Вы находитесь на странице: 1из 147

Managerial Accounting and Control

If all the three Dimensions Fall?....


“What we see often?”
Under new chief financial officer Sanjay Baweja, Flipkart Ltd is slashing hiring in all
but two functions, increasingly outsourcing order deliveries to logistics companies,
improving its supply chain planning and boosting marketplace sales to bring the
company’s ballooning costs under control.
“As the industry matures we need to show the path to profitability,” Baweja said in
an interview. “We’re moving into a cost-containment mode where our fixed costs
will become smaller of the overall pie going forward. The aim is to make most of
our costs variable so that we spend only as per the volumes or sales we’re
generating. Hiring for our corporate functions will need to be much more
controlled. We’ll continue to hire aggressively in technology and logistics but we
don’t need to add people in functions such as HR (human resources), finance and
legal.”
Supply chain costs, primarily warehouse management and logistics, are one of
Flipkart’s largest expenses. The company has struggled to operate its large logistics
network, which includes more than 15,000 employees, in a cost-efficient manner,
partly because its focus was toward adding capacity to meet surging demand rather
than saving costs.
Asian Paints and high oil prices:
JP Morgan, December 4, 2014
Stock pick: Asian Paints to see significant rise in
margins on back of fall in crude prices, Nov 3, 2014,

Asian Paints India Ltd (APNT) is India’s largest paint manufacturer with a 52%
overall market share. Paint Industry being one of raw material intensive and the raw
material cost accounts for about 50-60% of the total cost of production.
Asian Paints will be a direct beneficiary of lower crude oil prices. Another key raw
material, Titanium Dioxide has also been down by around 13%. Some gains to be
offset by higher promotions/marketing investments. Possibility of some of the
benefits being passed on to consumers in the form of price cuts and higher brand
investments.
An increase in employment cost due to one-time spike in gratuity provisioning is yet
another reason for the margin contraction. We assume marginally negative pricing
growth and expecting no price increases. We also forecast higher brand investments
to push for volume growth.

Key upside risk to our EPS estimates is a more prolonged/severe reduction in crude
oil/titanium dioxide prices and higher volume growth rate Key downside risk is
increase in raw material costs, competitive spends and lower demand growth.
Classification of Costs

•Variable / Fixed costs

•Direct / Indirect costs

•Prime costs / Overheads

•Cost hierarchy (types of activities and


their associated costs)
6
Direct and Indirect costs
 Whether a cost is classified as direct or indirect depends on
the nature of the cost object.
 Manufacturing (service) costs that can be traced to product
in an economic manner are direct product,service costs
 Indirect costs are manufacturing costs that cannot be traced
to products in an economic manner. When the cost varies in
proportion to some activity that supports several products,
then the cost will be indirect to the individual products.
 When the cost object is a product (services), variable costs
can be direct or indirect. Fixed costs can also be direct or
indirect as well.
7
Variable and Fixed Costs
Relevant Range
Break-Even Chart: The Break-even point TR
occurs where total revenue equals total costs Profit
Costs/Revenue
TC

VC

BEP

FC

Loss Q-BEP Q-High Output/Sales


Margin of Safety
Marginal Cost and Marginal Costing
 Marginal Cost: The amount at any given volume of output by
which the aggregate costs are charged if the volume of output is
changed by one unit. May also be defined as the "cost of producing
one additional unit of product."

 Marginal Costing:
• Costs are separated into fixed and variable cost.
• It is a technique which provides presentation of cost data in such a
way that true cost-volume-profit relationship is revealed.
• variable costs are charged to the cost units and fixed costs of the
period are written off in full against the aggregate contribution. Its
special value is in decision-making
• Fixed cost is charged to contribution ( i.e., Sales – Variable Cost) of
the period in which it is incurred and is considered period cost.
Marginal Cost Equation

Sales = Variable Cost + Fixed Expenses ± Profit I Loss


Sales - Variable Cost = Fixed Cost ± Profit or Loss
Sales - Variable Cost = Contribution
Contribution = Fixed Cost + Profit

In order to earn profit the contribution must be more than fixed expenses.
To avoid any loss, the contribution must be equal to fixed cost.

Contribution refers to the difference between Sales and Marginal Cost of


Sales. Contribution enables to meet fixed costs and profit. Thus,
contribution will first covered fixed cost and then the balance amount is
added to Net profit. (Sales - Variable Cost = Fixed Cost + Profit)
Break-Even Analysis
 In order to calculate how profitable a product will be, we
must firstly look at the Costs involved -
There are two basic types of costs a company incurs.

• Variable Costs
• Fixed Costs

Variable costs are costs that change with changes in production


levels or sales. Examples include: Costs of materials used in the
production of the goods.

Fixed costs remain roughly the same regardless of sales/output


levels. Examples include: Rent
 Total Costs is simply Fixed Costs and Variable Costs added
together. As Total Costs include some of the Variable Costs then
Total Costs will also change with any changes in output/sales.
Break-Even Analysis
• Break-Even Analysis is also called Cost Volume Profit Analysis. The
term Break-Even Analysis is used to measure inter relationship
between costs, volume and profit at various level of activity.
• A concern is said to break-even when its total sales are equal to its
total costs. It is a point of no profit no loss. Break-Even Point (B.E.P)
is a point where contribution is equal to fixed cost.

Break-Even Point (in Units)


= Total Fixed Cost/ Contribution per unit
 Profit Volume Ratio (P/V ratio) or Contribution Margin Ratio
= Contribution/ Sales
Break-Even Point (in Sales)
= Total Fixed Cost/ PV Ratio or Contribution Margin Ratio
Sales required in units to maintain a desired profit
= (Total Fixed Cost + Desired Profit) / Contribution Margin Ratio
Manager’s Dilemma
• Manager’s cannot manage financial results: They can only manage the
activities that create those results.
• “Sometimes cost control requires the courage to experiment. Many
expenses exist in part because their existence benefits one part of an
organization and their removal benefits another.”
• “What gets measured gets improved.” Financial Results
Peter Drucker
• Cost
• Revenues
• Profits
• Sales Growth

Activities Causing Financial Results


Business Level Strategy • Developing products
and Value Proposition • Making products
• Price • Marketing Products
• Quality • Selling Products
• Functionality or Features • Servicing Products
• Service • Managing Business
• Managing Complete Value Chain
Time for CFOs to step up
• For most companies, shareholder value comes from internally generated growth,
through new products or services, new businesses or through cost/capital
efficiencies.

• Even the most sophisticated financial measures that aren’t adapted to your situation
will fail; a less sophisticated approach can create significant value if it is tailored to
your industry and your needs.
 Understand how your company creates value: understanding how your company
creates value isn’t conceptually difficult, but it does require a disciplined approach

Integrate financial and operational measures: seamlessly integrating financial


and nonfinancial measures to understand what drives financial results

Keep the measurement system transparent and uniform: Measuring financial


performance is an imprecise discipline, but any system should focus on the true
drivers of growth and return on investment.

Focus on the dialogue: The focus is not just on the measurement, but also on
control.
Financial v. Management Accounting

Financial Accounting Management Accounting


• Deals with reporting to parties • Deals with activities inside an
outside the organization organization
• Deals with the organization as • Deals within the different
a whole departments as well as with the
organization as a whole
• Highly regulated
• Unregulated
• Primarily uses historical data
• May use projections about the
• Money Measurement Concept future
• Time dimension and Report • Quantitative and qualitative
frequency information
• Requires details of expected
future costs and revenues and
may be prepared at daily,
weekly or monthly intervals.
18
Managing Complete Value Chain
Management Accounting
• The Institute of Management Accountants:
• A value-adding continuous improvement process of planning,
designing, measuring and operating both nonfinancial information
systems and financial information systems that guides management
action, motivates behavior, and supports and creates the cultural
values necessary to achieve an organization’s strategic, tactical and
operating objectives
Management Accounting Information

 Timely and accurate information about:


• Financial/ Nonfinancial Information • Supporting strategic (planning)
• Internal / External information • Operational efficiency
• Operational / Strategic information (operating)
• Control system (performance
evaluation)
• Key source of information for decision
• Management decision making
making, improvement, and control in
organizations
• Intended to meet specific decision- • Performance of the company
making needs at all levels in the • Creation of Shareholder Value
20
organization
What is management accounting?
The Evolution of Management Accounting

Stage

1990s Transformation

Transformation
1980s
Transformation

1950s
Transformation

1910s

Focus
Cost Information Reduction of Creation of Value
Determination for Waste of through Effective
and Financial Management Resources in Resource Use
Control Planning and Business
Control Processes
Cost Object
 A cost object is something for which we want to compute a
cost:
 A product, A product line, An organizational unit, service
rendered
 A cost object can be any unit of analysis including produc
product line, customer, department, division, geographica
area.
 Cost classification varies depending on the the chosen cos
object
Example - factory supervisor’s salary
• If the cost object is a product the factory supervisor’s salary is an indirec
cost
• If the factory is the cost object, the factory supervisor’s salary is a direct
cost
Plant Rent/
Lease Rentals
I F

Product Testing
Staff Salary
I F

Quality Control
Expenses
I V
Raw Material
Warehouse I V
Labour Expenses

Solid Raw
Materials D V

Liquid Raw
Materials D V

Ware House
Electricity
I V
Expenses
Cost Sheet
• It is a report on which is accumulated all of the costs associated
with a product or production job. A cost sheet is prepared to know
the outcome and breakup of costs for a particular product.
• 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.
• It can also be used as the basis for a variety of cost control
measures.

• There are three major components:


• Prime Cost
• Factory Cost
• Cost of Production
• Selling and Distribution Cost
• Total Cost
Specimen of Cost Sheet
Particulars Total Cost Cost per
unit
Direct Material … …
Direct Labor … …
Direct or Chargeable Expenses … …
Prime Cost … …
Add: Works Overhead or Factory … …
Overhead
Factory Cost/Works Cost … …
Add: Administrative Overheads … …
Cost of Production … …
Add: Selling and Distribution Expenses … …
Total Costs or Cost of Sales … …
Treatment of Stock
Cost Sheet Example
Cost Sheet Rs. Rs.
Direct Material 100000
Direct Labour 30000
Prime Cost 130000
Add: Factory Overheads
Wages 2500
Electric Power 500
Storekeeper's wages 1000
Oil and Wter 500
Factory rent 5000
Repairs and renewals-Factory 3500
Factory lighting 1500
Depreciation Factory plant 500
Consumable stores 2500
Total Factory Overheads 17500
Factory Cost 147500
Office rent 2500
Repairs and renewals-Office 500
Office lightenng 500
Depreciation-Office 1250
Manager's salary 5000
Director's fee 1250
Office stationary 500
Telephone charges 125
Postage and telegram 250
Total Administration Overhead 11875
Cost of Production 159375
Carriage outward 375
Sales Man's salary 1250
Travelling expenses 500
Advertising 1250
Warehouse Charges 500
Total Selling and distribution overhead 3875
Cost of Sale 163250
Add: Profit 26250
Sales 189500
Davey Brothers Watch Co.

 Decision dilemma in terms of the installation of photocopy


machine.
 Approximately 100 photocopy a day for 300 days a year.
 Refurbished machine worth Rs. 35,000 ( 10-15% loan finance)
 Photocopy paper 0.20 paisa, Power consumption 0.04 paisa
 Selling price Rs. 1 per copy ( expects competition and lowering the
price),
Other possible scope is to go for differential pricing.
 Monthly electricity is Rs. 250, Shop rent is Rs. 100 per month.
 Maintenance expenses for drum and film is Rs. 1400 (i.e., 1000 +
400),
 Machine maintenance is 1000.
 Foregone salary Rs. 30000
Cost Classification: Davey Brothers Watch Co.
Sr. Cost Amount Per Direct/In Actual/O Fixed/Vari Relevant/Irre
no. (Rs.) annum/u direct pportuni able/Semi levant
nit ty
1 Machine 7000 PA Indirect A F R
Dep.
2 Interest 3500 PA Indirect A F R
3 Shop Rent 1200 PA Indirect A F I
4 Shop 3000 PA Indirect A F I
Electricity (assumed)
5 Foregone 30000 PA ? O ? R/I?
Salary
6 Drum and 1400 PA Indirect A F R
Film
7 Maintenance 1000 PA Indirect A(budget F R
) (assumed)
8 Paper 0.20 Unit Direct A V R
9 Power 0.04 Unit Direct A V R
10 Toner 0.032 Unit Direct A V R
Different Approach for Costing

 Process Costing
 Joint Product and By Product
Costing
 Job Costing
Marginal Cost and Marginal Costing
 Marginal Cost: The amount at any given volume of output by
which the aggregate costs are charged if the volume of output is
changed by one unit. May also be defined as the "cost of producing
one additional unit of product."

 Marginal Costing:
• Costs are separated into fixed and variable cost.
• It is a technique which provides presentation of cost data in such a
way that true cost-volume-profit relationship is revealed.
• variable costs are charged to the cost units and fixed costs of the
period are written off in full against the aggregate contribution. Its
special value is in decision-making
• Fixed cost is charged to contribution ( i.e., Sales – Variable Cost) of
the period in which it is incurred and is considered period cost.
Marginal Cost Equation

Sales = Variable Cost + Fixed Expenses ± Profit I Loss


Sales - Variable Cost = Fixed Cost ± Profit or Loss
Sales - Variable Cost = Contribution
Contribution = Fixed Cost + Profit

In order to earn profit the contribution must be more than fixed expenses.
To avoid any loss, the contribution must be equal to fixed cost.

Contribution refers to the difference between Sales and Marginal Cost of


Sales. Contribution enables to meet fixed costs and profit. Thus,
contribution will first covered fixed cost and then the balance amount is
added to Net profit. (Sales - Variable Cost = Fixed Cost + Profit)
Break-Even Analysis
 In order to calculate how profitable a product will be, we
must firstly look at the Costs involved -
There are two basic types of costs a company incurs.

• Variable Costs
• Fixed Costs

Variable costs are costs that change with changes in production


levels or sales. Examples include: Costs of materials used in the
production of the goods.

Fixed costs remain roughly the same regardless of sales/output


levels. Examples include: Rent
 Total Costs is simply Fixed Costs and Variable Costs added
together. As Total Costs include some of the Variable Costs then
Total Costs will also change with any changes in output/sales.
Break-Even Analysis
• Break-Even Analysis is also called Cost Volume Profit Analysis. The
term Break-Even Analysis is used to measure inter relationship
between costs, volume and profit at various level of activity.
• A concern is said to break-even when its total sales are equal to its
total costs. It is a point of no profit no loss. Break-Even Point (B.E.P)
is a point where contribution is equal to fixed cost.

Break-Even Point (in Units)


= Total Fixed Cost/ Contribution per unit
 Profit Volume Ratio (P/V ratio) or Contribution Margin Ratio
= Contribution/ Sales
Break-Even Point (in Sales)
= Total Fixed Cost/ PV Ratio or Contribution Margin Ratio
Sales required in units to maintain a desired profit
= (Total Fixed Cost + Desired Profit) / Contribution Margin Ratio
Break-Even Chart: The Break-even point TR
occurs where total revenue equals total costs Profit
Costs/Revenue
TC

VC

BEP

FC

Loss Q-BEP Q-High Output/Sales


Margin of Safety
Shop Electricity Per month 250 250 250 250
Shop Rent Per month 100 100 100 100
Interest on Loan @10% Annual 3500 3500 3500 3500
Ravinder' Salary (Opportunity Cost) Monthly 2500 2500 2500 2500
Shop Electricity Per Year 3000 3000 3000 3000
Shop Rent Per Year 1200 1200 1200 1200
Ravinder' Salary Per Year 30000 30000 30000 30000
Break Even Point

Revenue / Price Per copy 1 0.75 0.6 0.5


Variable Cost Per Unit/Per Copy 0.272 0.272 0.272 0.272
Contribution Margin 0.728 0.478 0.328 0.228
Total Fixed Cost 9400 9400 9400 9400
Break Even Point 12912 19665 28659 41228
Projected Sales Unit 15000 22500 30000 37500
Margin of Safety 2088 2835 1341 -3728

Contribution Margin Ratio 0.73 0.64 0.55 0.46


Break Even Sales 12912 14749 17195 20614
Case Study: Bill French, Accountant
• The Duo-Products Corporation
• Bill French had done was to determine the level at which the company must operate
in order to break even.
• French reasoned that 37.5% of every sales dollar (Contribution: $1.20 - $0.75 = $
0.45 ) was left available to cover fixed costs. Thus, fixed costs of $520,000 require
sales of $1,386,667 ( i.e., Fixed cost/ contribution margin) in order to break even.

• Cooper (Production Control ): We’ll be pushing 90% of what we call capacity and
sales department’s guess that we’ll boost sales by 20%.
• Williams (Manufacturing):We’ve already got okays on investment money that will
boost your fixed costs by ten thousand dollars a month.
• Cooper (Production Control ): According to product lines, for last year makes it
pretty clear that the “average” is way out of line. How would the break-even point
look if we took this on an individual product basis?

• Bradshaw (Assistant Sales Manager) :The A line is really losing out and I imagine
that we’ll be lucky to hold two-thirds of the volume there next year. That’s not too
bad, though, because we expect that we should pick up the 200,000 that we lose,
and about a quarter-million units more, over in C production.
Case Study: Bill French, Accountant
• Winetki (General Sales Manager):I guess it was—up on C for next
year is on the basis of doubling the price with no change in cost.
We’ve been priced so low on this item that it’s been a crime—we’ve
got to raise, but good, for two reasons.

• Fraser (Administrative Assistant to President): Planning to paid


out dividends of $50,000 to the stockholders. Since we’ve got an
anniversary year coming up, we’d like to put out a special dividend of
about 50% extra. We ought to hold $25,000 in for the business, too.
This means that we’d like to hit $100,000 after the costs of being
governed.

• Arnie Winetki would like to see the influence of a price increase in


the C line, Fred Williams looks toward an increase in fixed
manufacturing costs of ten thousand a month, and Hugh Fraser has
suggested that we should consider taxes, dividends, expected union
demands, and the question of product emphasis.
Plant capacity 2,000,000 units
Past year's level of operations 1,500,000 units
Average unit selling price $1.20
Total fixed costs $520,000
Average variable unit cost $0.75
Exhibit 2 Product Class Cost Analysis (Normal Year)
Product Lines
Aggregate A B C
Sales at full capacity (units) 2,000,000
Actual sales volume (units) 1,500,000 600,000 400,000 500,000
Unit sales price ($) 1.20 1.67 1.50 0.40
Total sales revenue ($) 1,800,000 1,000,000 600,000 200,000
Variable cost per unit ($) 0.75 1.25 0.625 0.25
Total variable cost ($) 1,125,000 750,000 250,000 125,000
Fixed costs ($) 520,000 170,000 275,000 75,000
Net profit ($) 155,000 80,000 75,000 0

Ratios
Variable cost to sales .63 .75 .42 .63
Variable income to sales .37 .25 .58 .37
Utilization of capacity (%) 75.0 30.0 20.0 25.0
Product Class Cost Analysis (According to the new projections)
Product Lines
Aggregate A B C
Sales at full capacity(units) 2000000.00
Actual sales volume(units) 1750000.00 400000.00 400000.00 950000.00
Unit sales price($) 1.16 1.67 1.50 0.80
Total sales revenue($) 2028000.00 668000.00 600000.00 760000.00
Variable cost per unit($) 0.56 1.25 0.63 0.25
Total variable cost($) 987500.00 500000.00 250000.00 237500.00
Contribution Margin($) 1040500.00 168000.00 350000.00 522500.00
Fixed cost($) 640000.00 170000.00 275000.00 195000.00

Fixed cost (FC+50000 Assuming 200000


(dividend)+25000(50%extra- divided according to
dividend)+25000(retained- 840000.00 215714.29 320714.29 303571.43 the production ratio
earnings)+100000(government
taxes at 50%) )($)
Net profit($) 200500.00 -47714.29 29285.71 218928.57
Ratios
Variable cost to sales 0.49 0.75 0.42 0.31
Variable income to sales 0.51 0.25 0.58 0.69
Utilisation of capacity(%) 87.50 20.00 20.00 47.50
Break even unit 1412782.32 513605.44 366530.61 551948.05
Total no of units produced 950000
Sale price 0.8
Sale revenue 760000
Variable cost 0.275
Total Variable cost 261250
Contribution 498750
Fixed cost 303571
Investment the co. can afford 195179

The company can afford to invest $ 195179


Goals and objectives
 Activity Based Costing/Management (ABC/M) is a tool that helps to explore
opportunities for improving profitability of your company. Unlike traditional cost
analysis approaches, ABC/M provides more accurate cost information for each activity,
client/customer and product. Using activity-based approaches can help to overcome the
following business challenges:

• Improving sales strategy based on a profitability analysis of various cost objects (clients,
products, services, regions and sales channels)
• Planning and controlling how resources are used, identifying wasteful expenditure, and
exploring opportunities for cost reduction without affecting core operations
• Establishing the cost of internal functions and considering options for optimising them,
including centralisation or outsourcing.
Gujarat Gas Company Ltd.

Company History -

- The Company was incorporated on 17th January 1980

1993

- The Company has introduced two major systems of Cost


Planning and Control viz. Budgetory Control System and
Activity Based Costing System.
Today’s businesses are working in an
increasingly complex environment.

Use of Advanced Technology

Product Life Cycle

Product Complexity
Channels of Distribution
Quality Requirements
Product Diversity
Activity-Based Costing

 Traditional allocation method

Costs Products

 Activity-based allocation method

Costs Activities Products

First stage Second stage

50
Introduction to ABC

• Identifies activities required to produce the product


or service
• Determines the cost of the activities
• Allocates costs to the cost object based on
the object’s consumption of activities
ABC Definitions

 Activity based costing is an approach for


allocating overhead costs.
 An activity is an event that incurs costs.
 A cost driver is any factor or activity that has a direct
cause and effect relationship with the resources
consumed.
 Activity Cost Driver Rate = Total Activity Cost/ Activity Cost
Driver
Classic Pen Company: Developing an ABC Model
• To move ahead with the traditional pens or with specialized red
and purple pens.
• Cost overrun has made the profitability in recent years to decline
• What is the future features for red and purple pens
• Whether to go ABC or not.
Blue Pens Black Pens Red Pens Purple Pens Total
Sales 75,000 60,000 13,950 1,650 1,50,600

Material Cost 25,000 20,000 4,680 550 50,230


Direct Labour 10,000 8,000 1,800 200 20,000

Overheads:
40% fringe on Direct Labour 4000 3200 720 80 8000
Production Run Cost 7,333 7,333 5,573 1,760 22,000
Set up 4,259 1,065 4,855 1,022 11,200
Parts admin 1,200 1,200 1,200 1,200 4,800
Run Machine Support 7,000 5,600 1,260 140 14,000
Total Cost 58,792 46,398 20,088 4,952 1,30,230

Income 16,208 13,602 -6,138 -3,302 20,370


Return on Sales 21.61% 22.67% -44.00% -200.12% 13.53%
Exhibit 1 Wilkerson Company: Operating Results (March 2000)

Sales $21,52,500 100%


Direct Labor Expense 2,71,250
Direct Materials Expense 4,58,000
Manufacturing overhead
Machine-related expenses $3,36,000
Setup labor 40,000
Receiving and production control 1,80,000
Engineering 1,00,000
Packaging and shipping 1,50,000
Total Manufacturing Overhead 8,06,000
Gross Margin $6,17,250 29%
General, Selling & Admin. Expense 5,59,650
Operating Income (pre-tax) $57,600 3%
Resource
Wilkerson ABC Product Flow Unused Resource Cost Driver
Valves Pumps
Costs at Capacity Controllers Capacity Expenses Rate
Production 7,500 12,500 4,000

DL Expenses 75,000 1,56,250 40,000 2,71,250


Material Expenses 1,20,000 2,50,000 88,000 4,58,000
Manufacturing
Overhead
Machine Expenses 1,05,000 1,75,000 33,600 22,400 3,36,000 28
Setup Labor 2,222 11,111 22,222 4,444 40,000 222
Receiving and
10,000 50,000 1,00,000 20,000 1,80,000 1,000
Production Control
Engineering 20,000 30,000 50,000 - 1,00,000 80
Package & Ship 3,750 26,250 82,500 37,500 1,50,000 375
ABC Manufacturing
$140,972 $292,361 $288,322 $84,344 $806,000
Overhead
Total Costs $335,972 $698,611 $416,322 $84,344 $1,535,250
Exhibit 1 Dakota Office Products: Income Statement CY2000

Sales 4,25,00,000 121.4%

Cost of Items Purchased 3,50,00,000 100.0%

Gross margin 75,00,000 21.4%


Warehouse Personnel Expense 24,00,000
24,00,000 6.9%
Warehouse Expenses (excluding 20,00,000
20,00,000 5.7%
personnel)
Freight 4,50,000
4,50,000 1.3%
Delivery Truck Expenses 2,00,000
2,00,000 0.6%
Order entry expenses 8,00,000
8,00,000 2.3%
General and selling expenses 20,00,000 5.7%
Interest expense 1,20,000 0.3%
Net Income Before Taxes -4,70,000 -1.3%

Operating Costs
58,50,000
Customer A Customer B
Sales 1,03,000 1,04,000
Cost of Items 85,000 85,000
Purchased
Gross margin 18,000 19,000
Number of cartons 200 10400 200 10400
Number of cartons
shipped, commercial
freight 200 1200 150 900
Number of Dextop
Deliveries 25 5500
Number of orders
mannual 6 60 100 1000
Number of line items,
mannual order 60 240 180 720
Number of EDI Orders 6 30
Average Accounts
Receivables $9000 900 $30000 3000
12830 21520
Customer contribution 5,170 -2,520
• Kronecker Company, a growing mail order clothing and accessory
company, is concerned about its growing marketing, distribution, selling
and administration expenses.
• It therefore examined its customer ordering patterns for the past year and
identified four different types of customers, as illustrated in the following
table.
• Kronecker sends catalogs and flyers to all its customers several times a
year. Orders are taken by mail or over the phone by the toll free number.
Kronecker prides it self on the personal attention it provides shoppers
who order over the phone.
• All purchases are paid for by check or credit card. It also maintains a
very generous return policy if customers are not satisfied with the
product. Customers must pay return shipping charges, but their purchase
price is then fully refunded.
Customer 1 Customer 2 Customer 3 Customer 4

Initial Sales Rs. 1000 Rs. 1000 Rs. 2,500 Rs. 3,000

Number of items returned 0 4 2 24

Dollar value of items returned 0 Rs. 200 Rs. 500 Rs. 1,500

Number of orders per year 1 6 4 12

Number of phone orders per year 1 0 0 12

Time spent on phone placing orders 0.25 hour 0 0 1 hour

Number of overnight delivery 1 0 0 12

Number of regular delivery 0 6 4 0

Activity Activity Cost Driver


Prices are set so that cost of goods sold is Rate (Rs.)
on average about 75% of the sales price. Process mail orders 5
Customers pay actual shipping charges, but Process phone orders 80
extra processing is required for overnight Process returns 5
delivery. The company has developed the
Process over night delivery request 4
following activity cost driver rates for its
support costs. What advice will you give to Maintain customer relations 50

the company.
Customer 1 Customer 2 Customer 3 Customer-4

Sales $1,000 $1,000 $2,500 $3,000


Less returns 0 200 500 1,500
Net sales $1,000 $800 $2,000 $1,500

Cost of goods sold,


75% of sales 750 600 1,500 1,125

Processing mail orders, Customer 4


$5 per nonphone order 0 30 20 0 is the
most
Process phone orders,
20 0 0 80 expensive
$80 per hour

Process returns,
$5 per item returned 0 20 10 120 Customer 1 is fairly
low-cost to serve
Process overnight
4 0 0 48
delivery requests,
$4 per request
50 50 50 50
Maintain customer
relations

Profit $176 $100 $420 $


7
7
Profit  Sales 0.18 0.10 0.17 0.0
3
11
Management Accounting and
Control
Session-7
Process costing
 Process costing is a method of costing used mainly in manufacturing
where units are continuously mass-produced through one or more
processes.

 In process costing, it is the process that is costed (unlike job costing


where each job is costed separately). The method used is to take the total
cost of the process and average it over the units of production.

 Process costing is adopted when there is mass production through a


sequence of several processes. Example include chemical, flour and glass
manufacturing
Direct material
Direct labour
overheads Process 1

Direct material
Direct labour Process 2
overheads

Direct material Process 3


Direct labour
overheads
Finished goods Cost of goods sold

64
Process Cost Systems
 In a process cost system, costs are tracked through a series of connected
manufacturing processes or departments; used for large volume production of
uniform products
 An accounting system used to apply costs:
• To similar products
• That are mass-produced
• In a continuous fashion
• Manufacturing process can be clearly segregated in to clearly identifiable
processes or departments.

 Process costing is appropriate for industries: chemicals, food processing,


breweries, petroleum refining, metal manufacturing, steel making, paper
industry etc.
 Process costing assumes a sequential flow of costs from one process to
another as units of output passes through a specified production process.
Process Cost Accounting System
Accounting for Process Costing
• Costs are accumulated by each process
• Each process maintains its process account
• The process account is debited with the costs incurred and
credited with goods completed and transferred to other process
account
• When the goods are completed, they will be transferred to
finished goods account
• When the goods are sold, the amount will be transferred to the
cost of goods sold account

70
Process A Process B

Material 500 Process B 800 Process A800 Process C 1100


Labour 100 Material 50
Overhead200 Labour 150
Overhead100
800 800
1100 1100

Process C Finished Goods

Process B 1100 Finished Gds 1500 Process C 1500 Cost of GDs Sold 1300
Material 80
Labour 110 Bal c/d 200
Overhead 210
1500 1500 1500
1500

71
Joint-Cost Basics

Split-off point
Joint costs are costs
Incurred in
Raw milk producing the raw milk

Separable costs are costs


Cream Liquid Skim incurred in producing these
separately identifiable products
Lilac Flour Meal
 Processed Wheat to produce White flour (60%), Suji (10%), Wholemeal Flour (10%) and
Bran (20%)
 The purchase price of wheat and operating cost up to the point of separation of end
products were treated as Joint Costs.
 Packing, Selling and distribution cost incurred after the sieving stage was identified with
individual products and treated as Separable costs.

 At Present: The average unit cost for each product Joint Costs 1665000

was arrived at by dividing the total joint costs by the Seperable Costs 55620

combined output of the four products.


Total 17,20,620
Profit 21,780
Profit margin 1.266%
Monthly Wheat Input = 900 tons
Joint Cost
allocated Profit
on the Joint Cost Separable Sales Profit (Loss) for
Production Production Total Cost Per
Product basis of Per Ton Costs per Price per (Loss) per Total
in % in tons Ton (Rs.)
production (Rs.) Ton (Rs.) Ton (Rs.) ton (Rs.) Output
quantities (Rs.)
(Rs.)
White flour 60 540 999000 1850 78 1928 2100 172 92880
Suji 10 90 166500 1850 84 1934 2480 546 49140
Wholemeal flour 10 90 166500 1850 34 1884 2000 116 10440
Bran 20 180 333000 1850 16 1866 1140 -726 -130680
900 16,65,000 1850 21780
Product Production Production Sales Value Total Sales % of Total Joint Cost Allocated Separable Total Cost Profit Profit (Loss)
in % in tons Per ton Value (Rs.) Sales allocated on the Cost Per Costs per Per Ton (Loss) per for Total
(Rs.) Value basis of Sales ton Ton (Rs.) ton (Rs.) Output (Rs.)
White flour 60 540 2100 1134000 65.08 Value 1083780 2007 78 2005 15 8100
Suji 10 90 2480 223200 12.81 213300 2370 84 2454 26 2340
Wholemeal flour 10 90 2000 180000 10.33 172260 1914 34 1948 52 4680
Bran 20 180 1140 205200 11.78 195660 1087 16 1103 37 6660
900 1742400 100.00 1665000 21780
Methods of allocating the Joint Cost
1. Net Realisable Value Method
2. Relative Sales Value Method
3. Physical Unit Method
4. Weighted Average Method
5. Profit Method
Net Realisable Value (NRV) Method
• It is based on the assumption that the processing costs incurred
subsequent to the split-off point contribute nothing to profit i.e., the
increase in the products sales value is equal to the separable costs.
Joint Costs 1665000
White flour Suji WholeMeal Bran Total
Selling Price per ton (Rs.) 2100 2480 2000 1140
Prodn in tons 540 90 90 180
Sales Value (Rs.) 1134000 223200 180000 205200 1742400

Seperable Cost per ton (Rs.) 78 84 34 16


Total Separable Cost 42120 7560 3060 2880

NRV (Sales- Separable costs) 1091880 215640 176940 202320 1686780


NRV weight 0.65 0.13 0.10 0.12
Jt Cost Allocation (NRV Approach) 1077781 212856 174655 199708
Per Ton Joint Cost 1996 2365 1941 1109
Relative Sales Value Method
• As per this method the joint cost is allocated on the basis of the market
value of the products manufactured.
• Assumption is: if a product is having higher sales price it costs more to
produce and hence market value is the basis to allocate joint cost.
Joint Costs 1665000 White flour Suji WholeMeal Bran Total
Selling Price per ton (Rs.) 2100 2480 2000 1140
Prodn in tons 540 90 90 180
Sales Value (Rs.) 1134000 223200 180000 205200 1742400
Sales weight 0.65 0.13 0.10 0.12
Jt Cost on Sales Value (SalesValueWt X Jt Cost) 1083626 213285 172004 196085
Per Ton Cost 2007 2370 1911 1089
Physical Unit Method
• On the basis of units manufactured

Joint Costs 1665000


White flour Suji WholeMeal Bran Total
Prodn in tons 540 90 90 180 900
Physical Unit Method
Output Proportion 0.6 0.1 0.1 0.2
Joint Cost on PU 999000 166500 166500 333000
Per Ton Jt Cost 1850 1850 1850 1850
Weighted Average Method
• When Products are heterogeneous, the weighted average approach can be used.
• This method by logic superior to the physical unit method as it assigns weight to
each individual product and thus recognises the unique importance of each product.
• The weight factor may be the time required to process the units, the production
procedure, Sale price, Amount of prime cost ( direct labour and direct material ) used
for each product etc.
Joint Costs 1665000 Assuming Each Product is unique
White flour Suji WholeMeal Bran Total
Prodn in tons 540 90 90 180 900
Weighted Average Method
Wheat Consumption weight 4 3 2 1
Weighted Output 2160 270 180 180 2790
Ratio 0.77 0.10 0.06 0.06
Joint Cost (Weighted Average) 1289032 161129 107419 107419 1665000
Profit Margin Method
• This method is based on the assumption that profits are earned on the
total cost incurred and not on the joint cost only.
White flour Suji WholeMeal Bran Total
Selling Price per ton (Rs.) 2100 2480 2000 1140
Prodn in tons 540 90 90 180
Sales Value (Rs.) 1134000 223200 180000 205200 1742400
Sales weight 0.65 0.13 0.10 0.12
Jt Cost on Sales Value (SalesValueWt X Jt Cost) 1083626 213285 172004 196085
Per Ton Cost 2007 2370 1911 1089
Seperable Cost per ton (Rs.) 78 84 34 16
Total Separable Cost 42120 7560 3060 2880 55620
Joint Cost 1665000
Total Cost 1720620
Profit 21780
Profit Margin 1.25
Profit Margin (Selling price x profit margin) 26.25 31 25 14.25
Production Cost (Selling Price- Profit) 2074 2449 1975 1126
Joint Cost allocated/ton (Prod Cost - Seperable
Cost) 1996 2365 1941 1110
MMC manufactures memory modules in two step process. Chip fabrication
and module assembly. In chip fabrication, each batch of raw silicon wafers
yields 500 standard chips and 500 deluxe chips. Chips are classified as
standard and deluxe on the basis of their density ( number of memory bits
on each chip). Standard chips have 500 memory bits per chip and deluxe
chips have 1000 memory bits per chip. Joint costs to process each batch are
$24000.
In module assembly each batch of standard chips is converted in to standard
memory modules at a separately identified cost of $1000 and then sold for
$8500. Each batch of deluxe chips is converted into deluxe memory
modules at a separately identified cost of $1500 and then sold for $25000.
Q1. Allocate joint costs of each batch.
Q2. Which method should MMC use?
Q3. MMC can further process each batch to 500 standard memory modules to yield
400 DRAM. The selling price per DRAM product will be $26. products at an
additional costs of $1600
Net Realizable Value Standard Delux Total
Step I Units Price Value Units Price Value
Sale Value Given 500 $8,500 $42,50,000 500 $25,000 $125,00,000 $167,50,000
Memory Bits per chip Given 500 1000
Step 2
Sperable Cost Given $1,000 $5,00,000 $1,500 $7,50,000
NRV at Split Off Pt $7,500 $37,50,000 $23,500 $117,50,000 $155,00,000
Total NRV of Both
products at Spilt off Pt $31,000
Joint Cost Given $24,000

Weightege 24% 76%


Joint Cost allocated $5,806 $18,194
Unit Jt Cost $11.6 $18.2
Total Cost per Chip $6,806 $19,694
Net Realizable Value Standard Delux Total
Step I
Physical Unit Method Units Price Value Units Price Value
Sale Value Given 500 $8,500 $42,50,000 500 $25,000 $125,00,000 $167,50,0
Memory Bits per chip Given 500 1000
Physical Meausres of Total Production 500 1000
Step 2
Weightage
Sperable Cost Given 33%
$1,000 $5,00,000 $1,500 67%
$7,50,000
Joint
NRV CostOff
at Split Alloted
Pt $8,000
$7,500 $37,50,000 $16,000 $155,00,0
$23,500 $117,50,000
Total
Total NRVCost
of Both $9,000 $17,500
Unit Jtatcost
products Spilt off Pt divide/no of units $16.0 $16.0 $31,0
Joint Cost Given $24,0
Sales Value Method
Standard Delux
Sales Value $42,50,000 $125,00,000
Sales Value Proportion 25.4% 74.6%
Joint Cost Allocaiton $6,089.55 $17,910.45
Seperable Cost $1,000 $1,500
Total Cost $7,089.55 $19,410.45
Jt Cost per unit $12.18 $17.91
Relevant Cost and Decision Making

• A relevant cost is a cost that differs between alternatives.


• Relevant cost, in cost accounting, refers to the incremental and avoidable
cost of implementing a business decision. An avoidable cost can be
eliminated in whole or in part, by choosing one alternative over another.
• Avoidable costs are relevant costs. Unavoidable costs are irrelevant costs.
Relevant costs are also known as differential, or incremental costs.
• When making a particular decision-relevant costs are those that may
change, depending on the decision taken. Therefore, any increase or
decrease in future cash flows as a result of a decision is an indication of
relevant cost.
Relevant Costs for Decision Making

• Relevant Costs for Decision Making: Following alternative decision areas


can be explored further in the context of Relevant Costing.
1. Make or buy decision/ To produce or to purchase?
2. Drop or retain a segment.
3. Utilization of constrained resources.
4. Special order.
There are special decisions where relevant costs and benefits are to
identified before proceeding further. Such decisions are: Accept or reject
an order when there is excess capacity, Accepting or reject another when
there is no excess capacity, Outsource a product or service, Add, drop a
product, service or department, Sell or process further, Optimization of
limited resources or working under constraint
Hospital Supply Inc
Hospital Supply Inc
Identification of Problems
• Will it be beneficial for the company if ever they accept federal
Govt.’s offer to supply 500 units of hydraulic hoists?
• If ever company decides to enter the foreign market, will the
company benefited for it?
• Is it acceptable and beneficial if company disposed their unsold
inventory at a lower price?
• Will they accept contractor’s offer to produce their product and
reduce manufacturing cost without considering its impact on its
own plant output?
Question 3 Recommendation: Don't accept contract

Government revenue = (500 * $1,795) +.125 ($1,980,000) + $275,000 = $1,420,000,


assuming the government's "share" of March fixed manufacturing costs is .125 (500/4,000).
Question 6 All Production 1,000 Units
In-house Contracted
Total revenue $13,050,000 $13,050,000
Total variable manufacturing costs (5,385,000)
$3,590,000
Total variable marketing costs (825,000) $770,000
Total contribution margin 6,840,000
8,690,000
Total fixed manufacturing costs (1,980,000) 1,386,000
Total fixed marketing costs 2,310,000 2,310,000
Payment to contractor --
2,444,000
Income $ 2,550,000 2,550,000

$4,994,000 - X = $2,550,000
X = $2,444,000 or $2,444 per unit
maximum purchase price
All Production Contract 1,000 Regular Hoists and
Question 7 In-house Produce 800 Modified Hoists
Regular (In) Regular (Out) Modified Total
Total revenue $13,050,000 $8,700,000 $4,350,000 $3,960,000 $17,010,000
Total variable (5,385,000)
manufacturing (3,590,000) (2,420,000) (6,010,000)
costs
Total variable (825,000)
marketing costs (550,000 (220,000 (440,000) (1,210,000)
Total 6,840,000 ) )
4,560,000 4,130,000 1,100,000 9,790,000
contribution
margin
Fixed (1,980,000) (1,980,000)
manufacturing
Fixed 2,310,000 (2,310,000)
marketing $2,950,000
Contractor --
Income $ 2,550,000 $ 2,550,000
Example: ILAB manufactures design tables. ILAB has a policy of adding a 20% markup to
full costs and currently has excess capacity. Assume the cost driver for variable and fixed
manufacturing overhead costs is the number of output units. The following information
pertains to the company's normal operations per month:

Output units = 30,000 tables


Machine-hours = 8,000 hours
Direct manufacturing labor-hours =10,000 hours
Direct materials per unit = Rs. 50
Direct manufacturing labor per hour = Rs. 6
Variable manufacturing overhead cos = Rs. 161,250 per month
Fixed manufacturing overhead costs = Rs. 600,000 per month
Product and process design costs = Rs. 450,000 per month
Marketing and distribution costs = Rs. 562,500 per month
ILAB is approached by an overseas customer to fill a one-time-only special order for 2,000 units. All
cost relationships remain the same except for a one-time setup charge of Rs. 20,000. No additional
design, marketing, or distribution costs will be incurred. What is the minimum acceptable bid per unit
on this one-time-only special order? For long-run pricing of the coffee tables, what price will most
likely be used by the company?
Rs.
Direct materials Rs. 50.00
Direct manufacturing labor (Rs.6 x 10,000) / 30,000 2
Variable manufacturing (Rs.161,250 / 30,000) 5.375
Setup (Rs. 20,000 / 2,000) 10
Minimum acceptable bid Rs. 67.38

Direct materials 50.00


Direct manufacturing labor ($6 x 10,000)/30,000 2
Variable manufacturing ($161,250/30,000) 5.375
Fixed manufacturing ($600,000/30,000) 20
Product and process design costs ($450,000/30,000) 15
Marketing and distribution ($562,500/30,000) 18.75
Full cost per unit 111.125
Markup (20%) 22.225
Estimated selling price 133.35
Target Costing
• Target Costing is defined as a cost management tool for reducing
the overall cost of a product over its entire life-cycle with the help
of production, engineering, research and design.

• To identify the cost at which the product must be manufactured if


it's to earn its target profit margin at its expected or target selling
price. A target cost is the maximum amount of cost that can be
incurred on a product. Selling price – desired profit = target cost.

• “The target costing process is a system of profit planning and cost


management that is price led, customer focused, design centered
and cross functional. Target costing initiates cost management at the
earliest stages of product development and applies it throughout the
product life cycle by actively involving the entire value chain.”
TARGET-COSTING PRINCIPLES

1. Price-led costing.
Why do Target Costing?
2. Focus on customers.
3. Focus on design. • Improve profit, market or
cost position.
4. Cross-functional involvement. • Produce the right product
5. Value-chain involvement. at the right time for the
right price.
6. A life-cycle orientation..
What do competitors offer?
What do they want?
How much will they pay for it
Can we make a profit on it?
Market research. Who is the
target market?

A strategic profit and cost management process


Target Costing Process Overview
Target Establishment
Approaches to target costing
• Price-based targeting: Sets target cost for the product through
comparison with that of competitors. This means setting the price
of the product by observing what the market will bear.
• Cost-based targeting: It sets the cost 1st, then the desired profit
margin is derived at the price of the product. Focus on suppliers.

• Value-based targeting: It sets the price by what it thinks the market


will ‘value’ the product . After that, the producer sets the desired
profit margin and then tries all ways to keep the cost below that of
the target cost. Focus on customers.
Benefits
• Delivering the optimal value proposition to end customers.
• Minimizing product-line complexity.
• Selecting appropriate product and process technologies.
• Lowering product design late in the innovation process.
• Eliminating cost overruns.

Limitations
• The stress on the design team of companies using target costing
might be a disadvantage to the company.
• Product development time might be lengthen as product is repeatedly
designed to bring cost below that of target.
Kaizen Costing

• Continuous, incremental improvement of an activity to create more value


with less waste. A process of continually making incremental, ongoing
changes
• Form of continuous improvement Process: Cost reduction goal is
established, Actual costs are compared to goal, Actual cost achieved by
year end becomes the base for next year’s reduction target
• Ongoing improvement involves everyone: Top management, Managers,
Workers. A culture of supporting quality improvement more important than
the use of any specific tools. Support and acknowledge people’s process-
oriented efforts for improvement
• Kaizen costing is applied during manufacturing stage whereas target costing
is during planning stage. Kaizen costing focuses on production processes
whereas target costing focuses on the product.
Kaizen Teams

106
Tipton one stop decorators sells paint and supplies, carpets, and wallpapers at a
single store location in Mumbai. Al though the company has been very profitable
over the years, management has seen a significant decline in wallpaper sales and
earnings. Recent figures:
Particulars Paint & Supplies (Rs) Carpets (Rs) Wallpaper (Rs)
Sales 3,80,000 4,60,000 1,40,000
Variable Costs 2,28,000 3,22,000 1,12,000
Fixed Costs 56,000 75,000 45,000
Total Costs 2,84,000 3,97,000 1,57,000
Operating Income 96,000 63,000 (17,000)
Tipton is studying whether to drop wallpaper business because of the changing market
and accompanying loss. If the wallpaper business is dropped, the following changes are
expected to occur:
(a). The vacated space will be remodelled at a cost of Rs 12,400 and will be devoted to
an expanded line of high-end carpet business. The sales of carpet are expected to
increase by Rs 1,20,000, and line’s overall contribution margin ratio will rise by 5%.
(b). Tipton can cut wallpaper’s fixed cost by 40%. The remaining fixed cost will
continue to be incurred.
(c). Customers who purchased wallpaper often bought paint and paint supplies; hence
sales of paint and paint supplies are expected to fall by 20%.
(d). The firm will increase advertising expenditure by Rs. 25,000 to promote the
expanded carpet business.
The current contribution margin ratio for carpeting is 30% (Rs138,000 ÷ Rs460,000). This
ratio will increase to 35%, producing a new contribution for the line of Rs 203,000 [(Rs
460,000 + Rs 120,000) x 35%]. The end result is that carpeting’s contribution margin will rise
by Rs 65,000 (Rs 203,000 - Rs138,000), boosting firm profitability by the same amount.
Preparation of Budgets and Analysis

• Budget: “A planned expression of money”, “Quantitative expression of a plan”.


Essential to accomplishing goals in the strategic plan
• Budgeting: Is the process of identifying,
gathering, summarizing, and
communicating financial and nonfinancial
information about an organization's future
activities
• Many forms of budgets
• Production budget
• Sales Budget: prepared first No standard format for budget
• Expenses Budget preparation. Procedures vary from
• Cash budget organization to organization
• Operating budgets
• Financial budgets
• The Master Budget
Preparation of a Master Budget for a Manufacturing Organization
Preparation of a Master Budget for a Service Organization
Preparation of a Master Budget for a Retail Organization
Example: Production budget
• Your company manufactures two products, A and b. A forecast of the units to be
sold in the first seven months of the year is given below:
Jan Feb March April May June July
A 1000 1200 1600 2000 2400 2400 2000
B 2800 2800 2400 2000 1600 1600 1800

It is anticipated that (a) there will be no work-in-process at the end of any month, and (b)
finished units equal to half the sale for the next month will be in stock at the end of each
month (including the previous December). Budgeted production and production costs for the
whole year are as follows:
Particulars Product A Product B Prepare for the six months
Products (units) 22000 24000 period ending June 30
Direct material/unit Rs. 12.50 Rs. 19.00 (i) production budget for
Direct labour/unit 4.50 7.00 each month, and
(ii) a summarised production
Total factory O/H 66000 96000
cost budget.
(apportioned)
Production Budget of Products A and B (units) for six months (Jan to June)1
Month sales Planned Inventory Budget production
Closing Opening (col. 2+4-6) (col. 3+5-7)
A B A B A B A B
1 2 3 4 5 6 7 8 9
Jan 1000 2800 600 1400 500 1400 1100 2800
Feb 1200 2800 800 1200 600 1400 1400 2600
March 1600 2400 1000 1000 800 1200 1800 2200
April 2000 2000 1200 800 1000 1000 2200 1800
May 2400 1600 1200 800 1200 800 2400 1600
June 2400 1600 1000 900 1200 800 2200 1700

Cost of production Budget for six months from January to june of producta A and B
Particulars Product A Product B Total Cost
Number Total
Cost per of units Total Cost Number of produc (A+B)
Particulars unit produced Cost per units unit ed
Variable costs:
Direct material 12.5 11,100 1,38,750 19 12700 241300 380050
Direct labour 4.5 11,100 49,950 7 12700 88900 138850
Ficed Costs:
Factory overheades
apportioned at the
3 11100 33300 4 12700 50800 84100
rate of Rs.3 (A) and
Rs.4 (B)
20 11,100 222000 30 38100 381000 603000
Example: Financial budget
The Delhi Electrical supply Company Ltd has a business of supplying electrical goods to
various government and non - government companies. The controller, in collaboration with
the economist, has developed the following equation that, he says, will forecast sales quite
well, based on past pattern of behaviour: monthly sales (amount) = Rs. 100000+ (Rs. 2000*
orders received in prior month).
The sales manager is confused and seeks your advice. He presents you with the following
data regarding actual and forecast numbers of orders. The forecasts have generally been
quite accurate. August(actual) 200
September(forecast) 300
October 450
November 700
December 650
It is the first week of September, the sales manager would like the forecasts of sales and
income for as many months as you can prepare. The cost accountant informs you that costs of
goods sold is 50% of sales and other variable cost is 20% of sale. General selling and
administrative expenses which are all fixed costs, amount to Rs 200000 per month.
You are required to prepare the budgeted income statement for as many months as you can.
Budgeted Income statement of Delhi Electric Supply Company Limited
Particulars September October November December January
sales:
Fixed component 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000
Variable
Component Rs.
2,000 * orders
recevied in
perivous month) 4,00,000 6,00,000 9,00,000 14,00,000 13,00,000
Total sales 5,00,000 7,00,000 10,00,000 15,00,000 14,00,000
Less cost of
good sold(.50 of
sales ) 2,50,000 3,50,000 5,00,000 7,50,000 7,00,000
Contribution
(Manufacturing) 2,50,000 3,50,000 5,00,000 7,50,000 7,00,000
Less variable
cost (.20 of sales) 50,000 70,000 1,00,000 1,50,000 1,40,000
Contribution
(Final) 2,00,000 2,80,000 4,00,000 6,00,000 5,60,000
Less fixed cost 2,00,000 2,00,000 2,00,000 2,00,000 2,00,000
Income 0 80,000 2,00,000 4,00,000 3,60,000
Example: Flexible budget
The following data relate to the working of a small factory at Pitampur for the current quarter:
Capacity worked, 50 percent
Fixed costs:
Salaries Rs.84000
Rent and Rates 56000
Depreciation 70000
Other administrative expenses 80000 Rs.290000
Variable costs: Prepare a flexible budget
Materials 240000 and show the forecast of
Labour 256000 profit at 60,75,90 and 100
Other expenses 38000 534000 percent capacity
Possible sales at various Capacity (%) Sales (Rs.)
operations.
60 950000
levels of working are:
75 1150000
90 1375000
100 1525000
Flexible Budget
Percentage of
capacity worked 60 75 90 100
Sales revenue 9,50,000 11,50,000 13,75,000 15,25,000
Less: Costs:
Variable Costs:
Materials 2,88,000 3,60,000 4,32,000 4,80,000
Labour 3,07,200 3,84,000 4,60,800 5,12,000
Other expenses 45,600 57,000 68,400 76,000
(A) Total Variable cost 6,40,800 8,01,000 9,61,200 10,68,000
Fixed costs:
Salaries 84,000 84,000 84,000 84,000
Rent and Rates 56,000 56,000 56,000 56,000
Depriciation 70,000 70,000 70,000 70,000
Other administrative
expenses 80,000 80,000 80,000 80,000
(B) Total fixed costs 2,90,000 2,90,000 2,90,000 2,90,000
Total cost (A+B) 9,30,800 10,91,000 12,51,200 13,58,000
Forecast profits 19,200 59,000 1,23,800 1,67,000
Example: Financial budget
The GEC Ltd manufacturers pumps used in coolers. The firm has developed a forecasting tool
that has been successful in predicting sales for the company: Sales = 10000 + (0.25 * coolers
sold). The pump contains material costing Rs.50. Direct labour is Rs. 60 per unit and variable
manufacturing O/H is Rs.40 per pump. Besides the variable manufacturing costs, there are
commission to sales people of 10% of sales amount. The pump sells for Rs.250 per unit. Fixed
costs of manufacturing are Rs.1000000 per year and fixed selling and administrative expenses
are Rs.500000 per year. Both are incurred evenly over the year. Sales are seasonal and about 75
percent are in the April-September period which begins from April
1. The sales forecast by months, as percentages of yearly sales, are given below:
April 10 The Company has a policy of keeping inventory of
May 15 finished product equal to the budgeted sales for the
June 20 following two months. Materials are purchased and
July 15 delivered daily and no inventory is kept. The inventory
August 8 of finished product on march 31 is expected to be 15500
units.
September 7
You are required to prepare a: Budgeted income statement
October 5
for the coming year, Budgeted income statement for the six
November 3 months of the year, Production budgeted by months for the
first six months, in unit.
(i) Sales forecast for the coming year= 10000+(0.25*200000)= 60,000 units

April(0.10) 6000
May(0.15) 9000
June(0.20) 12000
July(0.15) 9000
August(0.08) 4800
4200=45000
September(0.07) units(75%)
October(0.05) 3000
November(0.03) 1800
Budgeted Income Statement
Particulars Six months Year
Sales(units) 45000 60000
Sales price per unit Rs.250 Rs.250
Total sales Revenue 11250000 15000000
Less: Variable costs:
Materials(Rs. 60 per unit) 2250000 3000000
Labour (Rs. 50 per unit) 2700000 3600000
Overheads (Rs. 40 per unit) 1800000 2400000
Contribution(manufacturing) 4500000 6000000
Less: Sales commission (10% of sales) 1125000 1500000
Contiribution(final) 3375000 4500000
Less: fixed costs
Manufacturing 500000 1000000
Selling and adminstrative 250000 500000
Income 2625000 3000000
Prodduction Budget(units)

Month Sales Planned inventoty Required Production


Closing Opening (Col. 2+3-4)
1 2 3 4 5
April 6000 21000 15500 11500
May 9000 21000 21000 9000
June 12000 13800 21000 4800
July 9000 9000 13800 4200
August 4800 7200 9000 3000
September 4200 4800 7200 1800
Variance analysis
Functions of standard costing system

• Valuation
• Assigning the standard cost to the actual output
• Planning
• Use the current standards to estimate future sales volume and future costs
• Controlling
• Evaluating performance by determining how efficiently the current operations are
being carried out

124
Variance analysis
• A variance is the difference between the standards and the actual
performance
• When the actual results are better than the expected results, there will be a
favorable variance (F)
• If the actual results are worse than the expected results, there will be an
adverse variance (A)

125
Sum of Decomposed Variance
Total Variance
• Quantity variance + Price variance
• = [(AQ-SQ) x SP] + [(AP-SP) x AQ]
• = (AQ x SP) – (SQ x SP) + (AP x AQ) – (SP x AQ)
• = (AP x AQ) – (SQ x SP)
• = Actual Cost – Budgeted Cost
Flexible Budget Variance
Flexible Budget for 1,80,000 units
Variance

• Flash Memories Price Variance


= (AP-SP) x AQ
= $2 X 181 = $362 U

• Flash Memories Usage or Efficiency Variance


= (AQ-SQ) x SP
= 1 x $ 27 = $ 27 U
• Flash Memories total Variance
• = $ 362 + $ 27 = $ 389 U
Variance
• Labor Price or Rate Variance
= (AP-SP) x AQ
= AP*AQ – SP*AQ
SP*AQ = AP*AQ/1.3 = $ 3092/1.3 = $2378
Price Variance = $ 3092 - $ 2378 = $ 714 (k)

Labor Quantity or Efficiency Variance


= $732-$714 = $ 18 (k)
Reasons for variances
• Material price variance
• Price changes in market conditions
• Change in the efficiency of purchasing dept. to obtain good
terms from suppliers
• Purchase of different grades or wrong types of materials

• Materials usage variance


– More effective use of materials/ wastage arising from the
efficient production process
– Purchase of different grade or wrong types of materials
– Wastage by the staff
– Change in production methods
131
Reasons for variances
 Labour rate variance
oNon-controllable market changes in the basic wage rate
oUse of higher/lower grade of workers
oUnexpected overtime allowance paid

 Labour efficiency variance


o Breakdown of machinery
o High/low labour turnover
o Changes in production method
o Introduction of new machinery
o Assignment wrong type of worker to work
o Adequacy of supervision
o Changes in working condition
o Change in motivation methods
132
Prepare a flexible budget for the month and compare with actual results and
Calculate the variances which have arisen.
Brief Case:
Pharout company uses a standard cost system. Job 822 is for the
manufacturing of 500 units of the product P521. The company’s
standards for one unit of product P521 are as follows:

Quantity Price ($)


Direct material 5 ounces 2 per ounce
Direct labour 2 hours 10 per hour

The job required 2,800 ounces of raw material costing $ 5880. An unfavorable
labour rate variance of $ 250 and a favorable labour efficiency variance of $100
also were determined for this job.

• Determine the direct material price variance for job 822 based on actual
quantity.
• Determine the direct material quantity variance for job 822.
• Determine the actual quantity of direct labour hours used in job 822 based on
the actual quantity of materials used.
• Determine the actual labour costs incurred for job 822.
Each unit of job Y703 has standard requirements of 5 pounds of raw
material at a price of $ 100 per pound and 0.5 hour of direct labour at
$12 per hour. To produce 9,000 units of this product, Job Y703
actually required 40,000 pounds of the raw material costing $97 per
pound. The job used a total of 5,000 direct labour hours costing total
of $60,000.

• Determine the material price and material quantity variance for job
Y703.
• Assume that the material used on this job were purchased from a
new supplier. Would you recommend continuing with this new
supplier? Why or why not?
• Determine the direct labor rate and direct labor efficiency
variance.
Yes, the relationship with this new supplier should be maintained because it is
providing materials of good quality for a price that is less than expected.
Software Associates
• What is the problem of Susan Jenkins is terms of the performance
analysis?
• What are the areas that needs concern in Software Associates?
Exhibit 1: Norton Associates, Income Statement, Q2 2000

Actual Budget
$
Revenues 32,64,000 $ 32,31,900
Expenses 29,67,610 26,25,550
Operating $
Profit 2,96,390 $ 6,06,350
Profit
Percentage 9.1% 18.8%

Q1: Prepare a variance analysis report based on the information in Exhibit 1.


Would this be sufficient to explain the profit shortfall to Norton at the 8 AM
meeting?
Budgeted Variance Favorable/Unfavo
Actual Value Value Amount rable?
Revenues
Expenses
Profits

F
U
U
Thank you