FINANCIAL AND MANAGEMENT ACCOUNTING

(M.B.A. Sem.-I)
Dr. R. D. Patil
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Q.1 Write in detail the Accounting Concepts.
Answer :
The Accounting Concepts and Accounting Conventions have been developed over the years
from experience, reason, usage and necessity and are generally accepted for accounting of
transactions and preparation of Financial Statements. Accounting Concepts are the necessary
assumptions, conditions or postulates upon which the accounting is based. They are
developed to facilitate communication of the accounting and financial information to all the
readers of the Financial Statements, so that all readers interpret the statements in the same
meaning and context.
The Accounting Concepts are as follows:
1. Entity Concept:
For accounting purposes, an “organisation” is treated as a separate entity from the
“owners” or “stakeholders”. This concept helps in keeping private affairs of the owners and
stakeholders separate from the business affairs. For example, a ULB is a separate, independent
and autonomous entity and is governed by a separate legislation and the regulations formed by it.
The various stakeholders of the ULBs, including citizens, State Government,
environmentalists, etc., do not own the ULBs. Thus, a separate Balance Sheet and Income &
Expenditure Statement is prepared in respect of the operations of the ULB. This concept is
applicable to all forms of organisations.
2. Dual Aspect or Accounting Equivalence Concept :
This concept follows from the Entity Concept. All entities own certain assets. Such assets
are acquired through contributions of those who have provided the funds for the purpose.
Funds are made available either through the surpluses of the entity or loans or payables.
In a sense, such providers of funds are claimants to the assets. At any point in time, the assets
will be equal to the claims. Since the claims on the assets could be those of “outsiders”
(i.e. liabilities) or “owners” (i.e. capital, reserves, etc.), it results in the accounting equation:
Assets = Own Funds + Liabilities.

3. Going Concern Concept

It is assumed that the organisation will continue for a long time, unless and until it has entered
into a state of liquidation. It is as per this concept, that the accountant does not take into
consideration the market value of the assets while valuing them, irrespective of whether the
market value is higher or lower than the book value. Similarly, depreciation on fixed assets is
provided on the basis of expected lives of the assets rather than on their market values.
Also, the financial statements are prepared at defined periodend to measure the performance of
the entity during that period and not only on the closure or liquidation of the entity.
4. Money Measurement Concept
In accounting, every transaction is recorded in terms of money. Events or transactions that
cannot be expressed in terms of money are not recorded in the books of accounts. Receipt
of income, payment of expenses, purchase and sale of assets, etc., are monetary
transactions that are recorded in the books of accounts. For example, the event of a machinery
breakdown is not recorded as it does not have a monetary value. However, the expenditure
incurred for the repair of the machinery can be measured in monetary value and hence is
recorded.
5. Cost Concept
As per this concept, an asset is ordinarily recorded at the price paid to acquire it, i.e., at its cost
and this cost is the basis for all subsequent accounting for the asset. The cost concept
does not mean that the asset will always be shown at cost. This basically signifies that each time
the financial statements are prepared, the fixed assets need not be revised and recorded at
its realisable or replacement or market value. The assets recorded at cost at the time of
purchase may systematically be reduced through depreciation.
6. Accounting Period Concept
An accounting period is the interval of time at the end of which the financial statements are
prepared to ascertain the financial performance of the organisation. Although the “going
concern” concept stresses the continuing nature of the entity, it is necessary for an
organisation (e.g. ULB) to review how it is performing. The preparation of financial
statements at periodic intervals helps in taking timely corrective action and developing
appropriate strategies. The accounting period is normally considered to be of twelve months.
7. Accrual Concept
Under the cash system of accounting, the revenues and expenses are recorded only if they are
actually received or paid in cash, irrespective of the accounting period to which they belong. But
under the accrual concept, occurrence of claims and obligations in respect of incomes or
expenditures, assets or liabilities based on happening of any event, passage of time, rendering of
services, fulfillment (partially or fully) of contracts, diminution in values, etc., are recorded even
though actual receipts or payments of money may not have taken place. In respect of an
accounting period, the outstanding expenses and the prepaid expenses and similarly the
income receivable and the income received in advance are shown separately in the books of
accounts under the accrual method.
8. Periodic Matching of Cost and Revenue Concept
To ascertain the surplus or deficit made by the entity during an accounting period, it is necessary
that the costs incurred are matched with the revenue earned by the entity during that accounting
period. The matching concept is a corollary drawn from the accrual concept. To ascertain the
correct surplus or deficit, it is necessary to make adjustments for all outstanding expenses,
prepaid expenses, income receivable and income received in advance to correctly depict and
match the income and expenditure relating to that accounting period.
9. Realisation Concept
According to this concept, revenue should be accounted for only when it is actually realised or
it has become certain that the revenue will be realised. This signifies that revenue should be
recognised only when the services are rendered or the sale is effected. However, in order to
recognise revenue, actual receipt of cash is not necessary. What is important is that the
organisation should be legally entitled to receive the amount for the services rendered or the sale
effected.

Q.2 What is “Accounting Principles”? Discuss accounting conventions in detail.

Answer:
There are general rules and concepts that govern the field of accounting. These general rules–
referred to as basic accounting principles and guidelines–form the groundwork on which more
detailed, complicated, and legalistic accounting rules are based. For example, the Financial
Accounting Standards Board (FASB) uses the basic accounting principles and guidelines as a
basis for their own detailed and comprehensive set of accounting rules and standards.
The phrase "generally accepted accounting principles" (or "GAAP") consists of three important
sets of rules: (1) the basic accounting principles and guidelines, (2) the detailed rules and
standards issued by FASB and its predecessor the Accounting Principles Board (APB), and (3)
the generally accepted industry practices.
If a company distributes its financial statements to the public, it is required to follow generally
accepted accounting principles in the preparation of those statements. Further, if a company's
stock is publicly traded, federal law requires the company's financial statements be audited by
independent public accountants. Both the company's management and the independent
accountants must certify that the financial statements and the related notes to the financial
statements have been prepared in accordance with GAAP.
GAAP is exceedingly useful because it attempts to standardize and regulate accounting
definitions, assumptions, and methods. Because of generally accepted accounting principles we
are able to assume that there is consistency from year to year in the methods used to prepare a
company's financial statements. And although variations may exist, we can make reasonably
confident conclusions when comparing one company to another, or comparing one company's
financial statistics to the statistics for its industry. Over the years the generally accepted
accounting principles have become more complex because financial transactions have become
more complex.
Accounting Conventions
Each of the accounting conventions are discussed below.
1. Convention of Disclosure
The term “disclosure” implies that there must be a sufficient revelation of information which is
of material interest to owners, creditors, lenders, investors, citizen and other stakeholders.
The accounts and the financial statements of an entity should disclose full and fair information
to the beneficiaries in order to enable them to form a correct opinion on the performance of such
entity, which in turn would allow them to take correct decisions. For example, the
Accounting Principles that have been followed for preparation of the Financial Statements
should be disclosed along with the Financial Statements for proper understanding and
interpretation of the same.
2. Convention of Materiality
2.20 An item should be regarded as material, if there is a sufficient reason to believe that
knowledge of it would influence the decision of informed creditors, lenders, investors, citizen
and other stakeholders. The accounts and the financial statements should impart importance to all
material information so that true and fair view of the state of affairs of the entity is given to its
beneficiaries. Hence, keeping the convention of materiality in view, unimportant items are not
disclosed separately and are merged with other items. For example, the expenditure
incurred on repairs and maintenance of a certain asset of the ULBs, which are small, may not be
disclosed separately in respect of each such small item but may be grouped together and shown
as a single item of expenditure.
3. Convention of Consistency
2.21 The convention of consistency facilitates comparison of financial performance of an
entity from one accounting period to another. This means that the accounting principles
followed by an entity should be consistently applied by it over the years. For example,
an organisation should not change its method of depreciation every year, i.e., from Straight Line
Method to Written Down Value Method or viceversa. Similarly, the method adopted for
valuation of stocks, viz., First In First Out (FIFO) or Weighted Average should be consistently
followed. In case a change is made, it should be disclosed.
4. Convention of Conservatism
As per this convention, the anticipated profits should be ignored but all anticipated losses
should be provided for in the books of accounts of an entity. This means that all
prospective losses are taken into consideration, however, no doubtful income is taken into
consideration in recording of transactions by an entity. For example, while provision for
doubtful debts and discount is made on debtors or Accounts Receivable, no provision is made for
likely discount receivable from creditors or Accounts Payable. Similarly, provision is made for
diminution in value of investments, however, no provision is made for any appreciation in value
of investments.

Q.3 What is Financial Accounting ? Explain its nature and scope.

Answer:
The process of recording, summarizing and reporting the myriad of transactions from a business,
so as to provide an accurate picture of its financial position and performance. The primary
objective of financial accounting is the preparation of financial statements - including the
balance sheet, income statement and cash flow statement - that summarizes the company's
operating performance over a particular period, and financial position at a specific point in time.
These statements - which are generally prepared quarterly and annually, and in accordance with
Generally Accepted Accounting Principles (GAAP) - are aimed at external parties including
investors, creditors, regulators and tax authorities.
Definition:
“The art of recording, classifying and summarizing in significant manner and in terms of money
the transactions and events, which are in part at least of financial character and interpreting
results thereof.”
Nature of Accounting:
We know Accounting is the systematic recording of financial transactions and presentation of the
related information of the appropriate persons. The basic features of accounting are as follows:
1. Accounting is a process: A process refers to the method of performing any specific job step
by step according to the objectives, or target. Accounting is identified as a process as it performs
the specific task of collecting, processing and communicating financial information. In doing so,
it follows some definite steps like collection of data recording, classification summarization,
finalization and reporting.
2. Accounting is an art: Accounting is an art of recording, classifying, summarizing and
finalizing the financial data. The word ‘art’ refers to the way of performing something. It is a
behavioral knowledge involving certain creativity and skill that may help us to attain some
specific objectives. Accounting is a systematic method consisting of definite techniques and its
proper application requires applied skill and expertise. So, by nature accounting is an art.
3. Accounting is means and not an end: Accounting finds out the financial results and position
of an entity and the same time, it communicates this information to its users. The users then take
their own decisions on the basis of such information. So, it can be said that mere keeping of
accounts can be the primary objective of any person or entity. On the other hand, the main
objective may be identified as taking decisions on the basis of financial information supplied by
accounting. Thus, accounting itself is not an objective, it helps attaining a specific objective. So
it is said the accounting is ‘a means to an end’ and it is not ‘an end in itself.’
4. Accounting deals with financial information and transactions; Accounting records the
financial transactions and date after classifying the same and finalizes their result for a definite
period for conveying them to their users. So, from starting to the end, at every stage, accounting
deals with financial information. Only financial information is its subject matter. It does not deal
with non-monetary information of non-financial aspect.
5. Accounting is an information system: Accounting is recognized and characterized as a
storehouse of information. As a service function, it collects processes and communicates
financial information of any entity. This discipline of knowledge has been evolved out to meet
the need of financial information required by different interested groups.
Scope of Accounting:
Accounting has got a very wide scope and area of application. Its use is not confined to the
business world alone, but spread over in all the spheres of the society and in all professions.
Now-a-days, in any social institution or professional activity, whether that is profit earning or
not, financial transactions must take place. So there arises the need for recording and
summarizing these transactions when they occur and the necessity of finding out the net result of
the same after the expiry of a certain fixed period. Besides, there is also the need for
interpretation and communication of this information to the appropriate persons. Only
accounting use can help overcome these problems.
In the modern world, accounting system is practiced not only in all the business institutions but
also in many non-trading institutions like Schools, Colleges, Hospitals, Charitable Trust Clubs,
Co-operative Society etc. and also Government and Local Self-Government in the form of
Municipality, Panchayat. The professional persons like Medical practitioners, practicing
Lawyers, Chartered Accountants etc.also adopt some suitable types of accounting methods. As a
matter of fact, accounting methods are used by all who are involved in a series of financial
transactions.
The scope of accounting as it was in earlier days has undergone lots of changes in recent times.
As accounting is a dynamic subject, its scope and area of operation have been always increasing
keeping pace with the changes in socio-economic changes. As a result of continuous research in
this field the new areas of application of accounting principles and policies are emerged.
National accounting, human resources accounting and social Accounting are examples of the
new areas of application of accounting systems.

Q.4 Explain the role of Management Accountant in the Managerial Functions?

Answer:
Also known as corporate accountants, management accountants work within one specific
company. The role of the management accountant is to perform a series of tasks to ensure their
company's financial security, handling essentially all financial matters and thus helping to drive
the business's overall management and strategy.
Management accountants are key figures in determining the status and success of a company.
Some choose to become a Certified Management Accountant (CMA), a similar credential to
CPA, but with a greater focus on cost accounting, financial planning, and management issues.
Job responsibilities can range widely. Depending on the company, accountant’s level of
experience, the time of year and the type of industry, he could find himself doing any of the
following tasks:
 Budgeting
 Handling taxes
 Managing assets to helping determine compensation and benefits packages
 Aiding in strategic planning
Role of Management Accountant:
Consistent with other roles in today's corporation, management accountants have a dual reporting
relationship. As a strategic partner and provider of decision based financial and operational
information, management accountants are responsible for managing the business team and at the
same time having to report relationships and responsibilities to the corporation's finance
organization.
The activities management accountants provide inclusive of forecasting and planning,
performing variance analysis, reviewing and monitoring costs inherent in the business are ones
that have dual accountability to both finance and the business team. Examples of tasks where
accountability may be more meaningful to the business management team vs. the corporate
finance department are the development of new product costing, operations research, business
driver metrics, sales management score carding, and client profitability analysis. (See Financial
modeling.) Conversely, the preparation of certain financial reports, reconciliations of the
financial data to source systems, risk and regulatory reporting will be more useful to the
corporate finance team as they are charged with aggregating certain financial information from
all segments of the corporation.
In corporations that derive much of their profits from the information economy, such as banks,
publishing houses, telecommunications companies and defence contractors, IT costs are a
significant source of uncontrollable spending, which in size is often the greatest corporate cost
after total compensation costs and property related costs. A function of management accounting
in such organizations is to work closely with the IT department to provide IT cost transparency.
Given the above, one widely held view of the progression of the accounting and finance career
path is that financial accounting is a stepping stone to management accounting. Consistent with
the notion of value creation, management accountants help drive the success of the business
while strict financial accounting is more of a compliance and historical endeavor.

The role of the management accountant is to perform a series of tasks to ensure their company's
financial security, handling essentially all financial matters and thus helping to drive the
business's overall management and strategy.

Management accountants are key figures in determining the status and success of a company.
Management accountants give greater focus on cost accounting, financial planning, and
management issues. In Management accounting or managerial accounting, managers use the
provisions of accounting information in order to better inform themselves before they decide
matters within their organizations, which allows them to better manage and perform control
functions.

If you like keeping track of a company's income and expenses but also want to hold a position
with significant responsibility and authority, management accounting could be the job for you.
This article will teach you about the profession of management accounting, from a management
accountant's job responsibilities, skill set and formal educational requirements to the professional
designations that can help you get ahead, as well as the career ladder for a management
accounting job.

Job Description
Management accountants work for public companies, private businesses and government
agencies. They may also be called cost accountants, managerial accountants, industrial
accountants, private accountants or corporate accountants, but all perform similar functions
within a company. Indeed, preparing data for use within a company is one of the features that
distinguishes a management accountant's job from other types of accounting jobs, such as public
accounting.

Instead, you'll be recording and crunching numbers for internal review to help companies budget
and perform better. In conjunction with other managers in the company, you may help the
company choose and manage its investments. Management accountants are risk managers,
budgeters, planners, strategists and decision makers. They do the work that helps the company's
owner, manager or board of directors make decisions.

As a management accountant, you'll likely supervise lower-level accountants who handle a

company's basic accounting tasks, such as recording income and expenses, tracking tax liabilities
and using these data to prepare income statements, cash flow statements and balance sheets, but
in a smaller firm, you might perform these tasks yourself. A management accountant will
analyze these basic data and make forecasts, budgets, performance measurements and plans, then
present them to senior management to assist in its operational decision making.

A management accountant may also identify trends and opportunities for improvement, analyze
and manage risk, arrange the funding and financing of operations and monitor and enforce
compliance. They might also create and maintain a company's financial system and supervise its
bookkeepers and data processors. Further, management accountants may have an area of
expertise, such as taxes or budgeting.

Q.5 What are the advantages and limitations of Financial Accounting?

Answer:
Financial accounting is the field of accountancy concerned with the preparation of financial
statements for decision makers such as stockholders, suppliers, banks, employees, government
agencies, owners, and other stakeholders. The practice is used to prepare accounting information
for people outside the organization or not involved in the day-to-day running of the company. It
also helps people to store information on a company or organization that would be difficult to
memorize.
It allows people to measure the profitability and value of a business, rather like having a dossier
of the business’s transactions you can see how well or how poorly the company is doing. It also
helps when attempting to compile a company report for those outside the company, this might be
for prospective buyers or investors, who wish to see a full and detailed account before becoming
involved. Financial accounting and the information it generates can act like a barometer for an
organization, allowing achievements and losses to be measured against rivals and competitors
and produce a clear picture of where a firm stands in its particular field.

Advantages:

1. Accounting supplies numerical information to the institution relating to its management

and administration
2. Exact results of the institution are disclosed through accounting
3. The firm can ascertain the financial status of the business operation
4. Firm can compare the financial position of two/more years
5. Books accounts are very valuable documents
6. Proper accounting makes the firm credible to other party
7. Tax authority can assess taxes for the firm using the accounting information
8. Firm can determine the actual assets and liabilities
9. Using accounting data a firm can formulate policy and take many decision on future
operation

Limitations:
(i) No detail information about cost:
Financial Accounting provides information as a whole in terms of income, expenses, assets and
liabilities. It does not provide detail of cost involved by departments, processes, products,
services or other unit of activity within the organisation.
(ii) No cost control method:
It does not have proper mechanism to control expenditure on various elements of cost, viz,
material and labour. As a result, misappropriation, wastage and losses of materials are left
unchecked. Proper utilization of labour becomes impossible and suitability of different labour
incentive plans goes without evaluation.
(iii) No information on efficiency:
It does not have a system to judge the» efficiency in the use of material, labour and overhead
costs of the organisation in comparison to the standard fixed for their use.
(iv) No classification of expenses:
It does not classify expenses as direct and indirect or fixed and variable. Besides, these are also
not allocated to different stages of production or departments or processes to show the
controllable and uncontrollable items on overhead cost.
(v) Historical in nature:
It is prepared at the end of the accounting ♦period. It fails to provide day-to-day information to
pre-determine cost.
(vi) Not helpful in price fixation:
It does not provide adequate cost information to fix up the price of products manufactured and
service rendered by the organisation.
(vii) No analysis of losses:
It does not provide detail information about the reasons of losses. It also does not help to
determine the variations in the cost between different working times, idle time and seasonal
conditions of the industry.
(viii) No technique to evaluate alternative methods:
In planning expansions contraction of plants, equipment, products and processes it is not poses to
calculate and compare the profitability of alternatives with the help Financial Accounting.
(ix) No cause and effect analysis:
As financial account fails to provide o and profit information product-wise, the causes of profit
or loss cannot effectively determined and analyzed.
(x) No data for comparison:
It does not provide data to facilitate compare of costs of operation of the firm with other firms in
the industry.
Cost Accounting is developed from within the accounting process to overcoat the limitations of
Financial Accounting and it helps in calculating, controlling and reducing cost.

Q. 6 What is Trial Balance? Explain its purpose and limitations and give format of the
Trial Balance.

Answer:
Trial Balance is a list of closing balances of ledger accounts on a certain date and is the first step
towards the preparation of financial statements. It is usually prepared at the end of an accounting
period to assist in the drafting of financial statements. Ledger balances are segregated into debit
balances and credit balances. Asset and expense accounts appear on the debit side of the trial
balance whereas liabilities, capital and income accounts appear on the credit side. If all
accounting entries are recorded correctly and all the ledger balances are accurately extracted, the
total of all debit balances appearing in the trial balance must equal to the sum of all credit
balances.
Purpose of a Trial Balance
Trial Balance acts as the first step in the preparation of financial statements. It is a working paper
that accountants use as a basis while preparing financial statements.
Trial balance ensures that for every debit entry recorded, a corresponding credit entry has been
recorded in the books in accordance with the double entry concept of accounting. If the totals of
the trial balance do not agree, the differences may be investigated and resolved before financial
statements are prepared. Rectifying basic accounting errors can be a much lengthy task after the
financial statements have been prepared because of the changes that would be required to correct
the financial statements.
Trial balance ensures that the account balances are accurately extracted from accounting ledgers.
Trail balance assists in the identification and rectification of errors.

Example
Following is an example of what a simple Trial Balance looks like:

ABC LTD
Trial Balance as at 31 December 2016
Account Title Debit Credit
Rs. ‘000’ Rs. ‘000’
Share Capital 15,000
Furniture & Fixture 5,000
Building 10,000
Creditor 5,000
Debtors 3,000
Cash 2,000
Sales 10,000
Cost of sales 8,000
General and Administration
2,000
Expense
Total 30,000 30,000

Title provided at the top shows the name of the entity and accounting period end for which the
trial balance has been prepared.
Account Title shows the name of the accounting ledgers from which the balances have been
extracted.
Balances relating to assets and expenses are presented in the left column (debit side) whereas
those relating to liabilities, income and equity are shown on the right column (credit side).
The sum of all debit and credit balances is shown at the bottom of their respective columns.
Limitations of a trial balance
Trial Balance only confirms that the total of all debit balances match the total of all credit
balances. Trial balance totals may agree in spite of errors. An example would be an incorrect
debit entry being offset by an equal credit entry. Likewise, a trial balance gives no proof that
certain transactions have not been recorded at all because in such case, both debit and credit
sides of a transaction would be omitted causing the trial balance totals to still agree. Types of
accounting errors and their effect on trial balance are more fully discussed in the section on
Suspense Accounts.

Q.7 What is “Cost Accounting”? State its importance.

Answer:
A method of accounting in which all costs incurred in carrying out an activity or accomplishing a
purpose are collected, classified, and recorded. This data is then summarized and analyzed to
arrive at a selling price, or to determine where savings are possible.
In contrast to financial accounting (which considers money as the measure of economic
performance) cost accounting considers money as the economic factor of production.
Cost accounting is a process of collecting, analyzing, summarizing and evaluating various
alternative courses of action. Its goal is to advise the management on the most appropriate course
of action based on the cost efficiency and capability. Cost accounting provides the detailed cost
information that management needs to control current operations and plan for the future.
Since managers are making decisions only for their own organization, there is no need for the
information to be comparable to similar information from other organizations. Instead,
information must be relevant for a particular environment. Cost accounting information is
commonly used in financial accounting information, but its primary function is for use by
managers to facilitate making decisions.
Unlike the accounting systems that help in the preparation of financial reports periodically, the
cost accounting systems and reports are not subject to rules and standards like the Generally
Accepted Accounting Principles. As a result, there is wide variety in the cost accounting systems
of the different companies and sometimes even in different parts of the same company or
organization.

Importance of Cost Accounting

The limitation of financial accounting has made the management to realize the importance of
cost accounting. The importance of cost accounting is as follows:
Importance to Management
Cost accounting provides invaluable help to management. It is difficult to indicate where the
work of cost accountant ends and managerial control begins. The advantages are as follows:
i. Helps in ascertainment of cost
Cost accounting helps the management in the ascertainment of cost of process, product,
Job, contract, activity, etc., by using different techniques such as Job costing and Process
costing.
ii. Aids in Price fixation
By using demand and supply, activities of competitors, market condition to a great extent,
also determine the price of product and cost to the producer does play an important role.
The producer can take necessary help from his costing records.
 iii. Helps in Cost reduction
Cost can be reduced in the long-run when cost reduction programme and improved
methods are tried to reduce costs.
iv. Elimination of wastage
As it is possible to know the cost of product at every stage, it becomes possible to check
the forms of waste, such as time and expenses etc., are in the use of machine equipment
and material.
v. Helps in identifying unprofitable activities
With the help of cost accounting the unprofitable activities are identified, so that the
necessary correct action may be taken.
vi. Helps in checking the accuracy of financial account
Cost accounting helps in checking the accuracy of financial account with the help of
reconciliation of the profit as per financial accounts with the profit as per cost account.
vii. Helps in fixing selling Prices. It helps the management in fixing selling prices of product
by providing detailed cost information.

Importance to Employees
Worker and employees have an interest in which they are employed. An efficient costing system
benefits employees through incentives plan in their enterprise, etc. As a result both the
productivity and earning capacity increases.

Cost accounting and creditors

Suppliers, investor’s financial institution and other moneylenders have a stake in the success of
the business concern and therefore are benefited by installation of an efficient costing system.
They can base their judgment about the profitability and prospects of the enterprise upon the
studies and reports submitted by the cost accountant.

Importance to National Economy

An efficient costing system benefits national economy by stepping up the government revenue
by achieving higher production. The overall economic developments of a country take place due
to efficiency of production.

Data Base for operating policy

Cost Accounting offers a thoroughly analyzed cost data which forms the basis of formulating
policy regarding day to day business.

Q.8 Discuss various types of costs in detail.

Answer:
In production, research, retail, and accounting, a cost is the value of money that has been used up
to produce something, and hence is not available for use anymore. In business, the cost may be
one of acquisition, in which case the amount of money expended to acquire it is counted as cost.
In this case, money is the input that is gone in order to acquire the thing. This acquisition cost
may be the sum of the cost of production as incurred by the original producer, and further costs
of transaction as incurred by the acquirer over and above the price paid to the producer. Usually,
the price also includes a mark-up for profit over the cost of production.

An amount that has to be paid or given up in order to get something is called as cost. In business,
cost is usually a monetary valuation of (1) effort, (2) material, (3) resources, (4) time and utilities
consumed, (5) risks incurred, and (6) opportunity forgone in production and delivery of a good
or service. All expenses are costs, but not all costs (such as those incurred in acquisition of an
income-generating asset) are expenses.

Definition of Cost
“Something of value, usually an amount of money, given up in exchange for something else,
usually goods or services. All expenses are costs, but not all costs are expenses. (An expense is
the cost of resources used to produce revenue.) As a verb, cost means to estimate the amount of
money needed to produce a product or perform a service.”

Cost and Cost Classifications

Cost is a sacrifice of resources to obtain a benefit or any other resource. For example in
production of a car, we sacrifice material, electricity, the value of machine's life (depreciation),
and labor wages etc. Thus these are our costs.

Costs are usually classified as follows:

1. Product Costs Vs. Period Costs

Product costs are costs assigned to the manufacture of products and recognized for financial
reporting when sold. They include direct materials, direct labor, factory wages, factory
depreciation, etc.
Period costs are on the other hand are all costs other than product costs. They include marketing
costs and administrative costs, etc.
2. Breakup of Product Costs
The product costs are further classified into:
Direct materials: Represents the cost of the materials that can be identified directly with the
product at reasonable cost. For example, cost of paper in newspaper printing, cost of
Direct labor: Represents the cost of the labor time spent on that product, for example cost of the
time spent by a petroleum engineer on an oil rig, etc.
Manufacturing overhead: Represents all production costs except those for direct labor and
direct materials, for example the cost of an accountant's time in an organization, depreciation on
equipment, electricity, fuel, etc.
The product costs that can be specifically identified with each unit of a product are called direct
product costs. Whereas those which cannot be traced to a specific unit are indirect product costs.
Thus direct material cost and direct labor cost are direct product costs whereas manufacturing
overhead cost is indirect product cost.
3. Prime Costs Vs. Conversion Costs
Prime costs are the sum of all direct costs such as direct materials, direct labor and any other
direct costs.
Conversion costs are all costs incurred to convert the raw materials to finished products and they
equal the sum of direct labor, other direct costs (other than materials) and manufacturing
overheads.
4. Fixed Costs Vs. Variable Costs
Fixed costs are costs which remain constant within a certain level of output or sales. This certain
limit where fixed costs remain constant regardless of the level of activity is called relevant range.
For example, depreciation on fixed assets, etc.
Variable costs are costs which change with a change in the level of activity. Examples include
direct materials, direct labor, etc.
5. Sunk Costs Vs. Opportunity Costs
The costs discussed so far are historical costs which means they have been incurred in past and
cannot be avoided by our current decisions. Relevant in this regard is another cost classification,
called sunk costs. Sunk costs are those costs that have been irreversibly incurred or committed;
they may also be termed unrecoverable costs.
In contrast to sunk costs are opportunity costs which are costs of a potential benefit foregone. For
example the opportunity cost of going on a picnic is the money that you would have earned in
that time.

Q.9 Describe the nature and scope of Management Accounting?

Answer:
Management accounting can be viewed as Management-oriented Accounting. Basically it is the
study of managerial aspect of financial accounting, "accounting in relation to management
function". It shows how the accounting function can be re-oriented so as to fit it within the
framework of management activity. The primary task of management accounting is, therefore, to
redesign the entire accounting system so that it may serve the operational needs of the firm. If
furnishes definite accounting information, past, present or future, which may be used as a basis
for management action. The financial data are so devised and systematically development that
they become a unique tool for management decision.
The term “Management Accounting”, observe, Broad and Carmichael, covers all those services
by which the accounting department can assist the top management and other departments in the
formation of policy, control of execution and appreciation of effectiveness. This definition points
out that management is entrusted with the primary task of planning, execution and control of the
operating activities of an enterprise. It constantly needs accounting information on which to base
its decision. A decision based on data is usually correct and the risk of erring is minimized.

Definitions –
“Any form of accounting which enable the business to be conducted more efficiently may
regarded as Management Accounting”
“Accounting for Management”

According to the Institute of Management Accountants (IMA): "Management accounting is a

profession that involves partnering in management decision making, devising planning and
performance management systems, and providing expertise in financial reporting and control to
assist management in the formulation and implementation of an organization's strategy"

The Management Accounting Practices Committee (MAPC) of the National Accounting

Association (NAA) in the United States defines Management Accounting as “the process of
identification, measurement, accumulation, analysis, preparation and communication of financial
information used by management to plan, evaluate and control within an organisation and to
ensure appropriate use of accountability for its resources.”
Management Accounting can also be defined as “the application of professional skills in
preparation and presentation of accounting information in such a way as to assist to management
in the formulation of policies and in the planning and control of the operations of the
undertaking.” (Sizer 1996).

Nature of Management Accounting

The term management accounting is composed of 'management' and 'accounting'. The word
'management' here does not signify only the top management but the entire personnel charged
with the authority and responsibility of operating an enterprise. The task of management
accounting involves furnishing accounting information to the management, which may base its
decisions on it. It is through management accounting that the management gets the tools for an
analysis of its administrative action and can lay suitable stress on the possible alternatives in
terms of costs, prices and profits, etc. but it should be understood that the accounting information
supplied to management is not the sole basis for managerial decisions. Along with the
accounting information, management takes into consideration or weighs other factors concerning
actual execution. For reaching a final decision, management has to apply its common sense,
foresight, knowledge and experience of operating an enterprise, in addition to the information
that is already has. The word 'accounting' used in this phrase should not lead us to believe that it
is restricted to a mere record of business transactions i.e., book keeping only. It has indeed a
'macro-economic approach'. As it draws its raw material from several other disciplines like
costing, statistics, mathematics, financial accounting, etc., it can be called an interdisciplinary
subject, the scope of which is not clearly demarcated. Other fields of study, which can be
covered by management accounting, are political science, sociology, psychology, management,
economics, statistics, law, etc. A knowledge of political science helps to understand authority
relationship and responsibility identification in an organization. A study of sociology helps to
understand the behaviour of man in groups. Psychology enables us to know the mental make-up
of employers and employees. A knowledge of these subjects helps to increase motivation, and to
control the actions of the people who are ultimately responsible for costs. This builds a better
employer-employee relationship and a sound morale. The subject of management reveals the
processes involved in the art of managing, a knowledge of economics assists in the determination
of optimum output in the forecasting of sales and production, etc., and also makes it possible to
analyze management action in terms of cost revenues, profits, growth, etc. It is with the help of
statistics that this information is presented to the management in a form that can be assimilated.
The subject of management accounting also encompasses the subject of law, knowledge of
which is necessary to find out if the management action is ultra-vires or not.
It is, therefore, a wide and diverse subject.
Management accounting has no set principles such as the double entry system of bookkeeping.
In place of generally accepted accounting principles, the philosophy of cost benefit analysis is
the core guide of this discipline. It says that no accounting system is good or bad but is can be
considered desirable so long as it brings incremental benefits in excess of its incremental costs.
Applying management accounting principles to financial matters can arrive at no single perfect
solution. It is, therefore, an inexact science, which uses its own conventions rather than
standardized principles. Since management accounting is managerially oriented, its data is
selective in nature. It focuses on potential opportunities rather than opportunities lost. The data is
operative in nature catering to the operational needs of a firm. It details events, monetary and
non-monetary. The nature of data, the form of presentation and its duration are mainly
determined by managerial needs. It is quite frequently reported as it is meant for internal uses
and managerial control. An accountant should look at his enterprise from the management's point
of view. Whenever he fails to do that he ceases to be a management accountant.

Scope of Management Accounting

The scope or field of management accounting is very wide and broad based and it includes a
variety of aspects of business operations. The main aim of management accounting is to help
management in its functions of planning, directing, controlling and areas of specialization
included within the admit of management accounting. The scope of management accounting can
be studied as follows:
1. Financial Accounting
Financial accounting forms the basis for analysis and interpretation for furnishing meaningful
data to the management. The control aspect is based on financial data and performance
evaluation, on recorded facts and figures. So, management accounting is closely related to
financial accounting in many respects.
2. Cost Accounting
Cost accounting is the process and techniques of ascertaining cost. Planning, decision making
and control are the basic managerial functions. The cost accounting system provides the
necessary tool for carrying out such functions efficiently. The tools includes standard costing,
inventory management, variable costing etc.
3. Budgeting and Forecasting
Budgeting means expressing the plans, policies and goals of the firm for a definite period in
future. Forecasting on the other hand, is a prediction of what will happen as a result of a given
set of circumstances. Forecasting is a judgment whereas the budgeting is an organizational
object. These are useful for management accounting in planning.
4. Inventory Control
Inventory is necessary to control from the time it is acquire till its final disposal as it involves
large sum. For controlling inventory, management should determine different level of stock. The
inventory control technique will be helpful for taking managerial decisions.
5. Statistical Method
Statistical tools not only make the information more impressive, comprehensive and intelligible
but also are highly useful for planning and forecasting.
6. Interpretation of Data
Analysis and interpretation of financial statements are important part of management accounting.
After analyzing the financial statements, the interpretation is made and the reports drawn from
this analysis are presented to the management. Interpreting the accounting data to the authorities
in the management is the principal task of management accounting.
7. Reporting To Management
The interpreted information must be communicated to those who are interested in it. The report
may cover Profit and Loss Account, Cash Flow and Funds Flow statements etc.
8. Internal Audit and Tax Accounting
Management accounting studies all the tax matters to assist the management in investment
decisions vis-a-vis tax planning as a resource to enjoy tax relief.
Internal audit system is necessary to judge the performance of every department. Management is
able to know deviations in performance through internal audit. It also helps management in
fixing responsibility of different individuals.
9. Methods of Procedures
This includes maintenance of proper data processing and other office management services. It
may have to deal with filing, copying, duplicating, communicating and management information
system and also may have to report about the utility of different office machines.

Q.10 Distinguish between Financial Accounting and Cost Accounting.

Answer –
The Financial Accounting is the process of recording, summarizing and reporting the myriad of
transactions from a business, so as to provide an accurate picture of its financial position and
performance. The primary objective of financial accounting is the preparation of financial
statements - including the balance sheet, income statement and cash flow statement - that
summarizes the company's operating performance over a particular period, and financial position
at a specific point in time. These statements - which are generally prepared quarterly and
annually, and in accordance with Generally Accepted Accounting Principles (GAAP) - are aimed
at external parties including investors, creditors, regulators and tax authorities.
Cost accounting is a process of collecting, analyzing, summarizing and evaluating various
alternative courses of action. Its goal is to advise the management on the most appropriate course
of action based on the cost efficiency and capability. Cost accounting provides the detailed cost
information that management needs to control current operations and plan for the future. This
data is then summarized and analyzed to arrive at a selling price, or to determine where savings
are possible.
Even though, cost accounting and financial accounting are using the same method/materials for
recording and analyzing the transactions, the two systems different in their purpose and scope.
Main points of differences are given below:

Basis Financial Accounting Cost Accounting

1. Objective It provides information about It provides information of
the financial performance and ascertainment of cost to
financial position of the control cost and for decision
business making about the cost.
2. Nature It classifies records, presents It classifies, presents and
and interprets transactions in interprets in a significant
terms of money. manner the material, labour
and overheads cost
3. Recording of data It records Historical data It also records and presents
the estimated/budgeted data.
It makes use of both the
historical costs and
predetermined costs.
4. Users of information The users of financial The cost accounting
accounting statements are information is used by
shareholders, creditors, internal management at
financial analysts and different level.
government and its agencies
etc.
 5. Analysis of costs and It shows the profit/loss of the It provides the details of cost
profits organisation and profit of each product,
process, job, contracts etc.
6. Time period Financial statements are Its reports and statements are
prepared for a definite period, prepared as and when
usually a year. required.
7. Presentation of A set format is used for There are not any set formats
information presenting financial for presenting cost
information information.

Q.11 Distinguish between Financial Accounting and Management Accounting.

Answer-
The Financial Accounting is the process of recording, summarizing and reporting the myriad of
transactions from a business, so as to provide an accurate picture of its financial position and
performance. The primary objective of financial accounting is the preparation of financial
statements - including the balance sheet, income statement and cash flow statement - that
summarizes the company's operating performance over a particular period, and financial position
at a specific point in time. These statements - which are generally prepared quarterly and
annually, and in accordance with Generally Accepted Accounting Principles (GAAP) - are aimed
at external parties including investors, creditors, regulators and tax authorities.
Management accounting is a field of accounting that analyzes and provides cost information to
the internal management for the purposes of planning, controlling and decision making.
Management accounting refers to accounting information developed for managers within an
organization. CIMA (Chartered Institute of Management Accountants) defines Management
accounting as “Management Accounting is the process of identification, measurement,
accumulation, analysis, preparation, interpretation, and communication of information that used
by management to plan, evaluate, and control within an entity and to assure appropriate use of an
accountability for its resources”. This is the phase of accounting concerned with providing
information to managers for use in planning and controlling operations and in decision making.
Managerial accounting is concerned with providing information to managers i.e. people inside an
organization who direct and control its operations. In contrast, financial accounting is concerned
with providing information to stockholders, creditors, and others who are outside an
organization. Managerial accounting provides the essential data with which organizations are
actually run. Financial accounting provides the scorecard by which a company’s past
performance is judged.

Difference between Financial Accounting and Management Accounting:

Basis Financial Accounting Management Accounting

External vs. A financial accounting system A management accounting
Internal produces information that is used system produces information
by parties external to the that is used within an
organization, such as organization, by managers and
shareholders, bank and creditors. employees.
Segment reporting Pertains to the entire organization May pertain to smaller
or materially significant business business units or individual
units. departments, in addition to the
 entire organization.
Focus Financial accounting focuses on Management accounting
history. focuses on future & present.
Format Financial accounts are supposed No specific format is designed
to be in accordance with a for management accounting
specific format, so that financial systems. (Formal and informal
accounts of different recordkeeping)
organizations can be easily
compared. (Formal
recordkeeping)
Planning and Financial accounting helps in Management accounting helps
control making investment decisions, and management to record, plan
in credit rating. and control activities to aid
decision-making process.
Information Quantitative and monetary Quantitative and qualitative;
Monetary and non-monetary
Users Financial accounting reports are Management accounting
primarily used by external users, reports are exclusively used by
such as shareholders, bank and internal users’ viz. managers
creditors. and employees.
Reporting Well-defined - annually, semi- As needed - daily, weekly,
frequency annually, quarterly. (Verifiable) monthly.
and duration
Optional? Preparing financial accounting There are no legal
reports are mandatory especially requirements to prepare reports
for limited companies. on management accounting.
Objectives The main objectives of financial The main objectives of
accounting are :i) to disclose the Management Accounting are
end results of the business, and ii) to help management by
to depict the financial condition providing information that
of the business on a particular used by management to plan,
date. evaluate, and control.
Legal/rules Drafted according to GAAP - Drafted according to
General Accepted Accounting management suitability.
Procedure.
Accounting Follows a full process of Cost accounts are not
process recording, classifying, and preserved under Management
summmarising for the purpose of Accounting. The necessary
analysis and interpretation of the data from financial statements
finnancial information. and cost ledgers are analyzed.

Q.12. Write a note on marginal costing as a technique of cost control.

Answer:
The costs that vary with a decision should only be included in decision analysis. For many
decisions that involve relatively small variations from existing practice and/or are for relatively
limited periods of time, fixed costs are not relevant to the decision. This is because either fixed
costs tend to be impossible to alter in the short term or managers are reluctant to alter them in the
short term.
Marginal costing distinguishes between fixed costs and variable costs as conventionally
classified.
Marginal costing is an accounting technique. Marginal costing is not a system of costing such as
process or job costing. As marginal costing is a technique, it may be used in conjunction with
any costing method. Marginal costing as a technique helps the management to measure the
profitability of an undertaking by considering the underlying cost behaviour. Marginal costing is
an impotent technique, which guides the management theory. Marginal costing is also known as
direct costing or variable costing or differential costing or incremental costing or comparative
costing.

Definition:
According to ICMA London ³marginal cost is the amount for any given volume of output by
which aggregate costs are changed if the volume of output is increased or decreased by one unit´.
Marginal costing is the technique of applying the concept of marginal cost in decision making
process. Marginal costing is a technique that distinguishes between fixed and variable costs. The
³marginal´ cost of a product is its variable cost.

How is the concept of marginal costing practically applied to control the cost increase the
profit?

The concept of marginal costing is practically applied in the following situations:

1. Evaluation of Performance : The evaluation of the performance of various departments or
products can be evaluated with the help of marginal costing which is based on contribution
generating capacity.
2. Profit Planning : This technique through the calculation of P/V Ratio helps the management
to plan the activities in such a way that the profit can be maximised.
3. Fixation of Selling Price : The technique of marginal costing assists the management to fix
the price in such a way so that prices fixed can cover at least the variable cost.
4. Make or Buy decision : Marginal cost analysis helps the management in making or buying
decision.
5. Optimizing Product Mix : To maximise profits and increase sales volume it is necessary to
decide an optimized mix or proportion in which various products of a company can be sold.
6. Cost Control : Marginal Costing is a technique of cost classification and cost presentation
which enable the management to concentrate on the controllable costs.
7. Flexible Budget preparation: As the marginal costing particularly classifies costs as fixed
and variable costs which facilitates the preparation of flexible budgets.

Applications of Marginal Costing

To Check the Effect of Reducing of Current Price on profit

We all know, this is the time of competition, customer has become king. He wants product at
minimum price. One example, we can see free video on YouTube. Instead of buying costly CDs
and DVD, customers of entertainment industry see free films and movies on YouTube. But on
the other side, company wants to maintain his current profit. At that time, manager will be in
tension because it is not possible to maintain profit even after reducing price. But if manager
learns marginal costing techniques and uses it effective way, they can check the effect of
reducing of current price on net profit, after this, he can decide to reduce production or increase
production. It is the law of economics, variable cost will reduce by reducing units of production
in same proportion but when we increase production, fixed cost will fastly decreases due to
constant nature.
To Choose of Good Product Mix
It may be possible that company is producing more than one product, at that time company has to
calculate each product's contribution margin or gross profit margin. After this, manager see
which product is giving high contribution margin. Company manager will give preference to that
product whose contribution will high. One more decision can be taken by manger. He can check
contribution by producing different quantity of different products. If he see any quantity of
products is producing maximum contribution, it will be equilibrium point. Production of units at
that quantity will be benefited to company.
To Calculate of Margin of Safety
Marginal costing can be utilized for calculating margin of safety. Margin of safety is difference
between actual sale and sale at break even point. According to marginal costing rules, production
will follow sales. Suppose current sale is Rs. 4,00,000 and BEP is Rs. 3,00,000, margin of safety
is Rs.100000. We can calculate it with following formula

= Profit/ P/V ratio

If company's sale is less than margin of safety, then manager can take step to reduce both fixed
and variable cost or increase prices.

For Decision Regarding to sell goods at Different Prices to Different Customers

Sometime, company has to give special discount to special customers. These customers may be
govt, foreign companies or wholesaler. At that time manager has to take decision at what limit,
we can give discount to special customers. Marginal costing may help in this decision.

Q.13. What is “Marginal Costing”? Discuss its advantages and disadvantages.

Answer :

It is a costing technique based on the segregation of cost into fixed and variable. In this
technique, only variable manufacturing costs are considered while determining the cost of goods
sold and also for valuation of inventories. Fixed expenses are written off against the
‘contribution’ for that period. Contribution is the difference between the sales value and variable
cost. If the company is producing more than one product, the contribution from each product is
combined as a pool from which the total fixed cost is deducted to obtain the profit.
Definition:
According to ICMA London ³marginal cost is the amount for any given volume of output by
which aggregate costs are changed if the volume of output is increased or decreased by one unit´.
Marginal costing is the technique of applying the concept of marginal cost in decision making
process. Marginal costing is a technique that distinguishes between fixed and variable costs. The
marginal´ cost of a product is its variable cost.

Advantages and Disadvantages of Marginal Costing Technique

Advantages
1. Marginal costing is simple to understand.
 2. By not charging fixed overhead to cost of production, the effect of varying charges per
unit is avoided.
3. It prevents the illogical carry forward in stock valuation of some proportion of current
year’s fixed overhead.
4. The effects of alternative sales or production policies can be more readily available and
assessed, and decisions taken would yield the maximum return to business.
5. It eliminates large balances left in overhead control accounts which indicate the difficulty
of ascertaining an accurate overhead recovery rate.
6. Practical cost control is greatly facilitated. By avoiding arbitrary allocation of fixed
overhead, efforts can be concentrated on maintaining a uniform and consistent marginal
cost. It is useful to various levels of management.
7. It helps in short-term profit planning by breakeven and profitability analysis, both in
terms of quantity and graphs. Comparative profitability and performance between two or
more products and divisions can easily be assessed and brought to the notice of
management for decision making.

Disadvantages
1. The separation of costs into fixed and variable is difficult and sometimes gives
misleading results.
2. Normal costing systems also apply overhead under normal operating volume and this
shows that no advantage is gained by marginal costing.
3. Under marginal costing, stocks and work in progress are understated. The exclusion of
fixed costs from inventories affect profit, and true and fair view of financial affairs of an
organization may not be clearly transparent.
4. Volume variance in standard costing also discloses the effect of fluctuating output on
fixed overhead. Marginal cost data becomes unrealistic in case of highly fluctuating
levels of production, e.g., in case of seasonal factories.
5. Application of fixed overhead depends on estimates and not on the actuals and as such
there may be under or over absorption of the same.
6. Control affected by means of budgetary control is also accepted by many. In order to
know the net profit, we should not be satisfied with contribution and hence, fixed
overhead is also a valuable item. A system which ignores fixed costs is less effective
since a major portion of fixed cost is not taken care of under marginal costing.
7. In practice, sales price, fixed cost and variable cost per unit may vary. Thus, the
assumptions underlying the theory of marginal costing sometimes becomes unrealistic.
For long term profit planning, absorption costing is the only answer.

Q.14 Pass the following Journal entries in the Books of Madhura

June, 2012 1. Invested cash Rs. 1,00,000 into the business.

1. Sold goods worth Rs.12,00,000 at 5% trade discount to Radhika.
2. Borrowed Rs.2,00,000 from Amey.
3. Paid for stationery Rs.15,000.
4. Withdrawn cash for personal use Rs.5,000.
5. Purchased goods worth Rs.8,00,000 from Ram & Co,
6. Received commission Rs.18,000
7. Returned goods to Ram & Co. worth RS.20,000.
8. Paid cash Rs.78,000 to Sudhir in full-settlement of Rs. 80,000.
Answer:
Journal Entries
In the books of Madhura
Date Particulars L/F Debit Rs. Credit Rs.
June 2012
1. Cash A/C____Dr. 1,00,000
To Capital A/C 1,00,000
(Being business started)
2. Radhika’s A/C____Dr. 11,40,000
To Sales A/C 11,40,000
(Being goods sold on credit at 5% Trade
Discount)
3. Cash A/C_____Dr. 2,00,000
To Amey’s Loan A/C 2,00,000
(Being loan taken)
4. Stationery A/C__________Dr. 15,000
To Cash A/C 15,000
(Being stationery purchased)
5. Drawings A/C_______Dr. 5,000
To Cash A/C 5,000
(Being cash withdrawn for personal use)
6. Purchases A/C_______Dr. 8,00,000
To Ram & Co. A/C 8,00,000
(Being goods purchased on credit)
7. Cash A/C_______Dr. 18,000
To Commission A/C 18,000
(Being commission received)
8. Ram & Co. A/C_______Dr. 20,000
To Purchase Returns A/C 20,000
(Being purchased goods returned)
9. Sudhir’s A/C_________Dr. 80,000
To Cash A/C 78,000
To Discount A/C 2,000
(Being Sudhir paid in Full Settlement)
1,38,000 1,38,000

Q. 15 For production of 20,000 units the following are the budgeted expenses;

Per Unit (Rs.)

Direct Materials 500
Direct Labour 300
Variable Overheads 250
Fixed Overheads (Rs.20,00,000) 100
Variable Expenses (Direct) 80
Selling Expenses (10% Fixed) 200
Administrative Expenses (Rs.5,00,000 rigid 25
for all levels of production)
 Distribution Expenses (20% fixed) 150
Prepare a Flexible Budget for production of 22,000, 25,000 units showing distinctly marginal
cost and total cost.

Answer:
Flexible Budget

Particulars Per Unit Budget for Budget for

(Rs.) 22,000 units 25,000 units
Variable Costs
Direct Materials 500 1,10,00,000 1,25,00,000
Direct Labour 300 66,00,000 75,00,000
Variable Overheads 250 55,00,000 62,50,000
Variable Expenses (Direct) 80 17,60,000 20,00,000
Selling Expenses (90% Variable) 200 39,60,000 45,00,000
Distribution Expenses (80% Variable) 150 26,40,000 30,00,000
Total Marginal Cost 3,14,60,000 3,57,50,000
Fixed Costs
Fixed Overheads (Rs.20,00,000) 100 20,00,000 20,00,000
Administrative Expenses (Rs.5,00,000 25 5,00,000 5,00,000
rigid for all levels of production)
Selling Expenses (10% Fixed) 200 4,00,000 4,00,000
Distribution Expenses (20% fixed) 150 6,00,000 6,00,000
Total Fixed Cost 35,00,000 35,00,000
Total Costs

Q. 16 You are given the following data:-

Year Sales Profit
2012 12, 00,000 80,000
2013 14, 00,000 1,30,000
Find out – i) P/V Ratio ii) B.E. Point iii) Profit when Sales are Rs.18,00,000/-
iv) Sales are require to earn profit of Rs. 1, 20,000/- v) Margin of Safety in 2012.

Answer :-
Change in Profit
i. P/V Ratio = ----------------------- X 100
Change in Sales
1,30,000-80,000
= ------------------------- X 100
14,00,000 – 12,00,000
50,000
= ------------------- X 100
2,00,000

= 25%

ii. Fixed Costs = (Sales X P/V Ratio) – Profit

= (12,00,000 X 25%) – 80,000
 = 3,00,000 – 80,000
= 2,20,000

Fixed Costs
BEP = ----------------------
P/V Ratio
2,20,000
=-----------------
25%

= 8,80,000

iii. Profit when sales are Rs.18,00,000/-

Desired Profit = (Sales X P?V Ratio) – Fixed Costs

= (18,00,000 X 25% ) – 2,20,000
= 4,50,000 – 2,20,000
= 2,30,000/-

iv. Sales are require to earn profit of Rs. 1, 20,000/-

Fixed Cost + Profit

Desired Sales = ----------------------------------------
P/V Ratio
2,20,000 + 1,20,000
=----------------------------------
25%

3,40,000
=-----------------------
25%

= 13,60,000/-
v. Margin of Safety in 2012.

Margin of Safety = Sales – Sales at BEP

= 12,00,000 – 8,80,000
= 3,20,000

Q.17. The following information is given:

Standard hours per unit 15 hours
Standard rate Rs.4 per hour
Actual production 1000 units
Actual hours 15300 hours
Actual rate Rs.3.90 per hour
Idle time 200 hours
Calculate : a) Labour Cost Variance b) Labour Rate Variance c) Labour Efficiency Variance d)
Idle Time Variance
Answer :-

Standard For Actual Actual

Hours Rate Total Rate Total
15000 4 60000 15300 3.90 59670

200

i. Labour Cost Variance = Std. Cost for Actual Output – Actual Costs
= 60000 – 59,670
= 330 ( Favourable)

ii. Labour Rate Variance = (Std. Rate – Actual Rate) X Actual Hours
= (4 – 3.90) X 15300
= 1,530 (Favourable)

iii. Labour Efficiency Variance

= (Std. Hours for Actual Output – Actual Hours) X
Std. Rate
= (15000 – 15300) X 4
= 1,200 (Adverse)
Iv Idle Time Variance = Idle Hours X Std. Hourly Rate
= 200 X 4
= 800 (Adverse)
Q.18 What is “Budgetary Control”? Explain the objectives of Budgetary Control System.

Many people think of budgeting as something to do when they're short on cash. College students
might turn to a budget to figure out how to make due with their high expenses and limited
incomes. Wise new grads create budgets to make sure they're properly allocating their first
paychecks among emergency savings, retirement savings, student loan repayments, rent and
utilities, and rewards for their hard work like new gadgets and nights on the town. Young
couples trying to figure out how to afford a wedding, or newlyweds wondering how to fit the
expense of buying a house or having a child into their monthly cash flow, are also likely to make
budgets. Of course, budgets are commonly associated with people of all ages who are barely able
to make ends meet.

The truth is that budgeting isn't just for times when your money is tight or your life is undergoing
a major transition. Budgeting is for everyone, rich and poor alike. In fact, budgeting will be that
much easier in times of change if you do it all the time. Where do you think a Fortune 500
company like Amazon would be today without proper budgeting? What about wealthy people
like Warren Buffett? There's no way that he or his holding company, Berkshire Hathaway, could
have achieved such success without paying attention to their monthly, quarterly and annual cash
inflow and outflow. Budgeting won't just get you out of a rut - it can also help you get rich.

Definition of 'Budget’ and Budgeting:

A budget is a quantitative expression of a plan for a defined period of time. It may include
planned sales volumes and revenues, resource quantities, costs and expenses, assets, liabilities
and cash flows. It expresses strategic plans of business units, organizations, activities or events in
measurable terms.

An estimation of the revenue and expenses over a specified future period of time. A budget can
be made for a person, family, group of people, business, government, country, multinational
organization or just about anything else that makes and spends money.

A budget is a microeconomic concept that shows the tradeoff made when one good is exchanged
for another.

Budgeting for a business is a process. It is the process of preparing a detailed statement of

financial results that are expected for a given time period in the future. There are two keywords
in that statement. The first keyword is "expected." Expected means something that is likely to
happen. The second keyword is "future" which is a period in the time to come. So, budgeting is
the process of preparing a detailed statement of financial results that are likely to happen in a
period in a time to come.

Budgetary Control System :

Methodical control of an organization's operations through establishment of standards and targets

regarding income and expenditure, and a continuous monitoring and adjustment of performance
against them.

Objectives of Budgetary Control System:

The following are the objectives of Budgetary Control System;
1. Planning : A budget provides a detailed plan of action for a business over a definite period
of time. Detailed plans relating to production, sales, raw material requirements, labour needs,
advertising and sales promotion performance, research and development activities, capital
additions etc. are drawn up. By planning many problems are anticipated long before they
arise and solutions can be sought through careful study. Thus most business emergencies can
be avoided by planning. In brief, budgeting forces the management to think ahead, to
anticipate and prepare for the conditions.
2. Co-ordination: Budgeting aids managers in co-ordinating their efforts so that objectives of
the organization as a whole harmonise with the objectives of the divisions. Effective planning
and organization contributes a lot in achieving coordination. There should be co-ordination in
the budgets of various departments. For example, the budget of sales should be in co-
ordination the purchase budget. Similarly, production budget should be prepared in co-
ordination with the purchase budget and so on.
3. Communication: A budget is a communication device. The approved budget copies are
distributed to all management personnel which provides not only adequate understanding and
knowledge of the programmes and policies to be followed but also gives knowledge about
the restrictions to be adhered to. It is not the budget itself that facilitates communication, but
the vital information is communicated in the act of preparing budgets and participation of all
responsible individuals in this act.
4. Motivation: A budget is useful device for motivating managers to perform in line with the
company objectives. If individuals have actively participated in the preparation of budgets, it
acts as a strong motivating force to achieve the targets.
5. Control: Control is necessary to ensure that plans and objectives as laid down in the budgets
are being achieved. Control, as applied to budgeting, systematized effort to keep the
management informed of whether planned performance is being achieved or not. For this
 purpose, a comparison is made between plans and actual performance. The difference
between the two is reported to the management for taking corrective action.
6. Performance evaluation: A budget provides a useful means of informing managers how
well they are performing in meeting targets they have previously helped to set. In many
companies, there is a practice of rewarding employees on the basis of their achieving the
budget targets or promotion of a managers may be linked to his budget achievement record.

Q.19. What is “Budgeting?” Discuss the advantages and disadvantages of Budgetary

Control System.

A budget is a quantitative expression of a plan for a defined period of time. It may include
planned sales volumes and revenues, resource quantities, costs and expenses, assets, liabilities
and cash flows. It expresses strategic plans of business units, organizations, activities or events in
measurable terms.

An estimation of the revenue and expenses over a specified future period of time. A budget can
be made for a person, family, group of people, business, government, country, multinational
organization or just about anything else that makes and spends money.

A budget is a microeconomic concept that shows the tradeoff made when one good is exchanged
for another.

Budgeting for a business is a process. It is the process of preparing a detailed statement of

financial results that are expected for a given time period in the future. There are two keywords
in that statement. The first keyword is "expected." Expected means something that is likely to
happen. The second keyword is "future" which is a period in the time to come. So, budgeting is
the process of preparing a detailed statement of financial results that are likely to happen in a
period in a time to come.

Advantages:
1. Efficiency: Effective budgetary control system enables management of business concern
to conduct its business activities in very efficient manner.
2. Control of Expenses: It is powerful tool utilized by business houses for the control of
their expenses. It in fact provides yardstick and evaluates the performance of individuals
and their departments.
3. Finding deviations: It reveals deviations to management from the budgeted figures after
making a comparison with actual figures.
4. Effective utilization of resources: Effective utilization of various resources like men,
materials, machinery, money, matters and market- is made possible, as the production is
budgeted after taking them into consideration.
5. Revision of Plans: It helps in the review of current trends and framing of future policies.
6. Implementation of Standard Costing System: It creates suitable condition for the
implementation of in the business organization.
7. Cost Consciousness: Budgets are studied by outside fund providers also such as banking
and financial institutions, realizing that management encourages the cost consciousness
and maximum utilization of available resources.
 8. Credit Rating: Management which have deployed well-ordered budget plans and which
operates accordingly, receives greater credit from credit rating agencies.

Limitations of Budgetary Control

The list of advantages given in the previous chapter is impressive, but a budget is not a cure all
for organizational ills. Budgetary control system suffers from certain limitations and those using
the system should be fully aware of them.
1. The budget plan is based on estimates. Budgets are based on forecasts and forecasting
cannot be an exact science. Absolute accuracy, therefore, is riot possible in forecasting and
budgeting. The strength -or weakness of the budgetary control system depends to a large extent,
on the accuracy with which estimates are made. Thus, while using the system, the fact that
budget is based on estimates must be kept in view.
2. Danger of rigidity. A budget programme should be dynamic and continuously deal with the
changing business circumstances. Budgets will lose most of their usefulness if they obtain
rigidity and are not revised with the altering circumstances.
3. Budgeting is only an instrument of management. Budgeting cannot take the place of
management however only a device of management is. The budget needs to be regarded not like
a master, but as a servant. Occasionally it is believed that launch of a budget programme alone is
actually sufficient to ensure its good results. Execution of a budget will not take place
automatically. It is required that the entire organizational should participate enthusiastically in
the programme for that realization of the budgetary objectives.
4. Expensive technique. The operation and installation of a budgetary manage system is a costly
affair as it needs the employment of specialist staff and involves additional expenditure which
small concerns might find hard to incur. However, it is vital that the cost of introducing an
operating a budgetary control system must not exceed the rewards derived therefrom.

Q.20. State how the “Standard Costing” is useful technique to control the costs.

An estimated or predetermined cost of performing an operation or producing a good or service,

under normal conditions.

Standard costs are used as target costs (or basis for comparison with the actual costs), and are
developed from historical data analysis or from time and motion studies. They almost always
vary from actual costs, because every situation has its share of unpredictable factors. Also called
normal cost.

Concept and Meaning of Standard Costing

Historical costs are the actual costs that are ascertained after they are incurred. During the initial
stages of development of cost accounting, historical costing systems like process costing,
contract costing, service costing etc. were available for ascertaining the costs. The historical
costing methods are used to determine the cost incurred for the production of a particular
products or completion of a particular job.
The historical costing systems suffer from several limitations; some of them are as follows:
* No basis for cost control
* No yardstick for measuring efficiency
* Delay in availability of information
* Expensive
Although standard costing attempts to overcome the limitations of historical costing system, it is
not an alternative to the existing historical costing. Standard costing is the most widely used
technique of controlling costs.
Standard costing is a technique that establishes predetermined estimates of the cost of products
and services and compares these costs with the actual costs as they incur. Standard costing can
be considered as a yardstick to measure the efficiency with the actual cost incurred. Hence,
standard costing is system of costing which makes a comparison between the standard cost of
each product or service with its actual cost to determine the efficiency of the operation, with a
view to take corrective actions at the earliest possible time.
Thus, standard costing is the preparation and uses of standard costs, which involves the
following process:
* Establishment of standard costs
* Ascertainment of actual costs
* Comparison of the above two and measurement of variances
* Analysis of variances
* Reporting to responsibility centers to take appropriate and necessary remedial actions.

Applications of Standard Costing

Standard costing is a useful method of control in a number of ways.

First, the process of evaluating performance by determining how efficiently current operations
are being carried out may be facilitated by the process of management by exception. Very often
the problem facing management is the time lost in sifting large masses of feedback information
and in deciding what information is significant and relevant to the control problem. Management
by exception overcomes this problem by highlighting only the important control information that
is the variances between the standard set and the actual result. This process allows management
to focus attention on important problems so that maximum energy may be devoted to correcting
situations which are falling out of control.

Second, a standard costing system may lead to cost reductions. The installation of such a system
demands a re-appraisal of current production methods as it necessitates the standardization of
practices. This examination often leads to an improvement in the methods employed which is
reflected in a reduction of the costs of the product. One example of cost reductions through
increased efficiency may be seen in the simplication of the clerical procedures relating to
inventory control. All similar items of inventory may be recorded in the accounts at a uniform
price; this eliminates the need which arises under historical costing for re-calculating a new unit
price whenever a purchase of inventory is made at a different price.

Third, standard costs are used as a basis for determining selling prices. Standard costs represent
what the product should cost, and are a much better guide for pricing decisions than historical
costs which may contain purchasing and production inefficiencies which cannot be recouped in
competitive markets.

Finally, perhaps the most important benefit which may be derived from a standard costing
system is the atmosphere of cost consciousness which is fostered among executives and foremen.
Each individual is aware that the costs and output for which he is responsible are being
measured, and that he will be called on to take whatever action is necessary should large
variances occur. As we concluded earlier, if the philosophy of top management is positive and
supportive, standard costing may act as an incentive to individuals to act in the best interest of
the firm. Moreover, a standard costing system which allows subordinates to participate in setting
the standards fosters a knowledge of costing down to shop floor level, and assists in decision
making at all levels. Thus, if there should occur spoilt work necessitating a decision from the
foreman in charge on whether to scrap or rectify the part involved, a knowledge of costs will
enable him to make the best decision.

Q.21. Define “Standard Costing”. Discuss its advantages and disadvantages.

Historical costs are the actual costs that are ascertained after they are incurred. During the initial
stages of development of cost accounting, historical costing systems like process costing,
contract costing, service costing etc. were available for ascertaining the costs. The historical
costing methods are used to determine the cost incurred for the production of a particular
products or completion of a particular job.
Although standard costing attempts to overcome the limitations of historical costing system, it is
not an alternative to the existing historical costing. Standard costing is the most widely used
technique of controlling costs.
Standard costing is a technique that establishes predetermined estimates of the cost of products
and services and compares these costs with the actual costs as they incur. Standard costing can
be considered as a yardstick to measure the efficiency with the actual cost incurred. Hence,
standard costing is system of costing which makes a comparison between the standard cost of
each product or service with its actual cost to determine the efficiency of the operation, with a
view to take corrective actions at the earliest possible time.
Definition:
Standard costing is the practice of substituting an expected cost for an actual cost in the
accounting records, and then periodically recording variances that are the difference between the
expected and actual costs.

A management tool used to estimate the overall cost of production, assuming normal operations.

Advantages of Standard Costing

The following are the advantages of the standard costing system:
1. Management by Exception The standard costing is an example of management by exception.
By studying the variances, management’s attention is directed towards those items, which are not
proceeding according to the plan. Most of the management’s time is saved and can be directed to
other value adding activities. Management only concentrates on the ‘few’ exceptions reported.
2. Cost Reduction The process of setting, revising and monitoring standards encourages
reappraisal of methods, materials and techniques thus leading to cost reductions. Analysis of
unfavourable variances directs cost analysis to factors that are making costs to exceed the
budgeted costs thus these factors can be controlled, leading to cost reduction.
3. Reliable base of calculating total Pricing Standard costs serve as a reliable base of
calculating total cost of producing a good or service, to which a margin can be added to
determine the selling price.
4. Inventory Valuation Standard costing makes inventory valuation much easier, if the actual
number of physical units in the inventory is known, then the inventory value is simply
determined by multiplying the standard cot per unit by the physical units.
5. Motivation A properly developed standard costing system requires the full participation of all
management levels (upper, middle and lower levels) and the employees. This creates motivation
for the employees as they feel part of the system.
6. Cost Control A well implemented standard costing system acts as a yardstick against which
all costs are measured to determine whether the variance from the standard is favourable or
unfavourable. This creates cost consciousness in the organization and in the end enables the
organization to control costs.
7. Budgeting is made easier One of the greatest benefits of standard costing is to be found in
setting budgets for the organization and its departments. As earlier illustrated once the desired
output units are known, then the budgeted cost is simply the output units desired multiplied by
the standard cost per unit.

Disadvantages of Standard Costing

1. Expensive: The system of standard costing is expensive to install A lot of money is spent in
studying output requirements in terms of labour, materials and overheads.
2. Time Consuming A lot of time is also spent in developing and installing reliable standard
costing systems.
3. Obsolescence: In fast changing conditions (e.g. in hyperinflationary economies where prices
of labour, materials and overheads change rapidly), standards become out of date quickly. They
therefore lose their control and motivational effects.
4. Hard to Understand Some standard costing systems are overly elaborate and are therefore
not well understood by line managers and employees. This makes their implementation difficult.
5. Effectiveness depends on Environment For standard costing systems to be effective in cost
control and performance evaluation, then a participative and democratic management style is
required. The top management and employees need to be committed to attaining the set
standards of performance. An effective and efficient management information system is also
required so as to provide employees and managers with reliable, accurate and timely feedback
regarding their performance. Lack of one or more of these requirements frustrates the success of
a standard costing system so that its effectiveness cannot be realized.
6. It is Subjective As we have already seen, there are several types of standards that an
organization can adopt (basic, ideal, attainable and cement). What is therefore a standard in an
organization depends on its management. It is also important to note that what is referred to as a
significant variance depends on the organization’s management, thus the subjectivity. If this
subjectivity is poorly managed, (for example, punishing employees for insignificant
unfavourable variances of for variances arising from factors beyond their control), then a
standard costing system can lead to employee frustration and poor goal congruence in the
organization.

Q.22. Discuss the various types of Budgets in detail.

A budget is a quantitative expression of a plan for a defined period of time. It may include
planned sales volumes and revenues, resource quantities, costs and expenses, assets, liabilities
and cash flows. It expresses strategic plans of business units, organizations, activities or events in
measurable terms.
An estimation of the revenue and expenses over a specified future period of time. A budget can
be made for a person, family, group of people, business, government, country, multinational
organization or just about anything else that makes and spends money.

A budget is a microeconomic concept that shows the tradeoff made when one good is exchanged
for another.

Budgeting for a business is a process. It is the process of preparing a detailed statement of

financial results that are expected for a given time period in the future. There are two keywords
in that statement. The first keyword is "expected." Expected means something that is likely to
happen. The second keyword is "future" which is a period in the time to come. So, budgeting is
the process of preparing a detailed statement of financial results that are likely to happen in a
period in a time to come.

Types of Functional Budgets

Master Budget
A master budget is a comprehensive projection of how management expects to conduct all
aspects of business over the budget period, usually a fiscal year. The master budget summarizes
projected activity by way of a cash budget, budgeted income statement and budgeted balance
sheet. Most master budgets include interrelated budgets from the various departments. Managers
typically use these subset budgets to plan and set performance objectives. Master budgets are
generally used in larger businesses to keep many managers on the same page.
Capital Budgets
A capital budget estimates all capital asset acquisitions and summarizes all expenses and costs of
major purchases for the next year. Capital assets include items that have useful lives of more
than 12 months, such as buildings, building improvements, land, furniture, fixtures, equipment,
computers, musical instruments, works of art and books, writes David C. Maddox, the author of
the book “Budgeting for Not-for-Profit Organizations.” The main purpose of a capital budget is
to forecast costs of major capital purchases.
Operating Budgets
Operating budgets indicate the products and services a firm expects to use in a budget period. It
describes all the income-generating activities of a firm, including production, sales and
inventories of finished goods. An operating budget typically has two distinct parts: the expense
budget and the revenue budget. The expense budget indicates all expected expenses of a firm for
the coming year, while the revenue budget shows all projected revenues for the coming year.
Cash Budgets
A cash budget projects all cash inflows and outflows for the next year. Cash budgets have four
distinct elements: cash disbursements, cash receipts, net change in cash and new financing,
writes Arthur J. Keown in the book “Foundations of Finance.” A cash budget is important,
because it allows administrators to timely identify periods with cash overages and shortages so
they can take necessary remedial action.
Sales Budgets
Sales budgets indicate the sales a firm expects to make in units and dollars for a budget year.
They detail the quantities of products or services a firm expect to sell, revenues incurred from
those sales and all expenses accrued during selling. A sales budget is a planning instrument and a
control mechanism. Sales budget forecasts determine sales potential, or the maximum number of
sales a firm can make. This information is then used to plan resource allocations to achieve those
sales levels. Sales budgets serve as benchmarks or yardsticks against which actual sales
performance is measured and variables such as sales volume, profitability and selling expenses
are controlled.
Personnel Budgets
Personnel budgets, or salary and wage budgets, are cost estimations related to labor. They
forecast the costs of recruitment, hiring, training, assignment, salaries, overtime costs, additional
benefits and discharge. Calculating personnel budgets includes estimating the number of staff,
staffing ratios and overheads, write George M. Guess and Paul G. Farnham, the authors of the
book, “Cases in Public Policy Analysis.”

Q.23. What is a Cost Sheet? Give an example of cost sheet clearly indicating the headings
and the important items supplying imaginary figures.

A cost sheet is a report on which is accumulated all of the costs associated with a product or
production job. A cost sheet is used to compile the margin earned on a product or job, and can
form the basis for the setting of prices on similar products in the future.

A document that reflects the cost of the items and services required by a particular project or
department for the performance of its business purposes. For example, a departmental cost sheet
might include the material costs, labor costs and overhead costs incurred over a given time frame
by a department and it therefore provides a record of costs that are chargeable to that department.

Cost Sheet is a detailed statement of the elements of cost incurred in production, arranged in a
logical order under different heads such as materials, labor and overheads, prepared at short
intervals of time.

COST SHEET OF ZYX LTD.

For the financial year 2013-14

Particulars Amount Amount

Opening Stock of Raw Material 188000
Add: Purchase of Raw materials 832000
Add: Purchase Expenses 2000
1022000
Less: Closing stock of Raw Materials 200000
Raw Materials Consumed 822000
Direct Wages (Labour) 238000
Direct Charges 50000
Prime cost (1) 1110000
Add :- Factory Over Heads:
Factory Rent 10000
Factory Power 15000
Indirect Material 5000
Indirect Wages 35000
Supervisor Salary 20000
 Factory Insurance 1500
Factory Asset Depreciation 15000 101500
Works cost Incurred 1211500
Add: Opening Stock of WIP 120000
Less: Closing Stock of WIP 95000 25000
Works cost (2) 1236500
Add:- Administration Over Heads:-
Office Rent 12000
Asset Depreciation 15000
General Charges 8000
Audit Fees 12000
Bank Charges 900
Other Office Expenses 2000 49900
Cost of Production (3) 1286400
Add: Opening stock of Finished Goods 201000
Less: Closing stock of Finished Goods 165000 36000
Cost of Goods Sold 1322400
Add:- Selling and Distribution OH:-
Salesmen’s Commission 22000
Salesmen’s salary 15000
Traveling Expenses 7000
Advertisement 20000
Deliverymen’s expenses 5000
Sales Tax 8500 77500
Cost of Sales (5) 1399900
Profit (balancing figure) 100100
Sales 1500000

Q.24. What is Break-Even Analysis? Write assumptions and uses of Break-Even Analysis.

Break-even analysis is a supply-side analysis; that is, it only analyzes the costs of the sales. It
does not analyze how demand may be affected at different price levels. For example, if it costs
$50 to produce a widget, and there are fixed costs of $1,000, the break-even point for selling the
widgets would be:
If selling for $100: 20 Widgets (Calculated as 1000/(100-50)=20)
If selling for $200: 7 Widgets (Calculated as 1000/(200-50)=6.7)
An analysis to determine the point at which revenue received equals the costs associated with
receiving the revenue. Break-even analysis calculates what is known as a margin of safety, the
amount that revenues exceed the break-even point. This is the amount that revenues can fall
while still staying above the break-even point.
Break-even analysis is a technique widely used by production management and management
accountants. It is based on categorising production costs between those which are "variable"
(costs that change when the production output changes) and those that are "fixed" (costs not
directly related to the volume of production). Total variable and fixed costs are compared with
sales revenue in order to determine the level of sales volume, sales value or production at
which the business makes neither a profit nor a loss (the "break-even point").
The Break-Even Chart
In its simplest form, the break-even chart is a graphical representation of costs at various levels
of activity shown on the same chart as the variation of income (or sales, revenue) with the same
variation in activity. The point at which neither profit nor loss is made is known as the "break-
even point" and is represented on the chart below by the intersection of the two lines:

In the diagram above, the line OA represents the variation of income at varying levels of
production activity ("output"). OB represents the total fixed costs in the business. As output
increases, variable costs are incurred, meaning that total costs (fixed + variable) also increase. At
low levels of output, Costs are greater than Income. At the point of intersection, P, costs are
exactly equal to income, and hence neither profit nor loss is made.

Assumption of Break-Even Analysis :

1. It assumes that selling prices are constant no matter the level of output.
2. It assumes that all productions are sold without opening/closinginventories.
3. It assumes that fixed costs remain fixed at all levels of output.
4. It assumes that variable costs per unit remain the same no matter theoutput level.
5. It can only apply to single product or a single mix of products.

Uses of Break-Even Analysis :

1. Measure profits and losses at different levels of activity.

2. Predict the effect of changes in the prices of the products.
3. Analyze the relationship between fixed costs and variable costs.
4. Predict the effect on profitability of changes in cost and efficiency.

Q.25. Discuss in detail the various types of variances.

Standard Costing guides as a measuring rod to the management for determination of "Variances"
in order to evaluate the production performance. The term "Variances" may be defined as the
difference between Standard Cost and actual cost for each element of cost incurred during a
particular period. The term "Variance Analysis" may be defined as the process of analyzing
variance by subdividing the total variance in such a way that management can assign
responsibility for off-Standard Performance.
The variance may be favourable variance or unfavourable variance. When the actual
performance is better than the Standard, it resents "Favourable Variance." Similarly, where
actual performance is below the standard it is called as "Unfavourable Variance."
Variance analysis helps to fix the responsibility so that management can ascertain -
(a) The amount of the variance
(b) The reasons for the difference between the actual performance and budgeted performance
(c) The person responsible for poor performance
(d) Remedial actions to be taken
Variances are basically classified into following three categories :-
I. Direct Material Variance (DMV)
II. Direct Labour Variance (DLV)
III. Overhead Variance (OV)

I. Direct Material Variances

Direct Material Variances are also termed as Material Cost Variances. The Material Cost
Variance is the difference between the Standard cost of materials for the Actual Output and the
Actual Cost of materials used for producing actual output. If the actual costs is more than
standard cost the variance will be unfavourable or adverse variance and. on tile other hand. if the
actual cost is less than standard cost the variance will be favourabie variance. The material cost
variance is further classified into: (I) Material Price Variance (2) Material Usage Variance (3)
Material Mix Variance (4) Material Yield Variance
(1) Material Price Variance (MPV) : Material Price Variance is that portion of the Material
Cost Variance which is due to the difference between the Standard Price specified and the Actual
Price paid for purchase of materials. Material Price Variance may be calculated by
Material Price Variance = (Standard Price- Actual Price) x Actual Quantity
Note : If actual cost of materials used is more than the standard cost the variance is adverse. it
represents negative (-) symbol. And on the other hand. if the variance is favourable it is to be
represented by positive (+) symbol.

(2) Material Usage Variance (MUV): Material Usage Variance is that part of Material Cost
Variance which refers to the difference between the standard cost of standard quantity of
material for actual output and the Standard cost of the actual material used. Material Usage
Variance is calculated as follows:
Material Usage Variance = (Std. Qty. for Actual Output – Actual Qty.) x Std. Price
Note: This Variance will be favourable when standard cost of actual material is more than the
Standard material cost for actual output, and Vice Versa.

(3) Material Mix Variance (MMV) : It is the portion of the material usage variance which is
due to the difference between the Standard and the actual composition of mix. Material Mix
Variance is calculated under two situations as follows :
(a) When actual weight of mix is equal to standard weight to mix
(b) When actual weight of mix is different from the standard mix
(a) When Actual Weight and Standard Weight of Mix are equal.
(i) The formula is used to calculate the Variance:
Material Mix Variance = (Revised Std. Qty. – Actual Qty) x Std. Price
(4) Materials Yield Variance (MYV): It is the portion of Material Usage Variance. This
variance arises due to spoilage, low quality of materials and defective production planning etc.
Materials Yield Variance may be defined as "the difference between the Standard Yield
Specified and the Actual Yield Obtained." This variance may be calculated as under:
Material Yield Variance =
(Actual Yield – Std. Yield from actual input) x Std. Material cost per unit
The following equations may be used for verification of Material Cost Variances :
(1) Material Cost Variance
(2) Material Usage Variance
(3) Material Cost Variance
= Material Price Variance + Material Usage Variance = Material Mix Variance - Material Yield
Variance = Material Mix Variance + Material Yield Variance

II. Labour Variances

Labour Variances can be classified into:
(a) Labour Cost Variance (LCV)
(b) Labour Rate Variance or Wage Rate Variance
(c) Labour Efficiency Variance
(d) Labour Idle Time Variance
(e) Labour Mix Variance (0 Labour Revised Efficiency Variance
(g) Labour Yield Variance

(a) Labour Cost Variance (LCV): Labour Cost Variance is the difference between the Standard
Cost of labour allowed for the actual output achieved and the actual wages paid. It is also termed
as Direct Wage Variance or Wage Variance. Labour Cost Variance is calculated as follows:
Labour Cost Variance = Standard Cost of Labour - Actual Cost of Labour
Note: If actual labour cost is more than the standard labour cost, the variance represents negative
and vice versa.

(b) Labour Rate Variance: It is that part of labour cost variance which is due to the difference
between the standard rate specified and the actual rate paid. This variances arise from the
following reasons:
(a) Change in wage rate.
(b) Faulty recruitment.
(c) Payment of overtime.
(d) Employment of casual workers etc.
It is expressed as follows :
Labour Rate Variance = (Standard Rate- Actual Rate) x Actual Hours
Note: If the Standard rate is higher than the actual rate, the variance will be favourable and vice
versa.

(c) Labour Efficiency Variance: Labour Efficiency Variance otherwise known as Labour Time
Variance. It is that portion of the Labour Cost Variance which arises due to the difference
between standard labour hours specified and the actual labour hours spent. The usual reasons for
this variance are (a) poor supervision (b) poor working condition (c) increase in labour turnover
(d) defective materials. It may be calculated as following:
Note: If actual time taken is more than the specified standard time, the variance represents
unfavourable and vice versa.
(d) Labour Idle Time Variance: Labour Idle Time Variance arises due to abnormal situations
like strikes, lockout, breakdown of machinery etc. In other words, idle time occurs due to the
difference between the time for which workers are paid and that which they actually expend
upon production. It is calculated as follows :
Idle Time Variance = Idle Hours x Standard Rate

(e) Labour Mix Variance: It is otherwise known as Gang Composition Variance. This variance
arises due to the differences between the actual gang composition than the standard gang
composition. Labour Mix Variance is calculated in the same way of Materials Mix Variance.
This variance is calculated in two ways:
(i) When Standard Labour Mix is equal to Actual Labour Mix.
(ii) When Standard Labour mix is different from Actual Labour Mix.
(i) When Standard and actual times of the labour mix are same The formula for its computation
may be as follows :
Labour Mix Variance = { Standard Cost of Standard Labour Mix Standard Cost of } Actual
Labour Mix
(ii) When Standard and actual times of the labour mix are different : Changes in the composition
of a gang may arise due to shortage of a particular grade of labour. It may be calculated as
follows:
Labour Mix Variance ={Revised Standard Time -Actual Time } x Standard Rate

(I) Labour Yield Variance: 'This variance is calculated in the same way as Material Yield
Variance. Labour Yield Variance arises due to the variation in labour cost on account of increase
or decrease in yield or output as compared to relative standard. The formula for this purpose is as
follows:
Labour Yield Variance = (Actual Yield – Std. Yield from actual input) x Std. Labour cost per
unit
Note: If actual output is more than Standard output for actual time, the variance is favourable
and vice versa.
Verification: Labour Cost Variance = Labour Rate Variance + Labour Efficiency Variance

III. Overhead Variances

Overhead may be defined as the aggregate of indirect material cost, indirect labour cost and
indirect expenses. Overhead Variances may arise due to the difference between standard cost of
overhead for actual production and the actual overhead cost incurred.
Overhead Variances can be classified as :

a) Variable Overheads Variances

i) V. Overhead Cost Variance = (Std.Hrs.for Actual Output x Std.Overhead
Rate) – Actual Overheads
ii) V. Overhead Expenditure Variance = (Actual Hrs. X Std. Rate) – Actual Overheads.
iii) V. Overhead Efficiency Variance =(Std. hrs.for actual output – Actual hrs)
X Std. Overhead Rate.

b) Fixed Overheads Variances

i ) F. Overhead Cost Variance = (Std.Hrs.for Actual Output x Std.F.O.Rate) –
Actual Fixed Overheads
ii) F. Overhead Expenditure Variance = Budgeted F.O.- Actual F.Overheads.
iii) F. Overhead Volume Variance =(Std. hrs.for actual output – Budgeted hrs)
x Std. overhead Rate.