Amity Campus

Uttar Pradesh
India 201303

ASSIGNMENTS
PROGRAM: MFC
SEMESTER-II
Subject Name
:Cost Accounting
Study COUNTRY
: Sudan LC
Permanent Enrollment Number (PEN) : MFC001652014-2016014
Roll Number
: AMF201 (T)
Student Name
: SOMAIA TAMBAL YOUSIF ELMALIK
INSTRUCTIONS
a) Students are required to submit all three assignment sets.
ASSIGNMENT
Assignment A
Assignment B
Assignment C

DETAILS
Five Subjective Questions
Three Subjective Questions + Case Study
Objective or one line Questions

MARKS
10
10
10

b)
c)
d)
e)

Total weightage given to these assignments is 30%. OR 30 Marks

All assignments are to be completed as typed in word/pdf.
All questions are required to be attempted.
All the three assignments are to be completed by due dates and need to be submitted
for evaluation by Amity University.
f) The students have to attached a scan signature in the form.
Signature :
Date

_________________________________

( ) Tick mark in front of the assignments submitted

Assignment A
Assignment B
Assignment C

Cost Accounting
SECTION A:
Q1 what is cost accounting? What are its objectives?
What is cost accounting?
ANSWER ONE:
Cost accounting is an approach to evaluating the overall costs that are associated with conductingbusiness.
Generally based on standard accounting practices, cost accounting is one of the tools thatmanagers utilize to
determine what type and how much expenses is involved with maintaining the current
SECTION A
business model.At the same time, the principles of cost accounting can also be utilized to project changesto
these costs in the event that specific changes are implemented.When it comes to measuring how wisely
company resources are being utilized, cost accounting helps toprovide the data relevant to the current situation.
By identifying production costs and further defining thecost of production by three or more successive business
cycles, it is possible to note any trends thatindicate a rise in production costs without any appreciable changes or
increase in production of goods andservices.By using this approach, it is possible to identify the reason for the
change, and take steps tocontain the situation before bottom line profits are impacted to a greater degree.In the
management of a company's finances, the relationship between spending expenses and profitabilityis weighed
against its success or failure. Cost accounting is the branch of managerial accounting thatsystematically assists
managers in the internal balancing of spending and profits, as well as assessingoperational costs and budget
analyses
These are the following important objectives of cost accounting:
Ascertainment of Cost:
The primary objectives of the cost accounting is to ascertain cost of each product,process, job, operation or
service rendered.
Ascertainment of Profitability:
Cost accounting determines the profitability of each product, process, job,operation or service rendered. The
statement of profit or losses and Balance Sheet also submitted to themanagement periodically.
Classification of Cost:
Cost accounting classifies cost in to different elements such as materials, laborerand expenses. It has further
been divided as direct cost and indirect cost for cost control and recording.
Control of Cost:
Cost accounting aims at controlling cost by setting standards and compared with theactual, the deviation or
variation between two is identified and necessary steps are taken to control them.
Fixation or Selling Prices:
Cost accounting guides management in regard to fixation of selling prices of theproducts. It is also helpful for
preparing tender and quotations.
Cost Accounting
SECTION A:
Q1 What is cost accounting? What are its objectives?
A cost is the value of the economic resources used as a result of producing or doing the things costed. Note the
word value. In a majority of cases the value of the economic resources used is the amount of money spent in
acquiring or producing them, but this is not always so. For instance, if the market price of an article were at
the time of purchase and rose to by the time of it was actually used in production, and then one could well

say that the cost is 7, since this is the value of the article used.
Some people would probably disagree with this view of cost, and would regard cost as simply what was paid for
an economic resource. Yet clearly in the foregoing example, if the article were sold in its unmanufactured state
for 6, then 5 as the cost means there would be 1 profit. But this not a valid measure of managements
manufacturing performance (though it may be a good measure of their speculative performance). This simpler
concept of cost relates really to measuring excess of receipts over payments, that is, we are back to the financial
accounting concept of money as cash. In cost accounting one should, however, always bear in mind the ultimate
need to consider economic values for measuring economic performance rather than cash expenditure
Cost = usage x price
Cost has been defined as the value of economic resources used. Note that for each resource the value is always
made up of two components: the units of the resource used and the resource price per unit. Cost, therefore, can
be mathematically stated as:
Cost = usage x price
This means that costing involves ascertaining both a usage figure and a price figure. Students will find this
double component value arises throughout costing theory, and it is particularly significant in standard costing
and variance analysis.
It should, incidentally, be appreciated that in costing it is the economic resources used that are really important
multiplying by price to give cost is only the conversion to the common denominator of money. Improvement
by management of economic performance hinges on the more economical use of resources or the substitution of
cheaper resources for more expensive resources.
Cost accounting is really that aspect of management accounting which is concerned with measuring the
economic performance of departments, methods and equipment and of measuring the value of the resources
consumed in producing goods and services. It involves accounting for costs, i.e. explaining how they arose, and
detailing where they went. Costing, on the other hand, involves indicating to managers the economic
consequences of carrying out, or having carried out, any specified activity.

Cost Accounting is a system used to record, summarize and report cost information. Cost
information is presented in the form of special reports to the internal users, such as managers in
the company, which is used in deciding how to operate the organization. These decisions
are simply the choices managers make about how their organizations should do things. Some
cost information, is provided to external users, such as shareholders and creditors as part of the
financial statements).
Thus, cost accounting involves the accumulation, recording and reporting of costs and other
quantitative data. The information generated by the Cost Accounting system is used by an
organization for internal purposes and for external purposes. Providing cost information to
managers (internal purposes) to assist them in decision-making is called Management
Accounting.

What are its objectives?

The Purpose of Cost Information
Question Number
Implied Specific
Objective

1&2.
3.
4.
5.
6.

Will publishing the book be profitable to the

company?

Should the company offer a higher compensation to

its striking
employees to avoid the strike?
Should the company close its plant or install
pollution control equipment?
Will the new program generate enough sales
revenue to make it feasible?
Are the benefits of liberalization worth its cost?

The table shows that most of the implied specific objectives are decisions or choices to be made
by managers or the management, whether it is a business concern, academic institute or even a
country.
You would have noticed that the definition of cost given earlier referred to accomplishing a
specific objective. Each of the questions listed above also implies a specific objective or
purpose as indicated in Table above.
One of the most important objectives of Cost accounting is to provide necessary information to
management for cost control. But, the control function of management can be effective only if it
is preceded by planning. The basic objective of any type of control is to ensure that actual
performance conforms to a predetermined plan. Hence, for purposes of cost control it is
necessary to have planned costs indicating what the management wants to achieve. This is
where standard costing comes in, as it is one of the ways of planning costs.
Standard costing refers to the principles and procedure which involve the use of predetermined
standard costs relating to each element of cost, and for each line of product manufactured or
service rendered. A standard cost is an estimated cost which suggests what the cost should be
under given conditions. The significance of standard costing can be understood better if it is
viewed in contrast to actual historical costing. The system of costing in which costs are
recorded after they are incurred is known as historical costing.
2.2 CONCEPT & OBJECTIVES OF MATERIALS CONTROL
Materials cost constitutes a prime part of the total cost of production of manufacturing firms.
Proper accounting, therefore, for & control over materials purchase, consumptions, &
inventories are important for effective management of a business firm. Materials control
basically aims at efficient purchasing of materials, their efficient storing & efficient use or
consumption.
Material control consists of control at two levels: (i) Quantity controls, and (ii) finance controls.
For instance, the production department in a manufacturing company aims at quantity controls,
i.e. lesser and lesser units should be used in the production department. Although lesser units
would result in lower investments on purchase of materials, yet the user (production)
department normally does not think in terms of expenditure. In contrast, the finance manager is

interested in keeping the investments on materials at the lowest point. In material control,
balance has to be maintained between two opposing needs, that is
(i) Maintenance of sufficient material for efficient production(ii) Maintenance of investment in
inventory at the lowest level. IN detail, the following are the objectives in a good system of material control:
1. Material of the desired quality will be available when needed for efficient & uninterrupted production.
2. Material will be purchased, only when it is required, and in economic quantities.
3. The investment in material will be made at lowest level consistent with operating requirement.
4. Purchase of material will be made at the most favorable prices under the best possible terms.
5. Material will be protected against loss by fire, theft, spoilage etc.
6. Material should be stored in such a way that they can provide minimum of handling time & cost.
7. Vouchers will be approved for payment only if the material has been received & is available for issue.
8. Issues of material are properly authorized & properly accounted for.
9. Materials are, at all times, charged as the responsibility of some individual.

Q2 Briefly explains the different ways of classifying cost.

Q2. Briefly explain the different ways of classifying cost. Answer: CLASSIFICATION OF COST
Classification of costs is the process of grouping costs according to their common characteristics. The
following are criteria that are employed in the classification of cost. By The Nature of Element Under
criterion the cost are divided into three categories of materials, labour and overheads. Materials are
the principal substances that go into the production process. These can further be classified into
direct materials and indirect materials. Labour is the human effort to produce goods and services by
application of talent, training and skills. This can also be subdivided into direct and indirect labour.
Overheads are elements of cost that are incurred in the production of an item or provision of a service
which are not directly linked to the item/service output and as such can not be determined accurately
or readily. They result from objects of expenditure that can not be traced into the finished product or
end service. They do not form an integral part of finished product. By Functions This is the
classification of cost according to the division that exist due to the various functions carried out in a
business entity, or according to the basic managerial activities of administration , production
/operations, selling and distribution Administration costs are costs incurred for planning, directing,
controlling and operating a company. Such costs include salaries of managers or directors and other
administrative staff. Production costs are all those costs that constitute the process that is called
production which includes manufacturing and construction or fabrication of units of production. This
may also constitute operations for a service oriented business. Selling costs are costs incurred during
the process of seeking to create and stimulate demand for product and securing orders. These
include advertisement, salespersons salaries, etc. Distribution costs are the costs of a sequence of
operations which begin with making the final and ready product available for dispatch, through
making it available to the customer, and return of empty packages if any available for re-use,
depending on the case. Examples are insurance on goods in transit, warehousing and transportation.
By Traceability Classification by traceability divides total cost into direct and indirect costs. Direct
costs are those incurred for, and may be conveniently identified with a particular cost centre or cost
unit. Examples include materials used or labour employed in manufacturing an item or in a particular
process of production. Indirect costs are those costs that are incurred for the benefit of a number of
cost units or cost centres and can not be conveniently traced to a particular cost centre or cost unit.
Examples include rent of a building, managerial/administrative costs and electricity bills. By
Variability The basis for this classification is the behaviour of costs in response or in relation to
changes in the level of activity or volume of production. Fixed Costs are costs that remain the same in
total regardless of the level of activity or volume of production for a given period of time or for a
given range of output. Fixed costs per unit vary inversely with volume of production, since the more
produced the less the portion of fixed cost attributed to a single unit of output. Examples include rent,
salaries of permanent employees. Variable costs are costs whose total varies directly with volume of
output. The cost per unit remains relatively constant with changes in volume of production or level of
activity but the total varies directly with output. Examples include direct material costs, direct labour
cost, and power consumption costs. Semi-variable costs are costs that are partly fixed and partly vary

with the volume of production or level of activity. Examples include post paid phone bills which are
made up of a minimum charge and another part calculated from the calls made. By Controllability
Under this criterion for classification are controllable and uncontrollable costs. Controllable costs are
costs that can be influenced by the action of a specified member of an undertaking, i.e. they are at
least partly or in full under managements control. Uncontrollable costs are costs that can not be
influenced by the action of a specified member of an undertaking, i.e. they are not within the control
of management, e.g. licensing costs. By Normality This mode of classification brings out normal and
abnormal costs. Normal costs are costs that are normally incurred at a given level of output in the
conditions in which that level of output is normally attained, and therefore form part of production
cost. Abnormal Costs are costs that are not normally incurred at a given level of output in the
conditions in which that level of output is normally attained, and are therefore not considered part of
production cost and are charged to the costing profit and loss account. By Financial Accounting
(Capital or Revenue) This classification groups costs into capital costs and revenue costs. Capital
costs or capital expenditure are costs incurred in purchasing assets either to earn income or
increasing the earning capacity of a business, e.g. cost of a processing machine in a manufacturing
plant. Capital costs are not included when computing total cost. Revenue costs or revenue
expenditure are expenditure arising from the maintenance of the earning capacity of the business
e.g. cost of maintenance of an asset or cost of material used in production, labour costs, etc. These
are included when computing total cost. By Time Under this classification are historical costs and
predetermined costs Historical costs are costs which are only ascertained after being incurred and
therefore can not be used for cost control purposes. Predetermined costs are cost estimates,
computed before being incurred basing upon previous periods costs and factors affecting such costs.
These can be used for cost planning and controlling purposes. By Association with Product Under this
classification are product costs and period costs Product costs are costs associated with units of
output the ones absorbed by or attached to units produced. These include direct material costs,
direct labour and factory overheads (either partly or fully depending on the type of costing system).
These costs are carried forward to the next accounting period in the form of unsold finished stock.
Period costs are costs associated with the period for which they are incurred, rather than the units of
output or level of manufacturing activity. They are treated as expenses for the period for which they
are incurred. Examples include administrative, selling and distribution costs. According to Planning
and Control For purposes of the two important functions of management i.e. planning and control,
costs are classified as budgeted costs and standard costs. Budgeted costs represent an estimate of
expenditure for different phases or segments of business operations, such as administration,
production, sales, research and development, for a period of time in future - which become
managerial targets to be achieved. They are projections from financial accounting data adjusted to
future trends. Standard costs are predetermined costs asked on a technical estimation of materials,
labour and overhead for a selected period of time and for a prescribed set of working conditions. They
are projections of cost accounts made on the basis of scientifically predetermining costs under a set
of conditions. For Managerial decisions For purposes of managerial decision making, costs are
classified as follows: Marginal Cost: The additional cost to be incurred if an additional unit is produced.
Out of Pocket Cost: Portion of cost that gives rise to cash expenditure. Differential Cost: The change in
cost due to change in the level of activity or pattern cost, it is called incremental costs and if it
reduces the costs it is called detrimental cost. Sunk Cost/Historical Cost: A cost that has already been
incurred and is therefore irrelevant to the decision making process e.g. depreciation of a fixed asset.
Imputed/Notional Costs: These costs appear in cost accounts only e.g. notional rent charged for
business premises owned by proprietor. Opportunity Cost: This is made up of the maximum possible
alternative earnings that will be foregone if the productive capacity or services are put to some
alternative use. Replacement Cost: The cost at which there could be purchase of an asset or material
identical to that which is being replaced or devalued thus it is the cost of replacement at current
market price. Avoidable Cost: Cost which can be eliminated if a particular product or department with
which they are directly related to is discontinued, e.g. salaries of clerks in the department. Other
Types of Costs These are costs that are a class of their own as contrasted from the above
classifications. Future Costs: Costs expected to be incurred at a later date. Programmed Costs: Costs
that are incurred due to certain decisions that reflect the policies of top management, which result in
periodical appropriation. Joint Cost: The cost of manufacturing joint products up to or prior to the splitoff point. These can not be traced to a particular product. Conversation Cost: The cost of converting
raw material into finished product. Discretionary Costs: Costs that do not have obvious relationship to
the capacity of output or levels of activity, and are determined as part of the periodic planning

process. Examples include advertising, research and development. Committed Cost: Fixed cost which
results from the decisions of management in the prior period and is not subjected to managements
control in the present on a short run basis e.g. plant & machinery depreciation, taxes insurance
premium, rent charges.

ANSWER 2.
Cost classification is the process of grouping costs according to their common characteristics. A
suitableclassification of costs is very helpful in identifying a given cost with cost centers or cost units. Costs
may beclassified according to their nature, i.e., material, labor and expenses and a number of
othercharacteristics.
Ist : Direct Material Cost
Direct material cost comes in the first part of cost classification. Its cost is also important for calculation
of prime cost of any product. Raw material is the main source of any finished product. So, it may be 70% to90%
of total cost of production.

CLSSIFICATION OF COST:
Cost classification is the process of grouping costs according to their common characteristics. A
suitable classification of costs is very helpful in identifying a given cost with cost centers or
cost units. Costs may be classified according to their nature, i.e., material, labor and expenses
and a number of other characteristics. Depending upon the purpose to be achieved and
requirements of a particular concern the same cost figures may be classified into different
categories. The classification of costs can be done in the following ways:
1. By Nature of Element
2. By Functions
3. By Traceability
4. By Variability
5. By Controllability
6. By Normality
7. By Capital or Revenue
8. By Time
9. By Association with Product
10. According to Planning and Control
11. For Managerial Decisions
12. Others.
Each classification will be discussed in detail in the following paragraphs:
1. By Nature of Element
The costs are divided into three categories i.e. Materials, Labor and Overheads. Further subclassification of each element is possible; for example, material can be classified into raw
material components, spare parts, consumable stores, packing material, etc.
Materials: Materials are the principal substances that go into the production process and are
transformed into finished goods. Materials are further classified as direct materials and indirect
materials. Direct materials are that materials that can be directly identified with and easily
traced to finished goods. In manufacturing organizations, the cost of direct materials constitutes
a major proportion of the finished product cost. All the other materials that go into the

production of the finished goods are called indirect material costs. Indirect materials generally
form a part of the manufacturing overheads. For example. a furniture manufacturer, teak wood
is a direct material as it can be traced easily to the furniture made, and the nails, adhesives and
other sundry materials can be treated as indirect materials.
Labor: Labor refers to the human effort to produce goods and services. It is a factor of
production; the talents, training, and skills of people which contribute to the production of
goods and services. It involves the physical and mental effort. It can be further classified into
direct and indirect labor. Direct labor is the effort of employees who transforms direct materials
into a finished product and it is physically traceable to the finished good or service. In some
industries labor cost forms a significant portion of total costs. The labor which cannot be traced
to a product is considered to be the indirect labor. The indirect labor forms part of factory
overhead. In the above example, the cost of the workers who directly expend their energy on
making the furniture with the help of tools and machines is considered to be the direct labor.
The salary paid to a supervisor, who oversees the activities of a team of workers is considered
as indirect labor.
Overheads: Those elements of costs necessary in the production of an article or the
performance of a service which are of such a nature that the amount applicable to the product or
service cannot be determined accurately or readily. Usually they relate to those objects of
expenditures which do not become an integral part of the finished product or service such as
rent, heat, light, supplies, management, supervision, etc. In other words, overheads consist of
indirect materials, indirect labor and other indirect expenses. The overheads can be classified
into factory overheads, office and administration overheads and selling and distribution
overheads. Continuing with the above example, cost of factory lighting, rent of the factory, rent
of administrative building, salary of administrative staff and managers, depreciation of
machinery etc. constitute overheads.
2. By Functions
It leads to grouping of costs according to the broad divisions of functions of a business
undertaking or basic managerial activities, i.e. production, administration, selling and
distribution. According to this classification costs are divided as follows:
Manufacturing and Production Costs
This category includes the total of costs incurred in manufacture, construction and fabrication of
units of production. The manufacturing and production costs comprise of direct materials, direct
labor and factory overheads.
Administrative Costs
This category includes costs incurred on account of planning, directing, controlling and
operating a company. For example, salaries paid to managers and other administrative staff.
Selling and Distribution Costs
Selling costs and distribution costs are most often confused to be one and the same. However,
there is a distinction between the two. Selling costs are defined as the cost of seeking to
create and stimulate demand and of securing orders. Example of selling costs are
advertisement, salesman salaries, etc. Whereas, distribution costs are defined as the cost of
sequence of operations which begin with making the packed product available for dispatch and
ends with making the reconditioned, returned empty packages, if any available for re-use. For
example, insurance on goods in transit, warehousing etc. are distribution costs.

3. By Traceability
According to this classification, total cost is divided into direct costs and indirect costs
Direct costs are those costs which are incurred for and may be conveniently identified with or
easily traced to a particular cost center or cost unit. The common examples of direct costs are
materials used and labor employed in manufacturing an article or in a particular process of
production.
Indirect costs are those costs which are incurred for the benefit of a number of cost centers or
cost units and cannot be conveniently identified with a particular cost center or cost unit.
Examples of indirect costs include rent of building, management salaries, machinery
depreciation, etc. The nature of the business and the cost unit chosen will determine the costs as
direct and indirect. For example, the hire charges of a mobile crane used onsite by a contractor
would be regarded as a direct cost since it is identifiable with the project/site on which it is
employed, but if the crane is used as a part of the services of a factory, the hire charges would
be regarded as indirect cost because it will probably benefit more than one cost center or
department. The distinction between direct and indirect cost is essential because the direct costs
of a product or activity can be accurately identified with the cost object while the indirect costs
have to be apportioned on the basis of certain assumptions about their incidence.
4. By Variability
The basis for this classification is the behavior of costs in relation to changes in the level of
activity or volume of production. On this basis, costs are classified into three groups viz. fixed,
variable and semi-variable.
Fixed Costs
Fixed costs are those which remain fixed in total with increase or decrease in the volume of
output or activity for a given period of time or for a given range of output. Fixed costs per unit
vary inversely with the volume of production, i.e. fixed cost per unit decreases as production
increases and increases as production decreases. Examples of fixed costs are rent, insurance of
factory building, factory managers salary, etc. These costs are constant in total amount but
fluctuate per unit as production level changes. These costs are also termed as capacity costs.
Variable Costs
Variable costs are those which vary in total directly in proportion to the volume of output. These
costs per unit remain relatively constant with changes in volume of production or activity. Thus,
variable costs fluctuate in total amount but tend to remain constant per unit as production level
changes. Examples: direct material costs, direct labor costs, power, repairs, etc.
Semi-variable Costs
Semi-variable costs are those which are partly fixed and partly variable. For example, telephone
expenses include a fixed portion of monthly charge plus variable charge according to the
number of calls made; thus total telephone expenses are semi-variable. Other examples of such
costs are depreciation, repairs and maintenance of building and plant, etc. These are also called
semi-fixed costs or mixed costs.
5. By Controllability
On this basis costs are classified into two categories:
Controllable Costs
If the costs are influenced by the action of a specified member of an undertaking, that is to say,
costs which are at least partly within the control of management they are called controllable

costs. An organization is divided into a number of responsibility centers and controllable costs
incurred in a particular cost center can be influenced by the action of the manager responsible
for the center. Generally speaking, all direct costs including direct material, direct labor and
some of the overhead expenses are controllable by lower level of management.
Uncontrollable Costs
If the costs cannot be influenced by the action of a specified member of an undertaking, that is
to say, which are not within the control of management they are called uncontrollable costs.
Most of the fixed costs are uncontrollable. For example, rent of the building is not controllable
and so is managerial salaries. Overhead cost, which is incurred by one service section or
department and is apportioned to another which receives the service is also not controllable by
the latter.
Controllability of costs depends on the level of management (top, middle or lower) and the
period of time (long-term or short-term).
6. By Normality
On this basis, is the costs are classified into two categories.
Normal Cost
It is the cost which is normally incurred at a given level of output in the conditions in which that
level of output is normally attained. It forms a part of production cost.
Abnormal Cost
It is the cost which is not normally incurred at a given level of output in the conditions in which
that level of output is normally attained. It is not considered as a part of production cost, hence
it is charged to Costing Profit and Loss Account.
7. By Capital and Revenue or Financial Accounting Classification
If the cost is incurred in purchasing assets either to earn income or increasing the earning
capacity of the business it is called capital cost, for example, the cost of a rolling machine in
case of steel plant. Though the cost is incurred at one point of time the benefits accruing from it
are spread over a number of accounting years. Revenue expenditure is any expenditure done in
order to maintain the earning capacity of the concern such as cost of maintaining an asset or
running a business. Example, cost of materials used in production, labor charges paid to convert
the material into production, salaries, depreciation, repairs and maintenance charges, selling and
distribution charges, etc. While calculating cost, revenue items are considered whereas capital
items are completely ignored.
8. By Time
Costs can be classified as (i) Historical costs and (ii) Predetermined costs.
Historical Costs
The costs which are ascertained after being incurred are called historical costs. Such costs are
available only when the production of a particular thing has already been done. Such costs are
only of historical value and not at all helpful for cost control purposes.
Predetermined Costs
Such costs are estimated costs, i.e. computed in advance of production taking into consideration
the previous periods costs and the factors affecting such costs. If they are determined on
scientific basis they become standard cost. Such costs when compared with actual costs will
give the variances and reasons of variance and will help the management to fix the
responsibility and to take remedial action to avoid its recurrence in future.

Historical costs and predetermined costs are not mutually exclusive. Even in a system when
historical costs are used, predetermined costs have a very important role to play because a
figure of historical cost by itself has no meaning unless it is related to some other standard
figure to give meaningful information to the management.
9. By Association with Product
Costs on this basis are classified as Product Costs and Period Costs. This distinction is required
for the purpose of profit determination. This is because product costs are carried forward to the
next accounting period in the form of unsold finished stock. Whereas period costs are written
off in the accounting period in which it is incurred.
Product Cost
Product costs are associated with unit of output. Product costs are the costs absorbed by or
attached to the units produced. These costs go into the determination of inventory valuation
(finished goods and partly completed goods) hence are called Inventoriable costs. This consists
of direct materials, direct labor and factory overheads (partly or fully). The extent of inclusion
of factory costs depends on the type of costing system in force absorption or direct costing. If
absorption costing method is adopted, both the fixed and variable factory overheads are
included as part of product costs. If direct costing method is adopted only variable factory
overheads are included as part of inventoriable cost. Period costs are costs associated with
period for which they are incurred, rather than the unit of output or manufacturing activity.
These costs are not treated as part of inventory and hence they are treated as expenses of the
period for which they are incurred. Administrative, Selling and Distribution costs are treated as
period costs and are deducted as an expense for the determination of income and are not
regarded as a part of inventory.
10 According to Planning and Control
Cost accounting furnishes information to the management which is helpful in discharging the
two important functions of management i.e. planning and control. For the purpose of planning
and control, costs are classified as budgeted costs and standard costs.
Budgeted Costs
Budgeted costs represent an estimate of expenditure for different phases or segments of
business operations, such as manufacturing, administration, sales, research and development,
for a period of time in future which subsequently becomes the written expression of managerial
targets to be achieved. Various budgets are prepared for different phases/segments of business,
such as sales budget, raw material cost budget, labor cost budget, cost of production budget,
manufacturing overhead budget, office and administration overhead budget. Continuous
comparison of actual performance (i.e., actual cost) with that of the budgeted cost is made so as
to report the variations from the budgeted cost to the management for corrective action.
Standard Cost
The Institute of Cost and Management Accountants, London defines standard cost as the
predetermined cost based on a technical estimate for materials, labor and overhead for a
selected period of time and for a prescribed set of working conditions. Thus, standard cost is a
determination, in advance of production, of what should be its cost under a set of conditions.
Budgeted costs and standard costs are similar to each other to the extent that both of them
represent estimates of cost for a period of time in future. In spite of this, they differ in the
following respects:

Standard costs are scientifically predetermined costs of every aspect of business activity
whereas budgeted costs are mere estimates made on the basis of past actual financial accounting
data adjusted to future trends. Thus, budgeted costs are projection of financial accounts whereas
standard costs are projection of cost accounts.
The primary emphasis of budgeted costs is on the planning function of management whereas
the main thrust of standard costs is on control.
Budgeted costs are extensive whereas standard costs are intensive in their application. Budgeted
costs represent a macro approach of business operations because they are estimated in respect of
the operations of a department. Contrary to this, standard costs are concerned with each and
every aspect of business
operation carried in a department, budgeted costs are calculated for different functions of the
business, i.e. production, sales, purchases, etc. whereas standard costs are compiled for various
elements of costs, i.e. materials, labor and overhead.
11. For Managerial Decisions
On this basis, costs may be classified into the following categories:
Marginal Cost
Marginal cost is the additional cost to be incurred if an additional unit is produced. In other
words, marginal cost is the total of variable costs, i.e. prime cost plus variable overheads. It is
based on the distinction between fixed and variable costs.
Out of Pocket Costs
This is that portion of the cost which involves payment, i.e. gives rise to cash expenditure as
opposed to such costs as depreciation, which do not involve any cash expenditure. Such costs
are relevant for price fixation during recession or when make or buy decision is to be made.
Differential Costs
If there is a change in costs due to change in the level of activity or pattern or method of
production they are known as differential costs. If the change increases the cost, it will be called
incremental cost and if the change results in the decrease in cost it is known as decremental
cost.
Sunk Costs
Sunk cost is another name for historical cost. It is a cost that has already been incurred and is
irrelevant to the decision making process. A good example is depreciation on a fixed asset.
Depreciation on a given asset is a sunk cost because the cost (of purchasing the asset) has
already been incurred (when it was purchased) and it cannot be affected by any future action,
though we allocate the depreciation cost to future periods the original cost of the asset is
unavoidable. What is relevant in this context is the salvage value of the asset not the
depreciation. Thus, sunk costs are not relevant for decision making and are not affected by
increase or decrease in volume.
Imputed (or notional) Costs
These costs appear in cost accounts only. For example notional rent charged on business
premises owned by the proprietor, interest on capital for which no interest has been paid. When
alternative capital investment projects are being evaluated it is necessary to consider the
imputed interest on capital before a decision is arrived as to which is the most profitable project.
Opportunity Cost

It is the maximum possible alternative earnings that will be foregone if the productive capacity
or services are put to some alternative use. For example, if an owned building is proposed to be
used for a project, the likely rent of the building is the opportunity cost which should be taken
into consideration while evaluating the profitability of the project. Since opportunity costs are
not actually costs incurred but only are benefits foregone, they are not as a matter of fact
recorded in the accounting books. However, they are relevant costs for decision making
purposes and are considered while evaluating different alternatives.
Replacement Cost
It is the cost at which there could be purchase of an asset or material identical to that which is
being replaced or revalued. It is the cost of replacement at current market price.
Avoidable and unavoidable Cost
Avoidable costs are those which can be eliminated if a particular product or department with
which they are directly related to, is discontinued. For example, salary of the clerks employed in
a particular department can be eliminated, if the department is discontinued. Unavoidable cost
is that cost which will not be eliminated with the discontinuation of a product or department.
For example, salary of factory manager or factory rent cannot be eliminated even if a product is
eliminated.
12. Other Types of Costs
Future Costs
Are those costs that are expected to be incurred at a later date.
Programmed Cost
Certain decisions reflect the policies of the top management which results in periodic
appropriations and these costs are referred to as programmed cost. For example, the expenditure
incurred by the company under the Jawahar Rojgar Yojana program initiated by the prime
minister is a programmed cost which reflects the policy of the top management.
Joint Cost
Joint cost is the cost of manufacturing joint products up to or prior to the split-off point. Cost
incurred after the split-off point is called separable cost. Joint cost is common to the processing
of joint products and by-products till the point of separation and cannot be traced to a particular
product before the point of split-off. Conversion Cost
Conversion cost is the cost incurred in converting the raw material into finished product. It can
be calculated by deducting the cost of direct materials from the production cost.
Discretionary Costs
Discretionary costs are those costs which do not have obvious relationship to levels of capacity
or output activity and are determined as part of the periodic planning process. In each planning
period the management decides on how much to spend on certain discretionary items such as
advertising, research and development, employee
Committed Cost
Committed cost is a fixed cost which results from the decisions of the management in the prior
period and is not subject to the management control in the present on a short run basis. They
arise from the possession of production facilities, equipment, an organization setup, etc.
Some examples of committed costs are: plant and equipment depreciation, taxes, insurance
premium and rent charges.

Q3 What do you mean by ABC analysis? State its advantages.

Q3 What do you mean by ABC analysis? State its advantages.
The conventional view that overheads should be apportioned on the basis of benefit received has been adopted;
however, an alternative basis is the factor that has caused the cost. The more an activity (function, cost centre or
cost unit) causes an overhead, the more of the overhead cost, the more should be charged to it.
For example if activity x causes 50 % of overhead y then activity x should be charged 50 % of the overhead cost
of y. this approach to overhead apportionment is called ABC (Activity- Based Costing. And the activities that
cause the overheads are called drivers.
The essence of ABC involves:
a) Determining the activities which generate the cost
b) Allocating to these activities all the cost involved in undertaking them
c) Determining the cost driver for each activity
d) Computing cost driver rate per unit of activity
e) Charging each cost unit for its activity costs on the basis of the number of activity units involved in
producing the unity
To summarize, ABC embodies the principle of charging a cost as nearly as is possible to the activity that
generates it. The difficult part, of course, is identifying the cost-driver a problem that calls for its solution a
sound understanding of the behavior of costs.

SELECTIVE INVENTORY CONTROL: ABC ANALYSIS

Usually a firm has to maintain several types of inventories. It is not desirable to keep the same
degree of control on all the items. The firm should pay maximum attention to those items whose
value is the highest. The firm should, therefore, classify inventories to identify which items
should receive the most effort in controlling. The firm should be selective in its approach to
control investment in various types of inventories. This analytical approach is called the ABC
analysis and tends to measure the significance of each item of inventories in terms of its value.
The high-value items are classified as 'A items' and would be under the tightest control.
'C items' represent relatively least value and would be under simple control.
'B items' fall in between these two categories and require reasonable attention of management.
The ABC analysis concentrates on important items and is also known as control by importance
and exception (CIE). As the items are classified in the importance of their relative value, this
approach is also known as proportional value analysis. (PVA). .
The following steps are involved in implementing the ABC analysis:
1. Classify the items of inventories, determining the expected use in units and the price per unit
for each item.
2. Determine the total value of each item by multiplying the expected units by its units price
3. Rank the items in accordance with the total value, giving first rank to the item with highest
total value and so on.
4. Compute the ratios (percentage) of number of units of each item to total units of all items and
the ratio of total value of each item to total value of all items.
5. Combine items on the basis of their relative value to form three categories: -A, B and C.
Let us understand this with the help of an example.
Example

A firm has 7 different items in its inventory. The average number of each of these items held,
along with their unit costs, is listed below. The firm wishes to introduce an ABC inventory
system. Suggest a breakdown of the items into A, B & C classifications.
Item Number
1
2
3
4
5
6
7
Solution.
ABC Analysis
Item
(1)
1
2
3
4
5
6
7

Units
(2)
20000
10000
32000
28000
60000
30000
20000

Average number of units in

inventory
20000
10000
32000
28000
60000
30000
20000

Average cost per unit

% of Total
(3)
10
5
16
14
30
15
10

Total Cost
(5)

Unit Cost
(4)

Res.

60.80
102.40
11.00
10.28
3.40
3.00
1.3

% of Total
(6)

Figures in column are in lakhs. Here you will find of how the ABC system works. Under this
system all the items are classified into three groups. A category
inventory constitutes the first 70% of inventory. These inventories are required for strict control.
The next is B category where moderate control is imposed. The last one is the C category. So as
per this method which type of inventory requires the special attention is identified.

State ABC Analysis advantages:

If a manufacturer wants to know the true cost to produce specific products for specific
customers, the traditional method of cost accounting is inadequate. Activity based costing
(ABC) was developed to overcome the shortcomings of the traditional method. Instead of just
one cost driver such as machine hours, ABC will use many cost drivers to allocate a
manufacturers indirect costs. A few of the cost drivers that would be used under ABC include
the number of machine setups, the pounds of material purchased or used, the number of
engineering change orders, the number of machine hours, and so on.
What is the major weakness of the traditional method of allocating factory overhead?
Under the traditional method of allocating factory overhead (manufacturing overhead, burden),
most of the factory overhead costs are allocated on the basis of just one factor such as machine
hours or direct labor hours. In other words, the traditional method implies there is only one

driver of the factory overhead and the driver is machine hours (or direct labor hours, or some
other indicator of volume produced).
In reality there are many drivers of the factory overhead: machine setups, unique inspections,
special handling, special storage, and so on. The more diversity in products and/or in customer
demands, the bigger the problem of allocating all the costs of these various activities via only
one activity such as the production machines hours.
Under the traditional method, the costs of performing all of the diverse activities will be
contained in one cost pool and will be divided by the number of production machine hours. This
results is one average rate that is applied to all products regardless of the number of activities
and the complexity of those activities. Since the cost of many of the diverse activities do not
correlate at all with the number of production machine hours, the resulting allocations are
misleading.
Activity-based costing is intended to overcome the weakness of the traditional method by
having various pools of costs and then allocating each pools costs on the basis of its root cause.
Under ABC a manufacturer will use many cost drivers to assign overhead costs to products. The
objective of Activity Based Costing is to assign the overhead costs based on their root causes
rather than merely spreading the costs on the basis of direct labor hours or production machine
hours.
In the 1930s, the Comptroller of the Tennessee Valley Authority, Eric Kohler developped the
concept of Activity Accounting. The Tennessee Valley Authority was engaged in flood control,
navigation, hydro-electric power generation, etc. Kohler could not use a traditional managerial
accounting system for these kind of operations. Instead Kohler defined activities and introduced
activity accountants. An activity is (a portion of) a work carried out by a (part of) a company.
For each activity Kohler created an activity account (Aiyathurai, Cooper and Sinha, 1991, PP
61-64). An activity account is an income or expense account containing transactions over which
an activity supervisor exercises responsibility and control (Kohler, 1952, pp, 18-19). Thus
instead of determining the costs of a product, Kohler determined the costs of an activity. In
1971 Staubus described another activity accounting system. Staubus also created an account for
every activity. On the left side of this account Staubus recorded the costs of the inputs of the
activity. These inputs are the outputs from previous activities within the company and / or
outputs from another entity (for instance an outside supplier). On the right hand side of the
account Staubus recorded the value of the output of the activity. The outputs to another activity
are measured at standard costs. If however the output is sold to a customer, the output is
measured at the net realizable value (selling price minus selling costs). Staubus activity
accounting culminates in a comparison of outputs, at standard cost or net realizable value, and
inputs (Staubus, 1971).
Activity Cost Analysis at General Electric:
In 1963 General Electric formed a team which had to study indirect costs. This team focused
mainly on indirect activities in GE such as data processing, inspection, quality control etc. and
determined the costs of these activities. Then they identified the causes of these activities ("key
controlling parameters"). For instance a new drawing, made by the engineering department is a
key controlling parameter and triggers activities such as data processing, inspection, quality
control, etc. The team also collected information about the quantity or count of each key
controlling parameter, such as the number of new drawings per period. Then the team estimated

the total costs per unit key performance parameter, for instance the costs per 1 new drawing
made by the engineering department:

With this technique GE wanted to get better control of indirect costs by controlling the activities
that cause the indirect costs.
Like traditional cost accounting, activity based cost management is a cost allocation
methodology. But there is a significant difference - unlike traditional cost accounting, activity
based costing works on following principle:
Activities incur costs through the consumption of resources, while customer demand for
products and services causes activities to be performed.
Basic flow of activity based cost management is as follows:

ACTIVITY BASED COSTING BENEFITS:

Activity based cost management has several benefits. As a business process improvement (BPI)
tool activity based costing links elements such as process flow analysis, and performance
management. This supports ongoing evaluation of effectiveness of improvement initiatives,
including the activity based costing management endeavors.

By identifying cost pools, or activity centers, activity based accounting assigns costs to products
and services based on the number of transactions involved in the process of providing a product
or service. This supports managers to work out how to maximize shareholder value and improve
performance.
Activity based cost management also helps in identifying the most and least profitable
customers, products and channels. It also assists in determining the true contributors to- and
detractors from- financial performance. Moreover, activity based cost management equips
managers with cost intelligence to drive improvements.
Other benefits of activity based costing include accurately predicting costs, profits and resource
requirements associated with changes in the organization. These changes might include changes
in production volumes, resource costs and organizational structure.
DRAWBACKS
Activity Based Costing is a very helpful tool if your organization has clarity of methodology
and the process under observation.
One major limitation of the method comes up when looking at using it for estimation of
plans/budgets. It is next to impossible to have a proper estimation of the costs for some critical
activities such as R&D. When proper estimation of the costs for one activity is missed out it
results in breakdown in the whole chain of activities.
Another glaring drawback is that the potential for improved accuracy in product costs may be
limited if the organization is already using multiple absorption rates in each production centre.
Conclusion
Activity based cost management has more advantages than limitations. When implemented
properly, activity based cost management can bring about constructive changes in financial
control systems. For instance, when you carry out planning / budgeting with activity based
costing you can always have more accurate estimations done. You can always work-out where
your estimations went wrong, since you know what each activity contributed in your planning /
budgeting.
However, the true benefit of activity based cost management is not that it is an improvement
upon the existing accounting system. Activity based accounting provides the structure for the
establishment of a true management-oriented system and therein lies its true benefit.

Q4 What is idle time? What are the causes for idle time? How should
idle time wages be treated in cost Accounts?
Q4. What is idle time? What are the causes for idle time? How should idle time wages be treated in
cost accounts? Answer: IDLE TIME Idle time is that time for which there is cost incurred in terms of
labour and other costs but there is no production. It is that time for which the employer pays, but
from which he obtains no production. CAUSES FOR IDLE TIME The following are the causes of idle
time: a. Time used while moving from one job to another. b. Time for waiting for materials or
instructions. c. Time for temporary absence from duty due to minor accidents, sickness, tea breaks,
personal breaks, etc. d. Time taken in travelling from one department to another. e. Idle time due to
breakdown of machinery. f. Time lost due to shortage of materials. g. Halts due to temporary absence
of parts necessary for further processing. h. Strikes, lockout, etc. TREATMENT OF IDLE TIME WAGES IN
COST ACCOUNTS Wages paid for normal idle time are treated as production overheads and are
absorbed into cost of product by adopting an absorption rate. Normal idle time of direct workers, such
as time taken for machine setting, change over, or tool setting can be added to the product cost as
direct wages by inflating the hourly rate of wages. Normal idle time hours are subtracted from the
total working hours per annum to determine the effective working hours per annum. From this labour
cost per hour is determined by dividing the total labour cost per annum by the effective working

hours per annum. For example, considering daily total working hours, if idle time is normally 5
percent of total hours and wages paid for 8 hours ( 1 days working hours) is Rs. 760, then direct
labour cost hourly rate will be Rs. 760 divided by 7.6 hours (i.e. 8 hours minus 0.4 hours, i.e. 5%) =
Rs. 100 per hour. The cost of abnormal idle time should not be included in product cost but should be
debited to costing profit and loss account direct as an extra ordinary cost. The rate determined above
is multiplied by the abnormal idle time to determine loss due to idle time. This is loss is the idle time
wages which should be charged to the costing profit and loss account. In case abnormal idle time is
frequent, as in frequent power failure, such costs are incurred often and may be debited to idle time
wages under factory overheads as a normal cost.

Idle time is the time for which the Employer pays , but from which he obtains no production. For exampleif out
of eight hours that worker supposed to work , the workers job card shows only six hours work therest of the
time is called idle time. Idle time can be of two types.Normal idle time it is unavoidable of normal nature and is
inherited in production environment. Andabnormal idle time which is not caused by usual production routine.
Causes of idle time include:
a) Power outage which affects most business
b) Natural disaster like what happen in Japan if is not restored for days
c)The ways employers structure the work or schedule employees results in certain amount of idle time
.d)Lack of attendance time sheet /poor management
.e)Tea break
f)Moving from one department to another department
g)Temporary absence from duty due to accident.
h)Time lost through lack of Materials.

What is idle time?

Module III: Labor Costing & Overheads Costing
Classification; Labor turnover, Labor Cost Control:- Time keeping and Time booking;; Idle time; Overtime;,
Methods of remuneration
Classification of overheads - fixed, variable, semi-variable; Collection of overheads; Distribution; allocation and
absorption; under/over absorption.

CHAPTER 3 LABOUR COSTING

3.4 IDLE TIME:As we have already observed, there is bound to be some difference between the time booked to different jobs or
work orders & gate time. The difference of this time is known as idle time. Idle time is that time for which the
employer pays, but from which he obtains no production. For example, if out of eight hours that a worker is
supposed to put in the factory, the workers job card shows only seven hours spent on jobs, one hour will be idle time
in such a case. Idle time is of two types:
(a) Normal Idle Time , and
(b) Abnormal Idle Time
a. Normal Idle time:- It is unavoidable, of normal nature and is inherent in production environment. This may be due
to:Time lost in moving from one job to another
Time lost in waiting for materials or instructions
Temporary absence from duty because of minor accidents, personal breaks tea breaks etc.
Time taken in traveling form one dept to another dept.
b. Abnormal Idle Time:- This is not caused by usual production routine. It may be:Time lost through the break down of machinery
Time lost through lack of materials

Bottlenecks in production, resulting in a temporary absence of parts for further processing.

Strikes, lockout, fire etc.
GROUP BONUS SCHEMES
Where a group of workers is collectively responsible for manufacturing a product, it may not be possible to adopt
individual incentive schemes. The production of the workers as a whole is measured, and the total bonus is
determined by one of the individual incentive schemes capable of group application. The computed bonus can then
be shared equally, or between workers of different skills in differing specified proportions. A group bonus scheme
has the following objective:
1. Developing collective interest and team spirit among all workers and employees.
2. Developing interest among foremen and supervisors to improve performance.
3. Reducing spoilage in materials consumption.
4. Reducing idle time.
Advantages
It is more scientific, practical and accurate method of recovery of manufacturing overheads.
Comparison of relative efficiencies and cost of operating different machines can be made by this method.
It helps the management in decision-making. Idle time of machines, if any, can be detected.

What are the causes for idle time?

IDLE TIME VARIANCE
This variance will arise when workers are not able to do the work due to some reason during the hours for which
they are paid. It could be due to breakdown, lack of materials or power failures. Idle time variance will be equivalent
to the standard labor cost of the hours during which no work has been done but for which workers have been paid for
unproductive time. For example, in a factory, 2000 workers were idle due to a power failure and as a result of which,
a loss of production of 4,000 units of product X and 8,000 units of product Y occurred. Each employee was paid his
normal wage (a rate of Rs.2 per hour). One standard hour is needed to manufacture four units of product X and eight
units of product Y. Idle time variance will be calculated as follows:
Standard hours lost
Product X=4000/4=1,000hrs
Product Y=8000/8=1,000hrs
Total Hours Lost= 2,000hrs
Idle time variance (power failure)
2,000 hours @ Rs.2 per hour = Rs.4, 000 (A)
Idle Time Variance = Actual Idle Time X Standard Rate

CAUSES
The reasons for labor efficiency variance are:
Insufficient training;
Incompetent supervision;
Incorrect instructions;
Workers dissatisfaction;
Bad working conditions;

Inefficient organization waiting for materials, tools and instructions, delay in routing, if these are not treated as idle
time;
Use of defective machinery and equipment;
Wrong items of equipment for the type of work done;
High labor turnover; and
Fixation of incorrect standards.
3.3 CONTROL OVER LABOUR COSTS
Labour costs constitute a significant portion of the total cost of a product. Labour cost may be excessive due to
inefficiency of labour, high labour turnover, idle time and unusual overtime work, inclusion of bogus workers in the
wages sheet and many other related factors. Inefficiency of labour is also a cause of excessive material and overhead
costs. Therefore, economic utilization of labour is a need of the present day industry to reduce the cost of production
of the products manufactured or services rendered. Management is interested in labour costs on account of the
following;
(b) Time-booking: As stated earlier, time booking is the recording of time spent by the worker on different jobs or
work orders carried out by him during his period of attendance in the factory. The objects of time booking are:
1. To ensure that time paid for according to time-keeping is properly utilized on different jobs or work orders.
2. To ascertain the labour cost of each individual job or work order.
3. To provide a basis for the apportionment of overhead expenses over various jobs or work orders when the method
for the allocation of overheads depends upon time spent on different jobs.
4. To ascertain unproductive time or idle time.

How should idle time wages be treated in cost Accounts?

ILLUSTRATIONS:
Illustration 1:
Q4 Find out wage per hour based on the following information:
Name Sohan
Annual Wages 2400
Annual Bonus @ 20% of A Wages
Employer contribution of P.F. @ 10% of A wages
Employer contribution of E.S.I.@ 5% of A wages
Total Leave permitted during the year 60 days
Cost of labour welfare activities including canteen subsidy 8000/Number of workers 200
Normal idle time 80 hrs
Working days per annum 320 days of 8 hrs
How will you treat, if Sohan had lost 60 hrs on some days on account of failure of power supply?
Solution:
Calculation of total Labour Cost for the year
Rs
Wages 2,400
Bonus (20% of 2,400) 480
P.F. Contribution (10% of 2400) 240
ESI contribution (5% of 2400) 120
Gross wages (Total) 3240
Cost of Amenities per head (8000/200) 40
Total Labour cost 3280

Calculation of effective working hour per annum

Total Working days 320
Less Total leave days 60
Effective working days 260
Total Hors per day (260*8) 2,080
Less: Normal idle time (in hours) 80
effective hours per annum 2,000
labour cost per hour = Rs 3,280/2,000= Rs 1.64
Loss due to idle time = 60hours @ RS 1.64 p.h. = Rs 98.40
Loss of working hours due to failure of power supply in an abnormal loss & hence Rs 98.40 will be charged to
costing Profit & Loss Account.

Q5 What is cost volume profit analysis? Explain.

Q5 What is cost volume profit analysis? Explain.
CVP analysis examines the behavior of total revenues, total costs, and operating income as changes occur in the
output level, selling price, variable costs per unit or fixed cost.
1
For example, managers need to know how profits will change as units of a product or services change. In this
regard they (managers) ask themselves if they should decide to produce more or less of a particular product or
service, change the mix of product, or change their sales price then what will happen to the cost or profit of their
businesses before taking a decision.
CVP analysis involves the analysis of how total costs, total revenues and total profits are related to salesvolume,
and is therefore concerned with predicting the effects of changes in costs and sales volume onprofit. It is also
known as 'breakeven analysis.
ANSWER 5:
Cost-volume-profit (CVP) analysis expands the use of information provided by breakeven analysis. A
criticalpart of CVP analysis is the point where total revenues equal total costs (both fixed and variable costs).
Atthis breakeven point, a company will experience no income or loss. This BEP can be an initial
examinationthat precedes more detailed CVP analysis.Cost-volume-profit analysis employs the same basic
assumptions as in breakeven analysis. Theassumptions underlying CVP analysis are:The behavior of both costs
and revenues is linear throughout the relevant range of activity. (Thisassumption precludes the concept of
volume discounts on either purchased materials or sales.) Costs canbe classified accurately as either fixed or
variable. Changes in activity are the only factors that affect costs.All units produced are sold (there is no ending
finished goods inventory). When a company sells more thanone type of product, the sales mix (the ratio of each
product to total sales) will remain constant.Cost Volume Profit CVP analysis is applied in the following
situations:Planning and forecasting of profit at various levels of activity.Useful in developing flexible budgets
for cost control purposes.Helps the management in decision-making in the following typical areas:Identification
of the minimum volume of activity that the enterprise must achieve to avoid incurring loss.This analysis
presumes that costs can be reliably divided into fixed and variable category. This is verydifficult in practice.This
analysis presumes an ability to predict cost at different activity volumes. In practice, a lot of experience may be
required to reliably develop this ability.A series of break-even charts may be necessary where alternative pricing
policies are under consideration.Therefore, differential price policy makes break-even analysis a difficult
exercise.It assumes that variable cost fluctuates with volume proportionally, while in practical life the situation
maybe different.

Module IV: Marginal Costing and Cost Volume Profit Analysis

Meaning, marginal cost; Absorption costing vs. Marginal Costing and its reconciliation; B.E.P; Contribution; Key
factor; P/V ratio; margin of safety; Applications of marginal costing techniques; CVP analysis, alternative choices
decisions.

CHAPTER 5 MARGINAL COSTING AND COST VOLUME PROFIT

ANALYSIS
5.3 VALUE OF MARGINAL COSTING TO MANAGEMENT
Marginal costing is a valuable technique to the management for the following reasons:
1. It integrates with other aspects of management accounting example cost-volume-profit analysis, flexible
budgeting and standard costing.
5.8 COST-VOLUME-PROFIT ANALYSIS
CVP analysis involves the analysis of how total costs, total revenues and total profits are related to sales volume, and
is therefore concerned with predicting the effects of changes in costs and sales volume on profit. It is also known as
'breakeven analysis'.
Applying Cost Volume Profit Analysis:
Cost Volume Profit CVP analysis is applied in the following situations:
Planning and forecasting of profit at various levels of activity.
Useful in developing flexible budgets for cost control purposes.
Helps the management in decision-making in the following typical areas:
Identification of the minimum volume of activity that the enterprise must achieve to avoid incurring loss.
Identification of the minimum volume of activity that the enterprise must achieve to attain its profit objective.
Provision of an estimate of the probable profit or loss at different levels of activity within the range reasonably

expected.
The provision of data on relevant costs for special decisions relating to pricing, keeping or dropping product lines,

accepting or rejecting particular orders, make or buy decision, sales mix planning, altering plant layout, channels of
distribution specification, promotional activities, etc.
Guide in fixation of selling price where the volume has a close relationship with the price level.
Evaluates the impact of cost factors on profit.
Assumptions of Cost-Volume-Profit Analysis
This analysis presumes that costs can be reliably divided into fixed and variable category. This is very difficult in
practice.
This analysis presumes an ability to predict cost at different activity volumes. In practice, a lot of experience may be
required to reliably develop this ability.
A series of break-even charts may be necessary where alternative pricing policies are under consideration. Therefore,
differential price policy makes break-even analysis a difficult exercise.
It assumes that variable cost fluctuates with volume proportionally, while in practical life the situation may be
different.
This analysis presumes that efficiency and productivity remain unchanged. In other words, this analysis presents a
static picture of a dynamic situation.
The break-even analysis either covers a single product or presumes that product mix will not change. A change in
mix may significantly change the results.
This analysis disregards that selling prices are not constant at all levels of sales. A high level of sales may only be
obtained by offering substantial discounts, depending on the competition in the market.
This analysis presumes that volume is the only relevant factor affecting cost. In real life situations, other factors also
affect cost and sales profoundly. Break-even analysis becomes over-simplified presentation of facts, when other

factors are unjustifiably ignored. Technological methods, efficiency and cost control continuously influence different
variables and any analysis which completely disregards these over changing factors will be only of limited practical
value.
This analysis presumes that fixed cost remains constant over a given volume range. It is true that fixed costs are
fixed only in respect of a given capacity, but each fixed cost has its own capacity. This factor is completely
disregarded in the break-even analysis. While factory rent may not increase, supervision may increase with each
additional shift.
This analysis presumes that influence of managerial policies, technological methods and efficiency of men, material
and machine will remain constant and cost control will be neither strengthened nor weakened.
This analysis presumes that production and sales will be synchronized at all points of time or, in other words,
changes in beginning and ending inventory levels will remain insignificant in amount.
The analysis also presumes that prices of input factors will remain constant.
Cost-volume-profit analysis is based on the above-mentioned limitations. Attempts to draw inferences disregarding
these limitations will lead to formation of wrong conclusions. The application of cost-volume-profit relationship is
restricted by the assumptions on which it is based. Therefore, cost-volume-profit analysis cannot be used
indiscriminately.
Limitations of Cost-Volume-Profit Relationship
The cost-volume-profit relationship depends on the profit equation
P = (S V) Q F
where P = Profit
S = Unit Selling Price
V = Unit Variable Costs
F = Total Fixed Cost
Q = Sales Volume
This equation gives the basic Cost-Volume-Profit Model.
As long as S, V and F are constant the cost volume profit relationship will be linear.
In real life the following factors effect the linear Cost-Volume-Profit Relationship.
Variable cost per unit (V) may not be constant. For example, raw material cost is variable. However, as volumes of
production increase, raw material may be purchased in bulk so that quantity discounts are available. Hence, raw
material cost may be say Rs.50 per unit of production up to say 20,000 units and Rs.40 per unit thereafter. So the
linear relationship is affected at 20,000 units.
Fixed costs may stabilize at higher levels as volume increases. For example, depreciation on plant is a fixed cost. But
as production increases, the plant may be operated for an extra shift so that it may be necessary to provide extra shift
allowance of depreciation.
Selling prices may be lower at high volumes because of sales discounts allowed.
Changes in efficiency will affect the cost-volume-profit relationship. An increase in efficiency may increase volume
with less than the expected increase in cost.
More than one product may be produced. In this case volume may have to be redefined in terms of rupees as each
product may be measured in different units.

SECTIONB:
Q1 What is standard costing? How is it different from Historical
costing?

ANSWER 1: STANDARD COSTINGSECTION B

Since one of the most important objectives of cost accounting is to provide information to themanagement for
cost control, then cost control will be effective only if it is preceded by cost planning. Inorder management to
indicate what they want to achieve they to have planned cost and this is wherestandard costing comes in, as it is
one of the ways used for planning.
Standard costing refers to the principles and procedure which involve the use of predetermined standard costsrelating to each
element of cost, and for each line of product manufactured or service rendered. A standardcost is an estimated
cost which suggests what the cost should be under given conditions. The significance of standard costing can be
understood better if it is viewed in contrast to actual historical costing.However, a standard cost can be defined as

A pre-determined cost calculated with respect to a prescribed setof working conditions, correlating technical
specifications and scientific measurements of materials and laborto the price and wage rates expected to apply
during the period to which the standard cost is expected torelate, with an addition of an appropriate share of budgeted
overhead. Its main objective is to provide bases of control through variance accounting for the valuation of stocks and
work-in-progress and in exceptional casesfor fixing selling prices.The need for standard costs include:Cost
controlPricing decisionPerformance appraisalCost awarenessManagement by objective
The difference between Standard Costing and Historical Costing is that the standard costing is muchrelated to
historical costing because in the above definition of standard costing says that the significanceof standard
costing can be understand well if it is viewed in contrast to actual historical costing.So, the system of costing in
which costs are recorded after they incurred is knows as historical costing.Historical costing provides to
management records of what has happened.

What is standard costing:

Chapter 6 Standard Costing and variance analysis
Module V: Standard Costing and variance analysis
Standard cost, standard hour, standard cost sheet, cost variances-material, labour and overhead
CHAPTER-6 STANDARD COSTING AND VARIANCE ANALYSIS
1.6 ADVANTAGES OF COST ACCOUNTING:
4. Cost data can be obtained & compared with standard cost within the form or industry.
Predetermined Costs
Such costs are estimated costs, i.e. computed in advance of production taking into consideration the previous
periods costs and the factors affecting such costs. If they are determined on scientific basis they become standard
cost. Such costs when compared with actual costs will give the variances and reasons of variance and will help the
management to fix the responsibility and to take remedial action to avoid its recurrence in future.
10 According to Planning and Control
Cost accounting furnishes information to the management which is helpful in discharging the two important
functions of management i.e. planning and control. For the purpose of planning and control, costs are classified as
budgeted costs and standard costs.
Standard Cost
The Institute of Cost and Management Accountants, London defines standard cost as the predetermined cost based
on a technical estimate for materials, labor and overhead for a selected period of time and for a prescribed set of
working conditions. Thus, standard cost is a determination, in advance of production, of what should be its cost
under a set of conditions.
Budgeted costs and standard costs are similar to each other to the extent that both of them represent estimates of cost
for a period of time in future. In spite of this, they differ in the following respects:
Standard costs are scientifically predetermined costs of every aspect of business activity whereas budgeted costs are
mere estimates made on the basis of past actual financial accounting data adjusted to future trends. Thus, budgeted
costs are projection of financial accounts whereas standard costs are projection of cost accounts.
The primary emphasis of budgeted costs is on the planning function of management whereas the main thrust of
standard costs is on control.

Budgeted costs are extensive whereas standard costs are intensive in their application. Budgeted costs represent a
macro approach of business operations because they are estimated in respect of the operations of a department.
Contrary to this, standard costs are concerned with each and every aspect of business
operation carried in a department, budgeted costs are calculated for different functions of the business, i.e.
production, sales, purchases, etc. whereas standard costs are compiled for various elements of costs, i.e. materials,
labor and overhead.
Standard Price Method: Material is priced based on a standard cost which is predetermined. When the material is
purchased the stock account will be debited with the standard price. The difference between the purchase price and
the standard price will be carried into a variance account.
Present the overhead absorption account at the year-end assuming that standard costing is not in operation.
1. It integrates with other aspects of management accounting example cost-volume-profit analysis, flexible
budgeting and standard costing.
CHAPTER-6 STANDARD COSTING AND VARIANCE ANALYSIS
At the end of the chapter you will be conversant with:
6.1 Historical Costing And Its Limitations
6.2 Need For Standards
6.3 Establishment Of Standard Cost
6.4 Revision Of Standards
6.5 Computation & Analysis Of Variances
6.5.1 Material Cost Variance
6.5.2 Labor Cost Variance
6.5.3 Overhead Variance
Introduction
One of the most important objectives of Cost accounting is to provide necessary information to management for cost
control. But, the control function of management can be effective only if it is preceded by planning. The basic
objective of any type of control is to ensure that actual performance conforms to a predetermined plan. Hence, for
purposes of cost control it is necessary to have planned costs indicating what the management wants to achieve. This
is where standard costing comes in, as it is one of the ways of planning costs.
Standard costing refers to the principles and procedure which involve the use of predetermined standard costs
relating to each element of cost, and for each line of product manufactured or service rendered. A standard cost is an
estimated cost which suggests what the cost should be under given conditions. The significance of standard costing
can be understood better if it is viewed in contrast to actual historical costing. The system of costing in which costs
are recorded after they are incurred is known as historical costing.
6.2 NEED FOR STANDARDS
The use of standards facilitate many business functions. Standards are very useful in the monitoring and controlling
of business activities in general. The need for standard costs arises as a result of the benefits it provides for a
business, such as Cost control Pricing decisions Performance appraisal Cost awareness Management by objective
Limitations of Standards
Despite the above needs, the technique has its own limitations also, which can be summarized as shown hereunder:
Setting the standards is a difficult task as it involves technical skills. Accountants are not unanimous regarding the
circumstances to be taken as the basis for setting standard costs. Even if the standard to be used is well defined, since
conditions do not remain static, the standards have to be revised in the light of the changed circumstances. A revision
of standards becomes expensive and if some concerns do not revise the standards on this score, the same are likely to
become rigid, and as such, outmoded. Just as inaccurate standards are unreliable and harmful, so are outmoded
standards disadvantageous. The fixation of inaccurate standards, specially those that are incapable of achievement,
adversely affect the morale of the employees, and act as hindrance to increased efficiency. For localizing deviations
and fixing responsibilities, it becomes necessary to distinguish between controllable and uncontrollable variances.
Such a distinction may not always be possible. The system is unsuitable for the job type of industries producing
articles according to customers specifications. Even if the system is installed in the case of such industries, the
fixation of standards for each type of job becomes difficult and expensive. Even in the case of industries that are
liable to frequent technological changes affecting the conditions of production, standard costing may not be suitable.
If nevertheless it is installed, a constant revision of standards becomes necessary. Although the benefits accruing

from installing and operating a standard costing system are far in excess of the cost associated with it, small concerns
cannot afford this technique.
6.3 ESTABLISHMENT OF STANDARD COSTS
Standard costs must be ascertained for each of the following elements of cost: Direct material Direct labor Variable
overhead Fixed overhead.
Performance appraisal Cost awareness Management by objective
Limitations of Standards
Despite the above needs, the technique has its own limitations also, which can be summarized as shown hereunder:
Setting the standards is a difficult task as it involves technical skills. Accountants are not unanimous regarding the
circumstances to be taken as the basis for setting standard costs. Even if the standard to be used is well defined, since
conditions do not remain static, the standards have to be revised in the light of the changed circumstances. A revision
of standards becomes expensive and if some concerns do not revise the standards on this score, the same are likely to
become rigid, and as such, outmoded. Just as inaccurate standards are unreliable and harmful, so are outmoded
standards disadvantageous. The fixation of inaccurate standards, specially those that are incapable of achievement,
adversely affect the morale of the employees, and act as hindrance to increased efficiency. For localizing deviations
and fixing responsibilities, it becomes necessary to distinguish between controllable and uncontrollable variances.
Such a distinction may not always be possible. The system is unsuitable for the job type of industries producing
articles according to customers specifications. Even if the system is installed in the case of such industries, the
fixation of standards for each type of job becomes difficult and expensive. Even in the case of industries that are
liable to frequent technological changes affecting the conditions of production, standard costing may not be suitable.
If nevertheless it is installed, a constant revision of standards becomes necessary. Although the benefits accruing
from installing and operating a standard costing system are far in excess of the cost associated with it, small concerns
cannot afford this technique.
6.3 ESTABLISHMENT OF STANDARD COSTS
Standard costs must be ascertained for each of the following elements of cost: Direct material Direct labor Variable
overhead Fixed overhead.
Direct Material Standard quantities of material should be set for each product. It is thus necessary to establish a
standard drawing, formula or specification, which should be adhered to except in special circumstances, when a
revision may be necessary. If there is a normal loss in process, a standard loss should be set based on past experience
or by scientific analysis. Standard prices of all materials consumed should be set for each product. Prices should be
fixed in co-operation with the buyer, and allowing for the following:
Stocks in hand
The possibility of price fluctuations
The extent of contracts already placed for materials
6.4 REVISION OF STANDARDS
The question of whether standards should be revised is a difficult one. Some argue that many revisions in standards
only destroy the effectiveness and increase operational details. In contrast, standards if not revised, destroy its utility
as a means of inventory valuation and cost control. Therefore, standard costs require continuous review and, at times,
frequent change. Changing prices, technological advances, changing quality of materials, new labor negotiations
etc., all influence standards and make them obsolete resulting in unrealistic budgets, poor cost control and
unreasonable unit cost for inventory valuation and income determination.
A company should establish a program to revise standards wherever required so that standards can be set at a
currently attainable level. A periodic review of standards is desirable to accomplish the objectives of standard
costing. Standards through an annual review program will become current attainable or expected standards or at least
closer to such standards.
As indicated by the definition of standard costing given earlier there is more to the technique than simply setting
standard costs. This is important but it is only a means to an end control over costs and performances. The
variances obtained are analyzed and the reasons for their existence are determined. This allows management to take
action to prevent a recurrence of events that cause such variances.
All the time, therefore, there is a cycle of events. Actual and standard costs are compared, variances are calculated,
management is informed of what has gone wrong and then action is taken to prevent the same thing happening in the
future. There should, therefore, be a positive improvement in efficiency.
Module II: Material Control &Costing

Classification; Purchase Procedure; Material Control-: EOQ, Stock levels, JIT; ABC Analysis. Pricing of Material:LIFO,FIFO, weighted average method, standard cost method, Current price method.

How is it different from Historical costing?

8. By Time
Costs can be classified as (i) Historical costs and (ii) Predetermined costs.
Historical Costs
The costs which are ascertained after being incurred are called historical costs. Such costs are available only when
the production of a particular thing has already been done. Such costs are only of historical value and not at all
helpful for cost control purposes.
Predetermined Costs
Such costs are estimated costs, i.e. computed in advance of production taking into consideration the previous
periods costs and the factors affecting such costs. If they are determined on scientific basis they become standard
cost. Such costs when compared with actual costs will give the variances and reasons of variance and will help the
management to fix the responsibility and to take remedial action to avoid its recurrence in future.
Historical costs and predetermined costs are not mutually exclusive. Even in a system when historical costs are used,
predetermined costs have a very important role to play because a figure of historical cost by itself has no meaning
unless it is related to some other standard figure to give meaningful information to the management.
Sunk Costs
Sunk cost is another name for historical cost. It is a cost that has already been incurred and is irrelevant to the
decision making process. A good example is depreciation on a fixed asset. Depreciation on a given asset is a sunk
cost because the cost (of purchasing the asset) has already been incurred (when it was purchased) and it cannot be
affected by any future action, though we allocate the depreciation cost to future periods the original cost of the asset
is unavoidable. What is relevant in this context is the salvage value of the asset not the depreciation. Thus, sunk costs
are not relevant for decision making and are not affected by increase or decrease in volume.
CHAPTER-6 STANDARD COSTING AND VARIANCE ANALYSIS
At the end of the chapter you will be conversant with:
6.1 Historical Costing And Its Limitations
6.2 Need For Standards
6.3 Establishment Of Standard Cost
6.4 Revision Of Standards
6.5 Computation & Analysis Of Variances
6.5.1 Material Cost Variance
6.5.2 Labor Cost Variance
6.5.3 Overhead Variance
Standard costing refers to the principles and procedure which involve the use of predetermined standard costs
relating to each element of cost, and for each line of product manufactured or service rendered. A standard cost is an
estimated cost which suggests what the cost should be under given conditions. The significance of standard costing
can be understood better if it is viewed in contrast to actual historical costing. The system of costing in which costs
are recorded after they are incurred is known as historical costing.
6.1 HISTORICAL COSTING AND ITS LIMITATIONS
Historical costing has its own usefulness. It provides management with a record of what has happened. Information
regarding actual costs classified by elements are known to management accurately, at frequent intervals. The cost
data can be verified with the help of documents and evidence regarding various transactions. The result of activities
can also be known on the basis of actual performance. However, there are three serious limitations of historical
costing which are given below:
Actual records do not provide any basis for cost comparisons to evaluate the efficiency of operations;
Historical costs data are available only after a time-lag. Thus, corrective action cannot be taken in time to prevent
losses;
Historical costs fail to provide any guidance for future planning of operations, because they arise out of the
conditions peculiar to a particular period of time.

These limitations are sought to be overcome in the system of standard costing.

Definition
The Terminology of Cost Accountancy defines standard costing as the preparation and use of standard costs, their
comparison with actual costs, and analysis of variances to their causes and points of incidence . The technique of
standard costing thus involves:
The ascertainment of standard costs
The use of standard costs
Their comparison with the actual costs and the measurement of variances
The analysis of variances for ascertaining the reasons for the same and
The location of responsibility for the variances and the corrective action to be taken.
Since this technique is based wholly on the ascertainment of standard costs, it is necessary to know what these
standard costs are. Standard costs are pre-determined, or forecast estimates of cost to manufacture a single unit, or a
number of units of a product, during a specific immediate future period. They are usually the planned costs of the
products under current and anticipated conditions, but sometimes they are the costs under normal or ideal conditions
of efficiency, based on an assumed given output, and having regard to current conditions. They are revised to
conform to super-normal or sub-normal conditions, but more practically to allow for persisting alterations in the
prices of material and labor.
Therefore, a standard cost can be defined as A pre-determined cost calculated with respect to a prescribed set of
working conditions, correlating technical specifications and scientific measurements of materials and labor to the
price and wage rates expected to apply during the period to which the standard cost is expected to relate, with an
addition of an appropriate share of budgeted overhead. Its main objective is to provide bases of control through
variance accounting for the valuation of stocks and work-in-progress and in exceptional cases for fixing selling
prices.
6.1 HISTORICAL COSTING AND ITS LIMITATIONS
Historical costing has its own usefulness. It provides management with a record of what has happened. Information
regarding actual costs classified by elements are known to management accurately, at frequent intervals. The cost
data can be verified with the help of documents and evidence regarding various transactions. The result of activities
can also be known on the basis of actual performance. However, there are three serious limitations of historical
costing which are given below:
Actual records do not provide any basis for cost comparisons to evaluate the efficiency of operations;
Historical costs data are available only after a time-lag. Thus, corrective action cannot be taken in time to prevent
losses;
Historical costs fail to provide any guidance for future planning of operations, because they arise out of the
conditions peculiar to a particular period of time.
These limitations are sought to be overcome in the system of standard costing.
7.2 BUDGETING AS A TOOL OF MANAGEMENT PLANNING AND CONTROL
Measurement of Success: Success is determined by comparing past performance against a previous periods
performance. However, this comparison using historical records does not take into consideration the changes that
take place for example, the market for the product may have increased, etc. Whereas budgets provides us to compare
the actual performance with the budgeted performance which is an estimate of what might have been taking all the
possible changes into account. Though budget is only a prior estimate of future conditions and thus subject to
manipulation, it can be used as a success criterion, if done carefully and with additional data.
FLEXIBLE BUDGETING AN ILLUSTRATION
Typically, firms analyze historical cost data using techniques such as scatter diagram, linear regression, or other
methods. Behavior patterns suggested by historical cost data analysis are modified to reflect expected changes.
Generally, the behavior pattern for each cost is described in terms of fixed and variable components.
7.11 ZERO BASE BUDGETING (ZBB)
After a budgeting system has been in operation for some time, there is a tendency for next year's budget to be
justified by reference to the actual levels being achieved at present. In fact this is part of the financial analysis

discussed so far, but the proper analysis process takes into account all the changes which should affect the future
activities of the company. Even using such an analytical base, some businesses find that historical comparisons, and
particularly the current level of constraints on resources, can inhibit really innovative changes in budgets. This can
cause a severe handicap for the business because the budget should be the first year of the long range plan. Thus, if
changes are not started in the budget period, it will be difficult for the business to make the progress necessary to
achieve longer term objectives.

Q2 What is flexible budget. Explain

ANSWER 2:
A flexible budget is a budget that adjusts or flexes for changes in the volume of activity. The flexible budget is
moresophisticated and useful than a static budget, which remains at one amount regardless of the volume of
activity.
Flexible budget is defined as a budget which by recognizing the difference between fixed, semi-fixed
andvariable costs. It is designed to change in relation to the level of activity attained.
A flexible budget is defined as a budget which by recognizing the difference between fixed, semi
-fixed andvariable costs, is designed to change in relation to the level of activity attained.
Characteristics of Flexible Budgets
Flexible budgets have several desirable characteristics. TheyCover a range of activityAre dynamicFacilitate
performance measurement.
Steps in flexible budgetingThe following are the steps taken during flexible budgeting.
Deciding the range of activity to which the budget is to be prepared.
Determining the cost behavior patterns (fixed, variable, semi-variable) for each element of costto be included
in the budget.
Selecting the activity levels (generally in terms of production) to prepare budgets at thoselevels.
Preparing the budget at each activity level selected by associating the activity level withcorresponding costs.
The corresponding costs to be attached with each activity level aredetermined in terms of their behavior, i.e.,
fixed, variable and semi-variable
Module VI: Budgets, cost reduction and control
Budgetary control and budgeting-Objectives, advantages and limitations; Fixed and Flexible budgets, types of
budgets; Cost Reduction and control-techniques of cost reduction.
By comparing the above statements, it can be found out that the information furnished by the absorption costing
statement cannot be as useful as the one given by marginal costing because the conventional costing statement rarely
classifies costs into fixed and variable components. Thus, managers who are accustomed to look at operations from a
break-even analysis and flexible budget viewpoint, find that the conventional income statement fails to dovetail with
cost-volume-profit relationship. To illustrate, if management wishes to consider the effects of increasing the volume
of production, it cannot calculate the effect on profit from absorption costing statement but it can do so
5.3 VALUE OF MARGINAL COSTING TO MANAGEMENT
Marginal costing is a valuable technique to the management for the following reasons:
1. It integrates with other aspects of management accounting example cost-volume-profit analysis, flexible
budgeting and standard costing.
Cost Volume Profit CVP analysis is applied in the following situations:
Planning and forecasting of profit at various levels of activity.
Useful in developing flexible budgets for cost control purposes.

CHAPTER 7 BUDGETS, COST REDUCTION AND CONTROL

7.10 FIXED AND FLEXIBLE BUDGETING
FLEXIBLE BUDGETING
A flexible budget is defined as a budget which by recognizing the difference between fixed, semi-fixed and
variable costs, is designed to change in relation to the level of activity attained.
A flexible budget is defined as a budget which by recognizing the difference between fixed, semi-fixed and
variable costs, is designed to change in relation to the level of activity attained.

A flexible budget is a budget that is prepared for a range, i.e., for more than one level of activity. It is a set of
alternative budgets to different expected levels of activity. Thus, a flexible budget might be developed that would
apply to a relevant range of production, say 8,000 to 12,000 units. Under this approach, if actual production slips
to 9,000 units from a projected 10,000 units, the manager has a specific tool (i.e., the flexible budget) that can be
used to determine budgeted cost at 9,000 units of output. The flexible budget provides a reliable basis for
comparisons because it is automatically geared to changes in production activity.
Characteristics of Flexible Budgets
Flexible budgets have several desirable characteristics. They
Cover a range of activity
Are dynamic
Facilitate performance measurement.
Steps in Flexible Budgeting
The following steps (stages) are involved in developing a flexible budget:
Deciding the range of activity to which the budget is to be prepared.
Determining the cost behavior patterns (fixed, variable, semi-variable) for each element of cost to be included in the
budget.
Selecting the activity levels (generally in terms of production) to prepare budgets at those levels.
Preparing the budget at each activity level selected by associating the activity level with corresponding costs. The
corresponding costs to be attached with each activity level are determined in terms of their behavior, i.e., fixed,
variable and semi-variable.
FLEXIBLE BUDGETING AN ILLUSTRATION
A student health clinic of a college is used to illustrate the complete cycle in the development of a flexible budget
and the preparation of a flexible budget variance analysis report. The health clinic serves students enrolled in the
college. Most patients require out patient services, but facilities are available for students requiring hospitalization.
The clinic has a small permanent professional staff that is supplemented by doctors and nurses from the area who
work part-time as needed. Consequently, a part of the salaries is fixed, whereas a part of the medical salary cost
varies with the number of students served.
The following steps are needed to develop a flexible budget.
1. The first step in the budgeting process is to determine the range of activity the budget will cover. The activity
range is important because cost behavior patterns may be different in different ranges of activity. For example, the
building lease cost may be fixed from 0 to 25,000 student visits a year, but beyond 25,000 visits additional space
must be leased, causing a jump in the lease cost from Rs.18,000 to Rs.30,000 annually.
2. Typically, firms analyze historical cost data using techniques such as scatter diagram, linear regression, or other
methods. Behavior patterns suggested by historical cost data analysis are modified to reflect expected changes.
Generally, the behavior pattern for each cost is described in terms of fixed and variable components.
Although, measures of activity like the number of medical staff hours, could have been used, the number of student
visits is the most appropriate in this illustration. The health clinic manager selects an activity range of 12,000 to
20,000 student visits for the budget year. This relatively wide activity range is selected because student enrollment
figures for the coming year are not yet available. Also, the national health service is predicting a major epidemic
during the year. If the epidemic strikes the campus, health service visits will be noticeably higher than this years
level of 15,000.
3. Budgets are prepared for three activity levels in this illustration viz. 12,000, 16,000 and 20,000 student visits. The
number of budgets to be prepared for different activity levels is at the discretion of the management, their decision
being influenced by the cost-benefit relationship of preparing more budgets. The cost of preparing budgets, however,
is not high once cost behavior data have been developed.
It is simple to calculate the cost behavior data from the flexible budget. For example, consider the medical and
nursing salaries.

Variable Cost = cost activity at one activity level- cost activity at another activity
level/difference in activity level

Q3 What is Responsibility Accounting. Explain the responsibility

centers.
Q3. What is Responsibility Accounting? Explain the responsibility centers. Answer: RESPONSIBILITY
ACCOUNTING Responsibility accounting is a management control system based on the principles of
delegating and locating responsibility. Under responsibility accounting, managers are made
responsible for the activities, and given decision making authority, within specific areas or segments
referred to as departments, branches, etc. RESPONSIBILITY CENTRES A responsibility centre is an area
of responsibility which is controlled by an individual. In responsibility accounting, responsibility
centres are categorized into cost centres, profit centres and investment centres, for purposes of
control. Cost Centre In a cost centre of responsibility, the accounting system records only the cost
incurred by the centre while excluding the revenues earned. A cost centre thus measures financial
performance in terms of efficiency of operation in that centre, by quantity of inputs used in producing
some given output. Actual inputs are compared with predetermined/budgeted levels to give
efficiency. Profit Centre In a profit centre, both the inputs and outputs are measured in monetary
terms. Accounting is done for both cost incurred and revenue collected. The difference between
revenue and cost is termed profit, hence the name profit centre. Investment Centre These are centres
of responsibility where assets employed are also measured and accounted for in terms of value
besides inputs and outputs. Performance is measured not only in terms of profit but also in terms of
the assets employed to generate profit.

Q3 What is responsibility Accounting. Explain the responsibility centers.

Responsibility accounting is an underlying concept of accounting performance measurementsystems. The basic
idea is that large diversified organizations are difficult, if not impossible tomanage as a single segment, thus
they must be decentralized or separated into manageableparts.These parts or segments are referred to as
responsibility centers that include: 1) revenue centers,2) cost centers, 3) profit centers and 4) investment
centers.This approach allows responsibility to be assigned to the segment managers that have thegreatest
amount of influence over the key elements to be managed.These elements include revenue for a revenue center
(a segment that mainly generates revenuewith relatively little costs), costs for a cost center (a segment that
generates costs, but norevenue), a measure of profitability for a profit center (a segment that generates both
revenue andcosts) and return on investment (ROI) for an investment center (a segment such as a division of
acompany where the manager controls the acquisition and utilization of assets, as well as revenueand costs).
Responsibility Accounting is a system of management accounting under which accountability is established
according to the responsibility delegated to various levels of management andmanagement information and
reporting system instituted to give adequate feed back in terms of thedelegated responsibility.Below is an
example of how an organization which is separated into segments showing how theinformation flows and
managed.
Significance of Responsibility Accounting
The significance of responsibility accounting for management can be explained in the following way:
Easy Identification:
It enables the identification of individual managers responsible for satisfactory or unsatisfactory performance.
Motivational Benefits :
If a system of responsibility accounting is implemented, consider- able motivational benefits are assured.
Data Availability :
A mechanism for presenting performance data is provided. A framework of managerial performance
appraisalsystem can be established on that basis, besides motivating managers to act in the best interests of the
enterprise.
Ready-hand Information:
Relevant and up to the minutes information is made available which can be used to estimate future costs and
orrevenues and to fix up standards for departmental budgets.
Planning and Decision Making:

Responsibility accounting helps not only in control but in planning and decision making too.
Delegation and Control:
The twin objectives of management are delegating responsibility while retaining control are achieved
byadoption of responsibility accounting system.
Principles of responsibility Accounting
The main features of responsibility accounting are that it collects and reports planned and actual accounting.

What is Responsibility Accounting?

RESPONSIBILITY ACCOUNTING:
Responsibility accounting is a management control system based on the principles of delegating
and locating responsibility. The authority is delegated on responsibility centre and accounting
for the responsibility centre. Responsibility accounting is a system under which managers are
given decisions making authority and responsibility for each activity occurring within a specific
area of the company. Under this system, managers are made responsible for the activities of
segments. These segments may be called departments, branches or divisions etc., one of the
uses of management accounting is managerial control. Among the control techniques
responsibility accounting has assumed considerable significance. While the other control
devices are applicable to the organization as a whole, responsibility accounting represents a
method of measuring the performance of various divisions of an organization. The term
division with reference to responsibility accounting is used in general sense to include any
logical segment, component, sub-component of an organization. Defined in this way, it includes
a decision, a department, a branch office, a service centre, a product line, a channel of
distribution, for the operating performance it is separately identifiable and measurable is some
what of practical significance to management.
Concept of Responsibility accounting:
According to the Institute of Cost and Works Accountants of India (ICWAI) Responsibility
Accounting is a system of management accounting under which accountability is established
according to the responsibility delegated to various levels of management and management
information and reporting system instituted to give adequate feed back in terms of the delegated
responsibility. Under this system divisions or units of an organization under a specified
authority in person are developed as responsibility centers are evaluated individually for their
performance.
Significance of Responsibility Accounting
The significance of responsibility accounting for management can be explained in the following
way:
Easy Identification:
It enables the identification of individual managers responsible for satisfactory or unsatisfactory
performance.
Motivational Benefits :
If a system of responsibility accounting is implemented, consider- able motivational benefits are
assured.
Data Availability :

A mechanism for presenting performance data is provided. A framework of managerial

performance appraisal system can be established on that basis, besides motivating managers to
act in the best interests of the enterprise.
Ready-hand Information:
Relevant and up to the minutes information is made available which can be used to estimate
future costs and or revenues and to fix up standards for departmental budgets.
Planning and Decision Making:
Responsibility accounting helps not only in control but in planning and decision making too.
Delegation and Control:
The twin objectives of management are delegating responsibility while retaining control are
achieved by adoption of responsibility accounting system.
Principles of responsibility Accounting
The main features of responsibility accounting are that it collects and reports planned and actual
accounting information about the inputs and outputs of responsibility accounting.
Inputs and outputs:
Responsibility accounting is based on information relating to inputs and outputs. The resources
used are called inputs. The resources used by an organization are essentially physical in nature
such as quantity of materials consumed, hours of labour, and so on. For managerial control,
these heterogeneous physical resources are expressed in monetary terms they are called cost.
Thus, inputs are expressed as cost. Similarly, outputs are measured in monetary terms as
revenues. In other words, responsibility accounting is based on cost and revenue data or
financial information.
Objectives of Responsibility Accounting:
Responsibility accounting is a method of dividing the organizational structure into various
responsibility centers to measure their performance. In other words responsibility accounting is
a device to measure divisional performance measurement may be stated as under:
1. To determine the contribution that a division as a sub-unit makes to the total organization.
2. To provide a basis for evaluating the quality of the divisional managers performance.
Responsibility accounting is used to measure the performance of managers and it therefore,
influence the way the managers behave.
3. To motivate the divisional manager to operate his division in a manner consistent with the
basic goals of the organization as a whole.
Problems in Responsibility Accounting
While implementing the system of responsibility accounting, the following difficulties are
likely to be faced by the management:
1. Classification of costs: For responsibility accounting system to be effective a proper
classification between controllable and non controllable costs is a prime requisite. But practical
difficulties arise while doing so on account of the complex nature and variety of costs.
2. Inter-departmental Conflicts:

Separate departmental persuits may lead to inter-departmental rivalry and it may be prejudicial
to the interest of the enterprise as a whole. Managers may act in the best interests of their own,
but not in the best interests of the enterprise
3. Delay in Reporting: Responsibility reports may be delayed. Each responsibility centre can
take its own time in preparing reports.
4. Overloading of Information: Responsibility accounting reports may be overloading with all
available information. This danger is inherent in the system but with clear instructions by
management as to the functioning of the system and preparation of reports, etc., only relevant
information flow in.
5. Complete Reliance will be deceptive:
Responsibility accounting cant be relied upon completely as a tool of management control. It is
a system just to direct the attention of management to those areas of performance which
required further investigation.
Conclusion :
Responsibility accounting is a management control system fro measurement of division
performance of an organization. Responsibility accounting focuses on responsibility centers
such as cost centre, profit centre and investment centre. For effective implementation of
responsible accounting certain principles must be followed. Responsibility accounting helps not
only in control but in planning and decision making too.

Explain the responsibility centers:

Responsibility Centre:
For control purposes, responsibility centers are generally categorized into:
1. Cost centres
2. Profit centers
3. Investment centers.
1. Cost Centre or Expense Centre:
An expense centre is a responsibility centre in which inputs, but not outputs, are measured in
monetary terms. Responsibility accounting is based on financial information relating to inputs
(costs) and outputs (revenues). In an expense centre of responsibility, the accounting system
records only the cost incurred by the centre but the revenues earned (outputs) are excluded. An
expense centre measures financial performance in terms of cost incurred by it. In other words,
the performance measured in an expense centre is efficiency of operation in that centre in terms
of the quantity of inputs used in producing some given output. The modus operandi is to
compare actual inputs to some predetermined level that represents efficient utilization. The
variance between the actual and budget standard would be indicative of the efficiency of the
division.
2. Profit Centre:
A centre in which both the inputs and outputs are measured in monetary terms is called a profit
centre. In other words both costs and revenues of the centre are accounted for. Since the
difference of revenues and costs is termed as profit, this centre is called profit centre. In a
centre, there are financial measures of the outputs as well as of the input, it is possible to
measure the effectiveness and efficiency of performance in financial terms. Profit analysis can
be used as a basis for evaluating the performance of divisional manager. A profit centre as well

as additional data regarding revenues. Therefore, management can determine hether the division
was effective in attaining its objectives.
This objective is presumably to earn a satisfactory profit. Profit directly traceable to the
division and voidable if the division were closed down. The concept of divisional profit is
referred to as profit contribution as it is amount of profit contribution directly by the division.
The performance of the managers is measured by profit. In other words managers can be
expected to behave as if they were running their own business. For this reason, the profit centre
is good training for general management responsibility .
Measurement of Expenses :
Another problem with profit centers may relate to the measure of certain type of expenses
which have to be involved in the computation of profit centres. There is a scope for difference
of opinion relating to the treatment of those type of expenses which are not traceable or
attributable should be ignored in working out the profit of the division as a profit centre.
3. Investment Centres
A centre in which assets employed are also measured besides the measurement of inputs and
outputs is called an investment centre. Inputs are accounted for in terms of costs, outputs are
calculated on investment centre. Inputs are accounted for in terms of costs, outputs are
accounted for in terms of revenues and assets employed in terms of values. It is the broadest
measurement, in the sense that the performance is measured not only in terms of profits but also
in terms of assets employed to generate profits. An investment centre differs from a profit
centre in that as investment centre is evaluated on the basis of the rate of return earned on the
assets invested in the segment while a profit centre is evaluated on the basis of excess revenue
over expenses for the period.

CASE STUDY:
A retail dealer in garments is currently selling 24000 shirts annually. He supplies the
following details for the year ended 31st December,2007.
Rs
Selling Price per shirt
40
Variable Cost per shirt
25
Fixed cost:
staff salaries for the year
120000
General office cost for the year
80000
Advertising costs for the year
40000
As a cost accountant of the firm, you are required to answer the following each part
independently:(i)
Calculate the break-even point and margin of safety in sales revenue and no of
shirts sold.
(ii) Assume that 20000 shirts were sold in a year. Find out the net profit of the firm.
(iii) If it is decided to introduce selling commission of Rs 3 per shirt, how many shirts
would require to be sold in a year to earn a net income of Rs 15000/-.

Answer: (i) BREAK-EVEN POINT, MARGIN OF SAFETY IN SALES REVENUE, NUMBER OF SHIRTS SOLD.
Breakeven point of revenue = Fixed Costs C/S where C= selling price per unit variable cost per
unit = Rs. (40-25) = Rs. 15 S= selling price per unit = Rs. 40 Fixed costs= Rs.
(120,000+80,000+40,000) = Rs. 240,000 Break Even Point revenue = 240,00015/ 40 =Rs. 640,000
Number of shirts at Break Even = Rs. 640 000 Rs. 40 = 16 000 shirts Margin of Safety in Sales
Revenue = Annual Sales- Break Even point revenue = Rs. 4024,000 Rs. 640,000 = Rs. 960,000 Rs. 640,000 = Rs. 320, 000 Number of Shirts associated with Margin of Safety in Sales Revenue = Rs.
320 000 Rs. 40 = 8 000 shirts Therefore: Break even point revenue = Rs. 640,000 (16 000 shirts)
Margin of safety in sales revenue = Rs. 320,000 (8000 shirts) (ii) NET PROFIT OF THE FIRM ASSUMING
20000 SHIRTS WERE SOLD IN A YEAR Total Sales = 20, 000 x Rs. 40 = Rs. 800, 000 Variable Cost per
unit = Rs.25 Total Variable Cost = 20, 000 x Rs. 25 = Rs. 500, 000 Net Profit= Total Sales- (Fixed+
variable Costs) Net Profit = Rs. 800, 000- Rs. (240, 000+ 500, 000) Net profit = Rs. (800, 000- 740,
000) Net Profit = Rs. 60, 000 (iii) SHIRTS REQUIRED TO BE SOLD IN A YEAR TO EARN A NET INCOME
OF RS 15, 000, IF A SELLING COMMISSION OF RS 3 PER SHIRT IS INTRODUCED Net Income Profit = Rs.
15, 000 Variable cost = Rs. 25/unit Sales Commission = Rs. 3/unit Total Variable costs = Rs. 28/unit
Let the number of shirts be x, then: Profit = Total Sales (Fixed Costs + Variable Costs) 15, 000 = 40x (240,000+ 28x) 15, 000 = 40x - 240,000 - 28x 15, 000 = 12x - 240,000 12x= 240, 000+ 15, 000 12x= 255, 000
x= 21250 Thus, at a profit of Rs. 15,000 and selling commission of Rs. 3 per shirt, the number of shirts to be sold = 21, 250

Breakeven Quantity =Selling price Variable costFixed cost=Unit contributionFixed cost240,000 = 240,
00040-25 15= 16, 000
a) Breakeven Sales = Fixed CostUnit contributionX Unit selling price= (240,000/15)40= 640, 0000
b) Margin of safety =Selling price Variable cost(Profit*Selling price)
Profit = Selling price Total cost= 960,000- 840,000= 120
Then
Margin of safety =Selling-variable costProfit*selling price= 120*960,000960,000-600,000= 320,000
ANSWER 2:
Given :No. of shirts sold = 20,000Profit = ?Profit = Selling price Total cost= Selling price (Variable cost
+ Fixed cost)= 20,000*40 _(20,000*25-240,000)= 800,000-500,000-240,000= 60,000
ANSWER 3:
Variable cost = 28Given:Price = 40Fixed cost = 240,000Profit = 15,000Q = ?Q =PriceSalesSales = Profit +
Fixed costTherefore: Q =Unit priceprofit + fixed cost=1215,000 + 240,000=255,00012= 21,250

SECTION C
Q1
Which of the following best describes a fixed cost? A cost which:
(a)
Represents a fixed proportion of total costs
(b)
Remains at the same level up to a particular level of output
(c)
Has a direct relationship with output
(d)
Remains at the same level when output increases
(a) Remains at the same level when output increases
Q2 A business's telephone bill should be classified into which one of these categories?
(a)
Fixed cost
(b)
Stepped fixed cost
(c)
Semi-variable cost
(d)
Variable cost
(a) Semi-variable cost
Q3 The total production cost for making 20,000 units was 21,000 & total production cost for making 50,000
was 34,000. When production goes over 25,000 units, more fixed costs of 4,000 occur. So full production
cost per unit for making 30,000 units is:
(a)
0.30
(b)
0.68
(c)
0.84
(d)
0.93
(a) 0.93
Q4 Which of the following is least likely to be an objective of cost accounting system?
(a) Product Costing
(b) Optimum Sale Mix determination
Maximization of profits
(d) Sales Commission determination
(d) Sales Commission determination
Q5 The classification of costs as either direct or indirect depends upon
(a) The timing of the cash outlay for the cost
(b) The cost object to which the cost is being related
(c) The behavior of the cost in response to volume changes
(d) Whether the cost is expensed in the period in which it is incurred
(b) The cost object to which the cost is being related
Q6 Which of the following is false with regard to the supplementary rate method for accounting of under or
over absorption of overheads?
(a) It facilitates the absorption of actual overhead for production
(b) Correction of costs through supplementary rates is necessary for maintaining data for
comparison
(c) The supplementary rate can be determined only after the end of the accounting period
(d) It requires a lot of clerical work
(e) The value of stock is distorted under this method.
(e) The value of stock is distorted under this method.

Q7 Which of the following factors should not be taken into consideration for determining the basis for
applyingoverheads to products?
(a) Adequacy
(b) Convenience
(c) Time factor
(d) Seasonal fluctuation of overhead costs
(e) Manual or machine work.
(d) Seasonal fluctuation of overhead costs
Q8 Storekeeping expenses are to be apportioned on the basis of
(a) Floor area of the production departments
(b) Direct labor hours of each product
(c) Number of units manufactured of each product
(d) Number of material requisitions
(e) Sales price of each product.
(d) Number of material requisitions
Q9 A company has a margin of safety of Rs.40 lakh and earns an annual profit of Rs.10 lakh. If the fixed costs
amount toRs.20 lakh, the annual sales will be
(a) Rs.160 lakh
(b) Rs.140 lakh
(c) Rs.120 lakh
(d)Rs.200 lakh
(e) Rs.180 lak
(c) Rs.120 lakh
Q10 Which of the following statements is false with respect to the use of predetermined overhead absorption
rates?
(a) Product cost can be worked out promptly
(b) Use of predetermined overhead rate will provide data available for decision making but
not for cost control
(c) Product costs are not affected unnecessarily due to the vagaries of the calendar or
seasonal fluctuations
(d) By using normal capacity as base while determine the overhead rate, losses due to idle
capacity is highlighted and real cost of production is reflected
(e) Product cost can be estimated prior to commencement of production and can help the
management in price quotation and fixing selling price well in advance.
(b) Use of predetermined overhead rate will provide data available for decision making but
not for cost control
Q11 In process costing, equivalent units, using first in first out (FIFO) are a measure of
(a) Work done on the beginning as well as ending work-in-process inventory
(b) Work done on units started in the production process during the period
(c) Work done in the department during the period
(d) Work required to complete the beginning work-in-process inventory
(e) Work performed on the ending work-in-process inventory.
(a) Work done on the beginning as well as ending work-in-process inventory
Q12 A companys approach to a make or buy decision
(a) Depends on whether the company is operating at or below break-even level
(b) Depends on whether the company is operating at or below normal volume
(c) Depends on whether the company is operating at practical capacity level

(d) Involves an analysis of avoidable costs

(e) Requires use of absorption costing.
(d) Involves an analysis of avoidable costs
Q13 Which of the following statements is false?
(a) Historical costs are useful solely for estimating costs that lie ahead
(b) Abnormal cost is controllable
(c) Conversion cost is the production cost minus direct material cost
(d) Administrative expenses are mostly fixed
(e) Notional costs are not included while ascertaining costs.
(b) Abnormal cost is controllable
Q14 Ramesha Ltd. manufactures product DN for last seven years. The company maintains a margin of safety of
37.5%with an overall contribution to sales ratio of 40%. If fixed cost is Rs.5 lakh, the profit of the company is
(a) Rs.12.50 lakh
(b) Rs. 4.25 lakh
(c) Rs. 3.00 lakh
(d) Rs.24.00 lakh
(e) Rs.20.00 lakh.
Q15 Which of the following statements is true for a firm that uses variable costing?
(a) Profits fluctuate with sales
(b) An idle facility variation is calculated
(c) Product costs include variable administrative costs
(d) Product costs include variable selling costs
(e)The cost of a unit of product changes because of changes in number of units
manufactured.
Q16 If the price rises, which of the following methods of valuing stock will give the highest profit?
(a) LIFO method
(b) Replacement cost method
(c) FIFO method
(d) Simple average method
(e) Specific order method.
Q17 An accounting system that collects financial and operating data on the basis of underlying nature and
extent to the costdrivers is
(a) Direct costing
(b) Target costing
(c) Activity based costing
(d) Variable costing
(e) Cycle-time costing.
(c) Activity based costing
Q18 In allocating factory service department costs to producing departments, which of the following items
would mostlikely be used as an activity base?
(a) Salary of service department employees
(b) Units of electric power consumed
(c) Direct materials usage
(d) Units of finished goods shipped to customers
(e) Units of product sold.

Q19 Apportionment of overhead cost may be defined as

(a) Charge to a cost center of an overhead cost item with no estimation
(b) Charge to cost center for the use of an overhead cost
(c) Charge to cost units for the use of an overhead cost
(d) Classification of overhead cost as fixed or variable
(e) Charge each cost center with a share of an overhead cost using an apportionment basis
to estimate the benefit extracted by each cost center.
(e) Charge each cost center with a share of an overhead cost using an apportionment basis
to estimate the benefit extracted by each cost center.
Q20 An increase in variable costs where selling price and fixed cost remain constant will result in which of the
following?
(a) An increase in margin of safety
(b) No change in margin of safety
(c) A fall in the sales level at which break even point will occur
(d) A rise in the sales level at which break even point will occur
(e) No change in the sales level at which break even point will occur.
Q21 Which of the following is a cause of materials usage variance?
(a) Emergency buying in smaller quantities
(b) Carriage, freight and other charges absorbed instead of being charged to suppliers
(c) Cash discount not taken
(d) Rectification required when many components do not pass through inspection
(e) Claims not made on suppliers for substandard materials or short receipt of materials.
(a) Emergency buying in smaller quantities
Q22 The following are the causes of labour efficiency variance except
(a) Bad working condition
(b) Defective tools, equipment and materials
(c) Defective supervision
(d) Bad workmanship due to dissatisfaction among the workers
(e) Employing people of different grades than planned.
(e) Employing people of different grades than planned.
Q23 Which of the following transfer pricing methods will preserve the sub-unit autonomy?
(a) Cost-based pricing
(b) Negotiated pricing
(c) Variable-cost pricing
(d) Full-cost pricing
(e) Marginal cost pricing.
Q24 The most fundamental responsibility center affected by the use of market-based transfer prices is
(a) Revenue center
(b) Cost center
(c) Profit center
(d) Investment center
(e) Production center.
Q25 Target pricing
(a) Is a pricing strategy used to create competitive advantage

(b) Considers the variable costs and excludes fixed costs

(c) Is often used when costs are difficult to control
(d) Is more appropriate when applied to mature and long-established products
(e) Is well suited for complex products that require many sub-assemblies.
(a) Is a pricing strategy used to create competitive advantage
Q26 A segment of an organization is referred to as a profit center if it has
(a) Responsibility for developing markets and selling the output of the organization
(b) Responsibility for combining materials, labor and other factors of production into a final output
(c) Authority to provide specialized support to other units within the organization
(d) Authority to make decisions affecting the major determinants of profit, including the power to choose its
markets and sources of supply
(e) Authority to make decisions affecting the major determinants of profit, including the power to choose
its markets and sources of supply and significant control over the amount of invested capital.
(e) Authority to make decisions affecting the major determinants of profit, including the power to choose
its markets and sources of supply and significant control over the amount of invested capital.
Q27 Which of the following is false about standard costing system?
(a) It is based on a cost control concept
(b) It assumes stability in the current manufacturing process
(c) The goal is to meet cost performance standards
(d) It assumes production workers have the best knowledge to reduce costs
(e) It motivates employees to try to reach target established.
(d) It assumes production workers have the best knowledge to reduce costs
Q28 Which of the following service departments costs is apportioned on the basis of rate of labor turnover?
(a) Payroll department
(b) Personnel department
(c) Canteen service
(d) Store-keeping department
(e) Maintenance department.
(b) Personnel department
Q29 Which of the following bases is appropriate to apportion the cost incurred on supervision of machine?
(a) Floor area occupied by each machine
(b) Equitable basis
(c) Value of each machine
(d) On the basis of past experience
(e) Estimated time devoted.
Q30 Which of the following bases is used for apportionment of overtime premium of workers engaged in a
particular department?
(a) Direct allocation
(b) Direct labor hours
(c) Number of workers
(d) Technical estimates
(e) Relative areas of departments.
(a) Direct allocation

Q31 The rate used in addition to the original rates for ascertaining the true profit for adjusting the under or over
absorption of
overheads is known as
(a) Predetermined rate
(b) Blanket rate
(c) Moving average rate
(d) Supplementary overhead rate
(e) Multiple overhead rate.
Q32 Any activity for which a separate measurement of costs is desired is known as
(a) Cost unit
(b) Cost center
(c) Cost object
(d) Cost pool
(e) Cost allocation.
Q33 Which of the following is true regarding the difference between marginal costing and absorption costing?
(a)Under marginal costing, fixed costs are treated as product costs while it is excluded under absorption costing
(b)Under absorption costing, under absorption or over absorption of overhead occurs but it does not
occur under marginal costing
(c)The net income under absorption costing is always more than the net income under marginal costing
(d)If production is equal to sales, net income under absorption costing is greater than net income under marginal
costing
(e)In case of decreased inventory, the net income under marginal costing is less than the net income under
absorption costing.
Q34 Which of the following statements is false?
(a) The aggregate of indirect material, indirect wages and indirect expenses is overhead costs
(b)Direct costs are never treated as overhead costs even in cases where efforts involved in identifying and
accounting are disproportionately large
(c)The overheads can be apportioned to a cost center in accordance with the principles of benefit and/or
responsibilities
(d) Capital expenditure should be excluded from costs and should not be treated as overhead
(e) Expenditure that does not relate to production shall not be treated as overhead.
Q35 An increase in variable costs where selling price and fixed cost remain constant will result in which of the
following?
(a) An increase in margin of safety
(b) A fall in the sales level at which break even point will occur
(c) A rise in the sales level at which break even point will occur
(d) No change in the sales level at which break even point will occur
(e)No change in angle of incidence.
Q36 Which of the following statements is true for a firm that uses variable costing?
(a) Product costs include variable selling costs
(b) An idle facility variation is calculated
(c) The cost of a unit of product changes because of changes in number of units manufactured
(d) Profits fluctuate with sales
(e) Product costs include variable administrative costs.
Q37 Which of the following can improve break-even point?
(a) Increase in variable cost

(b) Increase in fixed cost

(c) Increase in sale price
(d) Increase in sales volume
(e) Increase in production volume.
(c) Increase in sale price
Q38 Which of the following statements is/are true?
I. A cost unit is a unit of output in the production of which costs are incurred.
II. A cost center is the smallest segment of activity or area of responsibility for which costs are accumulated.
III. Typically departments are cost centers and there may be many departments in a cost center.
(a) Only (I) above
(b) Only (II) above
(c) Both (I) and (III) above
(d) Both (I) and (II) above
(e) Both (II) and (III) above.
Q39 The Rowan Plan
(a)
Is the best for efficient workers
(b)
Pays lower bonus that that of Halsey beyond 50% saving in time.
(c)
Pays increased bonus at an increasing rate as the efficiency
(d)
None of the above
(b)
Pays lower bonus that that of Halsey beyond 50% saving in time.
Q40 A written request to a supplier for specified goods at an agreed upon price is called a
(a) Receiving Report
(b) Purchase order
(c) Material requisition form
(d) Purchase requisition