LECTURER BASHARAT SADDIQUE CHOUDHRY 03046337008

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Introduction to Cost Accounting

1. Costing: Costing is defined as the technique and process of ascertaining costs
2. Direct Material + Direct Labour + Direct Expenses = Prime Cost
3. Indirect Material+ Indirect Labour + Indirect Expenses = Overheads
4. Conversion Costs = Direct Labor Costs + Manufacturing Overhead Costs or
Direct wages + Direct expenses + overhead costs
5. Profit centre is a segment of a business that is responsible for all the activities involved
in the production and sales of products, systems and services.
6. Cost control is the practice of identifying and reducing business expenses to increase
profits.
7. Cost Classification by relation to cost centre:

8. Cost classification by function:

(i) Production or Manufacturing Costs
(ii) Administration Costs
(iii) Selling & Distribution cost
(iv) Research & Development costs
i. Production or Manufacturing Costs: -
Manufacturing cost can also be referred to as the aggregate of prime cost and
factory overhead.
(1) Direct Material
(2) Direct Labour
(3) Direct Expenses
(4) Factory overhead, i.e., aggregate of factory indirect material, indirect labour and
indirect expenses.
ii. Administration Costs:
(1) Formulation of policy
(2) Directing the organization
(3) Controlling the operations of an organization. But administrative function will not
include control activities concerned with production, selling and distribution and
research and development.
In most of the cases, administration cost includes indirect expenses of following types:

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(1) Salaries of office staff, accountants, directors

(2) Rent, rates and depreciation of office building
(3) Postage, stationery and telephone
(4) Office supplies and expenses
(5) General administration expenses.
iii. Selling & Distribution Costs:
Selling costs are indirect costs related to selling of products are services and include all
indirect costs in sales management for the organization.
examples of selling and distribution costs:
(1) Salaries and commission of salesmen and sales managers.
(2) Expenses of advertisement, insurance.
(3) Rent, rates, depreciation and insurance of sales office and warehouses.
(4) Cost of insurance, freight, export, duty, packing, shipping, etc.,
(5) Maintenance of Delivery vans.
iv. Research & Development Costs:
Research & development costs are the cost for undertaking research to improve quality of a
present product or improve process of manufacture, develop a new product, market
research...etc
R&D Costs comprises of the following: -
(1) Development of new product.
(2) Improvement of existing products.
(3) Finding new uses for known products.
(4) Solving technical problem arising in manufacture and application of products.
(5) Develop
9. Pre-Production Costs: These are costs incurred when a new factory is in the process of
establishment, a new project is undertaken, or a new product line or product is taken up
but there is no established or formal production to which such costs may be charged.
10.

11. Classification based on Costs for Management Decision Making

i. Marginal Costing:
Marginal Cost is the aggregate of variable costs, i.e. prime cost plus variable
overhead
ii. Differential Cost:
Differential cost is the change in the cost due to change in activity from one level
to another.

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iii. Opportunity Cost:

the value of the next-highest-valued alternative use of that resource
iv. Replacement Cost:
Replacement cost is the cost of an asset in the current market for the purpose of
replacement.
v. Relevant Costs:
Relevant costs are costs which are relevant for a specific purpose or situation.
vi. Imputed Costs:
imputed cost is an invisible cost that is not incurred directly.
vii. Sunk Costs:
Sunk costs are historical costs which are incurred.
viii. Controllable and Non-Controllable Costs:
Controllable Cost is that cost which is subject to direct control at some level of
managerial supervision. Non-controllable Cost is the cost which is not subject to
control at any level of managerial supervision.
12. Classification by nature of Production or Process:

a. Batch Costing: Batch Costing is the aggregate cost related to a cost unit which consists
of a group of similar articles which maintains its identity throughout one or more stages
of production.
b. Process Costing: When the production process is such that goods are produced from a
sequence of continuous or repetitive operations or processes, the cost incurred during a
period is considered as Process Cost.
c. Operation Cost: Operation Cost is the cost of a specific operation involved in a
production process or business activity.
d. Operating Cost: Operating cost is the cost incurred in conducting a business activity.
Operating cost refer to the cost of undertakings which do not manufacture any product
but which provide services.
e. Contract Costing: Contract cost is the cost of contract with some terms and conditions
between contractee and contractor
f. Joint Costs: Joint costs are the common cost of facilities or services employed in the
output of two or more simultaneously produced or otherwise closely related operations,
commodities or services.
By-product Cost: By-product Cost is the cost assigned to by-products till the split-off point.
13. Classification by Time:

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Historical Costs: Historical Costs are the actual costs of acquiring assets or producing goods or
services.
Predetermined Costs: Pre-determined Costs for a product are computed in advance of
production process, on the basis of a specification of all the factors affecting cost and cost data.

Techniques of Costing:
A. Marginal Costing
B. Standard Costing
C. Budgetary Control
D. Uniform Costing
A. Marginal costing
Marginal costing is based on the principle of dividing all costs into fixed cost and variable
cost.
Marginal costing, also known as variable costing, is defined as follows:
The ascertainment of marginal costs and of the effect on profit of changes in volume or type of
output by differentiating between fixed costs and variable costs.
Under marginal costing, costs are classified as fixed or variable. Fixed costs tend to remain fixed
or constant with changes in the volume of output, whereas variable costs typically vary in a
directly proportional way based on changes in the volume of output.
Other names of Marginal costing: Direct Costing, Contributory Costing, Variable Costing,
Comparative Costing, Differential Costing and Incremental Costing.
B. Standard costing
where the firm compares the costs that were incurred for the production of the goods and the
costs that should have been incurred for the same.
Essentially it is the comparison between actual costs and standard costs. The differences
between the two are variances.
C. Budgetary control
Budgetary control is the preparation of budgets and analysis of the actual performance of the
firm in comparison to the budgeted numbers.
D. Uniform Costing

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Uniform Costing may be defined as the application and use of the same costing principles and
procedures by different Organizations under the same management or on a common
understanding between members of an association.

State whether the following statement is True (or) False:

1. Differential Cost is the change in the cost due to change in activity from one level to another.
2. Cost unit of Hotel industry is student per year.
3. Multiple Costing is suitable for the banking Industry.
4. Direct Expenses are expenses related to manufacture of a product or rendering of services.
5. Profit is result of two varying factors sales sales and variable cost.
[Ans: T, F, F, T, F ]
Fill in the blanks:
1. Differential cost is the change in the cost due to change in _____________ from one level to
another.
2. Management accounting is primarily concerned with __________________.
3. In Cost Accounting stock are valued at ___________ only.
4. Profit is the resultant of two varying factors viz _______________ and _______________.
5. ___________ cost are historical costs which are incurred in the past.
[Ans: (1) activity; (2) management; (3) cost; (4) sales, cost; (5) sunk.
Multiple Choice Questions:
1. Batch Costing is suitable for-
A. Sugar Industry
B. Chemical Industry
C. Pharma Industry
D. Oil Industry
2. Joint Cost is suitable for-
A. Infrastructure Industry
B. Ornament Industry.
C. Oil Industry
D. Fertilizer Industry
3. Cost units of Hospital Industry is-
A. Tonne
B. Student per year
C. Kilowatt Hour
D. Patient Day
4. Cost units of Automobile Industry is-
A. Cubic meter
B. Bed Night
C. Number of Call
D. Number of vehicle
5. Depreciation is a example of-
A. Fixed Cost B. Variable Cost C. Semi Variable Cost D. None of these

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[Ans: C, C, D, D, A]
1.Financial accounting is concerned with:
 Recording business expenses and revenues
 Recording the cost of products and services
 Recording day-to-day business transactions
 None of the above
2.The nature of financial accounting is:
 Historical
 Gorward-looking
 Analytical
 Social
3.The main objective of cost accounting is:
 To record day-to-day business transactions
 To measure managerial efficiency
 To ascertain the true cost of products and services
 To determine tender price
4.Cost accounting emerged mainly due to:
 Statutory requirements
 Market competition
 Labor unrest
 Limitations of financial accounting
5.Who benefits from cost accounting?
 Only workers
 Only governments
 Only consumers
 Management, workers, consumers, and governments
6.Cost accounting is applied to:
 Public undertakings only
 Large business enterprises only
 Small business enterprises only
 Manufacturing and services concerns
7.A colliery company uses:
 Contract costing
 Batch costing
 Operating costing
 Single costing
8.Marginal costing is concerned with:
 Fixed costs
 Variable costs
 Semi-fixed costs
 None of the above

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9.A biscuit manufacturing company uses:

 Operating costing
 Departmental costing
 Batch costing
 Contract costing

Economic Order Quantity: (EOQ)

The total costs of a material usually consist of Buying Cost + Total Ordering Cost + Total Carrying
Cost.
Economic Order Quantity is ‘The size of the order for which both ordering and carrying cost are
minimum’.
Ordering Cost: The costs which are associated with the ordering of material. It includes cost of
staff posted for ordering of goods, expenses incurred on transportation, inspection expenses of
incoming material....etc
Carrying Cost: The costs for holding the inventories. It includes the cost of capital invested in
inventories. Cost of storage, Insurance.....etc

Illustration 1
Calculate the Economic Order Quantity from the following information. Also state the number of
orders to be placed in a year.
Consumption of materials per annum : 10,000 kg
Order placing cost per order : Rs. 50
Cost per kg. of raw materials : Rs. 2
Storage costs : 8% on average inventory

Solution:

A = Units consumed during year = 10,000 Kg.

O = Order cost per order = Rs. 50
C = Inventory carrying cost per unit per annum 2 × 8% = Rs. 0.16

EOQ = 2,500 kg.

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Maximum Level:
The Maximum Level indicates the maximum quantity of an item of material that can be held in
stock at any time.
Maximum Level = Re-Order Level + Re-Order Qty – (Minimum Rate of Consumption X
Minimum Re- Order Period)
Minimum Level:
The Minimum Level indicates the lowest quantitative balance of an item of material which must
be maintained at all times so that there is no stoppage of production due to the material being
not available.
Minimum Level = Re-Order level – (Normal Rate of Consumption X Normal Re-Order Period)

Re-Order Level:
When the stock in hand reach the ordering or re-ordering level, store keeper has to initiate the
action for replenish the material.

Re-Ordering level= Minimum Level + Consumption during lead time

= Minimum Level + (Normal Rate of Consumption × Normal Re-order Period)
Another formula for computing the Re-Order level is as below
Re-Order level = Maximum Rate of Consumption X Maximum Re-Order period (lead time)

Danger Level:
It is the level at which normal issue of raw materials are stopped and only emergency issues are
only made. This is a level fixed usually below the Minimum Level.

Danger Level = Normal Rate of Consumption × Maximum Reorder Period for emergency
purchases
Stores Records
The bin cards and the stores ledger are the two important stores records that are generally kept
for making a record of various items.
Bin Card:
Bin Card is a quantitative record of receipts, issues and closing balance of items of stores.
Separate bin cards are maintained for each item and are placed in shelves or bins. This card is
debited with the quantity of stores received, credited with the quantity of stores issued and the
balance of quantity of store is taken after every receipt or issue.

Stores Ledger:
Stores Ledger is maintained by the costing department to make record of all receipts, issues of
materials with quantities, values (Sometimes unit rates also).

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Difference between Bin Card and Stores Ledger: -

Bin Card Stores Ledger
(a) It is maintained by the store keeper. (a) It is maintained in the Costing department.
(b) It contains only quantitative details of materials
(b) It contains information both in quantity and
received, issued and returned to stores. value.
(c) Entries are made when transactions take place.(c) It is always posted after the transaction.
(d) Each transaction is individually posted. (d) Transactions may be summarized and then
posted.
(e) Inter-department transfers do not appear in Bin-(e) Material transfers from one job to another job
card. are recorded for costing purpose.

Perpetual Inventory System:

Perpetual Inventory System may be defined as ‘a system of records maintained by the
controlling department, which reflects the physical movements of stocks and their current
balance’.
What is ABC Analysis?
ABC Analysis classifies inventory items into three categories based on their value and
importance to the business:
A. high-value items
B. medium-value items
C. low-value items
The A items — typically the most expensive and most important — should be managed with
extra care and attention.

VED Analysis:
VED stands for Vital, Essential and Desirable- analysis is used primarily for control of spare
parts. The spare parts can be classified in to three categories i.e Vital, Essential and Desirable-
keeping in view the criticality to production.

FSN Analysis:
FSN analysis is the process of classifying the materials based on their movement from inventory
for a specified period.

Just-in-Time:
Just in time (JIT) is a production strategy that strives to improve a business return on
investment by reducing in-process inventory and associated carrying costs. Inventory is seen as
incurring costs, or waste, instead of adding and storing value, contrary to traditional
accounting. In short, the Just-in-Time inventory system focuses on “the right material, at the
right time, at the right place, and in the exact amount” without the safety net of inventory.

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Inventory Turnover Ratio: Inventory Turnover:

Inventory Turnover signifies a ratio of the value of materials consumed during a given period to
the average level of inventory held during that period. The ratio is worked out on the basis of
the following formula:

Several methods of pricing of material issues have been evolved; these may be classified into
the following:-
Cost Price Method
(a) First in First out
(b) Last-in-first out
(c) Base Stock Method
Specific price method
(a) Average Price Method
(b) Simple Average Price Method
(c) Weighted Average Price Method
(d) Moving Simple Average Method
(e) Moving Weighted Average Method
Market Price Methods
(a) Replacement Method
(b) Realisable Price Method

Notional Price Methods:

(a) Standard Price Method
(b) Inflated Price Method
We may now briefly discuss all the above methods
(1) First in – First Out Method:
It is a method of pricing the issue of materials in the order in which they are purchased.
(2) Last-in-First Out Method:
Under this method the prices of last received batch (lot) are used for pricing the issues, until it
is exhausted and so on.
(3) Base Stock Method:
A minimum quantity of stock under this method is always held at a fixed price as reserve in the
stock, to meet a state of emergency, if arises.
(4) Specific Price Method:
This method is useful, especially when the materials are purchased for a specific job or work
order, and as such these materials are issued subsequently to that specific job or work order at
the price at which they were purchased.

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(5) Simple Average Price Method:

Under this method material issued are valued at average price, which is computed by dividing
the total of all units rate by the number of units.
Material Issue Price = Total of unit prices of each purchase / Total No of Units

(6) Weighted Average Price Method:

This method removes the limitation of Simple Average Method in that it also takes into account
the quantities which are used as weights in order to find the issue price. This method uses total
cost of material available for issue divided by the quantity available for issue.
Issue Price = Total Cost of Materials in stock / Total Quantity of Materials in stock

(7) Moving Simple Average Price Method:

Under this method the rate for material issue is determined by dividing the total of the periodic
simple average prices of a given number of periods by the number of periods.

(8) Moving Weighted Average Price Method:

Under this method, the issue, rate is computed by dividing the total of the periodic weighted
average price of a given number of periods by the number of periods.
(9) Replacement Method:
Replacement price is defined as the price at which it is possible to purchase an item, identical to
that which is being replaced or revalued. Under this method, materials issued are valued at
replacement cost of the items

(10) Realisable Price method:

Realisable price means a price at which the material to be issued can be sold in the market. This
price may be more or less than the cost price, at which it was originally purchased.
(11) Standard Price Method:
Under this method, materials are priced at some predetermined rate of standard price
irrespective of the actual purchase cost of the materials.

(12) Inflated Price Method:

In case of materials that suffers loss in weight due to natural or climatic factors ex:
evaporation...etc the issue price of the materials is inflated to cover up the losses.

MULTIPLE CHOICE QUESTIONS

1. Which of the following is considered as normal loss of material?
A. Pilferage B. Loss due to accident C. Loss due to careless handling of material
D. None of these.
2. The most important element of cost is-
A. Material B. Labour C. Overheads D. All of these

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3. Direct material is a –
A. Adiministration Cost B. Selling and Distribution cost C. All of these D. None of these
4. Continuous stock taking is a part of-
A. ABC analysis B. Annual stock taking C. Perpetual Inventory D. None of these
5. Which of the following is considered as accounting record?
A. Bin Card B. Bill of material C. Store Ledger D. None of these
[Ans: C, A, D, C, C]
State whether the following statement is True (or) False:
1. Waste and Scrap of material have small realization value.
2. Slow moving materials have a high turnover ratio.
3. Bin card are not the part of accounting records.
4. ABC analysis is based on the principle of management by exception.
5. Store ledger is maintained inside the stores by store keeper.
[Ans: F, F, T,T, F]

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Pre-determined Overhead Rate

Predetermined Rate is computed by dividing the budgeted overhead expenses for the
accounting period by the budgeted base (quantity, hours, etc)
Overhead Rate= Budgeted overhead expenses for the period / Budgeted Base for the period

Multiple Choice Questions

1. The allotment of whole items of cost of centres or cost unit is called
A. Cost allocation
B. Cost apportionment
C. Overhead absorption
D. None of the above
2. Packing cost is a
A. Production of cost
B. Selling cost
C. Distribution cost
D. It may be any or the above
3. Directors remuneration and expenses form a part of
A. Production overhead
B. Administration overhead
C. Selling overhead
D. Distribution overhead
4. Charging to a cost center those overheads that result solely for the existence of that cost
Center is known as
A. Allocation
B. Apportionment
C. Absorption
D. Allotment
5. Absorption means
A. Charging or overheads to cost centers
B. Charging or overheads to cost units
C. Charging or overheads to cost centers or cost units
6. Which method of absorption of factory overheads do you suggest in a concern which
Produces only one uniform time of product
A. Percentage of direct wages basis
B. Direct labour rate
C. Machine hour rate
D. A rate per units of output
7. When the amount of under-or-over-absorption is significant, it should be disposed of by
A. Transferring to costing profit and loss A/c
B. The use of supplementary rates
C. Carrying over as a deferred charge to the next accounting year

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D. None of above
8. When the amount of overhead absorbed is less than the amount of overhead incurred, It is
called
A. Under- absorption of overhead
B. Over-absorption of overhead
C. Proper absorption of overhead
9. Warehouse expense is an example of
A. Production overhead
B. Selling overhead
C. Distribution overhead
D. None of above
10. Selling and Distribution overhead are absorbed on the basis of
A. Rate per unit
B. Percentage on works cost
C. Percentage on selling price of each unit
D. Any of these
[Ans: A, D, B, A , B, D, B, A, C, D]
Abnormal gains and losses:-
(i) Losses or gains on sale of fixed assets.
(ii) Loss to business property on account of theft, fire or other natural calamities.
In addition to above abnormal items (gain and losses) may also be excluded from cost accounts.
Alternatively, these may be taken to costing profit and loss account.
The following table shows the comparative journal entries in financial accounts, cost accounts
and integral accounts:
Sl. Transaction Financial Accounts Cost Accounts Integral
No. Accounts
(i) Credit purchase of Purchases A/c Dr Material Control A/c Dr Material Control
Material To, Creditors A/c To, General Ledger A/c A/c Dr
To, Creditors
(ii) Cash purchase of Purchases A/c Dr Material Control A/c Dr Material Control
materials To, Bank / Cash. A/c To, General Ledger A/c A/c Dr
To, Cash
(iii) Purchase of special Purchases A/c Dr WIP Control A/c Dr WIP Contrtol A/c
material for direct To, Cash / To, General Ledger Adj Dr
use in job Creditors. A/c A/c To, Cash or
Creditors A/c
(iv) Purchase of Purchases A/c Dr Factory OH control A/c Factory OH
materials for repairs To, Cash/Creditors. Dr control A/c Dr
A/c To, General Ledger Adj To, Cash /
A/c Creditors A/c

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(v) Materials returned Creditors A/c Dr General Ledger Control Creditors A/c Dr
to suppliers To, Purchases A/c A/c. Dr To Material To, Material
control A/c Control A/c
(vi) Payments to Creditors A/c Dr No Entry Creditors A/c Dr
creditors for To, Cash A/c To, Cash A/c
supplies made
(vii) Issue of direct No Entry WIP Control A/c Dr WIP Control A/c
materials to To, Materials Control A/c Dr
production shops To, Materials
Control A/c
(viii) Issue of indirect No Entry Factory OH Control A/c Factory OH
materials to Dr control A/c Dr
production shops To, Material Control A/c To, Material
Control A/c
(ix) Return of direct No Entry Material Control A/c Dr Material Control
materials to stores To, WIP Control A/c A/c Dr
To, WIP Control
A/c
(x) Return of indirect No Entry Material Control A/c Dr Material Control
materials to stores To, Factory Overheads A/c Dr
A/c To, Factory
Overheads A/c
(xi) Materials No Entry No Entry No Entry
transferred from
one Job to another
(xii) Adjustment of No Entry Factory Overheads Factory
normal depreciation Control A/c Dr Overheads
in material stocks To, Material Control A/c Control A/c Dr
To, Material
Control A/c

Sl. Transaction Financial Accounts Cost Accounts Integral

No. Accounts
(xiii) Adjustment of No Entry Material Control a/c Dr Material Control
normal surplus in To, Factory OH Control A/c Dr
material stocks A/c To, Factory OH
Control A/c
(xiv) Payment of wages Wages & Salaries Wages Control A/c Dr Wages & Salaries
& Salaries A/c Dr To, General Ledger A/c A/c Dr
To Cash / Bank A/c To, Cash / Bank
A/c

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(xv) Analysis of No Entry WIP Control A/c Dr WIP Control A/c

distribution of POH Control A/c Dr Dr
wages Admin OH Control A/c Dr POH Control A/c
Sellings Dis OH Control Dr
A/c Dr Admin OH
To, Wages Control A/c. Control A/c Dr
Sellings Dis OH
Control A/c Dr
To, Wages
Control A/c.
(xvi) Payment of Expenses A/c Dr POH Control A/c Dr POH Control A/c
Expenses To, Cash A/c Admin OH Control A/c Dr Dr
Selling & Dis OH Control Admin OH
A/c Dr To, General Control A/c Dr
Ledger Adj A/c Selling & Dis OH
Control A/c Dr
To, Cash A/c
(xvii) Recording of Depreciation A/c Dr POH Control A/c Dr POH Control A/c
Depreciation To, Asset A/c Admin OH Control A/c Dr Dr
Selling & Dis OH Control Admin OH
A/c Dr To, General Control A/c Dr
Ledger Adj A/c Selling & Dis OH
Control A/c Dr
To, Asset A/c
(xviii) Absorption of No Entry WIP Control A/c Dr WIP Control A/c
Factory Overheads To, Factory Overheads Dr
A/c To, Factory
Overheads A/c
(xix) Spoiled / Defective No Entry Costing Profit & Loss A/c Costing Profit &
Work Dr Loss A/c Dr
To, WIP Control A/c To, WIP Control
A/c
(xx) Recording of Cost No Entry Finished Goods Control Finished Goods
of Jobs completed A/c Dr To, WIP Control Control A/c Dr
A/c To, WIP Control
A/c
(xxi) Recording of Cost No Entry Cost of Sales A/c Dr Cost of Sales A/c
of goods sold To, Finished goods A/c Dr
To, Finished
goods Control
A/c

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(xxii) Recording of sales Cash/ Debtor A/c General Ledger Control Cash / Debors
Dr A/c Dr To, Costing P&L A/c Dr
To, Sales A/c A/c To, P&L A/c
(xxiii) Absorption of No Entry Finished Goods Control Finished Goods
Administration A/c Dr To, Admin OH Control A/c Dr
Overheads Control A/c To, Admin OH
control A/c
(xxiv) Absorption of No Entry Cost of Sales A/c Dr Cost of Sales A/c
Selling Overheads To, Selling & Dis. Dr
Overheads Control A/c To, Selling & Dis.
OH Control A/c
(xxv) Under absorption No Entry Costing Profit & Loss A/c Profit & Loss A/c
of overheads Dr Dr
To, OH Control A/c To, OH control
A/c
(xxvi) Over absorption of No Entry OH Control A/c Dr OH Control A/c
overheads To, Costing P&L A/c Dr
To, Costing P&L
A/c

Illustration 1 :
Journalise the following transactions assuming that cost and financial accounts are integrated:
Particulars Rs.
Raw material purchased 40,000
Direct materials issued to 30,000
production
Wages paid (30% indirect) 24,000
Wages charged to 16,800
production
Manufacturing expenses 19,000
incurred
Manufacturing overhead 18,000
charged to Production
Selling and distribution cost 4,000
Finished products (at cost) 40,000
Sales 58,000
Closing stock Nil
Receipts from debtors 13,800
payments to creditors 12,000

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Solution:
Journals
Dr. Cr.
Particulars Rs. Rs.
Material Control A/c Dr 40,000
To, Creditors A/c 40,000
Work In Progress Control A/c Dr 30,000
To, Material Control A/c 30,000
Wages Control A/c Dr 24,000
To, Cash A/c 24,000
Factory Overheads Control A/c Dr 7,200
To, Wages Control A/c 7,200
Work-in-Progress Control A/c Dr 16,800
To, Wages Control A/c 16,800
Factory Overhead Control A/c Dr 19,000
To, Cash A/c 19,000
Work-in-Progress Control A/c Dr 18,000
To, Factory overhead Control A/c 18,000
S & D O.H. Control A/c Dr 4,000
To, Cash A/c 4,000
Cost of Sales A/c Dr 4,000
To, Selling & Distribution Overhead Control 4,000
A/c
Finished Goods Control A/c Dr 40,000
To, Work-in-progress control A/c 40,000
Debtors A/c Dr 58,000
To, Profit & Loss A/c 58,000
Cash A/c Dr 13,800
To, Debtors A/c 13,800
Creditors A/c Dr 12,000
To, Cash A/c 12,000

Difference between Job Costing and Process Costing:

Job Costing Process Costing
(i) The form of specific order costing That form of costing which applies where
which applies where the work is standardised goods are produced and production
undertaken to customer’s special is in continuous flow, the products being
requirements. homogeneous.
(ii) The job is the cost unit and costs are Costs are collected by process or department on
collected for each job. time basis and divided by output for a period to get
an average cost per unit.

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(iii) Losses are generally not segregated. Normal losses are carefully predetermined and
abnormal losses are segregated.
(iv) Overheads are allocated and Units pass through the same processes.
apportioned to cost centres then Overheades are apportioned to processes on some
absorbed by jobs, in proportion to the suitable basis, some times, pre-detarmined rates
time taken. may be used
(v) Joint products / By-products do not Joint products/By-products do arise and joint cost
usually arise in jobbing work. apportionment is necessary.
(vi) Standard costing is generally not The standardised nature of products and
suitable for jobbing work. processing methods lends itself to the adoption of
standard costing.
(vii) Work-in-progress valuation is specific For WIP valuation operating costs have to be
and is obtained from analysis of spread over fully complete output and partially
outstanding jobs. complete products using the concept of equivalent
units.
(viii) Each job is separate and independent Products lose their individual identity as they are
of others. Costs are computed when a manufactured in a continuous flow. Costs are
job is complete. calculated at the end of cost period.
(ix) There are usually no transfers from Transfer of costs from one process to another is
one job to another unless there is a made, as the product moves from one process to
surplus work or excess production. another.
(x) There may or may not be work-in- There is always some work-in-process at the
progress at the beginning or end of the beginning as well as at the end of the accounting
accounting period. period.
(xi) Proper control is comparatively Proper control is comparatively easier, as the
difficult as each product unit is production is standardised and is more stable.
different and the production is not
continuous.
(xii) It requires more forms and details. It requires few forms and less details.

Normal Process Loss:

It is the loss which is unavoidable on account of inherent nature of production process. Such
loss can be estimated in advance on the basis of past experience or available data. The normal
process loss is recorded only in terms of quantity and the cost per unit of usable production is
increased accordingly. Where scrap possesses some value as a waste product or as raw material
for an earlier process, the value thereof is credited to the process account. This reduces the
cost of normal output; process loss is shared by usable units.
Abnormal Process Loss:
Any loss caused by unexpected or abnormal conditions such as plants breakdown, sub-
standard materials, carelessness, accident etc., or loss in excess of the margin anticipated for
normal process loss should be regarded as abnormal process loss. The units of abnormal loss
or gain are calculated as under:

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Abnormal loss (or gain) = Total Loss – Normal Loss

The valuation of abnormal loss should be done with the help of this formula:
Value of Abnormal Loss = (Normal Cost of Normal Output) x Units of Abnormal Loss (Normal
Output)
Abnormal Gain:
when actual loss in a process is smaller than that was expected, an abnormal gain results.
The value of the gain will be calculated in similar manner to an abnormal loss.
The Abnormal Gain Account is to be debited for the loss of income on account of less quantity
of sale of scrap available as a result of abnormal gain and Normal Process Loss Account credited
accordingly. The balance is transferred to Costing Profit and Loss Account as abnormal gain.

Equivalent Production:
Equivalent units of work-in-progress
= Actual no.of units in process of manufacture x Percentage of work completed
Note: FIFO method and Weighted Average Method is used in equivalent production.
MULTIPLE CHOICE QUESTIONS:
1. Job costing is used in
A. Furniture making
B. Repair shops
C. Printing press
D. All of the above
2. In a job cost system, costs are accumulated
A. On a monthly basis
B. By specific job
C. By department or process
D. By kind of material used
3. The most suitable cost system where the products differ in type of material and work
performed is
A. Operating Costing
B. Job costing
C. Process costing
D. All of these.
4. Cost Price is not fixed in case of
A. Cost plus contracts
B. Escalation clause
C. De escalation clause
D. All of the above
5. Most of the expenses are direct in
A. Job costing
B. Batch costing
C. Contact costing
D. None of the above

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6. Cost plus contact is usually entered into those cases where

A. Cost can be easily estimated
B. Cost of certified and uncertified work
C. Cost of certified work, cost of uncertified work and amount of profit transferred to Profit
and Loss Accounts.
7. Equivalent production of 1,000 units, 60% complete in all respects, is :
A. 1000 units
B. 1600 units
C. 600 units
D. 1060 units
8. In a process 8000 units are introduced during a period. 5% of input is normal loss. Closing
work in progress 60% complete is 1000 units. 6600 completed units are transferred to next
process. Equivalent production for the period is:
A. 9000 units
B. 7440 units
C. 5400 units
D. 7200 units
9. Cost of service under operating costing is ascertained by preparing:
A. Cost sheet
B. Process account
C. Job cost sheet
D. Production account
10. Operating costing is applicable to:
A. Hospitals
B. Cinemas
C. Transport undertaking
D. All of the above
[Ans: D, B, B, A, C, B, C, D, A, D]

Marginal Costing:
Marginal cost is a crucial concept in managerial accounting and economics. It helps
organizations optimize production by understanding the cost of producing one additional unit.
Here are the key points:
1. Definition: Marginal cost represents the change in total production cost resulting from
producing one more unit. It allows companies to analyze the impact of increasing or
decreasing production levels.
2. Formula:
o Marginal Cost (MC) = Change in Total Expenses ÷ Change in Quantity of Units
Produced
o The change in total expenses is the difference between costs at two production
levels.
o The change in quantity of units produced reflects the increase in units.

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3. Optimization:
o Companies aim to maximize profits by producing where MC equals marginal
revenue (MR).
o Fixed costs remain constant regardless of production levels, while variable costs
change based on production.
o Economies of scale occur when producing more units reduces fixed cost per unit.
4. Considerations:
o Be mindful of step costs (e.g., additional machinery or storage space) when
increasing production.
o Marginal cost is used to find the optimal production level.

Differences between Absorption Costing and Marginal Costing:

Absorption Costing Marginal Costing
1. Both fixed and variable costs are considered for Only variable costs are considered for
product costing and inventory valuation. product costing and inventory
valuation.
2. Fixed costs are charged to the cost of production. Each Fixed costs are regarded as period
product bears a reasonable share of fixed cost and thus costs. The profitability of different
the profitability of a product is influenced by the products is judged by their P/V ratio.
apportionment of fixed costs.
3. Cost data are presented in conventional pattern. Net Cost data are presented to highlight
profit of each product is determined after subtracting the total contribution of each
fixed cost along with their variable cost. product.
4. The difference in the magnitude of opening stock and The difference in the magnitude of
closing stock affects the unit cost of production due to opening stock and closing stock does
the impact of related fixed cost. not affect the unit cost of production.
5. In case of absorption costing the cost per unit reduces, In case of marginal costing the cost
as the production increases as it is fixed cost which per unit remains the same,
reduces, whereas, the variable cost remains the same irrespective of the
per unit.

Tools and Techniques of Marginal Costing:

1. Contribution:
it is defined as the amount recovered towards fixed cost and profit.
Contribution can be computed by subtracting variable cost from sales or by adding fixed costs
and profit.
Symbolically, C = S-V (1)
Where C = Contribution
S = Selling Price
V = Variable Cost
Also C = F+P (2)
Where F = Fixed Cost
P = Profit

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From (1) and (2) above, we may deduce the following equation called Fundamental Equation of
Marginal Costing i.e.
S-V = F+P (3)
Contribution is helpful in determination of profitability of the products and/or priorities for
profitabilities of the products. When there are two or more products, the product having more
contribution is more profitable.

2. Profit Volume Ratio (P/V Ratio) or Contribution Ratio:

For example:
Gross profit ratio: It may be expressed as follows:
Gross profit is ¼th of sales
Sales is 4 times that of gross profit
Gross profit ratio is 25%
Gross profit is 0.25 of sales and lastly
Gross profit and sales are in the ratio of 1:4
So, P/V ratio or contribution ratio is association of two variables. From this, one may assume that
it is the ratio of profit and sales. But it is not so. It is the ratio of Contribution to Sales.
Symbolically, P/V ratio = Contribution ×100 Sales (1)
⇒ P/V ratio = C/S ×100
⇒ Contribution = Sales x P/V ratio (2)
⇒ Sales = Contribution P Ratio V (3)
When cost accounting data is given for two periods, then:
P/V ratio = Change in Contribution ×100 Change in Sales
P/V ratio = Change in Profit ×100 Change in Sales

Usually, Sales = Cost + Profit

i.e. it can also be written as Sales = Variable Cost + Fixed Cost + Profit and this is called general
sales equation.

Since Sales consists of variable costs and contribution, given the variable cost ratio, P/V ratio
can be found out. Similarly, given the P/V ratio, variable cost ratio can be found out.

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Break Even Point:

When someone asks a layman about his business he may reply that it is alright. But a technical
man may reply that it is break even. So, Break Even means the volume of production or sales
where there is no profit or loss. In other words, Break Even Point is the volume of production or
sales where total costs are equal to revenue. It helps in finding out the relationship of costs and
revenues to output. In understanding the breakeven point, cost, volume and profit are always
used.

Cash Break-Even Point:

When break-even point is calculated only with those fixed costs which are payable in cash, such
a break-even point is known as cash break-even point.

Cash break even point = Cash fixed costs / Contribution per unit.

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Margin of Safety:
It is the sales point beyond the breakeven point. Margin of safety can be obtained by subtracting
break even sales from Total sales.
Margin of Safety = Total Sales – Break Even Sales (1)
Total Sales = Break Even Sales + Margin of Safety Sales

Illustration 5 :
The following results of a company for the last two years are as follows:

Year Sales (Rs.) Profit (Rs.)

2014 1,50,000 20,000
2015 1,70,000 25,000
You are required to calculate:
(i) P/V Ratio
(ii) B.E.P
(iii) The sales required to earn a profit of Rs. 40,000
(iv) Profit when sales are Rs. 2,50,000
(v) Margin of safety at a profit of Rs. 50,000 and
(vi) Variable costs of the two periods.
Solution:
(i) P/V ratio = (Change in profit / Change in sales) x 100
= (5,000 / 20,000) x 100 = 25%
Fixed cost = (Sales x P/V ratio) – Profit
= (1,50,000 x 25%) – 20,000 = Rs. 17,500
(ii) Break even sales = Fixed cost / PV ratio
= 17,500 / 25% = Rs. 70,000
(iii) Sales required to earn a profit of Rs. 40,000 = Fixed cost + desired profit
P/V ratio
= (17,500 + 40,000) / 25% = Rs. 2,30,000

(iv) Profit at sales Rs. 2,50,000 = (Sales x P/V ratio) – Fixed cost
= (2,50,000 x 25%) – 17,500 = Rs. 45,000

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(v) Margin of safety at profit of Rs. 50,000 = Profit / PV ratio

= 50,000 / 25% = Rs. 2,00,000
(vi) Variable cost for 2011 = 1,50,000 x 75% = Rs. 1,12,500
Variable cost for 2012 = 1,70,000 x 75% = Rs. 1,27,500

Illustration 6:
SV Ltd a multi product company furnishes you the following data relating to the year 2015:

First Half of the year (Rs.) Second Half of the year (Rs.)
Sales 45,000 50,000
Total cost 40,000 43,000

Assuming that there is no change in prices and variable cost and that the fixed expenses are
incurred equally in the two half year period, calculate for the year, 2015
(i) The P/V Ratio, (iii) Break-even sales
(ii) Fixed Expenses (iv) Percentage of Margin of safety.
Solution:
(i) P/V ratio = [(7,000 – 5,000) / (50,000 – 45,000)] x 100
= 40%
(ii) Fixed expenses for first half year : = (Sales x PV ratio) – Profit
= (45,000 x 0.4) – 5,000 = Rs. 13,000
Fixed expenses for the year = 13,000 + 13,000 = Rs. 26,000
(iii) Break even sales = 26,000 / 40% = Rs. 65,000
(iv) Margin of safety = (50,000 + 45,000) – 65,000 = Rs. 30,000
Margin of safety ratio = [30,000 / (50,000 + 45,000)] x 100 = 31.58%
MULTIPLE CHOICE QUESTIONS:
1. If sales are Rs. 90,000 and variable cost to sales is 75%, contribution is
A. Rs. 21,500
B. Rs. 22,500
C. Rs. 23,500
D. Rs. 67,500
2. Variable cost
A. Remains fixed in total
B. Remains fixed per unit
C. Varies per unit
D. Nor increase or decrease
3. If sales are Rs. 150,000 and variable cost are Rs. 50,000. Compute P/V ratio.
A. 66.66%
B. 100%
C. 133.33%
D. 65.66%

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4. Marginal Costing technique follows the following basic of classification

A. Element wise
B. Function Wise
C. Behaviour wise
D. Identifiability wise
5. P/V ratio will increase if the
A. There is an decrease in fixed cost
B. There is an increase in fixed cost
C. There is a decrease in selling price per unit.
D. There is a decrease in variable cost per unit.
6. The technique of differential cost is adopted when
A. To ascertain P/V ratio
B. To ascertain marginal cost
C. To ascertain cost per unit
D. To make choice between two or more alternative courses of action
7. Difference between the costs of two alternative is known as the
A. Variable cost
B. Opportunity cost
C. Marginal cost
D. Differential cost
8. Contribution is Rs. 300,000 and sales is Rs. 1,500,000. Compute P/V ratio.
A. 15%
B. 20%
C. 22%
D. 17.5%
9. Variable cost to sales ratio is 40%. Compute P/V ratio.
A. 60%
B. 40%
C. 100%
D. None of the these
10. Fixed cost is 30,000 and P/V ratio is 20%. Compute breakeven point.
A. Rs. 160,000
B. Rs. 150,000
C. Rs. 155,000
D. Rs. 145,000
[Ans: B, B, A, C, D, D, D, B, A, B]

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STANDARD COSTING & VARIANCE ANLYSIS

Standard Cost:
Standard Cost is defined as “the predetermined cost that is calculated at the management’s
standards of efficient operations and the relevant necessary expenditure”.

Estimated Costs are intended to determine what the costs ‘will’ be. Standard Costs aim at
what costs ‘should’ be.
differences between Standard Costing and Budgetary Control. 🌟
1. Definition:
o Standard Costing: It’s a cost accounting technique that evaluates performance
by comparing actual costs with standard costs for a given output. It focuses on
material, labor, and overhead variances.
o Budgetary Control: This system involves creating budgets based on
management plans and continuously comparing actual figures with budgeted
figures to achieve desired results.
2. Basis:
o Standard Costing: Determined based on data related to production.
o Budgetary Control: Prepared based on management’s plans.
3. Scope:
o Standard Costing: Narrow in scope, limited to cost details.
o Budgetary Control: Wider scope, includes both cost and financial data.
4. Reporting of Variances:
o Standard Costing: Reports variances between actual and standard costs.
o Budgetary Control: Does not specifically report variances.
5. Effect of Temporary Changes:
o Standard Costing: Short-term changes do not influence standard costs.
o Budgetary Control: Short-term changes are reflected in budgeted costs.
6. Comparison:
o Standard Costing: Compares actual costs with standard cost for actual output.
o Budgetary Control: Compares actual figures with budgeted figures.
7. Applicability:
o Standard Costing: Relevant for manufacturing concerns.
o Budgetary Control: Applicable to all business concerns.
In summary, while Standard Costing focuses on cost control and performance evaluation,
Budgetary Control encompasses overall financial planning and forecasting.

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1. Direct Materials Price Variance: The difference between the actual and standard price per unit
of the material applied to the actual quantity of material purchased or used.
Direct materials price variance = (Standard Price minus Actual Price) x Actual Quantity, or
= (SP-AP) AQ
= (Standard Price x Actual Quantity) minus (Actual Price x Actual Quantity)
= (AQSP-AQAP)

Causes of Material Price Variance:

a. Change in basic purchase price of material.
b. Change in quantity of purchase or uneconomical size of purchase order.
c. Rush order to meet shortage of supply, or purchase in less or more favourable market.
d. Failure to take advantage of off-season price, or failure to purchase when price is cheaper.

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e. Failure to obtain (or availability of) cash and trade discounts or change in the discount rates.
f. Weak purchase organisation.
g. Payment of excess or less freight.
h. Transit losses and discrepancies, if purchase price is inflated to include the loss.
i. Change in quality or specification of material purchased.
j. Use of substitute material having a higher or lower unit price.
k. Change in materials purchase, upkeep, and store-keeping cost. (This is applicable only when
such changes are allocated to direct material costs on a predetermined or standard cost
basis.)
l. Change in the pattern or amounts of taxes and duties.
2. Direct Materials Usage Variance: The difference between the actual quantity used and the
amount which should have been used, valued at standard price.
Direct materials usage variance = (Standard Quantity for actual output x Standard Price) minus
(Standard Price x Actual Quantity)
= SQSP-AQSP or
= Standard Price x (Standard Quantity for actual output minus Actual Quantity)
= SP (SQ-AQ)
Causes of Materials Usage Variance:
a. Variation in usage of materials due to inefficient or careless use, or economic use of materials.
b. Change in specification or design of product.
c. Inefficient and inadequate inspection of raw materials.
d. Purchase of inferior materials or change in quality of materials
e. Rigid technical specifications and strict inspection leading to more rejections which require
more materials for rectification.
f. Inefficiency in production resulting in wastages
g. Use of substitute materials.
h. Theft or pilferage of materials.
i. Inefficient labour force leading to excessive utilisation of materials.
j. Defective machines, tools, and equipments, and bad or improper maintenance leading to
breakdowns and more usage of materials.
k. Yield from materials in excess of or less than that provided as the standard yield.
l. Faulty materials processing. Timber, for example, if not properly seasoned may be wasted while
being used in subsequent processes.
m. Accounting errors, e.g. when materials returned from shop or transferred from one job to
another are not properly accounted for.
n. Inaccurate standards
o. Change in composition of a mixture of materials for a specified output.

(i) Direct Materials Mix Variance: One of the reasons for materials usage variance is the change
in the composition of the materials mix. The difference between the actual quantity of
material used and the standard proportion, priced at standard price.
Mix variance = (Revised Standard Quantity minus Actual Quantity) x Standard Price.
= RSQSP-AQSP

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(ii) Direct Materials Yield Variance: Yield variance is the difference between the standard cost of
production achieved and the actual total quantity of materials used, multiplied by the
standard weighted average price per unit.
Material yield variance = (Standard Yield for Actual Mix minus Actual Yield) x Standard Yield Price
(Standard yield price is obtained by dividing the total cost of the standard units by the total cost
of the standard mixture by the total quantity (number of physical units).

II. Direct Labour Cost Variance: Direct Labour Cost Variance (also termed Direct Wage
Variance) is the difference between the actual direct wages incurred and the standard direct
wages specified for the activity achieved.

1. Direct Labour Rate Variance (Wage Rate Variance): The difference between the actual and
standard wage rate per hour applied to the total hours worked.
Wages rate variance = (Standard Rate minus Actual Rate) x Actual Hours
= (SR-AR) x AH
= SRAH-ARAH
Causes of Direct Labour Rate Variances:
a. Change in basic wage structure or change in piece-work rate. These will give rise to a variance
till such time the standards are not revised.
b. Employment of workers of grades and rates of pay different from those specified, due to
shortage of labour of the proper category, or through mistake, or due to retention of
surplus labour.
c. Payment of guaranteed wages to workers who are unable to earn their normal wages if such
guaranteed wages form part of direct labour cost.
d. Use of a different method of payment, e.g. payment at day-rates while standards are based on
piece-work method of remuneration.
e. Higher or lower rates paid to casual and temporary workers employed to meet seasonal
demands, or urgent or special work.
f. New workers not being allowed full normal wage rates.
g. Overtime and night shift work in excess of or less than the standard, or where no provision has
been made in the standard. This will be applicable only if overtime and shift differential
payments form part of the direct labour cost.
h. The composition of a gang as regards the skill and rates of wages being different from that laid
down in the standard.
2. Direct Labour Efficiency Variance (also termed Labour Time Variance): The difference
between the standard hours which should have been worked and the hours actually worked,
valued at the standard wage rate.
Direct Labour Efficiency Variance = (Standard Hours for Actual Production minus Actual Hours) x
Standard Rate
= (SH-AH) x SR
= SRSH-SRAH

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Causes for Labour Efficiency Variance:

a. Lack of proper supervision or strict supervision than specified.
b. Poor working conditions.
c. Delays due to waiting for materials, tools, instructions, etc. if not treated as idle time.
d. Defective machines, tools and other equipments.
e. Machine break-down, if not booked to idle time.
f. Work on new machines requiring less time than provided for, till such time standard is not
revised.
g. Basic inefficiency of workers due to low morale, insufficient training, faulty instructions,
incorrect scheduling of jobs, etc.
h. Use of non-standard material requiring more or less operation time.
i. Carrying out operations not provided for a booking them as direct wages.
j. Incorrect standards
k. Wrong selection of workers, i.e., not employing the right type of man for doing a job.
l. Increase in labour turnover.
m. Incorrect recording of performances, i.e., time or output.
i. Direct Labour Composition or Mix or Gang Variance: This is a sub-variance of labour efficiency
variance. This variance arises due to change in the composition of a standard gang, or,
combination of labour force
Mix or Gang or Composition Variance = (Actual Hours at Standard Rate of Standard Gang) minus
(Actual Hours at Standard Rate of Actual Gang)
ii. Direct Labour Yield Variance: Just as material yield variance is calculated, similarly labour yield
variance can also be known. It is the variation in labour cost on account of increase or
decrease in yield or output as composed to the relative standard. The formula is –
Direct Labour Yield Standard Output – Actual Output
Variance = for Actual Mix
Standard Cost Per
Unit ×

MULTIPLE CHOICE QUESTIONS:

1. Excess of actual cost over standard cost is known as
A. Abnormal effectiveness
B. Unfavourable variance
C. Favourable variance
D. None of these.
2. Difference between standard cost and actual cost is called as
A. Wastage
B. Loss
C. Variance
D. Profit
3. Standards cost is used
A. To ascertain the breakeven point
B. To establish cost-volume profit relationship
C. As a basis for price fixation and cost control through variance analysis.

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4. Standard price of material per kg Rs. 20, standards consumption per unit of production is 5 kg.
Standard material cost for producing 100 units is
A. Rs. 20,000
B. Rs. 12,000
C. Rs. 8,000
D. Rs. 10,000
5. Standard cost of material for a given quantity of output is Rs. 15,000 while the actual cost of
material used is Rs. 16,200. The material cost variance is:
A. Rs. 1,200 (A)
B. Rs. 16,200 (A)
C. Rs. 15,000 (F)
D. Rs. 31,200 (A)
6. For the purpose of Proof, Material Cost Variance is equal to:
A. Material Usage Variance + Material Mix variance
B. Material Price Variance + Material Usage Variance
C. Material Price Variance + Material yield variance
D. Material Mix Variance + Material Yield Variance
7. Cost variance is the difference between
A. The standard cost and marginal cost
B. The standards cost and budgeted cost
C. The standards cost and the actual cost
D. None of these
8. Standard price of material per kg is Rs. 20, standard usage per unit of production is 5 kg. Actual
usage of production 100 units is 520 kgs, all of which was purchase at the rate of Rs. 22 per
kg. Material usage variance is
A. Rs. 400 (F)
B. Rs. 400 (A)
C. Rs. 1,040 (F)
D. Rs. 1,040 (A)
9. Standard price of material per kg is Rs. 20, standard usage per unit of production is 5 kg. Actual
usage of production 100 units is 520 kgs, all of which was purchase at the rate of Rs. 22 per
kg. Material cost variance is
A. 2,440 (A)
B. 1,440 (A)
C. 1,440 (F)
D. 2,300 (F)
10. Standard quantity of material for one unit of output is 10 kgs. @ Rs. 8 per kg. Actual output
during a given period is 800 units. The standards quantity of raw material
A. 8,000 kgs
B. 6,400 Kgs
C. 64,000 Kgs
D. None of these.
[Ans: B, C, C, D, A, B, C, B, B, A]

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BUDGET AND BUDGETARY CONTROL

CIMA defines a budget as, “A budget is a financial and/or quantitative statement, prepared
prior to a defined period of time, of the policy to be pursued during that period for the
purpose of attaining a given objective.”

Classification of Budgets:
(A) On the basis of time:
(i) Long term budget: Though there is no exact definition of long term budget, yet we can say
that a budget prepared covering a period of more than a year can be taken as long term
budget. Of course, it may be for 3 years, 5 years, 10 years and even 20 years etc.,
(ii) Short term budget: It is a budget prepared for a period covering a year or less than a year.
(B) On the basis nature of expenditure and receipts:
(i) Capital Budget: It is a budget prepared for capital receipts and expenditure such as obtaining
loans, issue of shares, purchase of assets, etc.,
(ii) Revenue Budget: A Budget covering revenue receipts and expenses for a certain period is
called Revenue Budget. Examples: Sales, other incomes, purchases, administrative expenses
etc.,
(C) On the basis of functions:
Functional Budget: If budgets are prepared of a business concern for a certain period taking
each and every function separately such budgets are called functional budgets. Example:
Production, Sales, purchases, cost of production, cash, materials etc.
The following are the various functional budgets, some of which are briefly explained here under:
(i) Sales Budget: The sales budget is a forecast of total sales, expressed in terms of money or
quantity or both. The first step in the preparation of the sales budget is to forecast as
accurately as possible, the sales anticipated during the budget period. Sales forecasts are
usually prepared by the sales manager assisted by the market research personnel.
(ii) Production Budget: The production budget is a forecast of the production for the budget
period. Production budget is prepared in two parts, viz. production volume budget for the
physical units of the products to be manufactured and the cost of production or manufacturing
budget detailing the budgeted cost under material, labour, and factory overhead in respect of
the products.
(iii) Materials Budget: The material budget includes quantities of direct materials; the quantities
of each raw material needed for each finished product in the budget period is specified. The input
data for this budget is obtained by applying standard material usage rates by each type of
material to the volume of output budgeted.
(iv) Purchase Budget: The purchase budget establishes the quantity and value of the various
items of materials to be purchased for delivery at specified points of time during the budget
period taking into account the production schedule of the concern and the inventory
requirements. It takes into account the requirements for the entire budget plan as per the sales,
materials, maintenance, research and development, and capital budgets. Purchases may be
required to be made in respect of direct and indirect materials, finished goods for resale,

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components and parts, and purchased services. Before incorporation in the purchase budget,
these purchase requirements should be suitably ascertained. Purchase budget also includes
material procurement budget.
(v) Cash Budget: Cash Budget is estimated receipts and expenses for a definite period, which
usually are cash sales, collection from debtors and other receipts and expenses and payment to
suppliers, payment of wages, payment of other expenses etc.
(vi) Direct Labour Budget.
(vii) Human Resources Budget.
(viii) Selling and Distribution cost budget.
(ix) Administration Cost Budget.
(x) Research and Development Cost Budget etc.
Master Budget: Master budget is the budget prepared to cover all the functions of the business
organisation. It can be taken as the integrated budget of business concern, that means, it shows
the profit or loss and financial position of the business concern such as Budgeted Profit and
Loss Account, Budgeted Balance Sheet etc. Master budget, also known as summary budget or
finalized profit plan, combines all the budgets for a period into one harmonious unit and thus, it
shows the overall budget plan.
(D) On the basis of capacity:
A fixed or static budget
is a financial plan that does not change due to activity or output level. Flexible budgets can be
adjusted depending on the business necessity. A fixed budget is rigid, notwithstanding the
activity level, and isn't susceptible to change..
What is a flexible budget?
A flexible budget is a budget that adjusts to a company's activity or volume levels. Unlike a
static budget , which doesn't change from the amounts established when the company creates
the budget, a flexible budget continuously changes with a business' cost variations..
Difference between Fixed and Flexible Budgets:
Fixed / Rigid Budget Flexible Budget
(i) It does not change with actual volume of It can be recasted on the basis of activity level to
activity achieved. Thus it is known as rigid be achieved. Thus it is not rigid.
or inflexible budget.
(ii) It operates on one level of activity and It consists of various budgets for different levels
under one set of conditions. It assumes of activity.
that there will be no change in the
prevailing conditions, which is unrealistic.
(iii) Here as all costs like – fixed, variable and Here analysis of variance provides useful
semi-variable are related to only one level information as each cost is analysed according to
of activity so variance analysis does not its behaviour.
give useful information.
(iv) If the budgeted and actual activity levels Flexible budgeting at different levels of activity
differ significantly, then the aspects like facilitates the ascertainment of cost, fixation of
selling price and tendering of quotations.

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cost ascertainment and price fixation do

not give a correct picture.
(v) Comparison of actual performance with It provides a meaningful basis of comparison of
budgeted targets will be meaningless the actual performance with the budgeted
specially when there is a difference targets.
between the two activity levels.
The principal budget factor is the resource or activity which is limited and which forms the base
for the preparation of the budgets. For example, sales volume, raw material, labor hours, or
machine hours.
The variable overhead cost variance is the difference between actual cost (AC) and standard
cost allowed (SC) multiplied by the actual quantity of direct labor hours (AQ).

Variable overhead rate variance = (Standard rate – Actual rate) x Actual quantity
Variable o’head efficiency variance = (Standard quantity – Actual quantity) x Standard rate
MULTIPLE CHOICE QUESTIONS:
1. Budgets are shown in ……. Terms
A. Qualitative
B. Quantitative
C. Materialistic
D. both (b) and (c)
2. Which of the following is not an element of master budget?
A. Capital Expenditure Budget
B. Production Schedule
C. Operating Expenses Budget
D. All above
3. Which of the following is not a potential benefit of using a budget?

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A. Enhanced coordination of firm activities

B. More motivated managers
C. Improved interdepartmental communication
D. More accurate external financial statements
4. Which of the following is a long-term budget?
A. Master Budget
B. Flexible Budget
C. Cash Budget
D. Capital Budget
5. Materials become key factor, if
A. quota restrictions exist
B. insufficient advertisement prevails
C. there is low demand
D. there is no problem with supplies of materials
6. The difference between fixed cost and variable cost assumes significance in the preparation of
the following budget.
A. Master Budget
B. Flexible Budget
C. Cash Budget
D. Capital Budget
7. The budget that is prepared first of all is …
A. Master budget
B. Budget, with key factor
C. Cash Budget
D. Capital expenditure budget
8. Sales budget is a …
A. expenditure budget
B. functional budget
C. Master budget
D. None of these
9. A flexible budget requires a careful study of
A. Fixed, semi-fixed and variable expenses
B. Past and current expenses
C. Overheads, selling and administrative expenses.
D. None of these.
10. The basic difference between a fixed budget and flexible budget is that a fixed budget…….
A. is concerned with a single level of activity, while flexible budget is prepared for different
levels of activity
B. Is concerned with fixed costs, while flexible budget is concerned with variable costs.
C. is fixed while flexible budget changes
D. None of these.
[Ans: D, B, D, D, A, B, B, B, A,A]
╰───┄ °❀ BEST OF LUCK FOR EXAMS❀° ┄───╮

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