMe.” The
which can be attained und assumption which is known as
standard is based upon the per wrman d n sucj, a basis assumes the
•tightness- of the standard. A standard ““n“ and absence of
absence of spoiled work break own o p towev(ji'i|Klude allowances for
XXE^p^

high level of efficiency, if achieved. definition itself

normal day - to -day control activitie accounting usually means

Expected Standard: The term 'Standard ‘" ““ “e slid which, it is
expected standard. Expected ™tod‘s taEperiod.” it is a
anticipated can be attained dumg^ operate during the period
target which is attainable if P what should be achieved under
XXXXhen plant and other facilities have been made, by positive,

actio^“s:-pected

contingencies such as waste, spoi age, incentive to the operating

rE—"XtEd'for prtx.nct eostmg. cost

control, inventory valuation and as a tests f"b“*""Beflect the conditions

Ec,ed
ZEXonE conditions change, ts the on!, disadvantage of this type

of standard.
 E-9

Normal Standard: Normal Standard is defined as. “The average standard

which it is anticipated can be attained over a future period of time, preferably
long enough to cover one trade cycle.” This type of standard is based upon
normal conditions, i.e., conditions which prevail over the entire life of a trade
cycle. The standard is thus an average which takes into consideration both
boom and depression.
As it is very difficult to estimate the length of a trade cycle with any
degree of certainty, this type of standards of very \itt\e use in setting standards.
Setting Standard Costs: Establishing standard costs and keeping them up-
to-date involves considerable effort and co-operation of various members of
the organization. The initial installation of standard costing, setting the standards
and their revision are normally within the functional responsibility of the cost
Accountant. However, the magnitude and complexity of the task often calls
for assistance from others.
Standards Committee: Much of the detailed work involved in fixing the
standards for every element of cost is carried out by clerks and engineers of
respective departments. However, a Standards Committee is formed to assist
the cost Accountant in his task of coordination. The Committee will provide
critical inputs in fixing the standards for various elements of cost.
The Standards committee is similar to a budget committee. The committee
will be composed of the production controller, purchase manager, personnel
manager, time study engineer, sales manager, chief engineer and the
Management Accountant.
The task of the Committee is to determine standard costs, revision of
standards, sending reports of Factual performance to accounts department for
ascertaining variances, sending reports of variances by the accounts department,
their form, the target dates for reporting etc. It collectively owns the
responsibility of setting the standards, analysis of variance and revision of
standards.
The committee is usually headed by the Management Accountant. Beside
coordinating the activities of the various functional heads in setting the
standards, it is also the function of the Management Accountant to present the
standard and the relevant statements, on the basis of inputs from the committee,
in the most satisfactory manner.
The Standards Manual: The standards manual is similar to the budget manual.
It is a document that sets out the responsibilities of the persons engaged in the
routine of setting the standards. It also contains the forms and records required
for setting the standards. The manual is necessary for establishing uniformity
of , procedures in setting the standards. These procedures act as standing
instructions to the standard committee members to guide them in their task.
Setting Standards for Direct Materials: The fixation of standard material
cost requires determination of standard price per unit of material and standard
material quantity.
 E-10

Standard Price: The standard price to be fixed depends on two factors, namely
the type of the standards used and the items included in the price of materials.
Of the various types of standards, the current standard is the most desirable
and effective. When this type of standard is used, the purchasing department
has to determine the future trend of price during the ensuing contracts with
suppliers or by use of various forecasting techniques. As regards the second
factor, ideally, the price of the material should include all costs incurred up to
the time the material is ready to be put into the manufacturing process. However,
the items to be included in material prices depend upon the practice prevailing
in the concern. It must be ensured that there is consistency in determination of
standard price.
Standard Quantity: Quantity or physical standards are based on quality
specifications, Quantity specifications and yield or spoilage factors. Before
determining the standard quantity of materials, it is necessary to fix standards
for quality or grade and size. This involves a study of the determination of its
different parts and the product’s material requirements. It is also necessary to
develop and compile certain basic data such as kind and quality of materials,
the method and sequence of processing, quantity requirements and description
of parts in assemblies, product design, production routines, etc. This may
involve the service of design engineers, production engineers, chemists and
the time and motion study engineers, besides those of the accounting
department.
In the case of a product which is absolutely new, the design or the drawing
office will prepare the quantity specification list with the help of drawing and
standard layout chart. Sometimes, a number of trail or sample runs or tests are
conducted on different days and under different conditions, and the average
of these is considered for determining the standard quantity. If the product is
not new, past data of performance are taken into consideration.
While determining the standard quantities, it is necessary to make
allowances for normal losses since the quantity purchased and the quantity
used in a product are rarely identical. However, losses of materials during
storage should not be included in the material utilization standard.
Setting Standards for Direct Labour: The method of setting standard costs
for direct labour is similar to the fixation of standard material costs. The
standard time for each operation multiplied by the standard wage rate gives
the standard labour cost. However, the techniques employed for fixing labour
standards are different from those employed for materials. This is on account
of the presence of human element in case of labour.
Standard Time: The fixation of standard labour time depends upon the nature
of operations to be performed, time required for each operation, the grade of
labour required and the working conditions that should prevail. It is necessary
to pay attention to standardised working conditions. The standardization
process can be carried out by determining the best plant layout, flow of work,
 E-ll

proper instructions to workers, lighting, heating and ventilation, and the

equipments required. Once working conditions are standardised, standard time
required to produce one unit can be determined.
There are different methods of determining the time required for each
operation. Before choosing a particular method it is necessary to prepare a
standard operation schedule’ similar to a standard material specification, and
show therein the details of operations to be performed. In case of a new product,
the drawing office may plan the operations. In other cases, past data may
become useful.
After the planning of standard operation schedule, it becomes necessary
to standardize the time to be taken for the operation. This may be the labour
time or the machine time. In either case, standard time is fixed by time and
motion study, past performance, test runs, or advance estimates. Of these, the
time and motion study method of determining time standards is most reliable.
Allowance should be made for normal delays, fatigue and other contingencies.
Standard Rate: The techniques of job analysis and job evaluation enable
management to fix different wage rates for different operations. These
techniques are useful in making effective utilization of manpower. While setting
the rate standards, it is necessary to consider the different wage plans, since
different plans result in a different unit cost for labour. Where workers are
paid on the basis of rate per hour, the standard labour cost of any operation
should be equal to the product of the standard time and the rate in force. If
more than one rate is prevalent, and the same is based on experience, skill etc.
an average rate is computed for each grade of labour. Where workers are paid
on the basis of result, the standard cost would be the fixed rate per piece.
Setting Standards for Overheads : Standard costs for production overhead
are established in the same manner as pre-determined overhead absorption
rates. Fixation of standard overhead cost involves (i) determination of overhead
(ii) determination of the standard base, and (iii) Computation of the standard
overhead rate.
Determination of overhead becomes easy if comprehensive budgetary
control system is in operation. The budgeted overhead costs, which indicate
what expense as expenses that should be incurred .
In the same way, budgeted production is adjusted to the level that should
be attained. While setting the standards, expenses should be classified into
fixed, variable and semi variable. Separate rates are to be computed for fixed
and variable items.
For converting these expenses into rates of recovery, it is necessary to
estimate the level of production in terms of production hours, production
units, labour wages, labour hours or machine hours. The level of production
estimated would be the standard production linked with any of the following
activity levels, also known as capacity levels.
 E-12

Maximum (Theoretical) Capacity: The maximum capacity in relation to a

plant is that which can be achieved without interruptions of any kind such as
breakdowns, waiting time, absenteeism of employees, shortage of materials,
etc.
If, for instance, a machine can operate for 200 hours a month and produce
one unit per hour, then the maximum capacity is 200 hours or 200 units. This
ideal capacity is very rarely achieved since interruptions are normal occurrences
which affect every business. Hence, maximum capacity is also known as
theoretical capacity and the use of the same as a basis for calculating overhead
costs is not recommended.
Practical Capacity: This is the maximum capacity minus unutilized capacity
due to normal interruptions. Thus, this is less than the maximum physical
capacity by the amount of unavoidable idleness for breakdowns and repairs,
shortage of materials and other interruptions beyond human control.
Having regard to the specific circumstances and the objective of
management, a 20% allowance for contingencies is considered quite reasonable.
Thus, 80% would be the practical capacity of the plant or department. This
percentage may differ from industry to industry. For practical purposes, the
practical capacity itself becomes the maximum capacity of a plant, and it is
also known as practical operating capacity or normal capacity to manufacture.
Normal Capacity: Although it is difficult to define the term, normal capacity
may be considered to be the capacity which should normally be achieved
under normal circumstances. Yet, for a proper understanding of this concept,
it is necessary to consider two commonly used methods of expressing the'
normal capacity. These are, the ability to make and the ability to make and
sell.
When demand is constant and the practical capacity is adjusted to
customer’s demands, practical capacity will be equal to the capacity to make
and sell. Under these circumstances, practical capacity would be the normal
capacity, However, if demand fluctuates and sales do not coincide with the
practical plant capacity potential, production should be adjusted by reducing
the number of hours representing the capacity to make. For this purpose, the
expected sales for a number of years are estimated and the plant capacity to
meet this expected demand is determined. The normal capacity will then be
the capacity thus determined. This may be called the actual capacity. When
sales fluctuate heavily, normal capacity will tend to be the average capacity of
the plant.
Rated Capacity: Physical plant capacity to produce as indicated by the
manufacturers is known as the rated capacity. This is usually taken as 100%
capacity. However, while fixing the rated capacity, manufacturers usually leave
margin and fix the capacity at a lower rate to ensure that plant should work up
to the capacity. In practice, if the maximum capacity is reached and the actual
production is much more than could be had with 100% capacity, we say that
 E-13

the capacity is 110% or 120% of rated capacity. It is very common for cycle
industries such as cement industry to operate at more than 100% of rated
capacity.
Idle Capacity: The difference between the practical capacity and the actual
capacity based on expected sales is known as idle capacity. This is represented
by the unutilized capacity due to lack of sales demand.
The choice of an appropriate capacity for computing the standard
overhead rate is a matter to be left to the business concerned. When the volume
of sales remains constant, capacity to make may be used as the basis. However,
when the volume of sales differs from year to year, capacity to sell appears to
be appropriate.
Thus, standard overhead recovery rates are computed with reference to
such bases as direct labour hours, direct labour wages, machine hours,
production unit, etc., and these are related to the capacity of the plant or the
department.
Standard Hour: A concern which produces only one type of product may
express its production in terms of unit of measurement such as a dozen, kg,
pound, liter, etc. However, difficulty arises in the case of a concern which
produces different types of articles which cannot be aggregated for the purpose
of expression in terms of a common unit of measurement. It is only with a
view to getting over this difficulty that production is expressed in terms of
what is known as the standard hour.
According to ICMA London, Standard hour is “a hypothetical unit pre-
established to represent the amount of work which should be performed in
one hour at standard performance.” According to this definition, the standard
hour is a measurement of work, not of time. It is the amount of work which
should be performed in one hour. For example, if 120 units of article A can be
produced in 8 hours and 100 units of article B can be produced in 10 hours,
the standard hour represents 15 units of A and represent 10 units of B. An
output of 300 units of A and 500 units of B would represent 70 standard
hours.
Standard Cost Card: The process of setting standard for materials, labour
and overhead result in the establishment of the standard cost for product. The
build -up of the standard cost is recorded on a standard cost card.
Usually, a separate standard cost card or standard cost sheet is prepared
for every product. Depending upon the type of product, it may be advisable to
prepare a separate card for each of several processes, or for each of the different
parts which go to make a sub-assembly or assembly. The final total cost of
product can be obtained by adding together the cards for the different processes,
or fix’ the different parts and assemblies which go to make up the finished
product.
Apart from being used constantly in the controlling of standard costs
and the extraction of variances, these cost cards, are useful to management in
their pricing policies, planning production and analyzing market possibilities.
 E-14

Revision of Standards: Accounts are not unanimous in their opinion regarding

revision of standards. One group contends that standards are the resultant
effect of a number of factors and these factors are bound to vary from time to
time. When changes take place, the standards should be revised in the light of
such changes. Without revision, the standards become outmoded. This impacts
the initiative and incentive of the operating personnel. Standards which reflect
the most up to date position are required for day-to-day control and motivation.
Consequently continuous revision becomes necessary.
Another school of thought feels that standards constitute yardstick of
actual performance. As such, frequent revisions destroy the means of measuring
efficiency. To show trends and to be able to compare performance and costs
between different periods, standards should not be revised too frequently.
It is true that up to date standards are more meaningful to the operating
personnel. However, frequent revisions may defeat the very purpose of having
defined Standards. Thus, frequent revision of standards must be avoided but
standards must not be permanently fixed. It is necessary to revise the standards
when:
(i) Prices of materials or labour change significantly
(ii) Manufacturing methods change
(iii) Product designs or specifications change
(iv) There are errors in setting the standards, and
(v) There are other relevant circumstances such as technological
advancement.
Variance Analysis
A variance means a deviation. A Variance occurs when actual costs differ
from standard costs. Variance Analysis is a study of such variances. It involves
not only measurement of variances, but also an examination of the causes for
the variance, explaining clearly the contribution of each cause or factor to the
overall variance.
Favourable and Unfavorable Variances : A variance is said to be favourable
if it is indicative of greater efficiency. If it indicates inefficiency, then the
variance is unfavourable. If actual costs are less than the standard costs, the
variance is said to be ‘favourable.’ If the actual costs are more the standard
costs, the variance is unfavourable.
Controllable and Uncontrollable Variances: When a variance indicate the
degree of efficiency of an individual or a department, which is capable of
further improvement, such a variance is said to be controllable. However, a
variance occurring due to external factors beyond the control of the individual
I department is said to be an uncontrollable variance. A controllable variance
is amenable to control, where as in uncontrollable variance is not.
Principal and Sub Variances: Variances can be computed not only for each
cost element but for each of the factors which determines the cost of the element.
The variance of particular elements of cost relating to quantity and price are
 E-15

called "Principal” variances. A Principal variance may have a number of

,h,‘iS ‘ v-ianc. is
Computation of Variances
Material Variances : Material Variances involve calculation of Material Cost
vZDCe’ AT31 PrfCe VarianCC’ MateriaI U^e Variance, Material Sx
ance and Material Yield Variance or Material Sub-Usage Variance A
aZ:e\XdZ.X7AT and den°K‘l A is

Material Cost Variance (MCV): It is the difference between the standard

cost for the output achieved and actual cost incurred for achieving the same. It
is calculated with the help of the formula
MCV (SQ x SP) - (AQ x AP) where
SQ - Standard Quantity for Actual output
SP = Standard Price
AQ = Actual Quantity used
AP = Actual Price
Material Price Variance; It is the part of material cost variance which is due
the difference between the standard price specified and actual price paid It
is calculated for the actual quantity used. It is calculated as ?
MPV = AQ (SP-AP)
Material Usage (or Quantity) Variance: Material Usage Variance is also
nown as Material Quantity Variance. It explains the variance in material cost
caused on account of the difference between standard quantity specified and
the actual quantity used. It is a calculated as P
MUV = MQV= SP x (SQ - AQ)
Cost vX‘i V“a“e ““ M!“erial US*8C VMianCe ,Otal “P “

MCV - MPV + MUV

Sahv nhceXdVat A VarfanCe WiH reSult When materials are not
exnll t Production in the same ratio as the standard formula It
explains the variance due to difference between standard and actual
composition of a Mixture. The Variance is calculated as follows
MMV = SP* (RQ-AQ) where
RQ = Actual Quantity of Material used, in standard mix
AQ - Actual Quantity of Materials used in actual mix
For example, if the standard specifies that production of a product X
requires two materials A and B in the ratio of 3:2, it means that for every 5 kgs
of matenal going into production of X, 3 kgs of A and 2 kgs B are required It
is anticipated that 100 kgs of material would be required. However, the actual
48 kgsofBshouM h12° h8S’ S1HCu the Standard rati°iS 3 : 2’ 72 kgS of A and
rXit Sv S bCen USCd- This rePr^ents the Revised Quantity In
Ac3 Quangt-t°yf A 3nd 40 k§S °f B might have bee" used’ represents ’the
 E-16

Material Yield Variances : It is that part of materials usage variance which is

due to difference between the standard yield specified in terms of actual output
and actual yield obtained. It is calculated as
MYV = Standard yield rate (Actual yield - revised standard yield for
Actual input)
Where Standard Yield Rate
= Total of RQ x SP/ Revised Standard yield for Actual input
Material Sub- Usage Variance : It is another way of explaining the material
yield variance. It is always equal to material yield variance. It is calculated as
MSUV = (Standard Quantity - Revised Standard Proportion of Actual Input)
x Standard Cost per unit of input.
Material Mix Variance and Material Yield Variance total up to Materia.
Usage Variance i.e
MUV = MMV + MYV = MMV + MSUV
Illustration-1: M/s Shastri & Co. Produce M 5 The standard mix of M 5 is as
follows:
Kgs Material Price per kg
50 A 5.00
20 B 4.00
10.00
The standard loss in production is 10% of input. There is no scrap value.
Actual production for a month was 7.245 kg of M 5. Actual purchases and
consumption of material during the month were.
Material Price per kg
4,160 A Rs. 5.50
1,680 B Rs. 3.75
2,560 C Rs. 950
Calculate Material Variances.
1U11 .
Actual Input of Materials = 4,160 kg of A + 1,680 kg of B + 2,560 kg of
C = 8,400 kg
Actual output on M 5 - 7,245 kg
As per the standard, the loss in production should be 10% of input.
Therefore Standard input for actual output = 7,245 /0.9 = 8,050 kg
Therefore Standard Quantities of Materials used
A 50% x 8,050 kg 4,025 kg
B 20% x 8,050 kg 1,610 kg
C 30% x 8,050 kg 2,415 kg
However. Actual Input, in standard Ratio would be
A 50% x 8,050 kg 4,200 kg
B 20% x 8,050 kg 1,680 kg
C 30% x 8,050 kg 2,520 kg
 E-17

The above information, along with information of price, can be presented

in a tabular form as follows
Material Standard Standard Standard Revised Actual Actual Actual
Quantity Price Cost Qty Qty Price Cost
(SQ) (SP) (SC) (RQ) (AQ) (AP) (AC)
Kg ? kg kg
A 4.025 5.00 20,125 4,200 4,160 5.50 22,880
B 1,610 4.00 6,440 1,680 1,680 3.75 6,300
C 2,145 10.00 24,150 2,520 2,560 9.50 24,370
8,050 50,175 8,400 8,400 53,500
Less Loss 805 1,155
7,245 kg 7,245 kg
(1) Material Cost Variance = Total of SQ x SP - Total of AQ x AP
= SC-AC = ? 50,715 - ? 53,500
= ? 2,785 (Adverse)
(2) Material Price Variance = AQ (SP - AP)
Material A = 4,160 kg ( ? 5 - ? 5.50) 2080 (A)
B = 1680 kg (? 4 . ? 3.75) 420 (F)
C = 2560 kg (? 10 - ? 9.50) 1280 (F)
380(A)
(3) Material Usage Variance = SP (SQ - AQ)
Material A = ? 5 (4025 kg - 4160 kg) 675 (A)
B = ?4(1610kg- 1680 kg) 280 (A)
C = ? 10 (2415 kg-2560 kg) 1450 (A)
2405 (A)
(4) Material Mix Variance = SP (RQ - AQ)
Material A = ? 5 (4200 kg - 4160 kg) 200 (F)
B = ?4(1680kg- 1680 kg)
C = ? 10 (2520 kg - 2560 kg) 400 (A)
200 (A)
(5) Material Yield Variance : Standard Yield Rate (Actual Yield - Revised
Standard yield for actual input)
Standard Yield Rate (SYR) =
Total of RQ x SP / Revised Standard yield for Actual input
Revised Standard yield for Actual input (RSY)
= 90% x 8400 kg = 7560 kg
Therefore SYR = 4200 kg x 5 + 1680 kg x ? 4 +2520 kg x ?10/ 7560 kg
= ? 52920/? 7560 =?7
Therefore MYV = ? 7 (7245 kg - 7560 kg ) = ? 2205 (A)
Labour Variances: Labour variances arise when actual labour costs are
different from standard labour costs. Labour variance involve calculation of
labour Cost Variance, labour Rate Variance, labour Time (or Efficiency)
variances. A positive variance is favorable and denoted by (F). A negative
variance is adverse and is denoted by (A)
 E-18

Labour Cost Variance: It is difference between the standard direct wages

specified for the output achieved and the direct wages paid. It is calculated as
LCV = (SH x SR) - (AH x AR) Where
SH = Standard Hours AH = Actual Hours
SR = Standard Rate AR = Actual Rate
Labour Rate Variance : It is that part of labour cost variance which arises
due to change in specified wage rate. It is calculated as
LRV = AH x (SR-AR)
Labour Time (or Efficiency) Variance : It explains the variance in labour
cost caused on account of standard labour hours specified and the actual number
of hours worked by the labourers. It is calculated as .
LTV = LEV = SR (SH - AHW) where
AHW = actual hours worked
It is to be noted that in calculating the labour efficiency variance, the
time that is lost on account of workers being idle is not considered. Only
actual hours worked is taken into account. Idle hours are separately accounted
for by calculating idle time variance.
Idle Time Variance : Idle time is the time for which a worker is paid, but
during which time, he does not work. Power failure, shortage of materials etc.
are some of the reasons which may lead to Idle time. Variance is always
unfavourable, as it represents lost time. It is calculated as
ITV = Idle Hours x Standard Rate
= (AH - AHW) x SR
Labour Cost Variance is the sum of Labour Rate Variance, Labour
Efficiency Variance and Idle Time Variance.
LCV = LRV + LEV + ITV
Labour Mix Variance or Gang Composition Variance: A labour mix
variance will result if there is a change in the composition of the team which
is entrusted with the given work. It is calculated as.
LMV = SR (RH-AHW) where
RH = Actual Hours of work put in by the team, according to standard
composition
AHW = Actual Hours of work put in by team in reality
Labour Yield Variance : The output obtained will not only be on account of
material used, but it will also be influenced by the efficiency of the labour
working on the material. As such, Labour Yield Variance can be calculated to
know whether the output is as per the standard specified or not. It is calculated
as.
LYV = Standard Yield Rate (Actual Yield - Revised Standard Yield)
Where Standard Yield Rate = Total of RH x SR/ Revised Standard Yield
Labour Efficiency Variance is the sum of Labour Mix Variance and
Labour Yield Variance.
LEV = LMV + LYV
 E-19

Illustration-2 : A gang of workers normally consists of 30 men, 15 women

and 10 boys. They are paid at standard hourly rates as under.
Men Re.0.80 Women Re. 0.60 Boys Re.040
In a normal working week of 40 hours, the gang is expected to produce
2,200 units. During the week ended 31s1 December, 1994, the gang consisted
of 40 men, 10 Women and 5 boys. The actual wages paid were @ Re.0.70, Re.
0.65 and Re. 0.30 respectively, 4 hours were lost due to abnormal idle time
and 1,600 units were produced.
Calculate (i) Wage Cost Variance (ii) Wage Rate Variance (iii) Labour
Efficiency Variance (iv) Gang Composition Variance and (v) Labour Idle Time
Variance. (M.Com, Delhi, ICWA Final)
Solution : The normal production of the gang in 40 hrs is 2,000 units. However,
actual production is 1,600 units.
Thus, Standard time for producing 1,600 units
= 40 x 1,600 Hrs/2,000 = 32 hrs.
Therefore Standard Hours for each type of labour
Men 32 hours x 30 Men 960 hours
Women 32 hours x 15 Women 480 hours
Boys 32 hours x 10 boys 320 hours
1,760 hours
Actual Hours of each type of Labour
Men 40 hours x 40 Men 1,600 hours
Women 40 hours x 10 Women 400 hours
Boy 40 hours x 5 Boys 200 hours
2,200 hours
If Actual hours spent were allocated in the standard composition, the revised
hours would be
Men = 9601 1,760 x 2,200 hrs = 1,200 hours
Women = 4801 1760 x 2,200 hrs = 600 hours
Boys = 320 / 1760 x 2,200 hrs = 400 hours
The above information can be presented in the tabular form:
Labour SH SR SC RH AH AR AC AHW IH
? ? ? ?
Men 960 0.8 768 1,200 1,600 0.70 1,120 440 160
Women 480 0.6 288 600 400 0.65 260 360 40
Boys 320 0.4 128 400 200 0.30 60 180 20
1,184 1.440
(i) Labour Cost Variance = Standard Cost - Actual Cost
( = ? 1,184-? 1,440 = ? 256 (A)
(ii) Ljibour Rate Variance = AH (SR -AR)
Men : 1,600 hours (Re.0.80 - Re.0.70) ? 160 (F)
Women : 400 hours (Re.0.60 - Re.0.65) ? 20 (A)
Boys : 200 hours (Re.0.40 - Re. 0.30) ? 20 (F)
? 160 (F)
 E-20

(iii) Labour Efficiency Variance = SR (SH-AHW)

Men : 10.80 (960 hours - 1,440 hours) ?384 (A)
Women : ? 0.60 (480 hours - 360 hours) ? 72 (F)
Boys : ? 0.40 (320 hours - 180 hours) T56(F)
? 256(A)
(iv) Idle Time Variance = IH x SR
Men : 160 hrs x Re.0.80 = ? 128 (A)
Women : 40 hrs x Re. 0.60 = ? 24 (A)
Boys : 20 hrs x Re. 0.40 = ?8 (A)
t160 (A)
(v) Labour Mix Variance = SR (RH - AH)
Men : Re.0.80 (1,200 hrs - 1,600 hrs) ? 320 (A)
Women : Re.0.60 (600 hrs - 400 hrs) ? 120(F)
Boys : Re.0.40 (400 hrs - 200 hrs) ? 80 (F)
120 (A)
Overhead Variances: Overhead Variances refer to the differences between
the standard overhead cost for actual output and the actual overhead co^t
incurred. Overhead variances consist of
Total Overhead Variance: It is the difference between the standard cost of
overhead for the output and the actual overhead cost incurred. It is calculated
as.
= [(Standard Hours for Actual Output) x (Standard Overhead rate per hour)]
- Actual Overhead incurred.
- (Actual Output x Standard Overhead rate per unit) - Actual Overhead
incurred.
Overhead Expenditure (or Budget) Variance : It measures the difference
between budgeted overhead costs and actual overhead costs incurred. It is
calculated as
Expenditure Variance = Budgeted Overhead Cost - Actual Overhead Costs.
Overhead Volume Variance : It is the difference between the standard cost
of overhead absorbed in actual output and the standard overhead allowed for
that output. It is calculated as
Volume Variance
=Standard Overhead Rate per unit (Actual output- Standard Output)
It can also be calculated as Standard Overhead rate per hour (Standard hours
for actual output-Standard hours for budgeted output)
Overhead Capacity Variance: It arises due to increase / decrease in working
hours per day over standard working hours per day. It is calculated as
Capacity Variance
= Standard Overhead Rate per day (Actual Hours-Budgeted Hours)
Overhead Calendar Variance: It explains the variance on account of
difference in number of working days in the budget Period and acutal
number of working days. It is calculated as
Calendar Variance
 E-21

= Standard Overhead Rate per day (Actual Days- Budgeted Days)

Overhead Efficiency Variance: It explains the variance caused on account
of increase or decrease in efficiency expected. It is calculated as
Efficiency Variance = Standard Overhead rate per hour x (Standard Hours of
work done - Actual hours worked)
The above formula can be applied to both variable and fixed overhead.
A Positive difference is a favorable variance. A negative total difference is an
adverse variance.
Overhead Cost Variance
= Overhead Budget Variance + Overhaead Volume Variance
Overhead Volume Variance = Overhead Capacity Variance + Overhead
Calender Variance + Overhead Efficiency Variance.
Illustration -3 : The following figures are extracted from the books of Pravek
Ltd.
Budget Actual
Output(in units) 6,000 6,500
Hours 3,000 3,300
Overhead costs: Fixed ? 1,200 ? 1,250
Variable ?6,000 ? 6,650
Number of days 25 27
Compute and analyze the Fixed Overhead Variances
(JCWA Inter) adapted
Solution:
1. Fixed Overhead Cost Variance (FOCV) - (standard Fixed Overhead
rate per Unit x Actual Output) - Actual Fixed Overhead incurred.
Standard fixed overhead rate per unit =
Standard fixed Overhead cost / Standard Output
= n200/ 6000 Units = ? 0.20
Therefore FOCV = ( ? 0.20 x 6,500 units) - ?1,250.
= ? 1,300 - ?1,250 = ? 50 (F)
2. Fixed Overhead Budget Variance (FOB V)
= Budgeted Fixed overhead costs - Actual Fixed overhead Costs
= ? 1,200 - ?1,250 = ? 50 (A)
3. Fixed Overhead Volume Variance (FOVV)
FOVV = Standard Fixed Overhead Rate p.u.(Actual output-standard
output) =Re 0.20p (6,500 units - 6,000 units) = ?100 (F)
4. Fixed Overhead Capacity Variance (FOCapV)
FOcapV=Standard Fixed Overhead Rate per hour (Actual Hours for
actual days - Budgeted hours for actual days)
Standard Fixed Overhead Rate per hour
= Budgeted Fixed Overhead/ Budgeted Hours
 E-22

= ? 1,200/ 3,000 hrs.= Re.0.40p.

Budgeted Hours for actual days
For 25 days - Budgeted hours 3.000
27 days- " ? =3’240 hrs'
FO CapV = Re 0.40p (3,300 hrs- 3,240 hn) - ? 24(F)
Fixed Overhead Calender Variance: (FoCalV)= Std Fixed Overhead Rate
5.
per day (Actual Days - Budgeted day)
Standard Fixed Overhead Rate per day:
= Budgeted Fixed Overhead/Budgeted days
= ? 1.200/ 25 days = ? 48 per day
FocalV = ? 48 (27 days-25 days) = ? 96 (F)
6. Fixed Overhead Efficiency Variance (FOEV)
= Standard Fixed Overhead Rate per hour/ (Standard Hours of woi
done- actual hours worked)
Standard hours of work done =
For 6,000 units, standard hours = 3,000
For 6,500 units, " ? = 3’250 hrs
FOEV = Re 0.40p (3250hrs - 3,300 hrs) = ? 20 (A)
Illustration-4
Calculate Overhead Variances Budgeted Actual
Output (Units) 15,000 16,000
Working Days 25 27
Fixed Overhead (?) 30,000 30,500

Solution:
Total Overhead Cost Variance = (Actual No.of units) x (Standard Rate
per unit) - Actual Overhead Cost
= [(16,000 units ) x ( ?30,000/15,000 units]- ? 30,500
= ? 32,000 - ? 30,500 = f 1,500 (F)
Expenditure Variance = Budgeted Overheads - Actual Overheads
2.
= ? 30,000-? 30,500 = ? 1,500 (A)
Volume Variance = [(Actual No. of units) x (Standard Rate per unit)]
3.
- Budgeted Overhead
= (16,000 x 2) - ? 30,000 = ? 2,000 (F)
Capacity Variance = (Standard Rate p.u x [Revised Budgeted Umts-
4.
Budgeted Units)
Standard Rate p.u
Revised Budgeted Units
15,000
Original Budgeted Units for 25 days
(+) Budgeted Units for 2 days = 2/25 x 15,000= 1,200
16,200
Budgeted Units
810
(+) 5% increase in capacity
17,010
~ ■ 11 n 4 t A 15,000
^Variance = , 2 • <17.0)046,200) = .L62O (F)
 E-23

5. Calendar Variance = [Actual Days - Budgeted Days] x Budget Units

per Day x Standard Rate per Unit
= (27-25) x 600 x ? 2 = ? 2,400 (F)
6. Efficiency Variance = Standard Rate x (Actual Production - Standard
Production)
= ?2x (16,000 - 17,010) = ? 2,020 (A)
Sales Variances
Until now, we have learnt about Material, Labour and Overhead
variances. These are variances pertaining to cost. Similarly, we can also
calculate sales Variances.
Sales Variances are concerned with change in Revenue and consequently,
change in profit. Thus, they are calculated in 2 ways.
1. Sales Variances (Value Technique or Turnover Method): Under this
method or technique, the impact of variance on turnover is calculated.
The variances are calculated as under.
(i) Sales Value Variance: It is the difference between standard or Budgeted
Sales Value and Actual Sales Value. It is calculated as
(AQxAP) - (SQxSP) where
AQ = Actual Quantity Sold, AP = Actual Price
SQ= Standard Quantity, SP = Standard Price
Sales Value Variance is favourable if (AQ x AP) is greater than (SQxSP),
as it means actual sales are more than budgeted sales
(ii) Sales Price Variance : This variance explains the variance in value on
account of difference in Price. It is calculated as (AP-SP) x AQ
The variance is favourable if AP>SP
(iii) Sale Volume Variance : This Variance explains the difference in sales
value on account of difference in quantity sold. It is calculated as (AQ-
SQ) x SP as it means the actual price at which sales were made is
greater than what we had fixed as standard price.
The Variance is favourable if AQ>SQ, as it means we have sold more
quantity than what we had budgeted.
Students must note that
Sales Value Variance — Sales Price Variance + Sales Volume Variance.
Sales volume Variance is further split into 2 variances namely.
(iv) Sales Mix Variance : This variance is on account of the actual
composition of sales being different from standard composition. For
example, if we have 3 products and the standard composition was 35%,
25%, and 40%, but in reality we sold the 3 Products in the ratio of
40%, 30% and 30%, it gives rise to sales Mix Variance.
Sales Mix Variance = (AQ-RQ) xSP when AQ=Actual Quantity Sold
RQ = Actual Quantity in standard Mix SP = Standard Price
 E-24

(v) Sales Quantity Variance : This is another Variance arising on account

of difference between Revised standard Quantity and Budgeted sales
quantity It is calculated as
(RQ-SQ) x SP=Sales Volume Variance = Sales Mix Variance + Sales
Variance Quantity
Illustration-5: From the following information about sales calcuate (a) Total
Sales Variance (b) Sales Price Variance (c) Sales Volume Variance (d) Sales
Mix Variance (e) Sales Quantity Variance.
Standard Actual
Nos Rate in ? p.u Nos Rate in ? p.u
Product
5,000 5 6,000 6
A
4,000 6 5,000 5
B
3,000 7 4,000 8
C
(ICWA - adapted)
Solution:
Sales Value Variance=(AQxAP) - (SQxSP)

A (6,000x6) -(5,000x5)
A 36,000-25,000= 11,000 (F)
• B (5,000x5) - (4,000x6)
25,000-24,000 = t°00(F)
C (4,000x8)-(3,000x7)
32,000 - 21,000 = 11,000 (F)
23,000 (F)
Sales Price Variance = (AP-SP) x AQ
A (6-5) x 6,000 = 6,000 (F)
B (5-6) x 5,000 = 5,000 (A)
(8-7) x 4,000 = 4,000 (F)
C
5,000 (F)
SalesValue Variance = (AQ-SQ) x SP
(6,000 - 5000) x 5 = 5,000 (F)
A
(5,000 - 4,000) x 6 = 6,000 (F)
B
(4,000 - 3,000) x7 = 7,000 F
C
18,000 F
Sales Mix Variance : For this on have to calculated RQ
Actual Sales = 6,000 + 5,000+4,000 = 15,000
RQ : A : 5000/12,000 x 15,000 = 6,250
B : 4000/12,000 x 15,000 = 5,000
C : 3,000/12,000 x 15,000 = 3,750
15,000
Sales Mix Variance = (AQ - RQ) x SP
A (6.000-6,250) x5 = 1,250 (A)
 E-25

B (5,000 - 5,000) x 6 = 0
C (4,000 - 3,750) x 7 = 1,750 (F)
500 (F)
Sales Quantity Variance - (RQ-SQ) x SP
A (6,250 - 5,000) x 5 = 4,250 (F)
B (5,000 -4,000) x 6 6,000 (F)
C (3,750 - 3,000) x 7 5,250 (F)
17,500 (F)
2. Sales Margin I Profit Method : In this method, the focus is on the
change in profit on account of change in sales quantity and sales Price.
The Variance are calculated as under :
(i) Total Sales Margin Variance = Actual Profit-Standard Profit
= (Acutal Quantity x Actual Profit)-(Standard quantity x Standard
Profit)
(ii) Sales Margin Price Variance = AQ x (AP-SP)
(iii) Sales Margin Volume Variance = (AQ-SQ) / Standard Profit p.u
(iv) Sales Margin MixVariance = (AQ-RQ) x Standared Profit p.u
(v) Sales Margin Quantity Variance = (RQ-SQ) x Standared Profit
p.u
Illustration-6 : Let us use the same illustration used earlier, to understand
the calculation of Sales Margin Variances. However, we need information on
cost of the products. Let us take the cost of A, B and C as t 4.50, ? 5.50 and
? 6.50 respectively.
Solution:
(i) Total Sales Margin Variance = Actual Profit- Standard Profit
Actual Profit = AQ x (AP - Actual Cost)
A: 6,000 x (6.00 - 4.50) = 9,000
B : 5,000 x (5.00 - 5.50) = (2,500)
C: 4,000 x (8.00 - 6.50) = 6,000
12,500
Standard Profit = SQ x (SP - Standard Cost)
A: 5,000 x (5-4.50) = 2,500
B: 4,000 x (6-5.50) = 2,000
C: 3,000 x (7-6.50) = 1,500
6,000
Total Sales Margin Variance = 12,500 - 6,000 = 6,500 (F)
(ii) Sales Margin Price Variance = AQ x (AP - SP) = ? 5,000 (F)
This is same as calculated earlier as cost element is not involved. In
I ojfier words, out of total increase in Profit of ? 12,500, ? 5000 is on
I account of selling the products at a higher Price.
I (iii) Sales Margin Volume Variance = (AQ-SQ) x Standard Profit p.u
) Standard profit p.u = Standard Price p.u - Standared cost p.u
A: (6,000 - 5,000) x (5.00 - 4.50)
1,000x0.50 500 F
 B : (5.000 - 4.000) x (6.00 - 5.50) 500 F
C: (4,000 - 3,000) x (7.00 - 6.50) 500 F
1,500 F
(iv) Sales Margin Mix Variance (AQ - RQ) x Standard Profit P.U.
A: (6,000 - 6,250) x (0.50) = 125 A
B: (5,000 - 5,000) x (0.50) = 0
C: (4,000 - 3,750) - (0.50) = 125 F
o
(v) Margin Quantity Variance = (RQ-SQ) x Standared Profit P.U
A: (6,250 - 5,000) x 0.50 = 625 F
B : (5,000 - 4,000) x 0.50 = 500 F
C: (3,750 - 3.000) x 0.50 = 375 F
1500 F
PROBLEMS
1. The standard and actual requirements of Material ‘A’ are as under :
Standard : 10,000 Units @ ? 4.00 per unit
Actual : 13,000 Units @ ? 3.80 per unit
Calculate Material Cost Variance
(B.Com. Calcutta - adapted) (Ans : ? 9,400 (A)
2. The standard material required for producing 1 unit of Product X is 5
Kg and the standard price per kg. of mateial is ? 3. The Management
Accountant reports that 16,000 kg of material costing ? 52,000 were
used for producing 3,000 units of X. Calculate Material Cost Variance.
[B.Com. Punjab, adapted) (Ans : ? 7,000 (A)]
3. A factory works on the standard costing system. The standard estimate
of material for the manufacture of 1,000 units of a commodity is 400 Kg
at ? 2.50 per kg. When 2,000 units of the commodity are manufactured,
it is found that 820 Kg of materials is consumed at ? 2.60 per Kg.
Calculate Material Cost Variance. [M. Com. Calcutta) (Ans. f 132 (A)]
4. Calculate Material Price Variance of Products A and B
* A B
Standard Price (? per unit) 5.00 8.00
Actual Price (? per unit) 6.00 7.50
Units Produced 600 500
(B.Com. Osmania) [Ans : Product A: ? 600 (A), Product B: ? 250 (F)J
5. Calculate (a) Material Cost Variance (b) Material Price Variance (c)
Material Usage Variance
Standard Actual
Quantity (kg) 40 48
Rate per kg (?) 10 12
(B.Com. Osmania) [Ans : MCVt 176 (A), MPVl 96 (A) MUVl 80 (A)[
6. A furniture manufacturer uses Sunmica tops for tables. From the
following information, find Price Variance, Usage Variance and Cost
Variance.
Standard Quantity of Sunmica per table 4 sq.ft.
 E-27

Standard price per sq. ft Sunmica ? 5.00

Actual Production of tables 1,000
Sunmica atcually used 4,300 sq.ft.
Actual Purchase Price of Sunmica per sq.ft ? 5.50
(B.Com. Punjab) [Ans : MPVF 2,150 (A), MQV: F 1,500 (A) MCVF 3,650 (A)]
1. From the following information Calculate :
(a) Material cost variance
(b) Material usage variance
(c) Material price variance separately for X and Y.
Material Standard Price Actual Actual price
quality (standard) quantity
Kgs. F Kgs. F
X 10 4 12 3,75
Y 15 5 18 4.50
25 30
(B.Com. Nagarjuna) [Ans : Product X: MCVF 5 (A), MUVF 8 (A); MPVF 3 (F)
Product Y: MCVF 6 (A), MUVF 15 (A); MPVF 9 (F)
8. Compute Price, Usage and Mix Variance from the data given below :
Standard Actual
Qty Unit Price ? ? Qty Unit Price F ?
Material 6 1.50 9.00 5 2.40 12.00
Material 2 3.50 7.00 1 6.00 6.00
[Ans. MPV ? 7 (A), MUV ?5 (F), MMV Fl (F)J
9. The standard mix of a product ‘P’ is shown below :
Raw Material X 30 units at ? 2.00 each.
Raw Material Y 70 units at ? 3.00 each.
Standard loss is 10% of input. Actual mix is 34 units of X and 66 units of Y.
Rates are the same. The actual loss is 15% of input. Calculate 1) Mix 2) Yield
Variances. [A. U’s-Final (Adapted) (Ans: MMV: F4(F) MYV F 15(A)]
10. The standard cost of chemical mixture is as below
40% material C at ? 20 per Kg.
60% material D at ? 30 per Kg.
A standard loss of 10% of input is expected in producton.
The cost records for March, 1998 show the following usage.
90 kg of materia! C at ? 18 per kg.
110 Kg of material D at ? 34 per kg.
Th^> quantity produced was 182 kg. of good product. Calculate Yield
Variance. [B.Com. (Hons) Delhi-adapted) (Ans : MYVF 57.78(F)]
11. From the following details of a Brass Foundary Co. Calculate;
a) Material Cost Variance; b) Material Price Variance; c) Material Mix
Variance; d) Material Yield Variance; e) Total Material Usage Variance.
 E-28

Standard Mix
Qty Price Total
Material Kg. T
A 500 6.00 3,000
B 400 3.75 1,500
C 300 3.00 900
1,200
Less 10% normal loss 120
1,080 5,400
Actual Mix
Qty- Price Total
Material Kg. T
A 400 6.00 2,400
B 500 3.60 1,800
C 400 2.80 1,120
1,300
Actual Loss 220
1,080 5,320
(B.Com. (Kakatiya) [Ans ; MCV f 80(F) MPV ? 155 (F) MMV ?375
(F); MYV ? 450 (A); MUV ? 75 (A)]
12. The standard materal cost for 100 kg of Chemical X is made up of
Chemical A - 30 kg @ ? 4/kg
Chemical B - 40 kg @ ? 5/kg
Chemical C - 80 kg @ ? 6/kg
In a batch, 500 kgs of Chemical X was produced from a mix of Chemical
A -140 kg at a cost of ? 588, Chemical B-220 kg at a cost of ? 1,056 and
Chemical C-440 kg at a cost of ? 2,860.
Calculate all Material Variances.
(B.Com. Andhra) [Ans : MYV? 53.33 (A), MMV? 6.67 (A), MPV? 100.80 (A),
MUV? 60(A), MCV? 160.80(A)]
13. From the given data calculate :
a) Material Price Variance, b) Material Price Variance.
c) Material Cost Variance.
Standards:
1. 250 Kg. of raw material is required for producing 175 Kgs. of finished
products.
2. Price of material per Kg. ? 4
Actuals:
1. Pruduction ? 52,500 Kg.
2. Materials consumed 70,000 Kgs.
3. Cost of materials ? 2,73,000.
(B.Com SVU) [Ans : MPV ? 7,000 (F); MUV ?20,000 (F); MCV ?27,000 (F)J
14. The Standard material cost to produce tonnes of chemical X is
300 kg of material A @ ? 10 per kg
400 kg of material B @ ? 5 per kg
 E-29

500 kg of material C @ T 6 per kg

During a period, 100 tones of X were produced from the usage of
35 tons of material A @ ? 9,000 per tone
42 tons of material B @ ? 6,000 per tone
53 tons of material C @ ? 7,000 per tone
Calculate Price Usage and Mix Variance.
(B.Com (Hons) Delhi) [Ans : (i) MPV 160,000 (A) (ii) MUV ? 78,000 (A)
(iii) MMV 111,333 (A)]
15. Quantity of material purchased 800 kg.
Value of material used ? 3,400
Standard rate of material ? 4/kg
Opening Stock of material 35 kg.
Closing Stock of material 5 kg
Calculate (i) Material Price Variance (ii) Material Usage Variance (iii)
Material Cost Variance. (C.A. Inter-adapted)
[Ans : (i) MPV f 198.75 A, (ii) MUV 2 120A (iii) MCV ? 318.75 A/
Hint: Opening Stock can be assumed to have been bought at standard rate.
16. Calculate Material Price Variance, Material Usage Variance and Material
Cost Variance from the following information :
Quantity of materials purchased 3,000 units
Value of materials purchased ? 14,000
Standard quantity of material required
per ton of finished product 20 units
Standard Price of Material ? 5 per unit
Opening Stock of materials 100 units
Closing Stock of Material 600 units
Finished product manufactured 100 tonnes.
(B.Com. Punjab)
(Ans : (i) MPV ? 800 (F) (ii) MYVI 2,500 (A) (iii) MCA ? 1,700 (A)
17. The standard materials required for producing 100 units is 120 kgs. A
standard price of 0.50 ps. per kg. Units produced 2,40,000. Actual
material purchased were 3,00,000 kgs at a cost of ? 1,65,000. Calculate
Material cost variance. (B.Com. OU.Oct. 03) [Ans: MCV=A 21,000 (A)]
18 From the following data calculate.
i) Material cost variance (ii) Material price variance (iii) Material usage
variance.
Standard Standard Actual Acutal
Products quantity price Quanity Price
(Units) (Units)
A 1,050 2.00 1,100 2.25
B 1,500 3.25 1,400 3.50
C 2,100 3.50 2,000 3.75
[Ans : i) MCV = ? 550 (A) ii) MPV = l 1125 (A), (iii) MUV = 1575 (F)
 E-30

19. Data relating to a job are as thus :

? 10
Standard rate of wages per hour
300
Standard Hours
Actual Rate of wages per hour T12
200
Actual Hours
You are required to calculate (i) Labour Cost Variance (ii) Labour Rate
Variance (iii) Labour Efficiency Variance
[B.Com (hons) Delhi] (Ans : (i) LCVRs. 600 (F), (ii) LRVRs.400 (A)
(iii) LEV Rs. 1,000 (F) /
20 From the data given below, calculate each of the three wage variances
for the two Departments :
Department A Department B
? 1,968 ? 1,798
Actual Gross Wages
8,000 6,000
Standard Hours Produced
0.30 p 0.35 p
Standard Rate per hour
8,200 5,800
Actual Hours Worked
(ICHA Inter-adapted)
[Ans : Dept A (i) LCV? 432 (F), (ii) LRV? 492 (F) (iii) LEV? 60 (A) Dept. B (i)
LCV? 302 (F) (ii) LRV? 232 (F) (iii) LEV? 70 (F)J
21. The standard labour requirement per unit of a product was 20 hrs @ Re.
0.50 p per hour. For the production of 500 units, wages paid amounted
to ? 6,050 for 11,000 hours, including 20 hours idle time due to machine
break down. Calculate Labour Variance.
(M.Com. Bombay - adapted) [Ans. (i) LCV? 1,050 (A) (ii) LRV? 550 (A)
(iii) LEV? 490 (A) (iv) Idle time Variance ? 10 (A)]
22. One unit of X required 15 minutes of labour, at 50 paise per hour. The
actual wage bill for 24,000 units was ? 4,500 @ 60 paise per hour,
including 1000 hours of idle time.
Calculate Idle Time Variance, Labour Efficiency Variance and Labour
Rate Variance.
(M.Com. Calcutta-adapted) [Ans. (i) ITV? 500 (A) (ii) LEV? 250 (A)
(iii) LRV? 750 (A)]
23. The details regarding composition and weekly wage rates of labour force
'
engaged on a iob scheduled to be completed in 30 weeks' are as ^-»i —
follows
Weekly wage No.of Actual Weekly
Category of !Standard
Worker No.of rate per workers wage rate per
Workers labourers labourer
75 60 70 70
Skilled
45 40 30 50
Semi-skilled
60 30 80 20
Unskilled
The work is actually completed in 32 weeks. Calculate the various labour
variances.
(B.Com (Hons) Delhi) [Ans (i) LCV? 13,000 (A) (ii) LRV? 6,400 (A)
(iii) LEV? 6,600 (A) (iv)9,600 (F)J
 E-31

24. The standard labour hours and rates of payment per unit of article ‘A’
are as follows :
Category ofLabour Hours Rate per hour (?) Total (?)
Skilled 10 3.00 30
Semi-skilled 80 1.50 12
Unskilled 16 1.00 16
58
The actual production was 1,000 articles of ‘A’ for which the actual
hours worked and rates are given below.
Category of Hours Rater per hour Total
Labour (?) (?)
Skilled 9,000 4.00 36,000
Semiskilled 8.400 1.50 12,600
Unskilled 20,000 0.90 18,000
66,600
Calculate a) Labour Cost Variance b) Labour Rate Variance c) Labour
Efficiency Variance and d) Labour Mix Variance
[Ans : a) ? 8,600 (A) b) ? 7,000 (A) c) ? 1,600 (A) d) ? 4,200 F
25. In a manufacturing concern, the standard time fixed for a month is 8000
hours. A standard wage rate of ? 2.25 per hour has been fixed. There
was a stoppage of work due to power failure for 100 hours. Calculate
idle time variance. (B. Com. O. U, Mar. 03) [Ans: 225 (A)]
26.. Compute different labour variances and reconcile the same.
Particulars Standard Actual
Wage rate ? 16 per unit
Wages paid ? 18,000
Output 900 units 880 units
Time taken 40 Hours 45 Hours.
(B.Com KU, June 03) [Ans : LCV= 3.920 (A) ii) LBV = 1,800 (A)
iii) LEV2,120 (A)]
Overhead Variance
27. Calcuate Overhead Cost Variance
Budgeted Actual
Overhead Cost ? 80,000 ? 84,000
Output 80,000 83,160
(Ans : ? 840 (A)
Calculate Overhead Cost Variance.
Budgeted Actual
No. of Working Days 20 22
Standard man hours per day 8,000 8,400
Output per man hour in units 1.00 0.90
Overheads ? 1,60,000 ? 1,80,000
(ICWA Inter - adapted) [Ans. ? 13,680 (A )
 E-32

29. Figure out the overhead budget, volume, and efficiency variances from
the following data:
Standard hours allowed for production 4,000
Actual hours taken for production 4,130
Budgeted Overheads for 4,000 hours ? 4,000
Overhead recovered on standard hours basis ? 4,065
Actual overhead incurred ? 4,022
Standard Overhead Rate per hour 1.00
(1CWA Inter) [Ans: (i) Ttotal Overhead Cost Variance ? 43(F), (ii) Expenditure
Variance f 22(A), Volume Variance T 65(F), Capacity Variance T 130(F),
Efficiency Variance T 65(A)[
30. From the following data for a factory for the month of January 1981
compute overhead variances.
Standard Actual
No. of Units produced 15,000 8,000
Variable Overheads t 30,000 ? 15,500
Fixed Overheads ? 45,000 ? 46,000
(M.Com. Delhi) [Ans : Total Variable Overhead Cost variance ? 500(F), Fixed
Overhead Cost Variance T 22,000(A),fixed Overhead Volume Variance ? 21,000
(A), Fixed Overhead Expenditure Variance T1,000(A)]
31. Calculate Overhead Variances.
Standard Actual
No. of units 4,000 3,800
Working Days 20 21
Fixed Overhead 40,000 39,000
(C.A Inter adapted) [Cost Variance T1,000(A), Expenditure Variance ? 1,000(F),
Volume Variance T 2,000(A), Efficiency Variance 4,000(A),
Calendar Variance ? 2,000(F)
32. Calculate Overhead Variance.
Budget Actual
No. of working days 25 27
Production Units 20,000 22,000
Fixed Overheads 30,000 31,000
Budgeted Fixed Overhead Rate is Re. I/- per hour. The actual hours
worked were 31,500.
(C.A Inter adapted) [Ans: Total Overhead Variance ? 2,000 F, Expenditure
Variance ? 1,000 A, Volume Variance T 3,000 F, Calendar Variance T 2,400 F,
Capacity Variance T 900 A, Efficiency Variance T 1,500 F]
33. From the following, compute the different overhead variances: In a
factory 10,000 units are budgeted to be produced in a month with
budgeted fixed expenses being ? 15,000 i.e., ?1.50 per unit. The actual
output during the month was 11,000 units and actual fixed expenses
being ? 15,500 the increase in output was due to 5% increase in capacity.
The budgeted working days were 25 but factory worked for 27 days.
 E-33

(B.Com. Punjab) {Ans: Total Overhead Cost Variance ? 1,000 (F), Expenditure
Variance T 500 (A), Volume Variance ? 1,500 (F), Capacity Variance ( 810
(F), Calendar Variance T 1,200 (F), Efficiency Variance (510 (A)]
Sales Variance
34. From the data given below, calculate sales variance and analyse it
Budgeted units sold 2,000
Actual units sold 1,600
Budgeted selling price ? 15 per unit
Actual Selling Price ? 20 per unit
(Ans : Actual Sales ? 32,000 (ii) Budgeted Sales ? 30,000
(iii) Sales Variance^2,000)
35. From the following data, calculate Sales Variances.
Product Standard Actual
Unit Unit Price (?) Units Unit Price (?)
A 1,500 30 2000 29
B 1,000 50 700 50
Total 2,500 2,700
(Ans : Sales Quality Variance ( 7600)
36. The budget and actual sales for a period in respect of two products are
as follows
Budgeted Actual
Product Quantity Price Value Quantity Price Value
X 600 3 1,800 800 4 3,200
Y 800 4 3,200 600 3 1,800
Calculate Sales Variances.
(Ans : Sales Variance ( 0)
37. From the budgeted and actual sales for May 1999 in respect of three
products given below, calculate sales variance.
Product Standard Actual
Units Units Price (?) Units Unit Price (?)
X 5000 5 5000 5.00
Y 4000 6 6000 6.25
Z 3000 7 4000 6.75
Total 12,000 15,000
(Ans : Sales Quality Variance ? 19,000 (J) 1,500 (f) + 17,500 (f)
38. Compute Sales Variance from the following information
Products Actual Budget
Units Selling Price (?) Units Selling Price (?)
4,500 10 4,000 8
Y 3,000 8 2,500 6
Z 2,500 6 1,500 8
(Ans : Sales Variance (25,000)
 E-34

39. XYZ Ltd., furnished the following information relating to budgeted

sales and actual sales for April 1994.
Product Sales Selling Price
Quantity Per unit ?
Budgeted Sales A 1,200 15
B 800 20
C 2,000 40
Actual Sales A 880 18
B 880 20
C 2,640 38
Calculate the following Variances
(a) Total Sales Variance (b) Sales Price Variance
(c) Sales quantity variance (d) Sales Mix Variance
(Ans : Variance (i) ? 7600 (ii) ? 2,640 (iii) ? 22,400 (iv) ? 11,000)
40. Budgeted and actual sales for the month of December 1994 of two
products A & B of Messrs. XY Ltd. were as following.
Product Budgeted Sales Actual
Units Price / Unit (?) Units Price / Unit (?)
A 6,000 5.00 5,000 5.00
B 10,000 2.00 1,500 4.75
7,500 2.00
1,750 1.90
Budgeted costs for products A and B were ? 4.00 and ? 1.50 per Unit
respectively. Work out from the above data the following Variances.
(i) Sales Value Variance (ii) Sales Volume Variance (iii) Sales Price
Variance(iv) Sales Mixture Variance (v) Sales Quantity Variance
(Ans : Variance (i) ? 450 (ii) ? 1000 (iii) ? 500 (iv) f 1,781 (v) ? 781
41. Standard Manufactures Ltd., has given the following budgeted and actual
sales figures.
Budgeted Actual
Product Quantity Sale Price (?) Quantity Sales Price (?)
A 500 60 600 ' 65
B 700 40 650 38
The cost per unit of product A and B was ? 55 and ? 32 respectively. Compute
variances to explain difference between budgeted and actual profit.
(Ans : Sales Margin Variance (i) ? 1,800 (ii) ? 1,700 (iii) K 100
42. Modern Toys Ltd., has budgeted the following sales for Dec. 1995.
Toy A 900 units @ ? 50 per unit Toy B 650 units @ ? 100 per unit
Toy C 1,200 units @ ? 75 per unit
As against this, the actual sales were :
Toy A 1,000 units @ ? 55 per unit. Toy B 700 units @ ? 95 per unit
Toy C 1,100 units @ ? 78 per unit.
The cost per unit of A, B and C was ? 45, ? 85 and ? 65 respectively.
Calculate different variances to explain the difference between budgeted
and actual profit.
(Ans : Sales Margin Variance (i) ? 5,050 (ii) ? 250 unfavourable
 Chapter -6
IMPORTANCE AND ESTIMATION
OF WORKING CAPITAL

Importance : Working Capital can be Gross Working capital on Net Working

capital Gross working capital refers to the firm's investment in all the current
assets taken together. The term net working capital may be defined as the
excess of total current assets over total current liabilities. This is also called as
Net current assets.
Current Assets may be defined as (i) those which are convertible into
cash or equivalents within a short period of, say, one year, and (ii) those which
are required to meet day to day operations. A firm's working capital consists
of its investments in Current Assets, which include short-term assets such as
cash and bank balances, inventories, receivables (including debtors and bills),
and marketable securities. Working capital management refers to management
of current assets.
Current liabilities refer to liabilities that are payable within a period of
one year. A part of the funds required to maintain current assets is provided by
the current liabilities and the firm will be required to invest the funds in only
those current assets which are not financed by the current liabilities. A financial
manager must consider both gross working capital and net working capital.
The operations of an organization can be smooth only if supported by
sufficient working capital. The efficient management of working capital is
important from the point of view of both liquidity and profitability. Working
capital involves investment of funds of the firm. Poor management of working
capital means that funds are unnecessarily tied up in idle assets. It may result
in unnecessary blocking of scarce resources of the firm. Insufficient working
capital, on the hand, result in hindrances in smooth working of the firm.
Therefore, working capital management needs attention of all the financial
managers.
The management of working capital involves different concepts and
methodology than the techniques used in fixed assets management (learnt in
Capital Budgeting). Fixed assets affect long-term profitability of the firm while
current assets affect short-term liquidity position. The time horizon is usually
limited in case of working capital to one year only. Hence, the time value of
money concept is not considered. The fixed assets decisions are irreversible,
 F-2

whereas working capital decisions can be changed and modified without much
implication. The level of investment in each of the current assets varies from
day to day. The finance manager needs to continuously monitor these assets
to ensure that the desired levels are being maintained.
Thus, the working capital management may be defined as the
management of firm's sources and used of working capital in order to maximize
the wealth of the shareholders. Proper working capital management requires
both medium term planning (say up to three years) and also the immediate
adaptations to changes arising due to fluctuations in operating levels of the

stimation : The efficiency of planning and management is subject to the

correct estimate of working capital requirement. Correct estimation of working
capita requirements is the fundamental necessity of good and efficient working
capital management.
Estimation Process : A firm must estimate in advance as to how much net
working capital will be required for the smooth operations of the business.
is will enable bifurcation of the requirement into permanent working capital
and temporary working capital. This bifurcation will help in deciding the
financing pattern in terms of deciding the extent to which working capital
should be financed from long term sources and the extent to which it can be
financed from short term sources. There are different approaches available to
estimate the working capital requirements of a firm. These are as follows:
1. Working Capital as a Percentage of Net Sales : The Working Capital for
any firm is a function of the sales volume of that firm. Higher the sales level
greater could be the need for working capital. This method expresses the
working capital requirement as a percentage of expected sales for a particular
period. However, rather than calculating the Net working capital and expressing
it as a percentage of sales, this method estimates total current assets and
estimated current liabilities separately as a % of estimated net sales. Total
Current Assets as a % of net sales will give the gross working capital
requirements. Current liabilities as a % of net sales will give the funds provided
by current liabilities. The difference between the two is the net working capital
as a % of net sales. F
The percentage of total current assets and total current liabilities for a
given level of activity can be calculated on the basis of past experience of the
irm itself or on the basis of any other firm's experience in the same competitive
environment. The difference between the two is the net working capital which
the firm has to arrange for.
Note : While taking the average for calculation of total current assets and
estimated current liabilities as a % of estimated net sales, simple average is
taken. However, if there is a consistent trend (increase or decrease) in current
assets or current liabilities or both, then weighted average may be preferred
with highest weight to the most current year.
2. Working Capital as a Percentage of Total Assets of Fixed Assets : The
total assets of the firm consist of fixed assets and current assets. While Fixed
Assets are required to modernize or expand operations, working capital is
required to ensure that the fixed assets are used in an efficient and optimal
manner. Thus, working capital requirements depend upon the planned level
of fixed assets. On the basis of past experience, a relationship between Working
Capital (either gross working capital or net working capital) and total fixed
assets or total assets of the firm can be established. For example, a firm is
maintaining 25% of its total assets in the form of current assets and expects to
have total assets of ? 20,00,000 next year. Thus the current assets of the firm
would be ? 5,00,000 (i.e., 25% of ? 20,00,000). The working capital may also
be estimated as a % of fixed assets. It should be estimated together with capital
budgeting decisions.
The above two approaches are relatively simple but not very practical.
Working Capital is based on level of activity and the Fixed assets required to
work at a particular capacity. However, this relationship is not directly
proportional. Applying a percentage to either Sales or fixed assets may lead to
under or over estimation of working capital requirements. Moreover, past
experience may be neither available nor reliable. There is another approach to
estimate the working, capital requirements based on the concept of operating
cycle.
The Operating Cycle : The working capital requirements of a firm depend to
a great extent upon the operating cycle of the firm. The operating cycle may
be defined as the time duration starting from the procurement of goods or raw
materials and ending with the sales realization. The length and nature of the
operating cycle may differ from one firm to another depending upon the size
and nature of the firm.
Thus, the operating cycle of a firm consists of the time required for the
completion of the chronological sequence of some or all of the followings :
i. Procurement of raw materials and services.
ii. Conversion of raw materials into work -in-Progress
iii. Sale of finished goods (cash or credit)
iv. Sale of finished goods (cash or credit)
v. Conversion of receivable into cash.
The firm is often required to extend credit facilities to customers. The
finished goods must be kept in store to take care of the orders and a minimum
cash balance must be maintained. It must also have minimum raw materials in
store to have smooth and uninterrupted production. So, in order to have a
proper ^id smooth running of the business activities the firm must make
investments in all these current assets. This requirement of funds depends
upon the operating cycle period of the firm and is also denoted as the working
capital needs of the firm.
 F-4

3. Working Capital based on Operating Cycle : The concept of operating

cycle is very useful in estimating the working capital requirements of any
firm. This method of estimation is the most systematic and logical approach.
In this approach, the working capital estimate depends upon the operating
cycle of the firm. A detailed analysis is made for each component of working
capital and estimation is made for each of these components.
Different components of current assets require funds depending upon
the respective operating cycle and the cost involved. The current liabilities, on
the other hand, provide financing depending upon the respective operating
cycle or the lag period in payment. The estimation or working capital
requirements can be made by estimating the requirement of funds for each
component. This can be done as follows :
Cash and Bank Balance : Every firm must maintain some minimum cash
and bank balance to meet day to day requirements for petty expenses, general
expenses and unplanned for emergencies. The minimum cash requirements
for these transactions can be estimated on the basis of past experience. Proper
estimation of cash and bank balance is required to provide liquidity to the
firm. Moreover, cash and bank balance is the least productive of all current
assets. Hence,'the amount locked in must be restricted to a minimum.
Raw Materials : Every manufacturing firm has to maintain some stock of
raw material in stores to meet the requirements of the production process. The
number of units to be kept in stores for different types of raw materials depends
upon various factors such as raw material consumption rate, time lag in
procuring fresh stock, contingencies and other factors. For example, if it takes
3 days to procure fresh stock of raw materials, and 100 units are used daily,
then there should be a minimum of 300 units in stock. The firm may also like
to have a safety stock of 200 units. Thus, the total units to be maintained in
stores would be 500 units. If the cost per unit of this item of raw material is
?10 per unit, then the working capital requirement is ? 5,000 (i.e., 500 x ?10)
Work-in-progress : In any manufacturing firm, the production process is
continuous and is generally consisting of several stages. At any particular
point of time, there will be different number of units in different stages of
production. Some of these units may be 10% complete, some may be 60%
complete and some may be even 90% complete. These units, which can neither
be defined as raw material nor as finished goods, are known as work-in-progress
or semi-finished goods. The value of raw material, wages and other expenses
locked up in these semi-finished units is the working capital requirement for
work-in-progress.
Valuation of work in progress is based on the following assumptions:
• The value of raw material locked up in work-in-progress will be equal
to full cost of number of units of raw material being represented in work-
in-progress.
• The units in work-in-progress may be unfinished with respect to labour
and overheads expenses. Various units would be at various stages of
completion. Some of these units may be 10% complete, some may be
75% complete and some may be even 95% complete. It is assumed that
all work-in-progress units are on an average 50% complete with respect
to labour and overhead expenses. However, if some other information is
given, then the valuation of work-in-progress may be made accordingly.
Finished Goods : It may not be possible for any business to immediately sell
the goods after purchase/procurement/completion of production process. The
cost incurred in purchasing, procuring or production of these units is locked
up and hence working capital is required for them. It may be noted that these
finished goods are valued on the basis of cost of these units. The carriage in
ward, if any, is included.
Receivables : Receivables include debtors and bills receivable. In case of
credit sales, there is a time lag between sales and collection of sales revenue.
For example, a firm makes a credit sale of ? 1,50,000 per month and a credit of
45 days is given to customers. The working capital locked up in receivables is
? 2,25,000 (? 1,50,000 x 1.5 months). However, this calculation is based upon
selling price, whereas the actual funds locked up in investment in profit element.
Thus, working capital is calculated as the amount locked up in receivables on
cost basis. Continuing with the earlier example, if the firm is selling goods at
a gross profit of 20% then the working capital requirements for receivables
would be ^1,80,000 (i.e., ?l,50,000 x 80% x 1.5).
The total of working capital requirements for all the above elements is
the gross working capital of the firm. At any particular point of time, every
firm requires gross working capital as there will be some units of raw materials
in stores, some units in work-in-progress, some units as finished goods and
there will be some receivables yet to be collected.
Creditors for Purchases : A firm may procure/purchase raw materials and
finished goods on credit basis. The payment for these purchases may be
postponed for the period of credit allowed by suppliers. So, the suppliers of
the firm in fact provide working capital to the firm for the credit period. For
example, a firm makes credit purchases of ? 50,000 per month and the credit
allowed by suppliers is two months, then the working capital supplied by the
creditors is ? 1,00,000 (i.e., ? 50,000 x2 months). It means that the firm would
be getting the supplies without making any payment for two months. The
postponement of payment to creditors helps the firm to reduce the amount of
funds blocked in various components of Working capital.
Creditors for Expenses and Wages : Wages and expenses accumulate in the
woi/k-in-progress and finished goods on a regular basis. They are considered
for valuation of work-in-progress and finished goods. However, they are pai'
usually at the end of the month. The time lag in payment of wages and otlj
expenses provides some working capital to the firm. jg
due
.bour
 F-6

Working capital required to sustain the level of planned operations is

determined by calculating all the individual components of Current Assets
and deduction of current liabilities. The calculation of net working capital
may be shown as follows :
The work sheet for estimation of working capital requirements under
the operating cycle method may be presented as follows :
Estimation of Working Capital Requirements
I. Current Assets : Amount Amount
Minimum Cash Balance
xxxx
Inventories
Raw Materials xxxx
Work-in-progress xxxx
Finished Goods xxxx xxxx
Receivables :
Debtors xxxx
Bills Receivable xxxx xxxx
Gross Working Capital (A)
xxxx
II. Current Liabilities :
Creditors for Purchases
xxxx
Creditors for Wages
xxxx
Creditors for Overheads
xxxx
Total Current Liabilities (B)
xxxx
Excess of Current Assets over Current Liabilities
xxxx
Add Safety Margin
XXX
Net working Capital
xxxx
Points to be noted
1. Depreciation : The depreciation on fixed assets used in the production
process or other activities in not considered in working capital estimation.
Depreciation is a non-cash expense and there are no funds locked up in
depreciation. Hence, it is ignored. It is neither included in valuation of
work-in-progress nor in finished goods. The working capital calculated
y ignoring depreciation is known as cash basis working capital. In case,
depreciation is also included in working capital calculations, such
estimate is known as total basis working capital.
2. Safety Margin : A firm may like to have a safety margin of working
capital in order to meet any contingency. It is normally expressed as a %
of total current assets or total current liabilities or net working capital.
Any other method can also be followed. The safety margin is added to
excess of current assets over current liabilities to arrive at the net working
"’tai required for the firm.
• You are required to prepare for the Board of Directors of Excel
NJ, a Statement showing the working capital needed to finance
5,400 units of output per annum.
owing information.
 F-7

Cost Amount per unit (T)

Raw Materials 8
Direct labour 2
Overheads 6
Total cost (TC) 16
Profit 4
Selling Price (SP) 20
Raw materials are in stock, on average, for one month. Materials are in
process, on average, for half a month. Credit allowed by suppliers is 1 month.
Finished goods are in stock, on average, for six weeks. Credit allowed to debtors
is two months. Lag in payment of wages is V/2 weeks. Cash on hand and at
bank is expected to be ? 7,300. You are informed that production is carried on
evenly during the year and wages and overheads accrue similarly.
Solution

Raw Material 1 Month 3,600

Work in Progress
Material 1800
Labour 225
Overheads 675 2,700
Finished Goods 6 Weeks 9,968
Debtors 2 Months 14,400
Cash Balance 7,300
Gross Working Capital 37,968
Less
Creditors for Materials 1 Month 3,600
Creditors for Wages 1.5 Weeks 312 3,912
Networking Capital 34,056
Note : For the purpose of calculations, it is being assumed that 1 year is equal
to 52 weeks and 1 month is equal to 4 weeks. Hence, for all calculations,
number of units per month = 5400 units per annum / 12 months = 450 units.
Similarly, number of units per week = 5400 units per annum / 52 weeks =
103.85 units
Working Notes
1. Raw Material: Raw materials are in stock, on average, for one month.
The number of units of material required for 1 month is = 450 units.
Cost per unit = ? 8. Thus, amount blocked in raw materials = 450 units
8 = ? 3,600.
2. Work in Progress: Materials are in process, on average, for half a month.
Thus, number of units of work in progress = 450/2 = 225 units. Work in
progress has three components. Materials are introduced at the beginning
of the production process. Hence, the entire cost it taken. Hence, value
of materials in Work in progress - 225 units * ? 8 = ?l,800. Labour
 F-8

costs are incurred through out the production process. Hence, the standard
assumption is that all work-in-progress units are on an average 50%
complete with respect to labour and overhead expenses. Thus, labour
costs will be 225 units * ? 2 per unit * 50% = ? 225. Similarly, Overhead
costs will be 225 units * ? 6 per unit * 50% = ? 675.
3. Finished Goods: Finished goods are in stock, on average, for six weeks.
Thus, number of units of finished goods = 103.85*6 = 623 units. The
amount blocked in finished goods = 623 units * 116 - ? 9,968.
4. Debtors : It is being assumed that all sales are on credit. Credit allowed
to debtors is two months. Thus, number of units blocked in debtors =
450 units *2 = 900 units. The amount blocked in debtors = 900 units
*? 16 = ?14,400.
5. Creditors for Materials: Credit allowed by suppliers is 1 months. Hence,
amount required is equal to value of one month of raw materials = ?3,6OO.
6. Creditors for Wages : Lag in payment of wages is 1 ‘A weeks. Amount
of Wage per unit = ? 2. Thus, amount for 1.5 weeks = T 103.85 units
2 per unit* 1.5 weeks = ? 312.
PROBLEMS
1. Pravek Ltd provides you information in respect of its Sales and Working
capital for the last 3 years. You are required to estimate the Working
Capital requirements for the current year, given that the Sales forecast
for the current year is ? 1,00,00,000.

Net Sales 50,00,000 60,00,000 80,00,000

Stock 3,30,000 4,00,000 5,50,000
Debtors 8,00,000 10,00,000 12,50,000
Other Current Assets 20,000 50,000 1/00,000
Creditors 1,75,000 2,00,000 2\75,000
Outstanding Expenses 25,000 40,000 75,000
(Ans: Working Capital estimate ;• 119,51,389)
(Hint: CA as percentage ofSales = 23.64%, CL = 4.13% of Sales)
2. X wishes to commence a new trading business and gives the following
information.
1. The total estimated sales in a year will be ?12,00,000.
2. He expects to fix a sale price for each product which will be 25%
in excess of his cost of purchase.
3. He expects to turn over his stock four times in the year.
4. The sales and purchases will be evenly spread throughout the year.
All sales will be for cash but he expects one month's credit for
purchases.
Calculate his average working capital requirements.
(M.Com Osmania-adapted) (Ans : Net Working Capital T 1,60,000)
(Hint: Stock ? 2,40,000; Creditors ? 80,000)
 F-9

3. Prepare an estimate of working capital requirements from the following

information of a trading concern:
a. Projected annual Sales 1,00,000 units
b. Selling Price ? 8/- per unit
c. Percentage of net profit on sales 25%
d. Average Credit Period allowed by suppliers 4 weeks
e. Average Credit Period allowed to suppliers 8 weeks
f. Average Stock holding in terms of sales requirement 12 weeks
g- Allow 10% for contingencies (M.Com Osmania) (Ans: ? 2,03,077)
4. The cost sheet of a company provides the following particulars.
Elements of Cost Amount per unit
Raw Labour 50
Direct Labour 20
Overheads 10
Total cost 80
Profit20
Selling price 100
The following particulars are available :
(i) Raw material in stock, on average one month
(ii) materials in process, on average one month
(iii) Finished goods in stock, on average one month
(iv) Credit allowed to debtors is one month
(v) Credit allowed to debtors is one month
(vi) Lag in payment of wages is two weeks
One fourth of the output is sold against cash. Cash in hand and banks are
expected to be ? 20,000. Prepare a statement showing the working capital
needed to finance a level of activity of 1,30,000 units of production per annum.
Assume that year consists of 52 weeks and a month consists of 4 weeks.
(M.Com Osmania) (Ans: Net Working Capital?. 19,70,000)
5. You are given the following information.
Cost Amount per unit (?)
Raw Materials 50
Direct Labour 30
Overheads (including depreciation of ? 10) 40
Total cost (TC) 120
Profit 10
Selling Price (SP) 130
Average raw material in stock is for one month. Average material in
work-in-progress is for half month. Credit allowed by suppliers; one month;
credit allowed to debtors; one month. Average time lag in payment of wages;
10 days; average time lag in payment of overheads 30 days. 25% of the sales
are on cash basis. Cash balance expected to be ? 1,00,000. Finished goods lie
in the warehouse for one month.
 F-10

Youth are required to prepare a statement of the working capital needed

to finance a level of the activity of 54,000 units of output, production is carried
on evenly throughout the year and wages and overheads accrue similarly. State
your assumptions, if any, clearly.
(C.A. Final-adapted) (Ans: Net Working capital ? 9,66,250)
Additional Problems
1. The management of Manaank Ltd has called for a statement showing
the working capital needed to finance a level of activity of 3,00,000
units of output for the year. The cost structure for the company's product,
for the above mentioned activity level is detailed below:
Cost per Unit
Raw materials 20
Direct labour 5
Overheads 15
Total 40
Profit 10
Selling price 50
(a) Past experience indicates that raw materials are held in stock, on
an average, for two months.
(b) Work-in-progress (100% complete in respect of raw-materials and
50% in respect of labour and overheads) will be approximately
half month's production.
(c) Finished goods remain in warehouse on an average for a month.
(d) Suppliers of materials extend a month's credit.
(e) Two months credit allowed to sundry debtors, calculation are to be
made at selling price.
(f) A minimum cash balance of ? 25,000 is expected to be maintained.
(g) The production pattern is assumed to be even during the year,
prepare the statement of working capital requirement.
(I.C. W.A. final) Answer : ? 44,00,000
2) From the following information presented by a manufacturing company,
prepare a working capital requirement forecast statement for the coming
year. Expected monthly sales of 32,000 units at ? 10 per unit. The
anticipated ratios of cost to selling price are :
Raw Materials 40%
Labour 30%
Budgeted Overhead ? 16,000 per week
Planned stock will include raw materials for ? 96,000 and 16,000 units of
finished goods.
Materials will stay in process for 2 weeks.
Credit allowed to Debtors is 5 weeks.
Credit allowed by Creditors is 1 month.
 Lag in payment of overhead is 2 weeks.
Wages will be paid at the beginning of the week following the week of work.
Cash in hand is expected to be 10% of Net Working Capital.
Assume that production is carried on evenly throughout the year and overhead
ccrue similarly and a time period of 4 weeks is equivalent to a month.
(B.Com. (Hons). Calcutta-Adapted) (Ans.5,77,777)
3) Lucky Ltd, a trading concern, provides the following information :
Annual sales during the year 1983, ? 1,20,000
Analysis of sales show:
Material 60%
Expenses 15%
Profit 25%
Average credit allowed to Debtors 216 months.
Average credit period allowed by Creditors 116 months.
Raw materials are to remain in store on average 1 month.
Processing period on average 2 months.
Finished goods are to remain in warehouse on average 3 months.
Bank Overdraft ? 90,000
10% of the total working capital (including contingencies) is to be kept in
hand for contingencies.
You are required to determine the working capital requirement of Lucky Ltd.
on the basis of above information.
(B.Com (Hons) Calcutta) (Ans : Net Working capital requirement: ? 57,700.
Current surplus : ? 32,300)
Hint: Bank overdraft is a means of funding the working capital requirement.
Overdraft to the extent of? 32,300 can be reduced).
4) Bandhavi Ltd sells goods on a gross profit of 25%. Depreciation is taken
into account as a part of cost of production. The following are the annual
figures given to you:
Sales (two months credit) 18,00,000
Materials consumed (one month credit) 4,50,000
Wages paid (one month credit) 3,60,000
Cash manufacturing expenses (one month lag in payment) 4,80,000
Administration Expenses (one month lag in payment) 1,20,000
Sales promotion expenses (paid quarterly in advance) 60,000
Income tax payable in 4 installments of which one is
Payable next yr. 1,50,000
The company keeps one month stock each of raw materials and finished
goods. It also keeps ? 1,00,000 in cash. You are required to estimate the working
capital requirements of the company assuming 15% safety margin.
(B.Com. S.V.U. June 2003) (Ans: ? 4,57,125)
 F-12

Hints
1) Income tax is a tax on profit, which is not considered in calculation.
Hence, ignore.
2) Sales ?18,00,000. Gross profit = 25%, CoGS ? 13,50,000. Materials
? 4,50,000 wages ^3,60,000 other cash manufacturing expenses;
?4,80,000. Thus cash CoGS; 4,50,000 + 3,60,000+4,80,000=^ 12,90,000.
Thus, depreciation = ? 60,000.
3) Cash Cost of sales = Cash CoGS + Admn Exps. + Sales exp = 12,90,000
+ 1,20,000 + 60,000 = ? 14,70,000.
Debtors = 14,70,000 x 2/12 = ? ,45,000
4) Cash cost of production : Cash Comp, of CoGS + Admn. Exp =
?T 2,90,000 + 1,20,000 = 14,10,000 value of finished goods, in stock =
14,10,000 x P/2 = ? 1,17,500.
5) X&Co. is desirous to purchase a business and has consulted you and
one point on which you are asked to advise them is the average amount
of working capital which will be required in the first year's working.
You are given the following estimates and are instructed to add 10% to your
computed figure to allow for contingencies :
Figures for the year

(i) Amount blocked up for stocks:

Stocks of finished product 5,000
Stocks of stores, materials, etc. 8,000
(ii) Average credit given:
Inland Sales-6 weeks credit 3,12,000
Export Sales P/2 weeks credit 78,000
(iii) Lag in payment of wages and other outgoings:
Wage - P/2 Weeks 2,60,000
Stocks of materials, etc - P/2 months 48,000
Rent, Royalties, etc. 6 months 10,000
Clerical staff = Vi month 62.400
Manager Vi month 4,800
Miscellaneous Expenses - P/2 months 48,000
(iv) Payment in advance:
Payment of tax (paid Quarterly in advance) 8,000
(v) Undrawn profit on the average throughout the year 11,000
Set up your calculations of or the average amount of working capital.
(C.A. Final) (Ans : 28,545)
H : Ignore, undrawn profits. No separate calculation required for wip).
 OBJECTIVE TYPE QUESTIONS
UNIT -1
PRODUCTION

1. Financial Accounting deals with

(a) Planning and Forecasting (b) Inter prating Financial data
(c) Preparation of P&L and Balance Sheet (d) Budgeting
2. Management Accounting Provides
(a) P&L of the Organization
(b) Information to management accounting to its needs
(c) Focus on the Company’s revenues (d) None of the above
3. Management Accounting is used for making
(a) available- costs incurred by the organization (b) Its objective nature
(c) Managerial decision making (d) Analysis of Costs
4. The main objective of cost Accounting is to
(a) Provide information to management to formulate plans & Policies.
(b) determine and record the cost per unit of output.
(c) It is based on future oriented (d) Preparation of Balance Sheet
5. Financial Accounting Ignores
(a) qualitative aspects of business (b) Preparation of P&L & B/s
(c) Generally Prepared at the close of Accounting period.
(d) None of the above
6. Financial Accounting meet the requirement
(a) of Management to frame future Plans and Policies
(b) External Parties such as investors, Banks, Creditors etc.
(c) Taking appropriate control decisions (d) None of the above
7. Financial Accounting do not take into account
(a) National expenses (b) Balance Sheet compilation
(c) determination of P&L (d) Overall trading results for a period
8. Management Accounting leads to
(a) Recording cost per unit of the output
(b) efficient Planning and an effective organization
(c) recording of past and present accounting figures
(d) None of the above
9. Management Accounting prepares and presents information as per
(a) requirement of management
(b) only records & analysis costume data
(c) Always expresses transactions in ferrous of money (d) All the above
10. N|anagement Accounting is based on facts. But it enables the
management to forecast the methods of future planning and adopt
policies therefore it can be treated as
(a) Both Science and an art (b) only science based on facts
(c) only Art of policy formulation (d) None of the above
 2

11. Management Accounting

(a) Mandatorily Audited annually (b) Need not be audited
(c) Audited. Quarterly (d) None of the above
12. The effectiveness of Management Account
(a) depends upon the fairness and accuracy of accounting information.
(b) Accounting information is not relevant (c) only P&L is seen
(d) Plans & Policies for future is done at random
Fill in the Blanks
1. Accounting may be classified into financial Accounting---------------
and Management Accounting
2. Cost Accounting and____ are normally understood as one. However
there are a few differences between them.
3. Financial Accounting ignores notional costs and______
4. Preparation of Management Accounting is not_______
5. Financial Accounting ______ whether the profits are due to efficiency
in operations or due to external factors
6. Management Accounting Supplies information and not_______
7. One of the objectives of Management Accounting is to____ the wealth
of the organization
8. Management Accounting is useful to Managers in making_________
and attain its objectives
9. The decisions with which Management are concerned can be classified
as Planning, Organizing and_______ decisions.
10. Management Accounting is________ Oriented
11. Management Accounting lays greater emphasis on the nature of various

12. One of the main objectives of Management Accounting is to help the

management in the formulation of________ and______________
Short Answer Questions
1. List any 2 limitations of Financial Accounting
2. Define Management Accounting
3. State any 2 features of Management Accounting
4. State any 2 objectives of Management Accounting
5. How does management accounting help in taking organizing decisions?
6. List any 2 areas that come within the scope of Management Accounting.
7. List any 2 functions of Managerial Accounting.
8. List any 2 advantages of Managerial Accounting.
9. List any 2 limitations of Managerial Accounting.
10. State any one similarity between Financial Accounting and Management
Accounting
11. State any two differences between Financial Accounting and
Management Accounting
12. State any two differences between Cost Accounting and Management
Accounting
 3

Answers
Multiple Choice Question
(1) C (2) B (3) C (4) B (5) A (6) B
(7) A (8) B (9) A (10) A (H) (12) A
Fill in the Blanks
(1) Cost Accounting (2) Management Accounting (3) Revenues
(4) Mandatory (5) fails to inform (6) decisions
(7) Maximize (8) Intelligent decisions (9) Control
(10) Future (11) elements of Cost (12) Plans& Polices.
Unit -2
MARGINAL COSTING
Multiple Choice Questions
1. Marginal costing is also known as
(a) Direct costing (b) Variable costing
(c) Both a and b (d) None of the above
2. Under absorption costing, managerial decisions are based on
(a) Profit (b) Contribution
(c) Profit volume ratio (d) None of the above
3. Which of the following are advantages of marginal costing?
(a) Makes the process of cost accounting more simple
(b) Helps in proper valuation of closing stock
(c) Useful for standard and budgetary control (d) All of the above
4. Managers utilize marginal costing for
(a) Make or buy decision (b) Utilization of additional capacity
(c) Determination of dumping price (d) All of the above
5. In marginal costing, profitability of each product is measured on the
basis of its
(a) Cost (b) Profit (c) Contribution (d) None of the above
6. When there is tough competition and a price-war is on, the focus should
be on
(a) Normal price (b) Depression price
(c) Minimum price (d) None of the above
7. Which of the following are characteristics of Break Even Point?
(a) There is no loss and no profit to the firm.
(b) Total revenue is equal to total cost.
(c) Contribution is equal to fixed cost (d) All of the above.
8. The P/V ratio can be improved by
(a) Decreasing the selling price per unit (b) Increasing variable cost
(c) /Changing the sales mix (d) Reducing the Fixed Cost
9. Margin of safety can be increased by
(a) Decrease in selling price (b) Decline in volume of production
(c) Reduction in fixed or the variable costs or both
(d) Increase in Fixed Costs
 4

10. These costs remain fixed, as long as the output remains within a certain
level?
(a) Fixed Cost (b) Step Cost (c) Variable Cost (d) Semi-Variable Cost
Fill in the blanks
1. _______ helps management in profit planning by studying the
relationship between cost, volume and profits.
2. ________ costs consist of all such expenditure that is incurred only
when a product is being produced.
3. Under________ , the output at two different levels is compared with
corresponding amount of Semi variable expenses.
4. Telephone expenses are a good example of_________ costs.
5. _______ is the difference between sales and variable costs.
6. A business is said to___________ when its total sales are equal to its
total costs.
7. _____________ is the point where cash receipts on account of sales
are equal to cash expenses incurred.
8. ________ sales is the sales over and above the ‘break even’ sales.
9. ____ ratio is defined as Contribution/ Sales
10. Marginal costing completely ignores the__________
Short Answer Questions
1. State any one difference between Marginal Costing and Absorption
Costing
2. On the basis of their relationship with the volume of Production Cost
can be classified into how many types?
3. What is Fixed cost?
4. What are Semi Variable costs?
5. State the Marginal Costing equation.
6. Define Break-Even Point
7. What is cash break-even point?
8. What is margin of safety?
9. What do you understand by the term P/V ratio?
10. What do you understand by the term CVP Analysis?
Answers
Multiple Choice Questions
(1) C (2) A (3) D (4) D (5) C (6) C
(7) D (8) C (9) C (10) B
Fill in the Blanks
(1) Marginal Costing (2) Direct (3) Two Point Method
(4) semi variable (5) Contribution (6) Break even
(7) Cash Break Even point (8) Margin of Safety
(9) P/V 10. time factor
★★★
 5

Unit - 3
DECISION MAKING
Multiple Choice Questions
1. First step in decision making process is to
(a) identify the problem (b) identify the linear variable
(c) identify the certainty (d) identify the multiplier
2. Factors which can never be measured in numerical terms in books of
accounts are classified as
(a) expected factors (b) recorded factors
(c) qualitative factors (d) quantitative factors
3. An example of quantitative factors used in decision making is
(a) employee behavior at workplace (b) employee satisfaction
(c) employee morale (d) cost of materials
4. Decisions made regarding whether to outsource products or in-source
are classified as
(a) Demand or supply decisions (b) make or buy decisions
(c) relevant or irrelevant decision (d) idle or busy decisions
5. Difference that exists between total revenues that can be earned from
two different alternatives is termed as
(a) independent revenue (b) incremental revenue
(c) differential revenue (d) dependent revenue
6. The additional costs that are incurred when an activity is taken up are
called
(a) dependent cost (b) independent cost
(c) incremental cost (d) differential cost
7. costs that have already been incurred and no amount can be recovered
on that front, irrespective of the decision made, are called
(a) Fixed Costs (b) Sunk Costs
(c) Shut Down Cost (d) Opportunity Costs
8. Production of goods or services that can be bought from outside suppliers
is classified as
(a) idle sourcing (b) sunk sourcing (c) outsourcing (d) in-sourcing
9. Decisions made by company about which products to manufacture and
in what quantities, are called
(a) Make or Buy Decisions (b) Add/ Drop Products decisions
(c) product mix decisions (d) Replace or Retain Decisions
10. The decision to add or discontinue a product will depend on
(a)F Contribution p.u (b) Total Contribution
(c) Contribution p.u of Limiting factor (d) None of the above
11. The following should be ignored while evaluating a decision to Operate
or Shut-down
(a) Shut-Down costs (b) Sunk Costs (c) Fixed Costs (d) All of the above
 6

12. Which of the following statements is true?

(a) Pricing for special products should be based on incremental costs
(b) Book Value of asset should be ignored while evaluating Retain/
Replace decisions
(c) In a recessionary environment, an order should be accepted as long
as the price is greater than variable costs (d) All of the above
Fill in the blanks
1. _________ is about choosing among alternative courses of action, based
on quantitative as well as qualitative factors
2. __________ outcomes can be measured in numerical terms
3. Employee morale is an example of _________ factors considered in
decision making
4. When two alternatives are being evaluated, the difference in costs
incurred is respect of the two alternatives is called__________
5. _________ are costs have already been incurred and no amount can be
recovered on that front, irrespective of the decision made
6. ____________ are costs that will continue to be incurred even if there
is a temporary closure or shut-down of the production facilities
7. Fixed costs that can be saved by suspending activities are called

8. Money blocked in inventory is an example of____________

9. Businesses usually face challenges in terms of limited availability of
resources. Such scarce resource is called____________
10. .__________ are the additional costs that need to be incurred to process
the product further.
11. __________ should not impact the regular price at which the product is
being sold in the market
12. In a decision to retain or replace an asset, cost of acquisition of the
existing asset is a________
Short Answer Questions
1. What is decision making?
2. Define Differential Cost.
3. What is Sunk cost?
4. What is the difference between Sunk cost and Shutdown cost?
5. What are “Escapable” costs?
6. What do you understand by “Make or Buy” decision?
7. What costs should be considered while taking a decision to add or
discontinue a product?
8. What is “Key factor”?
9. What should be the treatment ofjoint costs while taking decision to sell
or further process?
10. What is Shut-down point? How is it calculated?
 7

11. What factors should be kept in mind before reducing price for a special
order?
12. List any 2 factors to be considered during a Retain/ Replace decision.
Answers
Multiple Choice Question
(1) A (2) C (3) D (4) B (5) C (6) C
(7) D (8) B (9)C (10) C (11) B (12) D
Fill in the blankes
(1) Decision making (2) Quantitative (3) Qualitative
(4) differential cost (5 sunk costs (6) Shut down costs
(7) ‘Avoidable ’ costs (8) Opportunity cost (9) Limiting factor
(10) Incremental costs (11) Special price (12) sunk cost
Unit - 4
BUDGETS AND BUDGETARY CONTROL
Multiple Choice Questions
1. _________ may be described as a process of finding out what is being
done and comparing actual results with the corresponding budget data
in order to approve accomplishment.
(a) Budgetary control (b) Budget (c) Budgeting (d) None of the above
2. R&D budget and Capital expenditure budget are examples of
(a) Short-term budget (b) Current budget
(c) Long-term budget (d) None of the above
3. Plant utilization budget and Manufacturing overhead budgets are types
of
(a) Production budget (b) Sales budget
(c) Cost budget (d) Functional budget
4. Which budget is the first step of budgetary system and all other budgets
depends on it.
(a) Cost budget (b) Sales budget
(c) Production budget (d) None of the above
5. Which budget contains the picture of total plans during the budget
period and it comprises information relating to sales, profit, cost,
production etc.
(a) Master budget (b) Functional budget
(c) Cost budget (d) None of the above
6. Which budget stated as a budget which is made to change as per the
levels of activity attained.
(a) Fixed budget (b) Flexible budget
i (c) ^Both a and b (d) None of the above
7. Which budget is prepared for single level of activity and single set of
business conditions?
(a) Fixed budget (b) Flexible budget
(c) Both a and b (d) None of the above
 8

8. On the basis of period, budgets may be classified into how many types
(a) Five (b) Four (c) Three (d) Two
9. The process of budgeting helps in the control of
(a) Cost of production (b) Liquidity
(c) Capital Expenditure (d All of the above
10. Which of the following statements are not true about budget, budgeting
& budgetary control?
(a) Budgetary control works on the basis of best option
(b) Budget is one of the important mediums of communication
(c) Budgeting develops the quality of objectivity in planning
(d) None of the above
Fill in the Blanks
1- _________ is the actual act of preparing the budget
2. The act of continuous monitoring and taking timely corrective action is

3. A budget a written plan covering projected activities of a firm for a

period”
4- ________ budgets are budgets, which are prepared in between two
budget periods.
5- ______ is the summary budget incorporating all functional budgets”
6. Forecasting of accurate results is difficult in case of_________ Budgets.
7- ______ budget involves forecasting all possible sources from which
cash will be received and the channels in which payments are to be
made
8. Long-term budgets are budgets prepared for a period of__________
9. _____ budgets relate to the different operations or activities of a firm.
10. ______ is a budget which is designed to remain unchanged irrespective
of the level of activity actually attained”
11. Without considering the external environment, the________ targets
may not be realistic.
12. The__________ Budget is the responsibility of the Factory Manager.
Short Answer Questions
1. What is Budget? 5
2. What is Budgetary Control?
3. What is the primary objective of Budgetary Control?
4. What are the two components of cash Budget? 6
5. What is key difference between Basic Budget and Current Budget?
6. What is production budget?
7. What is Sales Budget?
8. What is Capital Expenditure Budget?
9. What is Flexible Budget?
10. A Fixed Budget is prepared for how many different levels of activity?
 9

Answers
Multiple Choice Question
(1) A (2) C (3) D (4) B (5) A (6) B
(7) A (8) B (9) D (10) D
Fill in the Blanks
(1) Budgeting (2) Budgetary control (3) Defined
(4) Interim (5) Master Budget (6) Fixed
(7) Cash (8) 5 to 10 years (9) Operating
(10) Fixed budget (11) Sales (12) Production
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Unit - 5
STANDARD COSTING AND VARIANCE ANALYSIS
Multiple Choice Questions
1. Standard cost is .
(a) a historical cost (b) a pre-determined cost
(c) estimated future cost (d) recommended cost
2. The technique of Standard costing is
(a) Same as that of Historical costing
(b) Same as that of Marginal costing
(c) Same as that of Budgetary Control
(d) a unique technique in itself
3. Which of the following is not an advantage of Standard Costing
(a) It is a yardstick of performance
(b) Facilitates Management by Exception
(c) It is very simple to understand and easy to operate
(d) All of the above
4. Standard costing committee is responsible for
(a) Computation of variances
(b) Linking the deviations with responsibilities
(c) Setting all types of standards (d) All of the above
5. Standard Cost is most suitable to
(a) Jobbing Industry (b) Contracts
(c) Process Industries (d) All of the above
6. Which of the following is not a requirement of Standard Costing?
(a) Sound organization structure
(b) Standardization of functions and all activities
(c) ? Trends of last 5 years
/
(d) All of the above are required for implementation of standard costing
7. The standard that is not expected to be changed is
(a) Basic Standard (b) Expected Standard
(c) Normal Standard (d) Ideal Standard
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8. The best standard that can be achieved is

(a) Current Standard (b) Expected Standard
(c) Normal Standard (d) Ideal Standard
9. The type of standard that is best suited for cost control objective is
(a) Normal standard (b) Basic standard
(c) Expected standard (d) Ideal standard
10. The capacity of a plant that which can be achieved without interruptions
of any kind is known as
(a) Rated Capacity (b) Theoretical Capacity
(c) Normal Capacity (d) Practical Capacity
11. The term budgeted cost refers to the
(a) estimated expenses of budgeted production
(b) actual expenses of budgeted production
(c) estimated expenses of actual production
(d) actual expenses of actual production
12. Volume variance arises when
(a) There is rise in overhead rate per hour
(b) There is decline in overhead rate per hour
(c) There is decrease or increase in actual output compared to the
budgeted output (d) None of the above
13. A favorable direct material price variance occurs when:
(a) actual rate of direct materials is higher than standard rate of direct
materials
(b) actual rate of direct materials is equal to standard rate of direct
materials
(c) actual rate of direct materials is less than standard rate of direct
materials
(d) actual rate of direct materials is less than previous year’s rate of
direct materials
14. The labour engaged in the making of a product is known as
(a) Direct labour (b) Indirect labour
(c) Temporary labour (d) None of the above
15. Which of the following statements are true about standard labour time?
(a) Standard labour time indicates the time in hours needed for a
specified process
(b) It is standardized on the basis of past experience with no adjustments
made for time and motion study
(c) In fixing standard time due allowance should not be given to fatigue
and tool setting
(d) The Production manager does not provide any input in setting the
labour time standards
16. When actual price is higher or lower than the standard price, then it is
(a) Sales price variance (b) Sales volume variance
(c) Sales mix variance (d) Sales quantity variance
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17. The term standard cost refers to the

(a) average unit cost of product produced in the previous period
(b) budgeted unit cost of product produced in a particular period
(c) average unit cost of product produced by other companies
(d) average unit cost of product produced in the current period
Fill in the blanks
1. __________ Costing helps us in finding out the costs incurred
2. The shift in emphasis from cost ascertainment to_________ led to the
development of standard costing
3. Standard cost is a_______ cost
4. Standard costing is a logical development of ____________
5. Analysis and investigation of variances pinpointing inefficiency facilities

6. The standard that is not expected to be changed is__________

7. A______ Standard is a standard established for use over a short period
of time, related to current conditions
8. The standard that can be attained in the most favourable conditions
possible is called_______
9. ______ is the average standard which is anticipated to be attained over
a future period of time, preferably long enough to cover one trade cycle.
10. When we talk about standards in Cost accounting, we are actually
referring to_______
11. The techniques of job analysis and job evaluation are used to fix____
12. Standard costs for production overhead are established in the same
manner as______
13. _____ is the maximum capacity minus unutilized capacity due to
normal interruptions.
14. The difference between practical capacity and actual capacity based on
expected sales is known as_______
15. Physical plant capacity to produce as indicated by the manufacturers is
known as the______
16. A document that records the standard cost of a single unit of product is
known as______
17. A variance is said to be_____ if it is indicative of greater efficiency.
18. Material Usage Variance is also known as Material______ Variance
19. _____ is the time for which a worker is paid, but during which time, he
does not work. Power failure, shortage of materials etc.
20. Standard costing is most suitable to industries engaged in______
/production.
Short Answer Questions
1. Based on time factor differentiate Historical Costing and Standard
Costing
2. Define Standard Cost.
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3. What is Standard Costing

4. List any one difference between Historical costing and Standard Costing
5. What is the difference between Standard Cost and Estimated cost?
6. Are Budgetary Control and Standard Costing the same? List any one
difference.
7. List any 2 similarities between Standard Costing and Budgetary Control
8. List any 2 differences between Standard Costing and Budgetary Control
9. List any 2 advantages of Standard Costing
10. Define Basic Standard
11. Define Current Standard
12. Define Ideal Standard
13. DefineNormal Standard
14. Define Expected Standard
15. List the factors that determine Standard price.
16. List any two factors that need to be considered before fixing the standard
quantity
17. What is meant by Normal Capacity?
18. Explain Idle Capacity?
19. How can a plant operate above rated capacity?
20. Define Standard hour.
21. Explain Favourable and Unfavorable Variances
22. What is Material Yield Variance
23. Describe Gang Composition Variance.
24. How do you calculate Calendar Variance?
25. When is Capacity Variance unfavourable?
Answers
Multiple Choice Question
(1) B (2) D (3) C (4) D (5) C (6) C
(7) A (8) D (9) C (10) B (11) A (12) C
(13) C (14) A (15) A (16) A (17) B
Fill in the Blanks
(1) Historical (2) cost control (3) pre-determined
(4) Budgetary Control (5) Management by Exception
(6) Basic Standard (7) Current (8) Ideal Standard
(9) Normal Standard (10) Expected Standard (11) Standard Rate
(12) pre-determined overhead absorption rates (13) Practical Capacity
(14) idle capacity (15) rated capacity (16) standard cost card
(17) Favourable (18) Quantity (19) Idletime
(20) Mass
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