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					                     CHAPTER 1: MANAGEMENT ACCOUNTING

        Accounting may be broadly classified into two categories – accounting which is
meant to serve all parties external to the operating responsibility of the firms and the
accounting which is designed to serve internal parties who take care of the operational needs
of the firm. The first category which is conventionally referred to as financial accounting,
looks to the interest of those who have primarily a financial stake in the organization‟s affairs
– creditors, investors, employees etc. On the other hand the second category of accounting is
primarily concerned with providing information relating to the conduct of the various aspects
of a business like cost or profit associated with some portions of business operations to the
internal parties viz., management. This category of accounting is called as Management
        In order to perform the primary task of decision making managers of business
enterprises need information about the past, present and future in the functional areas of
management such as personnel, finance, marketing and production. Right decision making
has to be based on quantitative and qualitative information. The management thus constantly
needs accounting information to base its decisions upon. Thus management accounting
provides the information needed by management personnel.

        The Institute of Chartered Accountants of England has defined management
accounting as: “Any form of accounting which enables a business to be conducted more
efficiently can be regarded as Management Accounting”.
        As per American Accounting Association, “Management Accounting includes the
methods and concepts necessary for effective planning, for choosing among alternative
business actions and for control through the evaluation and interpretation of performances.
        As per Institute of Chartered Accountants of India, “Such of its techniques and
procedures by which accounting mainly seeks to aid the management collectively have come
to be known as management accounting”.
        The Chartered Institute of Management Accounts (UK) defines management
accounting as under:
“Management accounting is an integral part of management concerned with identifying,
presenting and interpreting information used for:
        1. Formulating strategy
        2. Planning and controlling activities
        3. Decision making
        4. Optimizing the use of resources
        5. Disclosures to shareholders and others external to the entity
        6. Disclosure to employees
        7. Safeguarding assets.”

Nature of management accounting:
Managerial personnel are entrusted with authority and responsibility of operating business
activities. Management accounting provides information to the personnel are entrusted with
authority and responsibility of operating business activities. Management accounting
provides information to the managerial personnel at three levels of management viz., top,
middle and lower levels of management. It provides the management with the tools for an
analysis of its administrative action that can lay suitable emphasis on the possible alternatives
in terms of costs, prices and profits. The decisions made by management are based on
quantitative information and common sense, foresight, knowledge and experience.
Management accounting includes financial accounting information and raw material from
several other disciplines such as costing, statistics, mathematics, political science, sociology,
psychology, management economics, law etc. With all these data he can ensure optimum
utilization of all the resources including employees by maintaining sound morale of the
employees, maximization of output and minimization of inputs, analyze the managerial
questions in terms of costs, revenues, profits and growth. It is thus a highly personalized
service with the help of which management can explore and exploit business opportunities
and take sound and correct decisions. It is not a precise science as it uses its own conventions
rather than standardized principles. Therefore the inferences drawn from the facts provided,
depends on the skill, judgment and common sense of different management accountants.
Thus it is said that management accounting serves as a management information system
which enables the effective management of an enterprise.

Scope of management accounting:
Management accounting is a wide and diverse subject. As stated earlier it includes various
branches of knowledge such as psychology, sociology, economics, laws, political science,
mathematics, statistics, finanacial accounting, cost accounting etc. It is thus very difficult to
define its scope, as it is a dynamic and ever growing discipline of knowledge. The important
techniques and systems used by management accounting are briefly stated below.
        a. Historical cost accounting: Maintenance of books of cost accounting enables to
            know the actual costs incurred by the firm.
        b. Standard costing: The standard costs laid down by experts are compared with the
            natural costs in order to know the deviations
        c. Marginal costing: The costs are divided into fixed and variable costs which help is
            making vital decisions.
        d. Decision accounting: Decisions are made after studying the impact of decisions in
            terms of costs, resource, profits, growth etc.
        e. Budgetary control: It is a system of controlling the cost with the help of budgets.
        f. Control accounting: It includes the techniques such as standard costing, budgetary
            control, control reports, internal check, internal audit and reports.
        g. Revaluation accounting: It is based on current costs to ensure that the investment
            is intact and profits from investment are kept in mind.
        h. Financial planning & policies: It consists of raising the long term and short term
            finance and invest it on optimum basis and enhance the profitability of the firm.
        i. Capital expenditure: The large amounts of future capital expenditure and future
            profits are analysed to take important decisions.
        j. Break even analysis: This is an important technique which is used to analyse the
            behavior of costs viz., fixed and marginal costs, indicating the level of activity at
            which the total costs would equal the total revenue and also the margin of safety.
        k. Inter-period comparison: It is a technique of comparing the present performance
            with the past performance.
        l. Techniques of forecasting: Some techniques like decision tree, probability and
            sensitivity analysis are used by management accountants for forecasting which
            forms a base for planning.
        m. Operations research: It consists of statistical and mathematical techniques that are
            increasingly used in decision making process.
        n. Statistics: The statistical techniques used by management accountant are
            correlation, regression, probability, time series, standard deviation, linear
            programming, control charts etc.
       o. Other techniques: Other techniques employed are: Financial reporting, data
          processing, project management and appraisal, management audit, efficiency
          audit, cost audit, performance budgeting, tax planning, social accounting & audit,
          human resource accounting, responsibility accounting and divisional performance.

Functions of management accounting:
   1. Modification of data: The management accounting system modifies the data furnished
      by financial accounting to serve the managerial needs in such a way that the process
      of classification and combination which enables to retain similarities without
      eliminating dissimilarities.
   2. Validating the data: To make reliable decisions valid data should be made available to
      managers. The effectiveness of managerial function depends too much upon the
      accuracy and adequacy of the data. It is the function of management accounting to
      present before the management the required data with some sort of reasonable
      accuracy and it need not be with perfect accuracy.
   3. Analysis and interpretation of data: Though management accounting is concerned
      with recording of business transactions, the analysis and interpretation of such data, in
      analyzing and interpreting the data lies the essence of management accounting. To
      discharge this function management accounting uses a number of tools like Marginal
      costing, budgeting, standard costing etc.
   4. Communicating the data: The collected and interpreted data must be communicated to
      those who are interested in it or to whom it has some meaning. Otherwise these data
      may not yield any meaningful result and the whole process of collecting, validating
      and interpreting would amount to be a futile exercise. The communication of the data
      should be done within a reasonable time. Data delayed is decision delayed and a
      delayed decision may delay the prosperity of its concern. To accomplish this function
      of management accounting several reports and statements are being used.

Functions of a management accountant: Although it is understood that all the functions of
management accounting are to be performed by the management accountant, the following
may be said to be the important role of the management accountant in the management of a
      1. Collection of data: The management accountant has to collect data about the
          problems faced by the management through primary and secondary sources.
      2. Analysis of data: After the collection of data, the management accountant has to
          analyse it for the purpose of interpretation using various tools and techniques.
      3. Presentation of data: The management accountant is required to present the data to
          the management in columns and rows to facilitate proper understanding.
      4. Planning: The management accountant assists the management in long range
          planning as well as in formulation of policies of the organisation.
      5. Controlling: The management accountant follows different techniques like
          standard costing, budgetary control etc to ensure adequate control for
          implementation of plans and achievement of objectives.
      6. Reporting: Reporting being a very important function of a management
          accountant, he has to prepare different types of reports periodically and
          communicated to the concerned departments to meet the requirements at different
          levels of management for necessary action.
      7. Co-ordinating: The management accountant has to co-ordinate the various
          activities of the organization for the preparation of master budget and other such
       8. Decision making: The management accountant has to assist the management in
          taking realistic decisions through analysis and interpretation of data that suggests
          a particular course of action with the help of various tools of management

Management accounting vs. financial accounting
Financial accounting and management accounting are two interrelated facets of the
accounting system. They are not independent of each other but they are interdependent.
Financial accounting provides the basic data which are analysed and interpreted suitably and
in the required manner by management accounting. Although there exists close relationships
between financial accounting and management accounting, distinction is always drawn
between financial accounting and management accounting since they differ in their emphasis
and approaches.

Dimension                  Management Accounting                 Financial Accounting
   1. Objective            To provide information for internal   To make periodical reports
                           management                            to shareholders, creditors,
                                                                 debenture holders and the
   2. Structure            Varies according to use of the        Unified structure
   3. Sources of           Whatever is useful to management      Generally accepted
      principles                                                 accounting principles
   4. Need                 Optional                              Statutory obligation

   5. Time-orientation     Historical and estimates of the       Historical
   6. Report entity        Responsibility centers                Overall organization

   7. Purpose              A means to the end of assisting       External reporting /
                           management                            statements for outside users
   8. Users                Relatively small group: known         Relatively large group:
                           identity                              mostly unknown
   9. Information          Monetary and non-monetary             Primarily monetary
   10. Information         Many approximations                   Few approximations
   11. Report frequency    Varies with purpose, monthly and      Quarterly and annual
   12. Report timeliness Reports issued promptly after end       Delay of weeks or even
                         of period covered                       months
   13. Period of            Reports are for shorter durations.     Generally adopts twelve
       reporting            The data is also collected for         months period for reporting
                            preparing long term plans for five     financial performance.
                            or more years.
   14. Liability            Virtually none.                        Few lawsuits but threat is
       potential                                                   always present.
   15. Record               Costs and revenues reported by         Records maintained in the
       maintenance &        responsibility centres or cost         form of personal, property
       reporting            centres                                and nominal accounts.

   16. Role of              Transcends beyond book-keeping         Limits the role to a book-
       accountant           into the managerial process of         keeper.
                            planning, organizing, control and
                            evaluating and also to different
                            functional areas.

Management accounting vs. cost accounting
        Costing has been defined as classifying, recording and appropriate allocation of
expenditure for the determination of the costs of products or services. Cost accounting will
tell the management as to how the business has fared at each stage of operation. But cost
accounting will not tell them anything about the future policy to be adopted. It is here that
management accounting differs from cost accounting. The aim of management accounting is
not to collect information as such but to utilize the information collected in order to help the
management to formulate their future policy and to make important policy decisions.
        Though there is a difference between management accounting and cost accounting in
their objective yet their functions are complementary in nature. Management accounting
depends heavily on cost data and other information derived from cost records. In one way,
management accounting is an expansion of cost accounting. Like cost accounting,
management accounting involves reporting at frequent intervals rather than at the end of a
year or half-year.
        Cost accounting deals primarily with cost data. But management accounting involves
the consideration of both costs and revenues. It is a broader concept than cost accounting. It
not only reports costs but also uses them to assist management in planning possible alternate
courses of action.
        Conceptually speaking management accounting is a blending together of cost
accounting, financial accounting and all aspects of financial management. It has a wider
scope as a tool of management. But it is not a substitute for other accounting functions. It is a
continuous process of reporting cost and financial data as well as other relevant information
to management.

Cost: Cost means the amount of expenditure incurred on a particular thing. CAS-1 (Cost
Accounting Standard 1, issued by the ICWA, India) defines Cost as: Cost is a measurement,
in monetary terms, of the amount of resources used for the purpose of production of goods or
rendering services.

Costing: Costing means the process of ascertainment of costs. Costing involves the following
steps (i) Ascertaining or collecting costs (ii) Analysing or classifying costs into basic
elements such as Material, Labour, Expenses etc. and (iii) Allocating total costs to a
„particular thing‟ i.e. a product, a contract or a process. Thus cost can now be defined as the
total expenditure, duly classified into materials, labour, expenses etc. allocated to a particular
product or contract or process.

Cost Accounting: The Institute of Cost and Management Accountant, England (ICMA) has
defined Cost Accounting as – “the process of accounting for the costs from the point at which
expenditure incurred, to the establishment of its ultimate relationship with cost centres and
cost units. In its widest sense, it embraces the preparation of statistical data, the application of
cost control methods and the ascertainment of the profitability of activities carried out or

Cost accounting is a term broader than costing. It covers costing plus the reporting and
control of costs. Thus Cost Accounting = Costing + Cost Reporting + Cost Control. Cost
accounting can be defined as the technique of recording, classification, allocation, reporting
and control of costs.

Objectives of cost accounting:
Cost accounting has the following basic aspects or objectives:
  1. Costing: It involves the following basic aspects or 5 „A‟s:
           a. Ascertain costs relating to a particular period,
           b. Analyse or classify costs under different heads of accounts such as material,
               labour, expenses etc.,
           c. Allocate costs fully to the direct expenses or the specific costs such as raw
               materials, labour to the relevant products, contracts or processes,
           d. Apportion or distribute common costs to each product, contract or process on a
               suitable basis and
           e. Absorb the total expenses of a department over its products so as to finalise the
               cost of each product that is then reported to the management.
  2. Cost reporting: Cost reporting has the following aspects:-
           a. What to report or the nature of information to be presented should be relevant
               and precise.
           b. Whom to report will determine the scope of the report to be submitted to the
               top management.
           c. When to report – daily, weekly, monthly, quarterly or yearly etc.
           d. How to report or the format will depend on the factors mentioned above. Once
               the cost report is received, management can take action to control the costs.
  3. Cost Control: Cost control has been defined by the ICMA as “the guidance and
       regulation by executive action of the costs of operating an undertaking”. Thus cost
       control means the control of costs by management. Following are the aspects or stages
       of cost control.
         a. Set targets for cost, production, profits etc. for each period.
         b. Measure Actual Performance relating to cost, production profits for the period
         c. Compare targets with actuals to find out the variations
         d. Analyse variations, the causes for variations whether favourable or adverse are
             to be investigated. While adverse variations denote wastages and loses,
             favourable variations may indicate the targets fixed are very low. In both cases
             the exact reasons for the variations are to be known.
         e. Take action once the causes are known to eliminate avoidable losses etc.
   4. Other aspects: The other aspects or objectives of cost accounting are as follows:
         a. Provide required data for fixing sales price for submitting tenders, quotations
         b. Assist the management in controlling inventory for raw materials, goods in
             process, finished goods, spares and consumables etc.
         c. Advice management on future policies regarding expansion, growth, capital
             investment etc.
         d. Install labour incentive system for getting maximum productivity from labour
             at optimum cost.
         e. Advice management in deciding optimum product-mix, merits and demerits of
             alternative courses of actions (make or buy etc.,) introduction of automation,
             mechanization, rationalization of system of production etc.

Thus the objectives can be summarized as follows:
   1. Ascertainment of costs
   2. Estimation of costs
   3. Cost control
   4. Cost reduction
   5. Determining selling price
   6. Facilitating preparation of financial and other statements
   7. Providing basis for operating policy

Importance and advantages of Cost Accounting:
Cost accounting is not only important to the management and owners but also to many others
like the workers, the Government, the consumers, the public at large and so on. The
advantages are as follows.

   1. To the management and the owners: Cost accounting helps the management of the
      concern to ascertain the cost and profitability of each individual product / service/
      contract/ process/ division/ branch separately. This also helps in valuation of the
      closing stock of goods at the end of the year. It helps the management of the concern
      in controlling costs in reducing the avoidable expenditure, and minimizing wastages
      and losses. It ensures the reconciliation of quantity of input with the quantities of
      output, wastages and scrap. The management is thus able to regulate and monitor the
      movement of materials thus preventing theft and loss of materials during processing
      and handling. It is of great help to the management in taking several decisions such
      as, which products to produce more, how much to produce, whether to make or buy a
      component, what price to charge or quote. Thus cost accounting is an invaluable
      decision aid to decision making. It also facilitates in preparation of budgets and
      implementation of budgetary control in the organization. The end result of all the
      above advantages of cost accounting is maximization of profits of the concern thus
      benefiting the owners by increasing their net worth or the share prices, higher
      dividends etc.
   2. To the workers: Cost accounting has an elaborate system of assessing the performance
      of workers and rewarding them suitably through incentives and bonus. The increase in
      profits due to a cost accounting system also leads to higher remuneration and bonus to
      the workers.
   3. To the Government / Consumers / Public: In case the products are under price control,
      cost accounting furnishes the data required by the government for fixing fair prices.
      Consumers benefit since the prices fixed on the basis of the cost data are just and
      reasonable and cannot be too high. It also leads to efficiency and productivity in the
      industrial sector. It ensure optimum utilization of the scarce economic resources of the
      country. Cost accounting leads to maximum profits for an organization. Naturally the
      Government also gains by way of more taxes on production, income and sales etc.
      The higher revenue is used by the Government for public welfare and economic

Criticisms of Cost accounting:
   1. Duplication: It is argued that cost accounting is duplication when a good financial
        accounting system is already in operation. Cost accounting takes its basic data from
        books of accounts and just rearranges it in a different way.
   2. Inapplicable: In a concern producing a single product involving no complex
        processes, cost accounting is inapplicable. It is also of no use in non-profitable
        organizations or in agriculture etc.
   3. Not useful for decision making: In many cases, the decisions of the management are
        not based on cost accounting data. Thus the decision regarding which item to produce
        and how much to produce depends on the license given by the Government and the
        market forces of demand and supply.
   4. Expensive and routine: A cost accounting system is quiet expensive to install and
        operate. At times the cost accounting systems become mere routing of filling the
        forms and submitting standard reports. Non-cooperation from staff also may lead to
        failure of the system in many concerns.

However, proper planning and implementation of the cost accounting system will overcome
these criticisms and would stand null and void in view of the objectives, importance and
advantages of the cost accounting system.

Functions of Cost Accountant:
The main functions of a cost accountant can be summarized as follows:
   1. Determining cost and analyzing income: A cost accountant determines the cost of a
      job, product or process as the case may be. He analyses and classifies costs according
      to different cost elements, viz., materials, labour and expenses. Such analysis enables
      him to tell the management the significance of the different cost elements and fixation
      of the selling prices of the products manufactured by the business. He advises the
      management about the profitability or otherwise of each job, product or process.
      Thus, he helps the management in maximizing business profits.
   2. Providing cost data for planning and control: A cost accountant collects, classifies and
      presents in appropriate form suitable data to the management for planning and
      controlling the operations of the business. He makes constant endeavour to control
      and reduce the cost by the following techniques:
          a. He submits regular reports to the management regarding wastage of material,
             idle time, idle capacity, etc. He identifies the causes and suggests suitable
             controlling measures to prevent or reduce losses on account of these causes.
          b. He makes product-wise or process-wise comparisons to identify non-profitable
             products or processes.
          c. He develops cost consciousness in the organization by adoption of budgetary
             control and standard costing techniques.
          d. He maintains an even flow of materials and at the same time prevents
             unnecessary investment of materials through different material control
             techniques e.g. ABC analysis, perpetual inventory system, materials turnover
             ratios, fixation of different levels of materials etc.
          e. He organizes various cost reduction programmes with the co-operation and co-
             ordination of different departmental heads.
   3. Undertaking special cost studies for managerial decision-making: A cost accountant
      undertakes special cost studies and carries out investigation for collecting and
      presenting suitably the data to the management for decision-making regarding the
      following areas:
          a. Introduction of new products, replacement of manual labour by machines etc.
          b. Make or buy decisions, replacing or repairing old machines, accepting orders
             below cost, etc.
          c. Expansion plans, installation of new capital project, etc.
          d. Utilisation of idle capacity and development of a proper information system to
             provide prompt and correct cost information to the management.
          e. Installation of a cost audit system.

All types of manufacturing concerns can broadly be classified into two categories – (i) Mass-
production concerns, (ii) Special order concerns. Mass production concerns such as chemical
plants, flour mills, paper manufacturing, tyre and rubber companies etc., produce uniform
standard products and involve generally a continuous production process. The finished
products are the result of successive operations. On the other hand, special-order concerns
manufacture products in clearly distinguishable lots in accordance with special orders and
individual specifications. Printing shops, construction companies, machine tool
manufacturing, repair shops, wood-working shops etc., come in this category. In case of mass
production concerns the products when produced are of the same type, and involve the same
material and labour and pass through the same set of process. In such industries each process
is designated as a separate cost-centre and the cost per unit is calculated by dividing total cost
of the process with the total number of units produced by the process. The cost of production
of the product is obtained by adding the unit costs of various processes through which the
product has passed. This method of costing is known as process costing.

Job Costing:
In case of special-order concerns products produced or jobs undertaken are of diverse nature.
They involve materials and labour in different quantities and entail different amounts of
overhead costs. In such concerns it is necessary to keep a separate record of each lot of
products or jobs from the time the work on the job or product begins till it is completed. A
separate job card or sheet is maintained for each job or product in which all expenses of
materials, labour, overheads are entered and cost of completing a job or manufacturing a
product is found out. Such a cost system is known as job or terminal or specific costing.

Objectives of job costing:
   1. It helps in finding out the cost of production of every order and thus helps in
       ascertaining profit or loss made out on its execution. The management can judge the
       profitability of each job and decide its future courses of action.
   2. It helps management in making more accurate estimates about the costs of similar
       jobs to be executed in future on the basis of past records. The management can
       conveniently and accurately determine and quote prices for orders of a similar nature
       which are in prospect.
   3. It enables management to control operational inefficiency by comparing actual costs
       with the estimated ones.
A system of job costing should be adopted after considering the following two factors.
   a. Each order or job should be continuously identifiable from the raw material stage to
       the stage of completion.
   b. The system is very expensive because it requires a lot of clerical work in estimating
       costs, designing and scheduling of production. It should, therefore, be adopted when
       absolutely warranted.

The following is the procedure adopted for costing purposes in a concern using job costing:
   1. Job order number: Every order received is allotted a certain number from a running
       list maintained for this purpose. Every order or job will be known by its number
       throughout its production process in the factory.
   2. Production / job order: A production / job order is a written order issued to the
       manufacturing department to proceed with a job. It is issued by the production
       planning department on receipt of a job order to the foreman of the relevant
       department. Instructions to the costing department to collect particulars of costs on
       execution of the job are also issued simultaneously. The production order is prepared
       with sufficient copies for all the departmental managers or foreman who will be
       required to take any part in the production.
   3. Bills of materials: The production and planning department also prepares a list of
       materials and stores required for the completion of the job. A copy is also sent to the
       concerned foreman with the production order which serves as an authority to him for
       collecting the materials and stores mentioned from the storekeeper. On the same
       pattern a list of tools required is also prepared.
   4. Job cost card: Job cost card or job cost sheet is the most important document used in
       the job costing system. A separate card or cost sheet is maintained for each job in
       which all expenses regarding materials, labour and overheads are recorded directly
       from costing records. The method of finding out the cost of these elements in respect
       of a particular order is as follows.
            a. Materials: The information regarding cost of materials or stores used for a
               particular job order can be obtained from materials or stores requisition slips.
               In case of large job orders, materials abstracts can be prepared for finding out
               the total value of materials issued to different jobs.
            b. Labour: The cost of labour incurred on each job can be ascertained with the
               help of time and job cards. In case of a large number of jobs, preparation of
               wages abstract may considerably help in computing the amount paid as wages
               for completion of specific jobs. Wages paid for indirect labour will constitute
               an item of factory overheads.
            c. Overheads: Every job will be charged with amount of overheads determined
               on the basis of the method selected for allocation of overheads. Normally on
              the basis of past results an overhead rate is determined and each job is charged
              for overheads at the pre-determined rate.
          Profit or loss on a job can also be found out by preparing a job account. The job
          account is debited with all expenses incurred on the job and is credited with the
          job price. The difference of the two sides will be the profit or loss made or
          suffered on the job.
   5. Work-in-process: The account is maintained in the cost ledger and it represents the
      jobs under production. The account may be maintained in any of the following two
      ways depending upon the requirements of the business:
          a. A composite work-in-process account for the entire factory.
          b. A composite work-in-process account for every department. For example, if
              the factory has three departments A, B and C, a work-in-process for each of
              these three departments will be opened.
          The work-in-process account is periodically debited with all costs direct and
          indirect incurred in execution of the jobs. At intervals of month or so a summary
          of completed jobs is prepared and the work-in-process account is credited with the
          cost of completed jobs. In case work-in-progress account for each department of
          the factory has been opened, it will be necessary to find out the cost of completed
          jobs regarding each department. The balance in work-in-process account at any
          time represents the cost of jobs not yet completed.
   6. Job ticket: In order to provide information regarding the progress of each job at each
      operation, generally a job ticket is issued by the production control department. The
      ticket contains detachable portions for different operations. The job ticket is useful for
      both production control and costing departments. On completion of an operation, the
      relevant portion of ticket is detached and sent to production control department. This
      enables production control department in keeping production schedule up-to-date. On
      the basis of detached portion a departmental summary of production can be prepared
      which is very useful for costing purposes. Moreover, the amount of work-in-process
      as shown by the cost ledger can be checked by listing the ticket number of jobs in
      process in any department and valuing this list.
   7. Progress advice: The foreman of a department may be required to send periodically a
      statement regarding the stage of completion of each job to ensure completion of jobs
      by scheduled dates. Such a note is called “progress advice”.

Advantages of job costing:
   1. Job costing enables the management to identify spoiled and defective work in respect
      to particular production orders, departments or groups of workers and hence the
      management can fix up responsibility for inefficiency.
   2. Management can determine the trends in costs and compare the operating efficiency
      of men and machines in each cost centre. It can also determine the completion cost of
      each job.
   3. It enables the preparation of estimates of costs of jobs before production.
   4. It enables comparison of estimated costs with actual costs as the costs are analysed on
      the basis of costs, services and production.
   5. It makes available to the management a complete file of production orders which
      contains valuable statistics on cost.
   6. It enables ascertainment of profit or loss on each job immediately after their
   7. It enables the management to identify unprofitable jobs.
   8. In case of cost plus contracts, job costing enables to provide precise quotations.
   9. It helps in production planning.
   10. It facilitates fixation of selling price.

Limitations of job costing:
   1. Job costing involves a lot of clerical work in identifying materials, labour and
       overheads with specific jobs and departments.
   2. Management cannot evaluate precisely the operating efficiency of men and machines.
   3. Since costs ascertained and compiled are historical costs, they are not of much utility
       to the management.
   4. It does not apply budgetary control to important cost elements such as labour,
       materials and overheads.
   5. Job costs over any period of time cannot be compared if major economic changes take
       place in between.
   6. It is expensive to operate and errors are possible due to increased clerical work.

Batch Costing:
Batch costing is a modified form of job costing. While job costing is concerned with costing
of jobs that are executed against specific orders of the customers, batch costing is used where
articles are manufactured in definite batches. The articles are usually kept in stock for selling
to customers on demand. The term batch refers to the lot in which the articles are to be
manufactured. Whenever a particular product is required, one unit of such product is not
produced but a lot of say 500 or 1000 units of such product are produced. It is therefore also
known as “Lot Costing”. This method of costing is used in case of pharmaceutical or drug
industries, ready-made garment factories, industries manufacturing component parts of radio
sets, television sets, watches, etc.
The costing procedure for batch costing is similar to that under job costing except with the
difference that a batch becomes the cost unit instead of a job. Separate job cost sheets are
maintained for each batch of products. Each batch is allotted a number. Material requisitions
are prepared batchwise, the direct labour is engaged batchwise and the overheads are also
recovered batchwise. Cost per unit is ascertained by dividing the total cost of a batch by
number of items produced in that batch. Ordinary principles of inventory control are used.
Production orders are issued only when the stock of finished goods reaches the ordering
level. In case the batches are repetitive, the costing work is much simplified.

Since in batch costing production is done in batches and each batch consists of a number of
units, the determination of optimum quantity to constitute an economical batch is all the more
important. Such a quantity can be fixed on the basis of same formulae and principles as are
applicable to economic order quantity of materials.

       Economic Batch Quantity                     =   2U x P
U = Annual demand
P = Setting up and order placing costs per batch
S = Storage or inventory carrying over cost per unit per annum
                         CHAPTER 3: STANDARD COSTING

Standard costing is defined as – “the preparation and use of Standard Costs, their comparison
with actual costs and the analysis of variance as to their causes and point of incidence.
ICWA London had defined Standard Costing as – “the preparation of Standard Costs and
applying them to measure the variations of actual costs from standard costs and analyzing the
causes of variations with a view to maintain maximum efficiency in production”.

Material Variances:
  1. Material Cost Variance [MCV]
      It is the difference between the standard cost of material specified for the output
      achieved and the actual cost of direct material used. It is said to be favourable when
      standard cost is more than actual cost and adverse when actual cost exceeds standard
      costs. It is further divided into Material Usage Variance and Material Price Variance.

              MCV = SC – AC
                  = (SQ x SP) – (AQ x AP)

   2. Material Usage Variance [MUV]
      It is that portion of the Material Cost Variance which is due to the difference between
      the Standard Quantity specified for the actual output and the Actual Quantity used for
      the actual output. It is said to be favourable when standard quantity is more than
      actual quantity and adverse when actual quantity exceeds standard quantity.

              MUV = (SQ – AQ) x SP

   3. Material Price Variance [MPV]
      It is that portion of the Material Cost Variance which is due to the difference between
      the Standard Price specified for the Actual Output and the Actual Price paid. Material
      Price Variance is said to be favourable when the actual price is less than the standard
      price and adverse when the actual price is more than the standard price.

              MPV = (SP – AP) x AQ

   4. Verification
      Material Cost Variance = Material Usage Variance + Material Price Variance
      i.e. MCV = MUV + MPV
Labour Variances:

   1. Labour Cost Variance [LCV]
      It is the difference between the standard cost of labour specified for the output
      achieved and the actual cost of direct labour used. It is said to be favourable when
      standard cost is more than actual cost and adverse when actual cost exceeds standard
      costs. It is further divided into Labour Efficiency Variance and Labour Rate Variance.

              LCV    = SC – AC
                     = (SH x SR) – (AH x AR)

   2. Labour Efficiency Variance [LEV]
      It is that portion of the Labour Cost Variance which is due to the difference between
      the Standard Hours specified for the actual output and the Actual Hours used for the
      actual output. It is said to be favourable when standard hour is more than actual hour
      and adverse when actual hour exceeds standard hour.

              LEV = (SH – AH) x SR

   3. Labour Rate Variance [LRV]
      It is that portion of the Labour Cost Variance which is due to the difference between
      the Standard Rate specified for the Actual Output and the Actual Rate paid. Labour
      Rate Variance is said to be favourable when the actual rate is less than the standard
      rate and adverse when the actual rate is more than the standard rate.

              LRV = (SR – AR) x AH

   4. Verification
      Labour Cost Variance = Labour Efficiency Variance + Labour Rate Variance
      i.e. LCV = LEV + LRV
                                    Standard Costing

   1. Given the cost standard for material consumption are 40 kg. @ Rs. 10 per kg.
      Compute the material variances when actuals are:
             a. 48 kg @ Rs.10 per kg.
             b. 40 kg @ Rs.12 per kg.
             c. 48 kg @ Rs. 12 per kg.
             d. 36 kg for a total cost of Rs.360.

   2. Gemini chemical industries provide the following information from their records. For
       making 10 kgs of GEMCO standard material requirement is :
                Material            Quantity (kg)        Rate per kg(Rs.)
                A                   8                    6.00
                B                   4                    4.00
       During April 1000 kg of GEMCO were produced. The actual consumption of
materials is as under:
                Material            Quantity (kg)        Cost (Rs.)
                A                   750                  5250
                B                   500                  2500
       Calculate material variances

   3. Using the following information of department X, calculate all possible labour
             Actual wage rate per hour Rs.3.40
             Standard hours for production 8640 hours
             Standard rate per hour Rs.3.00
             Actual hours worked 8200 hours.

   4. The standard cost card for one unit of a product shows the following costs for material
      and labour:
             Material 4 pieces @ Rs. 5.00 and Labour 10 hours @ Rs.1.50
      5700 units of product were manufactured during the month of March 2002 with the
      following material and labour costs:
             Material 23000 pieces @ Rs.4.95 and Labour 56,800 hours @ Rs.1.52
      Calculate material and labour variances.

   5. The standard cost card of a product shows the following
      Material cost Rs.5 for 2 kg. and Wages Re. 1.00 for 2 hours.
      The actual which have emerged from business operations are as follows:
      Production: 8000 units.
      Material consumed worth Rs.39600 for 16500 kg. and wages paid Rs.7200 for 18000
      hours of work.
      Calculate appropriate material and labour variances.
                               CHAPTER 4: MARGINAL COSTING
Marginal cost is the amount at any given volume of output by which aggregate costs are
changed if the volume of output is increased or decreased by one unit. Thus it is clear that
increase / decrease in one unit of output increases or decreases the total cost from the existing
level to the new level. This increase or decrease in variable cost from existing level to the
new level is called as marginal cost. Suppose the cost of producing 100 units is Rs.200, if 101
units are produced the cost goes up by Rs.2 and becomes Rs.202, if 99 units are
manufactured, the cost is reduced to Rs. 198, then the Rs.2 increase or decrease in the cost of
production of one unit is the marginal cost. Thus the marginal cost of producing one unit is
The ascertainment of marginal costs and of the effect on profit of changes in volume or type
of output by differentiating between fixed and variable costs is said to be marginal costing.

   1. Sales: This is the total amount of sales made by the firm or entity.
   2. Variable cost: This is the cost of the product that keeps changing with the change in
      the volume of production.
   3. Contribution: It is equal to Sales less variable cost. This is the profit before adjusting
      the Fixed Costs. It covers fixed cost and profit.
   4. Fixed cost: It is the cost of the product that does not change over a period even with
      the change in the volume of production.
   5. Profit: It is equal to contribution less fixed costs. This is the profit after adjusting the
      fixed costs. Thus, it does not include fixed cost.
   6. Profit Volume Ratio: The ascertainment of the impact of changes in volume of output
      on profit is done by means of the Profit – Volume Ratio.
               Profit – volume ratio [PV Ratio] = Contribution
      Sales, variable cost and contribution vary directly with the number of units. Thus,
      when the number of units produced or sold increases, the sales, the variable cost and
      the contribution also increase pro-rata. On the contrary, when the number of units
      goes down, the sales, the variable cost and contribution are also lower. Thus there is a
      direct relationship between volume, variable cost and contribution. This is known as
      the volume-cost-profit relationship. The profit-volume ratio indicates this relationship.
   7. Break Even Point: It means the point of no profit and no loss. BEP is the volume of
      output or sales at which the total cost is exactly equal to the revenue. Below BEP the
      concern makes losses, at the BEP, the concern makes neither profit nor loss, above
      BEP, the concern earns profits. BEP is calculated in terms of units or value. Thus
               BEP (in units) =       Fixed Cost             =     F
                                 Contribution per unit          S–V

             BEP (in Rs.) =         Fixed Cost        x Sales = Fixed Cost
                              Contribution per unit                     PV Ratio
   8. Margin of Safety: It is the difference between the Actual Sales and the Sales at the
      Break-even point. Larger Margin of safety indicates stronger business. Such business
      can continue to earn profits, even if sales decrease (i.e. in recession). Thus,
             Margin of Safety (in Rs.) = Actual Sales – BEP Sales (Rs.)
             Margin of safety (in units) = Actual Sales(units) – BEP Sales (in units)
   1. Sales – Variable Cost = Contribution
   2. Contribution – Fixed Cost = Profit
   3. Sales – Variable cost = Fixed cost + Profit
   4. Profit – volume ratio [PV Ratio] = Contribution

   5. BEP (in units) =        Fixed Cost
                        Contribution per unit
   6. BEP (in Rs.) =        Fixed Cost       x Sales = Fixed Cost .
                     Contribution per unit                  PV Ratio
   7. Required Sales (Rs.) = Fixed Cost + Desired Profit
                                     PV Ratio
   8. Required Sales (Units) = Fixed Cost + Desired Profit
                                     Contribution per Unit
   9. Actual Sales = Fixed Cost + Profit
                              PV Ratio
   10. Margin of Safety (in Rs.) = Actual Sales – BEP Sales (Rs.)
   11. Margin of Safety (in units) = Actual Sales(units) – BEP Sales (in units)
   12. Profit = Margin of Safety x PV Ratio

                               Problems for Marginal Costing

1. S. Ltd. furnishes you the following information relating to the half year ending 30th
   September 2007. Fixed expenses Rs.50,000, sales value Rs.2,00,000 and Profit
   Rs.50,000. During the second half of the same year the company, has projected a loss of
   Rs.10,000. Calculate:
       a. PV ratio, break-even point and margin of safety for six months ending 30th
           September 2007.
       b. Expected sales volume for second half of the year assuming that selling price and
           fixed expenses remain unchanged in the second half year also.
       c. The break-even point and margin of safety of the whole year 2007-08.
2. A company had incurred fixed expenses of Rs.2,25,000 with sales of Rs.7,50,000 and
   earned a profit of Rs.1,50,000 during the first half-year. In the second half-year, it
   suffered a loss of Rs.75,000. Calculate:
       a. The PV ratio, BEP, margin of safety of the first half-year
       b. Expected sales-volume for the second half year assuming that selling price and
           fixed expenses remained unchanged during the second half-year.
3. A retail dealer in garments is currently selling 24,000 shirts annually. He supplies the
   following details for the year ended 31st December 2007.
   Selling price per shirt Rs.40
   Variable cost per shirt Rs.25
   Fixed cost:
   Staff salaries for the year Rs.1,20,000
   General office costs for the year Rs.80,000
   Advertising costs for the year Rs.40,000.
   As a management accountant of the firm, you are required to answer each of the
   following independently.
          a. Calculate the BEP and margin of safety in sales revenue and number of shirts
          b. Assume that 20,000 shirts were sold in a year. Find out the net profit of the
          c. If it is decided to introduce selling commission of Rs.3 per shirt, how many
             would require to be sold in a year to earn a net income of Rs.15,000.
          d. Assuming that for the year 2008 an additional staff salary of Rs.33,000 is
             anticipated and price of a shirt is likely to be increased by 15% what should be
             the BEP in number of shirts and sales revenue?

4. Present the following information to show to the management
      a. The marginal product cost and the contribution per unit.
      b. The total contribution and profits resulting from each of the following sales

                                                          Product                Rs.     Per
              Direct materials                            A                      10
                                                          B                      9
              Direct wages                                A                      3
                                                          B                      2
            Fixed expenses Rs.800
            Variable expenses are allocated to products as 100% of direct wages.
            Sales price                                  A                    20
                                                         B                    15
            Sales mixtures:
             i. 1000 units of product A and 2000 units of B
            ii. 1500 units of product A and 1500 units of B
           iii. 2000 units of product A and 1000 units of B
          Which product mix is most profitable?

5. The following particulars are extracted from the records of a company:
             Particulars                                       Per Unit
                                                    Product A             Product B
             Sales                                  Rs.100                Rs.120
             Consumption of raw materials           2 Kg.                 3 Kg.
             Material Cost                          Rs.10                 Rs.15
             Direct Wages Cost                      Rs.15                 Rs.10
             Direct Expenses                        Rs.5                  Rs.6
             Machine hours used                     3hrs.                 2hrs.
             Overhead expenses:
             Fixed                                  Rs.15                 Rs.10
             Variable                               Rs.15                 Rs.20

          Direct Wages per hour is Rs.5. Comment on the profitability of each product (both
          products need the same raw materials) when:
               i. Total sales potentials in units is limited.
              ii. Total sales potential in value is limited.
             iii. Raw materials are in short supply.
             iv. Production capacity (in terms of machine hours) is the limiting factor.
           Assuming raw materials as the key factor, availability of which is 10,000 kg. and
           maximum sales potential of each product being 3,500 units, find the product mix
           which will yield the maximum profit.

6. A company produces a single product which is sold by it presently in the domestic market
   at Rs.75 per unit. The present production and sales is 40,000 units per month representing
   50% of the capacity available. The cost data of the product are as under:
       Variable costs per unit       Rs.50 Fixed costs per month                  Rs.10

       To improve the profitability, the management has 3 proposals on hand as under:
       a. To accept an export supply order for 30,000 units per month at a reduced price of
           Rs.60 per unit, incurring additional variable costs of Rs.5 per unit towards export
           packing, duties etc.
       b. To increase the domestic market sales by selling to a domestic chain stores 30,000
           units at Rs.55 per unit, retaining the existing sales at the existing price
       c. To reduce the selling price for the increased domestic sales as advised by the sales
           department as under:
               Reduce selling price per unit by Rs.                     Increase in sales expected
               (in units)
                       5                                                10,000
                       8                                                30,000
                       11                                               35,000

   Prepare a table to present the results of the above proposals and give your comments and
   advice on the proposals.

7. A company manufactures three products by processing materials through machine shop
   and finishing departments. Standard product costs are based on the following figures.
        Particulars                                    A          B           C
        Material Cost                                  Rs.2.30 Rs.3.50        Rs.5.00
        Labour Hours:
        Machine shop @50paise per hour                 2 hrs      2 ½ hrs     3 hrs
        Finishing department @60paise per hour 2 hrs              1 ½ hrs     1 hr
        Selling price                                  Rs.8.50 Rs.10.20 Rs.12.00
   Overhead rates based on normal production are Machine shop @Re.1 per hour and
   Finishing department @60 paise per hour. At the budgeted level of production half of the
   total overheads charged to each department is variable and the other half is fixed. Present
   the information to the management to assess the profitability of the products when there is
   a shortage of any of the three factors viz., time, labour and raw materials.
                           CHAPTER 5: PROCESS COSTING

A Process means a distinct manufacturing operation or stage. In process industries, the raw
material goes through a number of processes in a sequence before the finished product is
finally produced. For example, production of coconut oil involves the following distinct
processes: 1. Copra crushing 2. Refining and 3. Finishing.

Process costing is defined as “a method of costing used to ascertain the cost of the product at
each stage or operation of manufacture..”
Important calculations
   1. Normal loss = Input x % of normal loss
   2. Normal output = Input – Normal loss
   3. Unit Cost = Cost of process – Sale value of Normal loss
                              Input – Normal loss
   4. Abnormal loss = Normal Output – Actual output
   5. Abnormal gain = Actual output – Normal output
   6. Cost of actual output = Unit cost x Units of Actual Output
   7. Cost of Abnormal Loss = Unit cost x Units of Abnormal Loss
   8. Cost of Abnormal Gains = Unit cost x Units of Abnormal Gains

   1. Assemblers Ltd. have three Assembly shops viz., General Assembly, Lower
       Assembly. The Company furnished the following information.

                                                General Lower           Higher
        Raw Material ( in Litres)               5,000        1,920      3,576
        Material Cost per litre            Rs.  60           40         80
        Labour cost                         Rs. 4,28,000 1,06,000 2,10,000
        Direct Expenses                    Rs.  88,000       2,85,000 1,04,800
        Wastage as percentage of total input    4%           5%         10%
        a) Output transferred :
               To Lower Assembly                60%          -----      -----
               To Higher Assembly               -----        40%        -----
        b) Output sold in market :              40%          60%        100%
           Sale price per litre            Rs.  200          205        250
       Administration overhead Rs.36,000 and Marketing overhead Rs.48,000.
       Prepare various Assembly Accounts and Costing Profit and Loss Account.

   2. A product passes through three processes A, B and C. 10,000 units at a cost of Rs.
      1.10 per
      Unit were issued to Process A. The other direct expenses were as follows.

                             Process A    Process B     Process C
                             Rs.          Rs.           Rs.
        Sundry Materials     1,500        1,500         1,500
        Direct Labour        4,500        8,000         6,500
        Direct Expenses      1,000        1,000         1,503
   The wastage of Process A was 5% and in Process B 4% of inputs. The Wastage of
   Process A      was sold at Rs. 0.25 per unit and that of Process B at Rs. 0.50 per unit
   and that of Process C at Rs. 1.00 per unit. The overhead charges were 160% of direct
   labour. The final product was sold at Rs. 10 per unit fetching a profit of 20% on sales.
   Prepare all process accounts.

3. A product of a company passes through 3 processes viz., Process A, Process B and
   Process C, to obtain three consecutive grades of the product. Details relating to its
   production for the year 2001 are as follows.

            Particulars                       Process – A      Process - B      Process – C
    Raw materials used                        1,000 tonnes     ---              ---
    Cost per tonne                            Rs. 200          ---              ---
    Manufacturing Wages and Expenses          Rs. 75,000       Rs. 41,000       Rs. 11,000
    Weight Lost                               5%               10%              20%
    Scrap Sold at Rs. 50/- per tonne          50 tonnes        30 tonnes        51 tonnes
    Sale price per tonne                      400`             500              800

   Management expenses were Rs. 15,000, selling expenses were Rs. 10,000. Two-third
   output of Process A and one-half output of Process B are passed on the next process
   and the balance was sold.
   You are required to prepare process cost accounts and costing Profit and Loss
   Account        for the year 2001.
                          CHAPTER 6: BUDGETARY CONTROL

Controlling costs by making use of budgets is known as budgetary control. Budgetary control
and standard costing together help in achieving the two important functions of management
viz; planning and control.

Budget is a plan quantified in monetary terms, prepared and approved prior to a definite
period of time, usually showing planned income to be generated and / or expenditure to be
incurred during that period and the capital to be employed to attain a given objective. Budget
may also be prepared in quantitative terms. For example Production Budget, Plant utilization
budget etc. Budget is a plan showing expected achievement based on most efficient operating
standards. Against this actual accomplishment is regularly compared.

      Budgets may be time based
          o Short-term and
          o Long-term

      Based on functions also known as functional budgets
          o Sales budget
          o Production budget
          o Production cost budget
          o Purchase budget
          o Personnel budget
          o Plant Utilisation budget
          o Administrative cost budget
          o Selling and Distribution cost/ overhead budget
          o Capital expenditure budget
          o Cash budget
          o Research and Development cost budget.

      Budgets may be based on behavior
          o fixed budget and
          o flexible budget.

Budgetary control is a system of planning and controlling costs which involves the following
    1. Establishment of budgets: Functional budgets are prepared based on responsibilities
       of individuals. These budgets are then co-ordinated to prepare budgeted P&L A/c and
       budgeted balance sheet.
    2. Measurement of actual performance.
    3. Comparison of actual performance with budgeted performance to develop variances.
    4. Analysis of causes of variance and reporting for immediate action.

   1. A company manufactures product A and Product B. During the year ending
      December 2008, it is expected to sell 15,000 kgs of product A and 75,000 kgs of
      product B at Rs.15 and Rs.8 per kg respectively. The direct materials P, Q, and R are
      mixed in the proportion of 3:5:2 in the manufacture of product A. Material Q and R
      are mixed in the proportion of 1:2 in the manufacture of product B. the actual and
      budgeted inventories for the year are given below:
       Material / Product Opening Stock Expected closing Anticipated Cost
                              in kgs.          stock in kgs.     per Kg. in Rs.
       Material P             4,500            3,000             6/-
                Q             3,000            6,000             5/-
                R             30,000           9,000             4/-
       Product A              3,000            1,500             -
                B             4,000            5,500             -
      Prepare production budget and material purchase budget, showing the expenditure for
      the materials for the year ending 31-12-2008.

   2. Maya Limited has made the following sales estimates for April, May and June of the
      year 2009 from which you are required to prepare sales budget by units and rupees for
      each of the three months for each sales area and in total
                             Sales Area April May June
                             A             40% 30% 30%
                             B             45% 35% 20%
                             C             40% 35% 25%
                             D             30% 40% 30%
      The area-wise unit sales expected is as follows:
                                 Sales Area Sales (Units)
                                 A            2,500
                                 B            2,000
                                 C            3,000
                                 D            6,000
                                 Total        13,500
      The selling price has been fixed at Rs.6 per unit in Area A, Rs.8 per unit in Area B,
      Rs.12 per unit in Area D and Rs.10 per unit in Area C.

   3. Calculate the budgeted overhead cost per tonne at production level of 35 tonnes based
      on the following details at 80% capacity (40 tonnes)
      Particulars                                   Rs. in „000
      Depreciation                                  22
      Indirect labour                               24
      Insurance                                     6
      Power (80% variable)                          40
      Repairs and maintenance (50% fixed)           40
      Salaries                                      20
      Stores consumable                             8
      Also prepare budget for overhead cost at 100% capacity utilization.
4. Prepare Cash budget of Sandeep Ltd. for the months of April, May and June, 2007
             Month        Sales       Purchases Wages Expenses
             January      1,60,000         90,000 40,000       10,000
             February 1,60,000             80,000 36,000       12,000
             March        1,50,000         84,000 44,000       12,000
             April        1,80,000       1,00,000 48,000       14,000
             May          1,70,000         90,000 40,000       12,000
             June         1,60,000         70,000 36,000       10,000
   You are informed that:
      a. 50% of the purchases and sales are on cash.
      b. The average collection period of the company is ½ month and credit purchases
          are paid off regularly after 1 month.
      c. Time lag in payment of wages is 1 month.
      d. Rent of Rs.1000 is payable every month.
      e. Cash and bank balance as on 31st march, 2007 was Rs.3,00,000.
      f. Dividend received in May Rs.36,000.
      g. Professional fees to be paid in June Rs.1,500.
      h. Expenses are paid in the same month.