1. "Cost accounting is becoming more and more relevant in the emerging economic
scenario in India." comment
The reason why cost accounting is more relevant in an emerging economy like India is
that Indian business firm managers need the necessary accounting tools for planning
and control activities. These firms need the collection, presentation, and analysis of cost
data to help management accomplish the following tasks:
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Create and execute plans and budgets for operating under expected competitive
economic conditions
Establishing costing methods and procedures that permit control and, if possible,
reductions or improvements of costs
Creating inventory values for costing and pricing purposes and, at times
controlling physical quantities
Determining company costs and profit for an annual accounting period or a
shorter period
Choosing among two or more alternatives that might increase revenues or
decrease costs
2." Cost accounting system that simply records costs for the purpose of fixing sale price
has accomplished only a small part of its mission"-Explain.
The objectives of cost accounting are far much broader than what is stated above. Cost
accounting was designed to be a mechanism by which costs of products or services are
ascertained in a manufacturing firm for different purposes. One of the main objectives of
cost accounting is to ascertain the true cost of every operation through cost analysis and
allocation.
3. "Selling price is always based on total cost".comment
Total cost is one among many other methods for setting the selling price of a product or
service. Other methods include:
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Perceived-value pricing Method: Perceived-value pricing is a market-oriented
method for setting product prices
Going-rate Pricing Method also known as competitive parity method
Sealed-bid Pricing Method, a method followed in the construction industry
Target Return Pricing which is another cost-based pricing method
Break-even Analysis Method I is a managerial tool that establishes relationships
among costs, the volume of sales, and profits. It is also known as cost-volumeprofit analysis.
4. State the steps involved in the installation of a costing system in a large
manufacturing company
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The first step is to state the objective to be achieved by the costing system. The
objective should be very clear to ensure the purpose for which the system is
created is realized.
Study the product. The study of the product is very essential. The nature of the
product determines the type of costing system to be used. A product requiring
high costs on materials will need a costing system giving the main emphasis on
pricing, storing, issuing, and controlling of material cost.
Installation of a costing system. This is necessary to ensure the fits well within
the organization set up
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Selecting the cost rates. A decision is required for the allocation of various
expenses among different products. For instance, what costs are direct and
which ones are indirect.
Introducing the system. The success of a costing system will depend on its
proper implementation. To this end, employee cooperation is expected.
Follow up. A follow-up of the system is essential to make it practicable and
useful.
5. Cost accounting is a system of foresight and not a postmortem examination, it turns
losses into profits, speeds up activities and eliminates wastes. Comment.
In fulfilling its function cost accounting accomplishes many things which happen not only
to be historical in nature but forward-looking as well. These include:
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Establishment of budgets, standard costs and actual costs
Analyses past, present, and future data to provide the basis for managerial
decision-making.
6. Explain the meaning of relevant cost in managerial decisions; Give examples.
it is a managerial cost accounting term that describes avoidable when making specific
business decisions.
Examples include:
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Increases or decreases in cash flows caused by a project
Revenues forgone (given up) because of a decision are relevant
Cost of materials needed to produce a product
All other conversion costs such as direct labor
7. State differences between financial accounting and cost accounting. 8. What are the
main characteristics of an ideal cost accounting system?
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Cost Accounting refers to that branch of accounting that deals with costs incurred
in the production of units of an organization. On the other hand, financial
accounting refers to the accounting concerned with recording financial data of an
organization, in order to exhibit exact position of the business
Cost accounting generates information so as to keep a check on operations, with
an aim of maximizing profit and efficiency of the concern. Conversely, Financial
accounting ascertains the financial results, for the accounting period and the
position of the assets and liabilities on the last day of the period.
Cost Accounting is an accounting system, through which an organization keeps
track of various costs incurred in the business in production activities.
Financial Accounting is an accounting system that captures the records of
financial information about the business to show the correct financial position of
the company at a particular date.
cost accounting records the information related to material, labor, and overhead,
which are used in the production process while financial accounting records
information that is in monetary terms.
Cost accounting uses both historical and predetermined costs while financial
accounting uses historical information only
8. What are the main characteristics of an ideal cost accounting system?
The following are identified as the main characteristics of an ideal accounting system
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It must be simple, flexible, and adaptable to changing conditions
Economy. Its benefits must outweigh its cost of maintenance
Comparability. It must enable managers to be able to draw comparisons about
past, present performance
Minimum changes to the existing system. It should not seek to reinvent the
wheel if the current system is serving the organization
Less clerical work. It should be able to minimize paperwork
9. Write a note on cost control.
Cost control is the practice of identifying and reducing business expenses to increase
profits. It commences with the budgeting process. It entails the comparison of budgets
with the actual results and determines the reasons behind the variances. There are
various types of cost control. These include:
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Budget planning
Cost tracking.
Time management
Project change controlling
Earned value use
10.What is cost accounting? What are its objectives? In what respects does cost
accounting differ from financial accounting?
What is cost accounting
Cost Accounting refers to the classifying, recording, and appropriate allocation of
expenditure for the purpose of determining the costs of products or services. It also
helps in the presentation of arranged data for control purposes and guidance to the
management
Objectives of cost accounting
The following are the objectives of cost accounting
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Ascertainment of the cost per unit of the different products that a business
concern manufacturers.
To correctly analyze the cost of both the process and operations.
Disclosure of sources for wastage of material, time, expenses or in the use of the
equipment and the preparation of reports which may be necessary to control
such wastage.
Provide requisite data and help in fixing the price of products manufactured or
services rendered.
Determination of the profitability of each of the products and help management in
the maximization of these profits.
Exercise effective control of stocks of raw material, work-in-progress,
consumable stores, and finished goods so as to minimize the capital invested in
them.
Present and interpret data for management planning, decision-making, and
control.
Help in the preparation of budgets and implementation of budgetary control.
Aid management in the formulation and implementation of incentive bonus plans
on the basis of productivity and cost savings.
Organization of cost reduction programmes with the help of different
departmental managers.
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To provide specialized services for cost audit in order to prevent errors and
frauds.
To facilitate prompt and reliable information to management.
Determination of costing profit or loss by linking the revenues to costs of those
products or services by selling which the revenues have arisen.
Differences between financial accounting and cost accounting
There are a number of differences between cost accounting and financial accounting,
which are as follows:
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Audience. Financial accounting involves the preparation of a standard set of
reports for an outside audience, which may include investors, creditors, credit
rating agencies, and regulatory agencies. Cost accounting involves the
preparation of a broad range of reports that management needs to run a
business.
Format. The reports prepared under financial accounting are highly specific in
their format and content, as mandated by either generally accepted accounting
principles or international financial reporting standards. Cost accounting involves
creating reports that can be in any format specified by management, with the
intention of including only that information pertinent to a specific decision or
situation.
Level of detail. Financial accounting primarily focuses on reporting the financial
results and financial position of an entire business entity. Cost accounting usually
results in reports at a much higher level of detail within the company, such as for
individual products, product lines, geographical areas, customers, or subsidiaries.
Product costs. Cost accounting compiles the cost of raw materials, work-inprocess, and finished goods inventory, while financial accounting incorporates
this information into its financial reports (primarily into the balance sheet).
Regulatory framework. The structure of financial accounting reports are tightly
governed by either generally accepted accounting principles or international
financial reporting standards. There is no regulatory framework governing cost
accounting reports.
Report content. A financial report contains an aggregation of the financial
information recorded through the accounting system. The information in a cost
accounting report can contain both financial information and operational
information. The operational information can come from a variety of sources that
are not under the direct control of the accounting department.
Report timing. Financial accounting personnel issue reports only at the end of a
reporting period. Cost accounting staff may issue reports at any time and with
any degree of frequency, depending upon management's need for the
information.
Time horizon. Financial accounting is only concerned with reporting the results of
reporting periods that have already been completed. Cost accounting does this
too, but also can be involved in a variety of projections for future periods.
11.State the objectives of cost accounting briefly explain the advantages of cost
accounting
Objectives
The following are the objectives of cost accounting
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Ascertainment of the cost per unit of the different products that a business
concern manufacturers.
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To correctly analyze the cost of both the process and operations.
Disclosure of sources for wastage of material, time, expenses or in the use of the
equipment and the preparation of reports which may be necessary to control
such wastage.
Provide requisite data and help in fixing the price of products manufactured or
services rendered.
Determination of the profitability of each of the products and help management in
the maximization of these profits.
Exercise effective control of stocks of raw material, work-in-progress,
consumable stores, and finished goods so as to minimize the capital invested in
them.
Present and interpret data for management planning, decision-making, and
control.
Help in the preparation of budgets and implementation of budgetary control.
Aid management in the formulation and implementation of incentive bonus plans
on the basis of productivity and cost savings.
Organization of cost reduction programs with the help of different departmental
managers.
To provide specialized services for cost audits in order to prevent errors and
frauds.
To facilitate prompt and reliable information to management.
Determination of costing profit or loss by linking the revenues to costs of those
products or services by selling which the revenues have arisen.
Advantages
The advantages of cost accounting are:
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Disclosure of profitable and unprofitable activities. Since cost accounting
minutely calculates the cost, selling price, and profitability of the product,
segregation of profitable or unprofitable items or activities becomes easy.
Guidance for future production policies. On the basis of data provided by the
costing department about the cost of various processes and activities as well as
profit on it, it helps to plan the future.
Periodical determination of profit and losses. Cost accounting helps us to
determine the periodical profit and loss of a product.
To find out the exact cause of the decrease or increase in profit. With the help of
cost accounting, any organization can determine the exact cause of decrease or
increase in profit that may be due to higher cost of the product, lower selling price
or maybe due to unproductive activity or unused capacity.
Control over material and supplies. Cost accounting teaches us to account for
the cost of material and supplies according to the department, process, units of
production, or services that provide us control over material and supplies.
Relative efficiency of different workers. With the help of cost accounting, we may
introduce a suitable plan for wages, incentives, and rewards for workers and
employees of an organization.
Reliable comparison. Cost accounting provides us the reliable comparison of
products and services within and outside an organization with the products and
services available in the market. It also helps to achieve the lowest cost level of
product with the highest efficiency level of operations.
Helpful to the government. It helps the government in planning and policymaking
about import, export, industry, and taxation. It is helpful in the assessment of
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excise, service tax, and income tax, etc. It provides readymade data to the
government in price-fixing, price control, tariff protection, etc.
Helpful to consumers. Reduction of price due to the reduction in cost passes to
customer ultimately. Cost accounting builds confidence in customers about the
fairness of the price.
Classification and subdivision of cost. Cost accounting helps to classify the cost
according to department, process, product, activity, and service against financial
accounting which gives just consolidate net profit or loss figure of any
organization without any classification or sub-division of cost.
To find out the adequate selling price. In tough marketing conditions or in a
slump period, the costing helps to determine the selling price of the product at the
optimum level, neither too high nor too low.
Proper investment in inventory. Shifting deadstock items or slow-moving items
into fast-moving items may help the company to invest in more proper and
profitable inventory. It also helps us to maintain inventory at the most optimum
level in terms of investments as well as the variety of the stock.
Correct valuation of inventory. Cost accounting is an accurate and adequate
valuation technique that helps an organization in the valuation of inventory in a
more reliable and exact way. On the other hand, the valuation of inventory merely
depends on physical stocktaking and valuation thereof, which is not a proper and
scientific method to follow.
12."A Good system of costing must place the same emphasize on cost control as on
cost ascertainment". Comment on this statement.
Cost control is a way of improving profitability and therefore it is a very important aspect
of cost accounting. While cost ascertainment is equally important, management may not
be able to know the extent of the firm's performance in the achievement of results if cost
control is not exercised.
13."Cost accounting is better understood as cost control and cost reduction exercise and
not more of a cost ascertainment process"
Cost control" is operated through setting standards of targets and comparing actual
performance therewith, with a view to identifying the deviations from standard norms and
taking corrective actions in order to ensure that future performance conforms to standard
norms. In other words, it can be explained that it is a scientific management technique to
control and reduce the costs of doing business while cost reduction is a technique used
for saving the unit costs of the product without compromising its quality. Cost
accounting is more involved in these processes more than any other hence the assertion
that "Cost accounting is better understood as cost control and cost reduction exercise
and not more of a cost ascertainment process".
14. Define and explain the following terms with suitable examples: a. Cost b. Costing c.
Cost Accounting d. Cost Accountancy e. Cost Centre f. Cost Unit
a. Accountants define cost as an exchange price, foregoing, a sacrifice made to secure
a profit. an example of a cost would be $3 for half a gallon of milk
b. Costing is the proposed or estimated cost of producing a product or service. A good
example of a cost would cost of material for production purposes
c. Cost accounting defined as the recording of all the costs incurred in a business in a
way that can be used to improve its management. an example of cost accounting is cost
control.
d. Cost accountancy encompasses the practice of cost accounting as a profession.
e. A cost center is a department or function within an organization that does not directly
add to profit but still costs the organization money to operate. Examples of cost centers
include a company's accounting department, the information technology (IT) department,
and maintenance staff.
f. A unit cost is a total expenditure incurred by a company to produce, store, and sell
one unit of a particular product or service. Examples of cost units are; vehicles for a
vehicle manufacturer, passenger-mile in a transport business, and operation in a
hospital
15.Explain the classification of cost on various bases.
Classification of Costs
1. Classification by Nature
This is the analytical classification of costs. Let us divide as per their natures. So
basically there are three broad categories as per this classification, namely Labor Cost,
Materials Cost and Expenses. These heads make it easier to classify the costs in a cost
sheet. They help ascertain the total cost and determine the cost of the work-in-progress.
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Material Costs: Material costs are the costs of any materials we use in the
production of goods. We divide these costs further. For example, let's divide
material costs into raw material costs, spare parts, costs of packaging material
etc.
Labor Costs: Labor costs consists of the salary and wages paid to permanent
and temporary employees in the pursuit of the manufacturing of the goods
Expenses: All other expenses associated with making and selling the goods or
services.
2] Classification by Functions
This is the functional classification of costs. So the classification follows the pattern of
basic managerial activities of the organization.
The grouping of costs is according to the broad divisions of functions such as
production, administration, selling etc.
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Production Costs: All costs concerned with actual manufacturing or construction
of the goods
Commercial Costs: Total costs of the operation of an enterprise other than the
manufacturing costs. It includes the admin costs, selling and distribution costs,
etc.
Learn more about Meaning of Cost, Costing, and Cost Accounting here in detail
3. Classification by Traceability
This aspect one of the most important classifications of costs, into direct costs and
indirect costs. This classification is based on the degree of traceability to the final
product of the firm.
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Direct Costs: So these are the costs that are easily identified with a specific cost
unit or cost centers. Some of the most basic examples are the materials used in
the manufacturing of a product or the labor involved with the production process.
Indirect Costs: These costs are incurred for many purposes, i.e. between many
cost centers or units. So we cannot easily identify them to one particular cost
center. Take for example the rent of the building or the salary of the manager. We
will not be able to accurately determine how to ascertain such costs to a
particular cost unit.
4. Classification by Normality
This classification determines the costs as normal costs and abnormal costs. The norms
of normal costs are the costs that usually occur at a given level of output, under the
same set of conditions in which this level of output happens.
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Normal Costs: This is a part of the cost of production and a part of the costing
profit and loss. These are the costs that the firm incurs at the normal level of
output in standard conditions.
Abnormal Costs: These costs are not normally incurred at a given level of output
in conditions in which normal levels of output occur. These costs are charged to
the profit and loss account, they are not a part of the cost of production.
16.Discuss methods and techniques of cost accounting
The following are the methods and techniques of cost accounting
1. Job Costing:
Under this method, costs are collected and accumulated for each job, work order, or
project separately. Each job can be separately identified, so it becomes essential to
analyze the cost according to each job. A job card is prepared for each job for cost
accumulation. This method is applicable to printers, machine tool manufacturers,
foundries, and general engineering workshops.
2. Contract Costing:
When the job is big and spread over long periods of time, the method of contract costing
is used. A separate account is kept for each individual contract. This method is used by
builders, civil engineering contractors, construction and mechanical engineering firms,
etc.
3. Batch Costing:
This is an extension of job costing. A batch may represent a number of small orders
passed through the factory in batch. Each hatch is treated as a unit of cost and
separately cost. The cost per unit is determined by dividing the cost of the batch by the
number of units produced in a batch. This method is mainly applied in biscuit
manufacture, garments manufacture, and spare parts and components manufacture.
4. Process Costing:
This is suitable for industries where production is continuous, manufacturing is carried
on by distinct and well-defined processes, the finished products of one process becomes
the raw material of the subsequent process, different products with or without byproducts
are produced simultaneously at the same process and products produced during a
particular process are exactly identical.
17. Distinguish between cost accounting and financial accounting. (Or emphasis of cost
accounting is different from financial accounting.
Differences between financial accounting and cost accounting
There are a number of differences between cost accounting and financial accounting,
which are as follows:
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Audience. Financial accounting involves the preparation of a standard set of
reports for an outside audience, which may include investors, creditors, credit
rating agencies, and regulatory agencies. Cost accounting involves the
preparation of a broad range of reports that management needs to run a
business.
Format. The reports prepared under financial accounting are highly specific in
their format and content, as mandated by either generally accepted accounting
principles or international financial reporting standards. Cost accounting involves
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creating reports that can be in any format specified by management, with the
intention of including only that information pertinent to a specific decision or
situation.
Level of detail. Financial accounting primarily focuses on reporting the financial
results and financial position of an entire business entity. Cost accounting usually
results in reports at a much higher level of detail within the company, such as for
individual products, product lines, geographical areas, customers, or subsidiaries.
Product costs. Cost accounting compiles the cost of raw materials, work-inprocess, and finished goods inventory, while financial accounting incorporates
this information into its financial reports (primarily into the balance sheet).
Regulatory framework. The structure of financial accounting reports is tightly
governed by either generally accepted accounting principles or international
financial reporting standards. There is no regulatory framework governing cost
accounting reports.
Report content. A financial report contains an aggregation of the financial
information recorded through the accounting system. The information in a cost
accounting report can contain both financial information and operational
information. The operational information can come from a variety of sources that
are not under the direct control of the accounting department.
Report timing. Financial accounting personnel issue reports only at the end of a
reporting period. Cost accounting staff may issue reports at any time and with
any degree of frequency, depending upon management's need for the
information.
Time horizon. Financial accounting is only concerned with reporting the results of
reporting periods that have already been completed. Cost accounting does this
too but also can be involved in a variety of projections for future periods.
18. What is a cost audit? What are the objectives and advantages of cost audit?
Cost audit is the verification of the correctness of cost accounts and a check on the
adherence to the cost accounting plan.
This is, it involves not only the examination of cost accounts but also the fact that the
plan prepared in this connection has been duly executed. Cost audit as an audit of the
efficiency of minute details of expenditure in which the work is in progress and not a
post-mortem examination.
The first function of cost audit is the verification of cost accounting records according to
the cost accounting system, and the second function is the checking on the adherence
to the cost accounting plan.
A cost audit, therefore, includes verification of correctness of the cost accounts, cost
statements, cost reports, cost data, and costing techniques applied and finally checking
these data to see that they adhere to cost accounting principles, plans, procedures, and
objectives.
Objectives of Cost Audit
The following are some of the objectives for which cost audit is undertaken:
1. To establish the accuracy of costing data. This is done by verifying the
arithmetical accuracy of cost accounting entries in the books of accounts.
2. To ensure that cost accounting principles are governed by the management
objectives and these are strictly adhered to in preparing cost accounts.
3. To ensure that cost accounts are correct and also to detect errors, frauds, and
wrong practice in the existing system.
4. To check up the general working of the cost department of the organization and
to make suggestions for improvement.
5. To help the management in taking correct decisions on certain important matters
6. to determine the actual cost of production when the goods are ready.
7. To reduce the amount of detailed checking by the external auditor, its effective
internal cost audit system is in operation.
8. To find out whether each item of expenditure involved in the relevant components
of the goods manufactured or produced has been properly incurred or not.
Advantages of Cost Audit
The important advantages of cost audit are briefly discussed as follows:
Advantages of Cost Audit to the Management
1. It provides necessary information for prompt decision decisions.
2. It helps management to regulate production.
3. Errors, omissions, fraud, and mistakes can be detected and prevented due to the
effective auditing of cost accounts.
4. It reduces the cost of production through plugging loopholes relating to wastage
of material, labor, and overheads.
5. It can fix the responsibility of an individual wherever irregularities or wastage are
found.
6. It improves the efficiency of the organization as a whole and costing system in
particular by constant review, revision, and checking or routine procedures and
methods.
7. It helps in comparing actual results with budgeted results and points out the
areas where management action is more needed.
8. It also enables comparison among different units of the factory to find out the
profitability of the different units.
9. It exercises a moral influence on employees, which keeps them efficient and
alert.
10. It ensures that the cost accounts have been maintained under the principles of
costing employed in the industry concerned.
11. It ensures effective internal control.
12. It helps to increase the overall efficiency of productivity.
13. Inefficiency can be eliminated by suitable corrective actions.
14. It facilitates cost control and cost reduction.
15. It assists in the valuation of stock of materials, works in progress, and finished
goods.
16. It ensures maximum utilization of available resources,
17. It enables the management to choose economic methods of operations and thus
earn profits to satisfy the shareholders and the investing public.
18. It enables the management to chalk out the future policy based on the report by
the cost auditor, especially regarding labor, raw material, plant, etc. to maximize
production and reduce the cost of production.
19. It tests the effectiveness of cost control techniques and to evaluate their
advantages to the enterprise.
Advantages of Cost Audit to the Shareholders
1. It ensures that proper records are maintained as to purchases, utilization of
materials, and expenses incurred on various items i.e., wages and overheads,
etc. It also makes sure that the industrial unit has been working efficiently and
economically.
2. It enables shareholders to determine whether or not they are getting a fair return
on their investments. It reflects managerial efficiency or inefficiency.
3. It ensures a true picture of the company's state of affairs. It reveals whether
resources like plant and machinery are properly utilized or not.
4. It creates an image of the creditworthiness of the concern.
Advantages of Cost Audit to the Society
1. It tells the true cost of production. From this, the consumer may know whether the
market price of the article is fair or not. The consumer is saved from exploitation.
2. It improves the efficiency of industrial units and thereby assists in the economic
progress of the nation.
3. Since the price increase by the industry is not allowed without justification as to
an increase in the cost of production, consumers can maintain their standard of
living.
Advantages of Cost Audit to the Government
1. It assists the tariff board in deciding whether tariff protection should be extended
to a particular industry or not.
2. It helps to ascertain whether any particular industry should be given any subsidy
to develop that industry.
3. It provides reliable data to the government for fixing up the selling prices of the
various commodities.
4. It helps in fixing contract prices in a cost-plus contract.
5. It determines whether differential pricing within the industry is desirable.
6. It helps the government to take necessary measures to improve the efficiency of
sick industrial units.
7. It can reveal the fraudulent intentions of the management.
8. Cost statements may be helpful to authorities in imposing tax or duty at the cost
of finished products.
9. It facilitates the settlement of trade disputes of the companies.
10. It imposes an automatic check on inflation.
11. It assists the Tariff Board to consider the extension or removal of protection.
19. Explain the following concepts with reference to overheads, with a suitable example:
a. Classification b. Allocation c. Apportionment d. Absorption e. Under and over
absorption
a. Allocation and apportionment
Allocation and apportionment of overheads
The first stage of the absorption costing process involves the allocation and
apportionment of overheads.
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Allocation involves charging overheads directly to specific departments
(production and service).
If overheads relate to more than one specific department, then they must be
shared between these departments using a method known as apportionment.
Overheads must be apportioned between different production and service
departments on a fair basis.
c. Bases of apportionment
Bases of apportionment
There are no hard and fast rules for which basis of apportionment to use except that
whichever method is used to apportion overheads, it must be fair. Possible bases of
apportionment include the following:
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floor area â€" for rent and rates overheads
netbook value (NBV) of fixed assets â€" for depreciation and insurance of
machinery
number of employees â€" for canteen cost
d. Absorption is the amount of indirect costs assigned to cost objects.
e. Under and over absorption
If overhead is under absorbed, this means that more actual overhead costs were
incurred than expected, with the difference being charged to expense as incurred. This
usually means that the recognition of expense is accelerated into the current period, so
that the amount of profit recognized declines
20. Define budgetary control and state its advantages and disadvantages.
Budgetary control is the process by which budgets are prepared for the future period
and are compared with the actual performance for finding out variances if any. The
comparison of budgeted figures with actual figures will help the management to find out
variances and take corrective actions without any delay.
Some of the advantages of budgetary control are:
1. It defines the goals, plans, and policies of the enterprise. If there is no definite aim
then the efforts will be wasted in achieving some other aims.
2. Budgetary control fixes targets. Each and every department is forced to work
efficiently to reach the target. Thus, it is an effective method of controlling the activities of
various departments of a business unit.
3. It secures better coordination among various departments.
4. In case the performance is below expectation, budgetary control helps the
management in finding up the responsibility.
5. It helps in reducing the cost of production by eliminating wasteful expenditure.
6. By promoting cost consciousness among the employees, budgetary control brings in
efficiency and economy.
7. Budgetary control facilitates centralized control with decentralized activity.
21. Define Marginal Cost. Discuss the importance of classifying expenses into variable
and fixed
Marginal Cost of Production is the cost to provide one additional unit of a product or
service. It is a fundamental principle that is used to derive economically optimal
decisions and an important aspect of managerial accounting and financial analysis
The importance of classifying expenses into variable and fixed
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Profit Planning:
The Primary objective of doing any business is to earn profits. Hence, it is very important
to make profit planning. Profit planning is concerned with taking a series of decisions
and selecting amongst the various alternatives available. Thus, it is very important to
study the behavior of costs and profits in relation to change in the volume of output.
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Effective Cost Control:
Profits can also be increased through effective cost control and cost reduction.
Classification of costs into fixed and variable elements helps management to control
costs effectively as fixed costs are incurred by management decisions and can be
controlled only by the top management. Further, variable costs may be controlled even
at the lower levels of management.
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Fixation of Selling Prices:
Profits could be maximized either by reduction and control over costs or by increasing
the sales value through an increase in sales volume or prices. Fixation of proper selling
prices is thus very important for the management.
The segregation of costs into fixed and variable elements enables the management to
adopt the most appropriate selling price policy as sometimes one may have to sell even
below total cost. However, the selling prices should not be below the variable cost.
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Marginal Costing and Break-Even Analysis:
The basic assumption of marginal costing, breakeven analysis, and cost-volume-profit
analysis is that all elements of cost can be segregated into fixed and variable. Hence, for
the use of marginal costing and break-even techniques, the classification of costs as
fixed and variable is very essential.
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Budgetary Control:
For the preparation of flexible budgets and effective budgetary control, this classification
is a prerequisite. The flexible budget is designed to change in accordance with the level
of activity and hence the cost behavior is very important.
22. What do you understand by P/V ratio? Discuss the importance of P/V ratio and state
how P/V ratio can be improved?
The Profit Volume Ratio shows percentage of contribution to the sales value i.e. margin
as percentage of sales out of it; the fixed cost is met and there is a profit. It is one of the
tools used in marginal costing.
The Profit Volume (P/V) Ratio is the measurement of the rate of change of profit due to
change in volume of sales. It is one of the important ratios for computing profitability as it
indicates contribution earned with respect of sales.
Contribution = Sales Value × P/V Ratio
P/V ratio is a relative ratio. It cannot be adopted independently. If it is studied in an
isolated way, it will not give much information. As fixed costs are not relevant in the
calculation of P/V ratio, erroneous conclusions may be arrived.
Importance
P/V ratio is one of the most important ratios to watch in business. It is an indicator of the
rate at which profit is being earned. A high Profit volume ratio indicates high profitability
and a low ratio indicates low profitability in the business. The profitability of different
sections of the business, such as sales areas, classes of customers, product lines,
methods of production, etc., may also be compared with the help of profit-volume ratio.
The PV ratio is also used in making the following type of calculations:
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Calculation of break-even point.
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Calculation of profit at a given level of sales.
Calculation of the volume of sales required to earn a given profit.
Calculation of profit when the margin of safety is given
Calculation of the volume of sales required to maintain the present level of profit if
the selling price is reduced.
To determine the variable cost for any volume of sales,
To fix the selling prices,
To locate the break-even point and margin of safety
WAYS TO IMPROVE PV RATIO
P/V Ratio can be improved by:
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By reducing variable cost, or
By increasing the selling price, or
By improving Sales mix
Reducing direct and variable costs by effectively utilizing men, machines and
materials.
Switching the production to more profitable products showing a higher P/V ratio.
23. Explain in brief all functional Budgets? Which functional budgets are most
commonly used by the management?
Functional Budgets
A functional Budget is that budget that is associated with the functions of an
organization. For example Sales budget, Production budget, Labor budget, Cost budget,
Overhead budget, Capital expenditure budget, and Cash budget.
Types Of Functional Budgets
(1). Sales budgets
it is the first budget which is an estimate of expected sales during the budget period. It is
also known as the backbone of the organization. The sales budget is the starting point in
budgeting the other budgets are based on the Sales budget. The sales manager is
responsible for preparing the sales budget. The procedure of sales budget is as:
(i). Data for past Sales. The sales budget is based on past sales figures in the account.
The sales of the last many years speak about ups or downs in the Sale values.
(ii). Production budget. The production budget is based on the sales budget. Once the
sales quantity and values are determined, then arises the problem of how much to
produce to meet the budget sales. The production budget is an estimate of the number
of goods that must be produced during the budget period. While preparing the
production budget, the sales forecast, stock of closing stock and opening stock, plant
capacity, purchase of other related parts are taken into account.
(2). Production Cost Budget
The production cost budget shows in detail the estimated cost of carrying out the
production plans as per the production budget. It represents the cost of various elements
of production cost such as material, labor, and overheads fixed or variables and semivariables. The cost can be expressed as a product or department-wise.
(3). Purchase Budget
The purchase budget is concerned with purchases for the period of the budget. It is
referred to the purchase of raw materials, fixed assets, services like electricity and gas,
etc. The main object of the purchase budget is to formulate a plan which will allow all
purchases at a minimum cost.
(4). Labor Cost Budget
Labor Cost Budget lays emphasis on the labor requirements to meet the demand of the
company during the budget period. The labor cost budget always focuses on Direct and
Indirect labor costs. The labor requirements are referred to the Personnel Department
who is responsible for selection, training, and promotion.
(5). Promotion Overhead Budget
This budget represents the forecast of all production overheads to be incurred during the
budget period. The factory overheads are classified as fixed, variable, and semi-variable.
While preparing this budget, consideration showed to be given to the level of equality
likely to be achieved.
(6). Capital Expenditure Budget
This budget indicates the plans for addition in Capital expenditure (acquiring fixed
assets) improvement in old Assets and replacement of fixed assets. These may be Plant
addition, new building, land, and such as plants.
(7). Cash Budget
The cash budget represents the cash requirements of the business during the budget
period. It compares the estimated Cash Receipts and estimated Cash payments of the
company during the budget period. It ensures that sufficient cash is available when
required.
(8). Master Budget
This budget combines all functional budgets into one harmonious unit. It is a summary
plan of overall proposed operations developed by management for the company,
covering a specific period. It is a summary budget incorporating its functional budgets
which are finally approved, adopted, and employed. This budgeting contains the details
of sales budget, production budget, cash budget, etc. When it is complete, the budget
committee will review all the details and if approved, it will be submitted to the board of
directors. Once it is accepted and approved it becomes the target for the company
during a specific period to achieve the desired target.
24. What are the advantages arising out of the budgetary control system?
Advantages of budgeting and budgetary control
There are a number of advantages to budgeting and budgetary control
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·Compels management to think about the future, which is probably the most
important feature of a budgetary planning and control system. Forces
management to look ahead, to set out detailed plans for achieving the targets for
each department, operation, and (ideally) each manager, to anticipate and give
the organization purpose and direction.
· Promotes coordination and communication.
· Clearly defines areas of responsibility. Requires managers of budget centers to
be made responsible for the achievement of budget targets for the operations
under their personal control.
· Provides a basis for performance appraisal (variance analysis). A budget is
basically a yardstick against which actual performance is measured and
assessed. Control is provided by comparisons of actual results against the
budget plan. Departures from the budget can then be investigated and the
reasons for the differences can be divided into controllable and non-controllable
factors.
· Enables remedial action to be taken as variances emerge.
· Motivates employees by participating in the setting of budgets.
· Improves the allocation of scarce resources.
· Economises management time by using the management by exception principle
25. Distinguish between standard costing and budgetary control.
Key Differences Between Standard Costing and Budgetary Control
The following are the major differences between standard costing and budgetary control:
1. Standard costing is a cost accounting system, in which performance is measured
by comparing the actual and standard costs. Budgetary Control is a control
system in which actual and budgeted results are compared continuously in order
to achieve the desired result.
2. Standard Costing is limited to, cost data, but Budgetary Control is related to cost
as well as economic data of the enterprise.
3. standard costing is a unit concept, unlike budgetary control is a total concept.
4. Standard Costing has a restricted scope, limited to production costs only,
whereas Budgetary Control, has a comparatively wider scope as it covers all the
operations of the whole organization.
5. In Standard Costing variances are revealed and reported however in budgetary
control, as the control are being exercised at the same time, the variances are
not disclosed.
6. In Standard Costing the comparison is made between actual cost and standard
cost of actual output. On the other hand, in Budgetary Control the comparison is
made between the actual and budgeted performance.
7. Standard costs do not change due to short-term changes in the conditions, but
budgeted costs may change.
8. Standard Costing applies to manufacture concerns. In contrast to Budgetary
Control, which applies to all the organizations.
26. Write short notes:
a. Period cost
Period costs are all costs not included in product costs. Period costs are not directly tied
to the production process. Overhead or sales, general, and administrative (SG&A) costs
are considered period costs. SG&A includes costs of the corporate office, selling,
marketing, and the overall administration of company business.
b. Product cost
Product cost refers to the costs incurred to create a product. These costs include direct
labor, direct materials, consumable production supplies, and factory overhead. Product
cost can also be considered the cost of the labor required to deliver a service to a
customer.
c. Process costing
Process costing is a method of costing used mainly in manufacturing where units are
continuously mass-produced through one or more processes. Examples of this include
the manufacture of erasers, chemicals, or processed food.
d. Operating costing
Operating costing is an extension and refined form of process costing. It is also more or
less very similar to single or output costing. The operating costing gives more emphasis
on providing services rather than the cost of manufacturing an article. The services
provided may be for sale to the general public or they may be provided within an
organization.
e. Break-even analysis
Break-even analysis is a technique widely used by production management and
management accountants. It is based on categorizing production costs between those
which are "variable" (costs that change when the production output changes) and those
that are "fixed" (costs not directly related to the volume of production).
f. Make or buy decision
Make-or-Buy decision (also called the outsourcing decision) is a judgment made by
management whether to make a component internally or buy it from the market. While
making the decision, both qualitative and quantitative factors must be considered.
Examples of the qualitative factors in make-or-buy decisions are control over the quality
of the component, reliability of suppliers, the impact of the decision on suppliers and
customers, etc.
g. Types of costing
IMPORTANT METHODS OF COSTING:
Unit costing:
It is also called single output costing. It is used in the cost of products that are expressed
in identical units and suitable for products that are manufactured by continuous activity.
Example: Cement manufacturing, Dairy, Mining, etc.
Job costing:
Under this method, costs are ascertained for each work order separately as each has its
own specification and scope. Tailor-made products also get covered by this type of cost.
Contract costing:
In this method costing is done for jobs that involve heavy expenditure and stretches over
a long period and across different sites. It is also called terminal costing.
Example: Construction of roads and bridges, buildings, etc
Batch costing:
Through this method, the costing is done for units that are produced in batches that are
uniform in nature and design.
Example: Pharmaceuticals
Process costing:
It is used for products that go through different processes. Like in the process of
manufacturing cloth, different processes are involved namely spinning, weaving, and
finished product. Each process gives an output that is a finished product in itself and can
be sold. That is why; process costing is used to ascertain the cost of each stage of
production.
Service or operating costing:
It is the method used for the cost of operating a service such as Public Bus, Railways,
Nursing home. It is used to ascertain the cost of a particular service.
Multiple costing:
When the output comprises different assembled parts like in televisions, cars, or
electronic gadgets, the cost has to be ascertained for the component as well as the
finished product. Such costing may involve different/multiple methods of cost.
Product Costing:
Product costing methods are used to assign costs to a manufactured product. The main
costing methods available are process costing, job costing, and direct costing. Each of
these methods applies to different production and decision environments.
The main product costing methods are:
Job costing: This is the assignment of costs to a specific manufacturing job. This method
is used when individual products or batches of products are unique, and especially when
jobs are being billed directly to customers or are likely to be audited by customers.
Process costing: This is the accumulation of labor, material, and overhead costs across
departments or entities, with the total production cost, then being allocated to individual
units. Process costing is used when large quantities of the same product are
manufactured, usually in long production runs.
h. Job costing
Job costing:
Under this method, costs are ascertained for each work order separately as each has its
own specification and scope. Tailor-made products also get covered by this type of
costing
i. Cost audit
A cost audit represents the verification of cost accounts and checking on the adherence
to the cost accounting plan. Cost audit ascertains the accuracy of cost accounting
records to ensure that they are in conformity with cost accounting principles, plans,
procedures, and objectives
j. Profit Volume Ratio
The profit-volume ratio indicates the relationship between contribution and sales and is
usually expressed in percentage.
The ratio shows the amount of contribution per rupee of sales. Since, in the short-term,
fixed cost does not change, the profit-volume ratio also measures the rate of change of
profit due to a change in the volume of sales.
k. Back flush accounting
Backflush accounting is when you wait until the manufacture of a product has been
completed, and then record all of the related issuances of inventory from stock that were
required to create the product.
l. Types of budget
1. Incremental budgeting
Incremental budgeting takes last year's actual figures and adds or subtracts a
percentage to obtain the current year's budget. It is the most common method of
budgeting because it is simple and easy to understand. Incremental budgeting is
appropriate to use if the primary cost drivers do not change from year to year. However,
there are some problems with using the method:
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It is likely to perpetuate inefficiencies. For example, if a manager knows that there
is an opportunity to grow his budget by 10% every year, he will simply take that
opportunity to attain a bigger budget, while not putting effort into seeking ways to
cut costs or economize.
It is likely to result in budgetary slack. For example, a manager might overstate
the size of the budget that the team actually needs so it appears that the team is
always under budget.
It is also likely to ignore external drivers of activity and performance. For
example, there is very high inflation in certain input costs. Incremental budgeting
ignores any external factors and simply assumes the cost will grow by, for
example, 10% this year.
2. Activity-based budgeting
Activity-based budgeting is a top-down budgeting approach that determines the number
of inputs required to support the targets or outputs set by the company. For example, a
company sets an output target of $100 million in revenues. The company will need to
first determine the activities that need to be undertaken to meet the sales target, and
then find out the costs of carrying out these activities.
3. Value proposition budgeting
In value proposition budgeting, the budgeter considers the following questions:
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Why is this amount included in the budget?
Does the item create value for customers, staff, or other stakeholders?
Does the value of the item outweigh its cost? If not, then is there another reason
why the cost is justified?
Value proposition budgeting is really a mindset about making sure that everything that is
included in the budget delivers value for the business. Value proposition budgeting aims
to avoid unnecessary expenditures - although it is not as precisely aimed at that goal as
our final budgeting option, zero-based budgeting.
4. Zero-based budgeting
As one of the most commonly used budgeting methods, zero-based budgeting starts
with the assumption that all department budgets are zero and must be rebuilt from
scratch. Managers must be able to justify every single expense. No expenditures are
automatically "okayed". Zero-based budgeting is very tight, aiming to avoid any and all
expenditures that are not considered absolutely essential to the company's successful
(profitable) operation. This kind of bottom-up budgeting can be a highly effective way to
"shake things up".
The zero-based approach is good to use when there is an urgent need for cost
containment, for example, in a situation where a company is going through a financial
restructuring or a major economic or market downturn that requires it to reduce the
budget dramatically.
Zero-based budgeting is best suited for addressing discretionary costs rather than
essential operating costs. However, it can be an extremely time-consuming approach, so
many companies only use this appro
m. Activity based costing
Activity-based budgeting is a top-down budgeting approach that determines the number
of inputs required to support the targets or outputs set by the company. For example, a
company sets an output target of $100 million in revenues. The company will need to
first determine the activities that need to be undertaken to meet the sales target, and
then find out the costs of carrying out these
n. Inventory valuation
Inventory valuation is the monetary amount associated with the goods in the inventory at
the end of an accounting period. The valuation is based on the costs incurred to acquire
the inventory and get it ready for sale.
o. Labour Turnover
Labor turnover, also known as staffing turnover, refers to the ratio of the number of
employees who leave a company through attrition, dismissal or resignation to the total
number of employees on the payroll in that period
p. Zero based budgeting
Zero-based budgeting (ZBB) is an approach to making a budget from scratch. The
budget is not based on previous budgets. Instead, the budget starts at zero. With zerobased budgeting, you need to justify every expense before adding it to the official budget
q. Marginal costing
Marginal costing is the accounting system in which variable costs are charged to cost
units and fixed costs of the period are written off in full against the aggregate
contribution. Note that variable costs are those which change as output changes - these
are treated under marginal costing as costs of the product
r. Controllable cost Vs. Uncontrollable cost s
Controllable cost refers to a cost that can be altered based on a business decision or
need. On the other hand, uncontrollable cost refers to a cost that cannot be altered
based on a personal business