shutdown are expected at Rs.12,000. Should the plant be shut down? What is the shut- down point? Solution Note: The decisions regarding the plant to shut-down and the calculation of shut-down point requires the figure of selling price per unit of the units sold. As the statement of the question fails to indicate the selling price (per unit) therefore one is free to assume it. Let’s assume the selling price per unit be Rs.20 Statement of cost for taking a decision about shutdown of plant Plant is operated Plant is shut down Variable cost (Rs.) (Rs.) 26,000 — Fixed costs (2,000 units × Rs.13) Additional shut down cost Total cost 80,000 33,000 State of loss: Sales (20,000 units × Rs.4) (Inescapable cost) Less: Total cost (as above) _______ 12,000 Loss 1,06,000 45,000 40,000 - (2,000 units Rs. 20) 1,06,000 45,000 (66,000) (45,000) (if continued) (if shutdown) Recommendation: A comparison of loss figures indicated as above points out, that, loss is reduced if the plant is shut down. In fact, by doing so the concern’s loss would be reduced by Rs. 21,000 (Rs.66,000 – Rs. 45,000). Calculation of shut down point Shut-down point = Rs.80,000-Rs.45000/20-13 = 5000 units Pricing Decisions under Special Circumstances If goods were sold in the normal circumstances under normal business conditions, the price would cover the total cost plus a margin of profit. Selling prices are not always determined by the cost of production. They may be determined by market conditions but in the long run they tend to become equal to the cost of production of marginal firm. 101 CU IDOL SELF LEARNING MATERIAL (SLM)
Therefore, a business cannot continue to sell below the total cost for a long period. Occasionally, a firm may have to sell below the total cost. The problem of pricing can be summarized under three heads: (i) Pricing in periods of recession, (ii) Differential selling prices and (iii) Acceptance of an offer and submission of a tender. Pricing in periods of recession : In periods of recession, a firm may sell its articles at a price less than the total cost but above the marginal cost for a limited period. The advantages of this practice are: (i) The firm can continue to produce and use the services of skilled employees who are well trained and will be difficult to re-employ later if discharged. (ii) Plant and machinery can be prevented from deterioration through idleness. (iii) The business would be ready to take advantage of improved business conditions later. (iv) This avoids the competition of securing the business of the firm. One thing to remember here is that a situation like this should not lead to a drastic price cutting and the orders accepted should not cover a long period extending over the production facilities of a period when business conditions improve. It may also be justifiable to sell the product at a price below marginal cost for a limited period provided the following conditions prevail: (i) Where materials are of perishable nature. (ii) Where stocks have been accumulated in large quantities and the market prices have fallen. This will save the carrying cost of stocks. (iii) Is it essential to reduce the prices to such an extent in order to popularize a new product? (iv) Where such reduction enables the firm to boost the sales of other products having larger profit margin. Differential selling prices: Use of differential selling price which is above the marginal cost but below the total cost is resorted to in an order to absorb surplus capacity. There are two ways of doing this: (i) The firm producing a branded article may use the surplus capacity to produce the same article to be sold above marginal cost in a different market. Dumping of goods in the export market is an example of this type of pricing. The articles sold in the home market will recover all fixed expenses. Since price reduction in the home market is injurious to the normal sales, it is not resorted to. Any reduction in the selling prices in the export market will not affect the price prevailing in the home market. (ii) The firm may produce and sell a branded article, say product A, which covers the entire fixed overheads and use the surplus capacity to produce another product B, which 102 CU IDOL SELF LEARNING MATERIAL (SLM)
may be sold at a price above its marginal cost. The overall profitability will thus increase. The manufacture of product B, however, should be confined to surplus capacity and it should not have the possibility of becoming a major product at the low price at which it is sold. If it becomes so there will be a reduction in profit as Illustrated below: Condition 1 Condition 2 Product A Product Product A Product B B Capacity 90% 10% 60% 40% (Rs) (Rs) (Rs) (Rs) Sales 9,000 2,000 6,000 8,000 Marginal cost 6,000 1,800 4,000 7,200 Gross margin 3,000 200 2,000 800 Sell or Process Further One major decision a company has to make is to determine the point at which to sell their product—in other words, when it is no longer cost effective to continue processing the product before sale. For example, in refining oil, the refined oil can be sold at various stages of the refining process. The point at which some products are removed from production and sold while others receive additional processing is known as the split-off point. As you have learned, the relevant revenues and costs must be evaluated in order to make the best decision for the company. In making the decision, a company must consider the joint costs, or those costs that have been shared by products up to the split-off point. In some manufacturing processes, several end products are produced from a single raw material input. For example, once milk has been processed it can be sold as milk or it can be processed further into cheese, yogurt, cream, or ice cream. The costs of processing the milk to the stage at which it can be sold or processed further are the joint costs. These costs are allocated among all the products that are sold at the split off point as well as those products that are processed further. Ice cream has the basic costs of the milk plus the costs of processing it further into ice cream. As another example, suppose a company that makes leather jackets realizes it has a reasonable amount of unused leather from the cutting of the patterns for the jackets. Typically, this scrap leather is sold, but the company is beginning to consider using the scrap to make leather belts. How would the company allocate the costs incurred from processing and preparing the leather before cutting it if they decide to make both the 103 CU IDOL SELF LEARNING MATERIAL (SLM)
jackets and the belts? Would it be financially beneficial to process the scrap leather further into belts? When facing the choice of selling or processing further, the company must determine the revenues that would be received if the product is sold at the split-off point versus the net revenues that would be received if the product is processed further. This requires knowing the additional costs of further processing. In general, if the differential revenue from further processing is greater than the differential costs, then it will be profitable to process a joint product after the split-off point. Any costs incurred prior to the split-off point are irrelevant to the decision to process further as those are sunk costs; only future costs are relevant costs. Add or Drop A decision whether or not to continue an old product line or department, or to start a new one is called an add-or-drop decision. An add-or-drop decision must be based only on relevant information. Relevant information includes the revenues and costs which are directly related to a product line or department. Examples of relevant information are sales revenue, direct costs, variable overhead and direct fixed overhead. Such decision must not be based on irrelevant information such as allocated fixed overhead because allocated fixed overhead will not be eliminated if the product line or department is dropped. The following example illustrates an add-or-drop decision: A company has three products: Product A, Product B and Product C. Income statements of the three product lines for the latest month are given below: Product Line A B C Sales Rs.467,000 Rs.314,000 Rs.598,000 Variable Costs 241,000 169,000 321,000 Contribution Margin Rs.226,000 Rs.145,000 Rs.277,000 Direct Fixed Costs 91,000 86,000 112,000 Allocated Fixed Costs 93,000 62,000 120,000 Net Income Rs.42,000 − Rs.3,000 Rs.45,000 Use the incremental approach to determine if Product B should be dropped. Solution By dropping Product B, the company will lose the sale revenue from the product line. The company will also obtain gains in the form of avoided costs. But it can avoid only the variable costs and direct fixed costs of product B and not the allocated fixed costs. Hence: If Product B is Dropped 104 CU IDOL SELF LEARNING MATERIAL (SLM)
Gains: Rs.169,000 Rs.255,000 Variable Costs Avoided Rs.86,000 Rs.314,000 Direct Fixed Costs Avoided Rs.59,000 Less: Sales Revenue Lost Decrease in Net Income of the Company 8.4 SUMMARY Relevant Costs.: These are the estimated future costs that are different under alternative courses of action for a specific problem and hence are appropriate to a specific management decision. Differential cost: Difference in total cost that will arise from the selection of one alternative instead of another. Pricing Decisions under Special Circumstances If goods were sold in the normal circumstances under normal business conditions, the price would cover the total cost plus a margin of profit. The problem of pricing can be summarised under three heads: Pricing in periods of recession, Differential selling prices, and Acceptance of an offer and submission of a tender. Pricing in periods of recession: Sell its articles at a price less than the total cost but above the marginal cost for a limited period. Differential selling prices: Which is above, the marginal cost but below the total cost is resorted to in order to absorb surplus capacity 8.5 KEY WORDS Opportunity Cost: Value of the next best alternative. Sunk Cost: Cost which do not change under given circumstance and do not play any role in decision making process. Price-Mix Decision: When a firm can produce two or more products from the same production facilities and the demand of each product is affected by the change in their prices, the management may have to choose price mix which will give the maximum profit, particularly when the production capacity is limited. 8.6 LEARNING ACTIVITY 1. What are the circumstances when a company should outsource any work? 105 CU IDOL SELF LEARNING MATERIAL (SLM)
________________________________________________________________________ ________________________________________________________________________ 8.7 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1.Explain briefly about sell or further process decision and where it is applicable? 2.Explain briefly about differential cost 3.What do you understand by the term shut down point Long Questions 1. ‘S’ manages the school canteen (approximately 1,600 students) at Noida. The current cash payment system requires three clerks (each paid ₹90 per hour), employed for about 4 hours a day. The canteen operates approximately 240 days a year. ‘S’ is considering a Wireless Cash Management System (WCMS), where a student could just swipe an ID Card for payment. This system would cost ₹1,25,000 to setup and ₹36,000 per year to operate. ‘S’ believes that he could manage with one clerk if he were to implement the system. Required ADVISE ‘S’ on the choice of a plan, assuming working life of WCMS as 5 years 2. BNZ Ltd. is engaged in the manufacture of plastic bottles of a standard size and produced by a joint process of machines. The factory has 5 machines and capable of producing 40 bottles per hour. The variable cost per bottle is Rs. 0.32 and the selling price is Rs 0.80 each. The company has received an offer from another company for manufacture of 40,000 units of a plastic moulded toy. The price per toy is Rs.30 and the variable, cost is Rs. 24 each. In case of the company takes up the job, it has to meet the expenses of making a special mould required for the manufacture of the toy. The cost of the mould is Rs.1,00,000. The company's time study analysis shows that the machines can produce only 16 toys per hour. The company has a total capacity of 10,000 hours during the period in which the toy is required to be manufactured. The fixed costs excluding the cost of construction of the mould during the period will be Rs.10 Lakh The company has an order for the supply of 3,00,000 bottles during the period. Required (i) Do you ADVISE the company to take up the order for manufacturing plastic moulded toys during the time when it has an order in its book for the supply of 3,00,000 bottles. 106 CU IDOL SELF LEARNING MATERIAL (SLM)
(ii) If the order for the supply of bottles increases to 4,00,000 bottles, will you ADVISE the company to accept the order for the supply of plastic moulded toys? State the reasons. (iii) An associate company of BNZ Ltd. has idle capacity and is willing to take up the whole or part of the manufacturing of the plastic moulded toys on sub-contracting basis. The subcontract price inclusive of the cost of construction of mould is Rs.28 per ton. DETERMINE the minimum expected excess machine hour capacity needed to justify producing any portion of the toy order by the company itself rather than subcontracting. B. Multiple choice Questions 1. Difference in total cost that will arise from the selection of one alternative instead of another is known as a. Opportunity cost b. Sunk cost c. Differential cost d. None of these 2. The estimated future costs that are different under alternative courses of action for a specific problem and hence are appropriate to a specific management decision. a. Opportunity cost b. Relevant cost c. Differential cost d. None of these 3._____________ is a costing system where products or services and inventories are valued at variable costs only. It does not take consideration of fixed costs a. Opportunity cost b. Relevant cost c. Differential cost d. Marginal cost Answers 1-c 2-b 3-d 8.8 REFERENCES Text Books: T1 V.K. Saxana & C.D. Vashist, Advanced Cost of Management Accounting, Sultan Chand & Sons, New Delhi, 1998. 107 CU IDOL SELF LEARNING MATERIAL (SLM)
T2 Advanced Management Accounting By Ravi M.Kishore – Taxman Publication Reference Books: R1 Dr.Manmohan & S.N.Goyal, Principles of Management Accounting Shakithabhavan Publication, Agra. R2 Kaplan & Atkinson, Advanced Management Accounting, Prentice Hall of India – 1999 108 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT – 9 BUDGETING STRUCTURE 9.0 Learning Objective 9.1 Introduction 9.2 Essential elements of a budget 9.3 Characteristics of Budget 9.4 Objectives of Budgeting 9.5 Different types of Budget 9.6 Merits and demerits of fixed Budget 9.7 Flexible Budget 9.8 Suitability of Flexible Budget 9.9 Difference between Fixed and Flexible budget 9.10 Preparation of Flexible budget 9.11 Summary 9.12 Keywords 9.13 Learning Activity 9.14 Unit End Questions 9.15 References 9.0 LEARNING OBJECTIVE After studying this unit students will be able to Explain about budgeting and its essential elements Learn about characteristics and different types of budget Describe about Flexible budget Learn about Fixed budget its merits and demerits Analyse the preparation of Flexible budget 9.1 INTRODUCTION Budgetary control and standard costing systems are two essential tools frequently used by business executives for the purpose of planning and control. In the case of budgetary control, the entire exercise starts with the setting up of budgets or targets and ends with the taking of an action, in case the actual figures differed with the budgetary ones. Meaning of Budget and Budgeting 109 CU IDOL SELF LEARNING MATERIAL (SLM)
Budget: CIMA Official Terminology has defined the terms ‘budget’ as “Quantitative expression of a plan for a defined period of time. It may include planned sales volumes and revenues; resource quantities, costs and expenses; assets, liabilities and cash flows.” Budgeting: It is a means of coordinating the combined intelligence of an entire organisation into a plan of action based on past performance and governed by rational judgment of factors that will influence the course of business in the future. 9.2 ESSENTIAL ELEMENTS OF A BUDGET 1.Organisational structure must be clearly defined, and responsibility should be assigned to identifiable units within the organisation. 2.Setting of clear objectives and reasonable targets. Objectives should be in consonance with the long-term plan of the organisation. 3.Objectives and degree of responsibility should be clearly stated and communicated to the management or person responsible for. 4.Budgets are prepared for the future periods based on expected course of actions. 5.Budgets are updated for the events that were not kept into the mind while establishing budgets. Hence, budgets should flexible enough for mid- term revision. 6.The entire organisation must be committed to budgeting. 7.Budgets should be quantifiable and master budget should be broken down into various functional budgets. 8.Budgets should be monitored periodically. Variances from the set yardsticks (standards) should be analysed and responsibility should be fixed. 9.Budgetary performance needs to be linked effectively to the reward system. 9.3 CHARACTERISTIC OF BUDGET The main characteristics of budget are as follows: 1.A budget is concerned for a definite future period. 2.A budget is a written document. 3.A budget is a detailed plan of all the economic activities of a business. 4.All the departments of a business unit co-operate for the preparation of a business budget. 5.Budget is a mean to achieve business and it is not an end in itself. 6.Budget needs to be updated, corrected and controlled every time when circumstances changes. Therefore, it is a continuous process. 7.Budget helps in planning, coordination and control. 8.Different types of budgets are prepared by industries according to business requirements. 9.A budget acts a business barometer. 10.Budget is usually prepared in the light of Past Experience. 110 CU IDOL SELF LEARNING MATERIAL (SLM)
11.Budget is a constant endeavour of the Management 9.4 OBJECTIVES OF BUDGETING Planning: The process of budgeting begin with the establishment of specific targets of performance and is followed by executing plans to achieve such desired goals and from time to time comparing actual results with the target goals. These targets include both the overall business targets as well as the specific targets for the individual units within the business. Establishing specific targets for future operations is part of the planning function of management, while executing actions to meet the goals is the directing function of management. It may be explained as Budgets plans are made taking into account the objectives at different level of an organization i.e. Mission, corporate strategy and unit objectives. Individual plans at unit level should take overall organizational plan or objectives. Budgets reflect plans and that planning should have taken place before budgets are prepared. Budgets plans are quantified and responsibility is assigned to the persons who are responsible for execution of plan. Using the budget to communicate these expectations throughout the organization has helped many a companies to reduce expenses during a severe business recession. Planning not only motivates employees to attain goals but also improves overall decision making. During the planning phase of the budget process, all viewpoints are considered, options identified, and cost reduction opportunities assessed. This process may reveal opportunities or threats that were not known prior to the budget planning process. Directing and Coordinating: Once the budget plans are in place, they can be used to direct and coordinate operations in order to achieve the stated targets. A business, however, is much more complex and requires more formal direction and coordination. The budget is one way to direct and coordinate business activities and units to achieve stated targets of performance. The budgetary units of an organisation are called responsibility centres. Each responsibility centre is led by a manager who has the authority over and responsibility for the unit’s performance. 111 CU IDOL SELF LEARNING MATERIAL (SLM)
Objectives and degree of performance expected from a responsibility centres are communicated rapidly. Controlling: As time passes, the actual performance of an operation can be compared against the planned targets. This provides prompt feedback to employees about their performance. If necessary, employees can use such feedback to adjust their activities in the future. Feedback received in the form of budget report from the responsibility centre. This report is helpful to know the performance of the concerned unit. Any unexpected changes into the conditions which were prevailing at the time of preparing budget are taken into account and budgets are revised to show true performance yardstick. Comparing actual results to the plan also helps prevent unplanned expenditures. The budget encourages employees to establish their spending priorities. The main objective of Budgeting is to help in achieving the overall objective of the organization. 9.5 DIFFERENT TYPES OF BUDGET Classification on the basis of capacity or Flexibility 112 CU IDOL SELF LEARNING MATERIAL (SLM)
These types of budgets are prepared on the basis of activity level or utilization of capacity. These are also known as “Budgets on the basis of flexibility”. Fixed Budget : According to CIMA, “a fixed budget, is a budget designed to remain unchanged irrespective of the level of activity actually attained”. A fixed budget shows the expected results of a responsibility centre for only one activity level. Once the budget has been determined, it is not changed, even if the activity changes. Fixed budgeting is used by many service companies and for some administrative functions of manufacturing companies, such as purchasing, engineering, and accounting. Fixed Budget is used as an effective tool of cost control. In case, the level of activity attained is different from the level of activity for budgeting purposes, the fixed budget becomes ineffective. Such a budget is quite suitable for fixed expenses. It is also known as a static budget. Essential conditions: 1.When the nature of business is not seasonal. 2.There is no impact of external factors on the business activities 3.The demand of the product is certain and stable. 4.Supply orders are issued regularly. 5.The market of the product should be domestic rather than foreign. 6.There is no need of special labour or material in the production of the products. 7.Supply of production inputs is regular. 8.There is a trend of price stability. Generally, all above conditions are not found in practice. Hence Fixed budget is not important in business concerns. 9.6 MERITS AND DEMERITS OF FIXED BUDGET Merits and Demerits of fixed budgets are tabulated below: Merits Demerits 1. Very simple to understand 1. It is misleading. A poor performance 2. Less time consuming may remain undetected, and a good performance may go unrealized. 2. It is not suitable for long period. 3. It is also found unsuitable particularly when the business conditions are changing constantly. 4. Accurate estimates are not possible. 113 CU IDOL SELF LEARNING MATERIAL (SLM)
9.7 FLEXIBLE BUDGET Flexible Budget: According to CIMA, “a flexible budget is defined as a budget which, by recognizing the difference between fixed, semi-variable and variable costs is designed to change in relation to the level of activity attained.” Unlike static (fixed) budgets, flexible budgets show the expected results of a responsibility centre for different activity levels. You can think of a flexible budget as a series of static budgets for different levels of activity. Such budgets are especially useful in estimating and controlling factory costs and operating expenses. It is more realistic and practicable because it gives due consideration to cost behaviour at different levels of activity. While preparing a flexible budget the expenses are classified into three categories viz. (i) Fixed, (ii) Variable, and (iii) Semi-variable Semi-variable expenses are further segregated into fixed and variable expenses. Flexible budgeting may be resorted to under following situations: (i)In the case of new business venture due to its typical nature it may be difficult to forecast the demand of a product accurately. (ii)Where the business is dependent upon the mercy of nature e.g., a person dealing in wool trade may have enough market if temperature goes below the freezing point. (iii)In the case of labour-intensive industry where the production of the concern is dependent upon the availability of labour. Merits and Demerits of flexible budgets are tabulated below Merits Demerits 1) With the help of flexible budget, the sales1, . 1) The formulation of flexible budget is costs and profit may be calculated easily by possible only when there is proper the business at various levels of production accounting system maintained, perfect capacity. knowledge about the factors of 2) In flexible budget, adjustment is very production and various business simple according to change in business circumstances is available. conditions. 2. 2) Flexible Budget also requires the 3) It also helps in determination of production system of standard costing in business. level as it shows budgeted costs with 3. 3) It is very expensive and labour classification at various levels of activity along oriented. with sales. Hence the management can easily select the level of production which shows the profit predetermined by the owners of the business. 114 CU IDOL SELF LEARNING MATERIAL (SLM)
4. 4) It also shows the quantity of product to be produced to earn determined profit. 9.8 SUITABILITY FOR FLEXIBLE BUDGET 1.Seasonal fluctuations in sales and/or production, for example in soft drinks industry. 2.A company which keeps on introducing new products or makes changes in the design of its products frequently. 3.Industries engaged in make-to-order business like ship building. 4.An industry which is influenced by changes in fashion; and 5.General changes in sales. 9.9 DIFFERENCE BETWEEN FIXED AND FLEXIBLE BUDGETS Sl. Fixed Budget Flexible Budget no. 1. It does not change with actual volume of It can be re-casted on the basis of activity achieved. Thus it is known as rigid activity level to be achieved. Thus it is or inflexible budget not rigid. 2. It operates on one level of activity and under It consists of various budgets for one set of conditions. It assumes that there different levels of activity will be no change in the prevailing conditions, which is unrealistic. 3. Here as all costs like - fixed, variable and Here analysis of variance provides semi-variable are related to only one level useful information as each cost is of activity so variance analysis does not analyzed according to its behavior. give useful information. 4. If the budgeted and actual activity levels Flexible budgeting at different levels of differ significantly, then the aspects like cost activity facilitates the ascertainment of ascertainment and price fixation do not give cost, fixation of selling price and a correct picture. tendering of quotations. 5. Comparison of actual performance with It provides a meaningful basis of budgeted targets will be meaningless comparison of the actual performance specially when there is a difference between with the budgeted targets. the two activity levels. 115 CU IDOL SELF LEARNING MATERIAL (SLM)
9.10 PREPARATION OF FLEXIBLE BUDGET A department of Company X attains sale of Rs.6,00,000 at 80 per cent of its normal capacity and its expenses are given below : Administration costs: (Rs.) Office salaries 90,000 General expenses 2 per cent of sales Depreciation 7,500 Rates and taxes 8,750 Selling costs : Salaries 8 per cent of sales Travelling expenses 2 per cent of sales Sales office expenses 1 per cent of sales General expenses 1 per cent of sales Distribution costs : Wages 15,000 Rent 1 per cent of sales Other expenses 4 per cent of sales Draw up flexible administration, selling and distribution costs budget, operating at 90 per cent, 100 per cent and 110 per cent of normal capacity. Flexible Budget of Department. Of Company ‘X’ 80% (₹) 90% (₹) 100%(₹) 110%(₹) Sales 6,00,000 6,75,000 7,50,000 8,25,000 Administration Costs: 90,000 90,000 90,000 90,000 Office Salaries (fixed) 15,000 16,500 7,500 7,500 General expenses (2% of Sales) 12,000 13,500 8,750 8,750 Depreciation (fixed) 7,500 7,500 Rent and rates (fixed) 8,750 8,750 1,18,250 1,19,750 1,21,250 1,22,750 (A) Total Adm. Costs 116 CU IDOL SELF LEARNING MATERIAL (SLM)
Selling Costs : Salaries (8% of sales) 48,000 54,000 60,000 66,000 13,500 15,000 16,500 Travelling expenses (2% of sales) 12,000 6,750 7,500 8,250 6,750 7,500 8,250 Sales office (1% of sales) 6,000 81,000 General expenses (1% of sales) 6,000 72,000 90,000 99,000 (B) Total Selling Costs Distribution Costs : Wages (fixed) 15,000 15,000 15,000 15,000 6,750 7,500 8,250 Rent (1% of sales) 6,000 27,000 30,000 33,000 Other expenses (4% of sales) 24,000 45,000 48,750 52,500 56,250 (C) Total Distribution Costs 2,35,250 2,49,500 2,63,750 2,78,000 Total Costs (A + B + C) 9.11 SUMMARY 117 Budget is a quantitative expression of plan for a given period of time It may include planned sales volume, resources, cash flows assets etc Budgets are prepared for future periods on expected course of action CU IDOL SELF LEARNING MATERIAL (SLM)
Budget should be reviewed periodically variance should be analysed and responsibilities must be fixed Budgets must be quantifiable and master budgets must be broken into functional budgets Budgetary performance should be linked to reward system Objectives of budget includes planning directing and controlling of process 9.12 KEY WORDS Forecast- Activity mainly concerned with assessment of future probably event Budget – It is a planned result an organization tries to achieve 9.13 LEARNING ACTIVITY 1. A company operates at 50 % of capacity utilization. At this level of operation, the sales value is Rs9,00,000. At 100 % capacity utilization the following costs and relationships will apply: Factory Overheads Rs 1,80,000 (50 % Variable) Factory Cost 60 % of sales Selling Costs (75 Variable), i.e., 20 % of sales The company anticipates that its sales will increase up to 75 % of capacity utilization. The company also receives a special order from a government department. This order will occupy 15 % of capacity utilization of the plant. The prime cost in this order is ₹ 1,35,000 and the variable selling cost will only be 2 % of the sales value offered. Besides, the cost of processing the order is ₹ 8,000. The sales price offered is Rs 1,45,000. Required: (a) Present a statement of profitability at 50 % and 75 % level of activity. (b) Evaluate the government order and state whether it is acceptable or not. ________________________________________________________________________ ________________________________________________________________________ 9.14 UNIT END QUESTIONS A.Descriptive Questions 118 Short Questions 1. Briefly explain the characteristics of a budget 2.what is meant by flexible budget 3. List out the merits and demerits of a fixed budget CU IDOL SELF LEARNING MATERIAL (SLM)
Long Questions 1.Differentiate between fixed and flexible budget 2. Explain in detail the objectives of budgeting B. Multiple choice Questions 1. The budgetary control system is designed to fix responsibilities on executives through _________. a. preparation of budgets b. execution of budgets c. planning of budgets d. zero base budgeting 2. Budgetary Control helps as a basis for ______________. a. statutory audit b. internal audit c. both (a) and (b) d. None of these 3. Factors to be considered in Production Budget: a. Production plan b. The capacity of the business concern c. Inventory Policy d. All of these 4. If budgets are prepared of a business concern for a certain period taking each and every function separately such budgets are called ______________. a. Separate Budgets b. Functional Budgets c. Both of them d. None of these 5. Which of the following is not an example of functional budget? a. Production budget b. Cost of production budget c. Materials budget d. None of these Answers 119 1-a 2-b 3-d 4-b 5-d CU IDOL SELF LEARNING MATERIAL (SLM)
9.15 REFERENCES Text Books: T1 V.K. Saxana & C.D. Vashist, Advanced Cost of Management Accounting, Sultan Chand & Sons, New Delhi, 1998. T2 Advanced Management Accounting By Ravi M.Kishore – Taxman Publication Reference Books: R1 Dr.Manmohan & S.N.Goyal, Principles of Management Accounting Shakithabhavan Publication, Agra. R2 Kaplan & Atkinson, Advanced Management Accounting, Prentice Hall of India – 1999 120 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT – 10 BUDGETARY CONTROL STRUCTURE 10.0 Learning Objective 10.1 Introduction 10.2 Salient Features 10.3 Objectives of Budgetary Control 10.4 Working of a Budgetary Control System 10.5 Merits and limitations of a Budgetary Control System 10.6 Components of Budgetary Control system 10.7 Summary 10.8 Keywords 10.9 Learning Activity 10.10 Unit End Questions 10.11 References 10.0 LEARNING OBJECTIVE After studying this unit students will be able to Explain the meaning of budgetary control Learn the objectives of budgetary control Analyse how a budgetary control system works Learn about components of budgetary control system Evaluate merits and demerits of budgetary control system 10.1 INTRODUCTION CIMA has defined the terms ‘budgetary control’ as “Budgetary control is the establishment of budgets relating to the responsibilities of executives of a policy and the continuous comparison of the actual with the budgeted results, either to secure by individual action the objective of the policy or to provide a basis for its revision.” It is the system of management control and accounting in which all the operations are forecasted and planned in advance to the extent possible and the actual results compared with the forecasted and planned ones. Budgetary Control Involves: 1. Establishment of budgets 2. Continuous comparison of actual with budgets for achievement of targets 3. Revision of budgets after considering changed circumstances 4. Placing the responsibility for failure to achieve the budget targets. 121 CU IDOL SELF LEARNING MATERIAL (SLM)
10.2 SALIENT FEATURES The salient features of such a system are the following : 1. Determining the objectives to be achieved, over the budget period, and the policy or policies that might be adopted for the achievement of these ends. 2. Determining the variety of activities that should be undertaken for the achievement of the objectives. 3. Drawing up a plan or a scheme of operation in respect of each class of activity, in physical as well as monetary terms for the full budget period and its parts. 4. Laying out a system of comparison of actual performance by each person, section or department with the relevant budget and determination of causes for the discrepancies, if any. 5. Ensuring that corrective action will be taken where the plan is not being achieved and, if that be not possible, for the revision of the plan. In brief, it is a system to assist management in the allocation of responsibility and authority, to provide it with aid for making, estimating and planning for the future and to facilitate the analysis of the variation between estimated and actual performance. In order that budgetary control may function effectively, it is necessary that the concern should develop proper basis of measurement or standards with which to evaluate the efficiency of operations, i.e., it should have in operation a system of standard costing. Beside this, the organization of the concern should be so integrated that all lines of authority and responsibility are laid, allocated and defined. This is essential since the system of budgetary control postulates separation of functions and division of responsibilities and thus requires that the organization shall be planned in such a manner that everyone, from the Managing Director down to the Shop Foreman, will have his duties properly defined. 10.3 OBJECTIVES OF BUDGETARY CONTROL Objectives of Budgetary Control System: 1. Portraying with precision the overall aims of the business and determining targets of performance for each section or department of the business. 2. Laying down the responsibilities of each of the executives and other personnel so that everyone knows what is expected of him and how he will be judged. Budgetary control is one of the few ways in which an objective assessment of executives or department is possible. 3. Providing a basis for the comparison of actual performance with the predetermined targets and investigation of deviation, if any, of actual performance and expenses from the budgeted figures. This naturally helps in adopting corrective measures. 122 CU IDOL SELF LEARNING MATERIAL (SLM)
4. Ensuring the best use of all available resources to maximize profit or production, subject to the limiting factors. Since budgets cannot be properly drawn up without considering all aspects usually there is good co-ordination when a system of budgetary control operates. 5. Co-ordinating the various activities of the business and centralizing control and yet enabling management to decentralize responsibility and delegate authority in the overall interest of the business. 6. Engendering a spirit of careful forethought, assessment of what is possible and an attempt at it. It leads to dynamism without recklessness. Of course, much depends on the objectives of the firm and the vigor of its management. 7. Providing a basis for revision of current and future policies. 8. Drawing up long range plans with a fair measure of accuracy. Providing a yardstick against which actual results can be compared 10.4 WORKING OF A BUDGETARY CONTROL SYSTEM The responsibility for successfully introducing and implementing a Budgetary Control System rests with the Budget Committee acting through the Budget Officer. The Budget Committee would be composed of all functional heads and a member from the Board to preside over and guide the deliberations. The main responsibilities of the Budget Officer are: 1.To assist in the preparation of the various budgets by coordinating the work of the accounts department which is normally responsible to compile the budgets—with the relevant functional departments like Sales, Production, Plant maintenance etc. 2.To forward the budget to the individuals who are responsible to adhere to them, and to guide them in overcoming any practical difficulties in its working. 3.To prepare the periodical budget reports for circulation to the individuals concerned. 4.To follow-up action to be taken on the budget reports. 5.To prepare an overall budget working report for discussion at the Budget Committee meetings and to ensure follow-up on the lines of action suggested by the Committee; 6.To prepare periodical reports for the Board meeting. Comparing the budgeted Profit and Loss Account and the Balance Sheet with the actual results attained. It is necessary that every budget should be thoroughly discussed with the functional head before it is finalised. It is the duty of the Budget Officer to see that the periodical budget reports are supplied to the recipients at frequent intervals as far as possible. The efficiency of the Budget Officer, and through him of the Budget Committee, will be judged more by the smooth working of the system and the agreement between the actual figures and the budgeted figures. Budgets are primarily an incentive and a challenge for better 123 CU IDOL SELF LEARNING MATERIAL (SLM)
performance; it is up to the Budget Officer to see that attention of the different functional heads is drawn to it to face the challenge in a successful manner. 10.5 MERITS AND LIMITATIONS OF BUDGETARY CONTROL SYSTEM Advantages of Budgetary Control System: Points Description 1. Efficiency The use of budgetary control system enables the management of a business concern to conduct its business activities in the efficient manner. 2. Control on expenditure It is a powerful instrument used by business houses for the control of their expenditure. It in fact provides a yardstick for measuring and evaluating the performance of individuals and their departments. 3. Finding deviations It reveals the deviations to management, from the budgeted figures after making a comparison with actual 4. Effective utilization figures. resources ofEffective utilization of various resources like—men, material, machinery and money—is made possible, as the production is planned after taking them into account. 5. Revision of plans It helps in the review of current trends and framing of future policies. 6. Implementation of StandardIt creates suitable conditions for the implementation of Costing system standard costing system in a business organization. 7. Cost Consciousness Budgets are studied by outside fund providers also such as banking and financial institutions, realizing that management encourages cost consciousness and maximum utilization of available resources. 8. Credit Rating Management which have developed a well ordered budget plans and which operate accordingly, receive greater favour from credit agencies. Limitations of Budgetary Control System: Points Description 124 CU IDOL SELF LEARNING MATERIAL (SLM)
1. Based on Estimates Budgets are based on series of estimates which are based on the conditions prevailed or expected at the time budget is established. It requires revision in plan if conditions change. 2. Time factor Budgets cannot be executed automatically. Some preliminary steps are required to be accomplished before budgets are implemented. It requires proper attention and time of management. Management must not expect too much during the development period. 3. Co-operation Required Staff co-operation is usually not available during budgetary control exercise. In a decentralized organization each unit has its own objective and these units enjoy some degree of discretion. In this type of organization structure coordination among different units are required. The success of the budgetary control depends upon willing co-operation and teamwork, 4. Expensive Its implementation is quite expensive. For successful implementation of the budgetary control proper organization structure with responsibility is prerequisite. Budgeting process start from the collection of requirements to budget and performance analysis. It consumes valuable resources for these purpose, hence, it is an expensive process. 5. Not a substitute forBudget is only a managerial tool and must be applied correctly management for management to get benefited. Budgets are not a substitute for management. 6. Rigid document Budgets are considered as rigid document. But in reality, an organization is exposed to various uncertain internal and external factors. Budget should be flexible enough to incorporate ongoing developments in the internal and external factors affecting the very purpose of the budget. 10.6 COMPONENTS OF BUDGETARY CONTROL SYSTEM The policy of a business for a defined period is represented by the master budget the details of which are given in a number of individual budgets called functional budgets. These functional budgets are broadly grouped under the following heads: 1.Physical budgets: Those budgets which contain information in terms of physical units about sales, production etc. for example, quantity of sales, quantity of production, inventories, and manpower budgets are physical budgets. 125 CU IDOL SELF LEARNING MATERIAL (SLM)
2.Cost budgets: Budgets which provides cost information in respect of manufacturing, selling, administration etc. for example, manufacturing costs, selling costs, administration cost, and research and development cost budgets are cost budgets. 3.Profit budgets: A budget which enables in the ascertainment of profit, for example, sales budget, profit and loss budget, etc. 4.Financial budgets: A budget which facilitates in ascertaining the financial position of a concern, for example, cash budgets, capital expenditure budget, budgeted balance sheet etc. Steps in preparation of Budget 1. Definition of objectives: A budget being a plan for the achievement of certain operational objectives, it is desirable that the same are defined precisely. The objectives should be written out; the areas of control demarcated; and items of revenue and expenditure to be covered by the budget stated. This will give a clear understanding of the plan and its scope to all those who must cooperate to make it a success. 2. Location of the key (or budget) factor: There is usually one factor (sometimes there may be more than one) which sets a limit to the total activity. For instance, in India today sometimes non-availability of power does not allow production to increase in spite of heavy demand. Similarly, lack of demand may limit production. Such a factor is known as key factor. For proper budgeting, it must be located and estimated properly. 3. Appointment of controller: Formulation of a budget usually required whole time services of a senior executive; he must be assisted in this work by a Budget Committee, consisting of all the heads of department along with the Managing Director as the Chairman. The Controller is responsible for coordinating and development of budget programmes and preparing the manual of instruction, known as Budget manual. 4. Budget Manual: Effective budgetary planning relies on the provision of adequate information to the individuals involved in the planning process. Many of these information needs are contained in the budget manual. A budget manual is a collection of documents that contains key information for those involved in the planning process. Typical contents could include the following: •An introductory explanation of the budgetary planning and control process, including a statement of the budgetary objective and desired results. •A form of organisation chart to show who is responsible for the preparation of each functional budget and the way in which the budgets are interrelated. •A timetable for the preparation of each budget. This will prevent the formation of a ‘bottleneck’ with the late preparation of one budget holding up the preparation of all others. •Copies of all forms to be completed by those responsible for preparing budgets, with explanations concerning their completion. 126 CU IDOL SELF LEARNING MATERIAL (SLM)
•A list of the organization’s account codes, with full explanations of how to use them. •Information concerning key assumptions to be made by managers in their budgets, for example the rate of inflation, key exchange rates, etc. 5. Budget period: The period covered by a budget is known as budget period. There is no general rule governing the selection of the budget period. In practice the Budget Committee determines the length of the budget period suitable for the business. Normally, a calendar year or a period co-terminus with the financial year is adopted. The budget period is then sub-divided into shorter periods; it may be months or quarters or such periods as coincide with period of trading activity. 6. Standard of activity or output: For preparing budgets for the future, past statistics cannot be completely relied upon, for the past usually represents a combination of good and bad factors. Therefore, though results of the past should be studied but these should only be applied when there is a likelihood of similar conditions repeating in the future. Also, while setting the targets for the future, it must be remembered that in a progressive business, the achievement of a year must exceed those of earlier years. Therefore, what was good in the past is only fair for the current year. In budgeting, fixing the budget of sales and of capital expenditure is most important since these budgets determine the extent of development activity. For budgeting sales, one must consider the trend of economic activity of the country, reactions of salesmen, customers and employees, effect of price changes on sales, the provision for advertisement campaign plan capacity etc. 10.7 SUMMARY Budgetary Control: Budgetary Control is the establishment of budgets, relating the responsibilities of executives to the requirements of a policy, and the continuous comparison of actual with budgeted results, either to secure by individual action the objective of that policy or to provide a basis for its revision. Budget Manual: The Budget manual is a document or booklet which Contain guidelines for the preparation of budget in an organization. Budget Period: The period of time for which a budget is prepared and used. It may be a year, quarter or a month. Classification of Budgets: Capacity based - Fixed and Flexible Content based - Monetary and Physical/quantitative Functional based - Purchase, Sale, Production Cost, Administrative, Selling & Distribution, Research & Development, Plant Capital Expenditure, Cash, Plant Utilization. 127 CU IDOL SELF LEARNING MATERIAL (SLM)
•Fixed Budget: a fixed budget, is a budget designed to remain unchanged irrespective of the level of activity actually attained •Flexible Budget: a flexible budget is defined as a budget which, by recognizing the difference between fixed, semi-variable and variable costs is designed to change in relation to the level of activity attained. 10.8 KEY WORDS Bottleneck – It is a point of congestion in a production system (such as an assembly line or a computer network) that occurs when workloads arrive too quickly for the production process to handle. CEB- Capital Expenditure Budget 10.9 LEARNING ACTIVITY 1. Learn about the concept relating to ZERO budgeting ________________________________________________________________________ ________________________________________________________________________ 10.10 UNIT END QUESTIONS A.Descriptive Questions Short Questions 1.State the objectives of budgetary control system 2.Explain the merits of budgetary control system 3.What are the salient features of a budgetary control system Long Questions 1.Discuss the merits and demerits of a budgetary control system 2.Explain in detail involved in preparation of budget B. Multiple choice Questions 128 1.When preparing a production budget, the quantity to be produced equals a. sales quantity + opening inventory of finished goods + closing inventory of finished goods b. sales quantity – opening inventory of finished goods + closing inventory of finished goods c. sales quantity – opening inventory of finished goods – closing inventory of finished goods CU IDOL SELF LEARNING MATERIAL (SLM)
d. sales quantity + opening inventory of finished goods – closing inventory of finished goods 2. In comparing a fixed budget with a flexible budget, what is the reason for the difference between the profit figures in the two budgets? a. Different levels of activity b. Different levels of spending c. Different levels of efficiency d. The difference between actual and budgeted performance 3.When budget allowances are set without the involvement of the budget owner, the budgeting process can be described as: a. top-down budgeting b. negotiated budgeting c. zero based budgeting d. participative budgeting 4. For which of the following would zero based budgeting be most suitable? a. Building construction b. Mining company operations c. Transport company operations d. Government department activities Answers 1-b 2-a 3-a 4-d 10.11 REFERENCES Text Books: T1 V.K. Saxana & C.D. Vashist, Advanced Cost of Management Accounting, Sultan Chand & Sons, New Delhi, 1998. T2 Advanced Management Accounting By Ravi M.Kishore – Taxman Publication Reference Books: R1 Dr.Manmohan & S.N.Goyal, Principles of Management Accounting Shakithabhavan Publication, Agra. R2 Kaplan & Atkinson, Advanced Management Accounting, Prentice Hall of India – 1999 129 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT – 11 COST VOLUME PROFIT ANALYSIS Structure 11.0 Learning Objectives 11.1 Introduction 11.2Contribution 11.3 Cost volume profit analysis 11.4 Marginal cost equation 11.5PV ratio 11.6Methods of breakeven analysis 11.7 Multi product break even analysis 11.8Margin of safety 11.9 Summary 11.10 Keywords 11.11Learning activities 11.12 Unit end questions 11.13 References 11.0 LEARNING OBJECTIVES After studying this unit students will be able to Explain the cost volume profit analysis Learn marginal cost equation State the PV ratio Analyse methods of breakeven analysis Learn the concept of margin of safety 11.1 INTRODUCTION Cost has different meaning in different settings and the kind of cost concepts used in a particular situation depends upon the circumstances/requirement of each case. The costs reported by financial accountants are actual costs. For the purpose of decision making and control, costs are distinguished on the basis of their relevance to the different type of decisions and control functions. For business decision making purposes, relevant costs rather than actual costs are considered. Relevant costs constitute a practical basis of decision making which is different from historical cost approach. 130 CU IDOL SELF LEARNING MATERIAL (SLM)
11.2 CONTRIBUTION Contribution or contribution margin is the difference between sales revenue and total variable costs irrespective of manufacturing or non- manufacturing. It is obtained by subtracting variable costs from sales revenue. It can also be defined as excess of sales revenue over the variable costs. The contribution concept is based on the theory that the profit and fixed expenses of a business is a ‘joint cost’ which cannot be equitably apportioned to different segments of the business. In view of this difficulty the contribution serves as a measure of efficiency of operations of various segments of the business. The contribution forms a fund for fixed expenses and profit as illustrated below: Example: = ₹ 80,000 Variable Cost = ₹50,000, Fixed Cost = ₹ 20,000, Selling Price Contribution = Selling Price – Variable Cost = ₹ 80,000 – ₹ 50,000 = ₹ 30,000 Profit = Contribution – Fixed Cost = ₹ 30,000 – ₹ 20,000 = ₹10,000 Since, contribution exceeds fixed cost; the profit is of the magnitude of ₹ 10,000. Suppose the fixed cost is ₹ 40,000 then the position shall be: Contribution – Fixed cost = Profit or, = ₹ 30,000 – ₹ 40,000 = - ₹ 10,000 The amount of ₹10,000 represent extent of loss since the fixed costs are more than the contribution. At the level of fixed cost of ₹30,000, there shall be no profit and no loss. 11.3 COST VOLUME PROFIT ANALYSIS Meaning: It is a managerial tool showing the relationship between various ingredients of profit planning viz., cost, selling price and volume of activity. As the name suggests, cost volume profit (CVP) analysis is the analysis of three variables cost, volume and profit. Such an analysis explores the relationship between costs, revenue, activity levels and the resulting profit. It aims at measuring variations in cost and volume. Assumptions: 1.Changes in the levels of revenues and costs arise only because of changes in the number of product (or service) units produced and sold – for example, the number of television sets produced and sold by Sony Corporation or the number of packages delivered by Overnight Express. The number of output units is the only revenue driver and the only cost driver. Just as a cost driver is any factor that affects costs, a revenue driver is a variable, such as volume, that causally affects revenues. 131 CU IDOL SELF LEARNING MATERIAL (SLM)
2.Total costs can be separated into two components; a fixed component that does not vary with output level and a variable component that changes with respect to output level. Furthermore, variable costs include both direct variable costs and indirect variable costs of a product. Similarly, fixed costs include both direct fixed costs and indirect fixed costs of a product 3.When represented graphically, the behaviours of total revenues and total costs are linear (meaning they can be represented as a straight line) in relation to output level within a relevant range (and time period). 4.Selling price, variable cost per unit, and total fixed costs (within a relevant range and time period) are known and constant. 5.The analysis either covers a single product or assumes that the proportion of different products when multiple products are sold will remain constant as the level of total units sold changes. 6.All revenues and costs can be added, subtracted, and compared without taking into account the time value of money 11.4 MARGINAL COST EQUATION The contribution theory explains the relationship between the variable cost and selling price. It tells us that selling price minus variable cost of the units sold is the contribution towards fixed expenses and profit. If the contribution is equal to fixed expenses, there will be no profit or loss and if it is less than fixed expenses, loss is incurred. Since the variable cost varies in direct proportion to output, therefore if the firm does not produce any unit, the loss will be there to the extent of fixed expenses. These points can be described with the help of following marginal cost equation Marginal cost statement Sales (Rs.) Less: Variable Cost xxxx Contribution xxxx Less: Fixed Cost xxxx Profit xxxx xxxx 132 CU IDOL SELF LEARNING MATERIAL (SLM)
11.5 P/V RATIO This ratio shows the proportion of sales available to cover fixed costs and profit. Contribution represent the sales revenue after deducting variable costs. This ratio is usually expressed in percentage A higher contribution to sales ratio implies that the rate of growth of contribution is faster than that of sales. This is because, once the breakeven point is reached, profits shall grow at a faster rate when compared to a product with a lesser contribution to sales ratio. By transposition, we have derived the following equations: (i) C = S × P/V ratio (ii) S = C /P / V ratio Break-Even Analysis Break-even analysis is a generally used method to study the CVP analysis. This technique can be explained in two ways: (i)In narrow sense it is concerned with computing the break-even point. At this point of production level and sales there will be no profit and loss i.e. total cost is equal to total sales revenue. (ii)In broad sense this technique is used to determine the possible profit/loss at any given level of production or sales. 11.6 METHODS OF BREAK -EVEN ANALYSIS Break even analysis may be conducted by the following two methods: (A) Algebraic computations (B) Graphic presentations Breakeven Point The word contribution has been given its name because of the fact that it literally contributes towards the recovery of fixed costs and the making of profits. The contribution grows along with the sales revenue till the time it just covers the fixed cost. This is the point where neither profits nor losses have been made is known as a break- even point. This implies that in order to break even the amount of contribution generated should be exactly equal to the fixed costs incurred. Hence, if we know how much contribution is generated from each unit sold we shall have sufficient information for computing the number of units to be sold in order to break even. Mathematically BREAKEVEN POINT IN UNITS = Fixed cost/Contribution per unit ABC Ltd. manufacturing a single product, incurring variable costs of Rs.300 per unit and fixed costs of Rs.2,00,000 per month. If the product sells for Rs.500 per unit, the breakeven point shall be calculated as follows. BREAK EVEN POINT = 200000/200 = 1000 Units 133 CU IDOL SELF LEARNING MATERIAL (SLM)
Cash Breakeven point When break-even point is calculated only with those fixed costs which are payable in cash, such a break-even point is known as cash break-even point. This means that depreciation and other non-cash fixed costs are excluded from the fixed costs in computing cash break-even point. Its formula is Cash Breakeven point = Cash Fixed cost/contribution per unit MNP Ltd sold 2,75,000 units of its product at Rs.37.50 per unit. Variable costs are Rs. 17.50 per unit (manufacturing costs of Rs.14 and selling cost Rs.3.50 per unit). Fixed costs are incurred uniformly throughout the year and amounting to Rs.35,00,000 (including depreciation of Rs.15,00,000). There are no beginning or ending inventories. Required: COMPUTE breakeven sales level quantity and cash breakeven sales level quantity. Break even sales quantity = Fixed cost/contribution margin = 3500000/20 = 1,75,000 units Cash breakeven point = Cash Fixed cost/contribution margin 2000000/20 = 100000 units 11.7 MULTIPRODUCT BREAK-EVEN ANALYSIS In a multi-product environment, where more than one product is manufactured by using a common fixed cost, the break-even point formula needs some adjustments. The contribution is calculated by taking weights for the products. The weights may be of sales mix quantity or sales mix values. The calculation of Multi-Product Break-even analysis can be understood with the help of the following example Arnav Ltd. sells two products, J and K. The sales mix is 4 units of J and 3 units of K. The contribution margins per unit are Rs.40 for J and Rs.20 for K. Fixed costs are Rs.6,16,000 per month. Sales mix (in quantity) is 4 units of Product- J and 3 units of Product- K i.e., Sales ratio is 4 : 3 Composite contribution per unit by taking weights for the product sales quantity = product j -40*4/7 + product k-20*3/7 =22.86+8.57 = Rs.31.43 Breakeven point = 6,16,00/31.43= 19,600 units 134 Product j= 19600*4/7 = 11200 units CU IDOL SELF LEARNING MATERIAL (SLM)
Product k= 19600*3/7 = 8400 units 11.8 MARGIN OF SAFETY The margin of safety can be defined as the difference between the expected level of sale and the breakeven sales. The larger the margin of safety, the higher is the chances of making profits. In the Example-3 if the forecast sale is 1,700 units per month, the margin of safety can be calculated as follows, Margin of Safety = Projected sales – Breakeven sales = 1,700 units – 1,000 units = 700 units or 41% of sales. The Margin of Safety can also be calculated by identifying the difference between the projected sales and breakeven sales in units multiplied by the contribution per unit. This is possible because, at the breakeven point all the fixed costs are recovered, and any further contribution goes into the making of profits. It also can be calculated as Margin of safety = Profit/pv ratio The sports material manufacturing company budgeted the following data for the coming year. Sales= Rs.100000 V.C = 40,000 Fixed cost -50,000 calculate Margin of safety P/V ratio, B.E.P and Margin of Safety Contribution = Sales – Variable cost = 1,00,000 – 40,000 = Rs.60,000 P/V Ratio = (Contribution / Sales) x 100 = (60,000 / 1,00,000) x 100 = 60% B.E.P sales = Fixed cost / PV ratio = 50,000 / 60% = Rs.83,333 Margin of Safety = Total sales – B.E.P sales = 1,00,000 – 83,333 = Rs.16,667 11.9 SUMMARY Marginal Cost: Marginal cost as understood in economics is the incremental cost of production which arises due to one-unit increase in the production quantity. Marginal cost is measured by the total variable cost attributable to one unit. Marginal Costing: It is a costing system where products or services and inventories are valued at variable costs only. It does not take consideration of fixed costs. Absorption Costing: A method of costing by which all direct cost and applicable overheads are charged to products or cost centres for finding out the total cost of production. Absorbed cost includes production cost as well as administrative and other cost. 135 CU IDOL SELF LEARNING MATERIAL (SLM)
Contribution: Contribution or contribution margin is the difference between sales revenue and total variable costs irrespective of manufacturing or non- manufacturing. Cost-Volume-Profit (CVP) Analysis: It is an analysis of reciprocal effect of changes in cost, volume and profitability. Such an analysis explores the relationship between costs, revenue, activity levels and the resulting profit. It aims at measuring variations in cost and volume. Contribution to Sales Ratio (Profit Volume Ratio or P/V ratio): This ratio shows the proportion of sales available to cover fixed costs and profit. Contribution represents the sales revenue after deducting variable costs. Break-even Point (BEP): The level of sales where an entity neither earns profit nor incurs loss. BEP is indicated in both quantity and monetary value terms. Margin of Safety (MOS): The margin between sales and the break-even sales is known as margin of safety. It can either be indicated in quantitative or monetary terms. 11.10KEYWORDS BEP-Break Even point MOS- Margin of safety Limiting Factor - : Limiting factor is anything which limits the activity of an entity. Key Factor- . The factor is a key to determine the level of sale and production, thus it is also known as Key factor 11.11LEARNING ACTIVITIES 1. List out variable, fixed and semi variable costs involved in running a Coffee shop ___________________________________________________________________________ __________________________________________________________________________ 11.12 UNIT END QUESTIONS A.Descriptive Questions Short Questions 1. Discuss the basic assumptions of cost volume profit analysis 2.what is meant by margin of safety ? 3.Define the term contribution and PV ratio Long Questions 136 CU IDOL SELF LEARNING MATERIAL (SLM)
1. XY Ltd. makes two products X and Y, whose respective fixed costs are F1 and F2. You are given that the unit contribution of Y is one fifth less than the unit contribution of X, that the total of F 1 and F2 is Rs.1,50,000, that the BEP of X is 1,800 units (for BEP of X, F2 is not considered) and that 3,000 units is the indifference point between X and Y. (i.e., X and Y make equal profits at 3,000-unit volume, considering their respective fixed costs). There is no inventory build-up as whatever is produced is sold. Required FIND OUT the values F1 and F2 and units contributions of X and Y. 2. A single product company sells its product at Rs.60 per unit. In 2019, the company operated at a margin of safety of 40%. The fixed costs amounted to ` 3,60,000 and the variable cost ratio to sales was 80%. In 2020, it is estimated that the variable cost will go up by 10% and the fixed cost will increase by 5%. (i)FIND the selling price required to be fixed in 2020 to earn the same P/V ratio as in 2019. (ii)Assuming the same selling price of Rs. 60 per unit in 2020, FIND the number of units required to be produced and sold to earn the same profit as in 2019 B. Multiple choice Questions 1. The breakeven point is the point at which, a. There is no profit, no loss b. Contribution margin is equal to total fixed cost c. Total fixed cost is equal to total revenue d. All of these 2. A large margin of safety indicates a. Over capitalization b. The soundness of business c. Overproduction d. None of these 3. The selling price is Rs.20 per unit, variable cost Rs.12 per unit, and fixed cost Rs.16,000, the breakeven-point in units will be a. 800 units b. 2000 units c. 3000 units d. None of these 4. The P/V ratio of a product is 0.4 and the selling price is ₹40 per unit. The marginal cost of the product would be, a. ₹8 137 CU IDOL SELF LEARNING MATERIAL (SLM)
b. ₹24 c. ₹20 d. ₹25 5. Fixed cost per unit decreases when, a. Production volume increases b. Production volume decreases c. Variable cost per unit decreases d. Variable cost per unit increases Answers 1- d 2-b 3-b 4-b 5-a 11.13 REFERENCES Text Books: T1 V.K. Saxana & C.D. Vashist, Advanced Cost of Management Accounting, Sultan Chand & Sons, New Delhi, 1998. T2 Advanced Management Accounting By Ravi M.Kishore – Taxman Publication Reference Books: R1 Dr.Manmohan & S.N.Goyal, Principles of Management Accounting Shakithabhavan Publication, Agra. R2 Kaplan & Atkinson, Advanced Management Accounting, Prentice Hall of India – 1999 138 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT - 12 STRATEGIC COST MANAGEMENT AND ITS TOOLS Structure 12.0 learning objectives 12.1 introduction 12.2 target costing 12.3 life cycle costing 12.4 Kaizen costing 12.5 just in time 12.6 back flush casting 12.7 strategic cost management 12.8 summary 12.9 keywords 12.10learning activities 12.11unit end questions 12.12 references 12.0 LEARNING OBJECTIVES After studying this unit students will be able to Discuss the importance of cost management techniques Learn about target costing Describe the concepts relating to just in time Learn about backflush costing Describe about kaizen costing 12.1 INTRODUCTION In the modern business environment, it is not sufficient to control costs and a business must focus to manage cost strategically. The businesses today operate in an environment with stiff competition, increasing consumer demands for quality products and technology revolution. The ultimate objective of a business is to earn better profits and create value for shareholders. This can be achieved by superior performance as compared to the competitors which results in distinctive competitive advantages. Strategic cost management is the application of cost management techniques so that they improve the strategic position of a business as well as control costs. It also involves integrating cost information with the decision-making framework to support the overall 139 CU IDOL SELF LEARNING MATERIAL (SLM)
organisational strategy. It is not limited to controlling costs but using cost information for management decision making. The cost management techniques should be such that they improve the strategic position of a business apart from focusing on controlling costs. The basic aim of Strategic Cost Management is to help the organisation to achieve the sustainable competitive advantage through product differentiation and cost leadership 12.2 TARGET COSTING Target Costing is defined as “a structured approach to determine the cost at which a proposed product with specified functionality and quality must be produced, to generate a desired level of profitability at its anticipated-selling-price” Steps in Target Costing approach to pricing: Setting of target selling price: The setting of target selling price of a product which customers are prepared to pay, depend on many factors like design specifications of the product, competitive conditions, customer’s demand for increased functionality and higher quality projected production volume, sales forecasts etc. A concern can set its target selling price after taking into account all of the aforesaid factors. Determination of target costs: Target profit margin may be established after taking into account long- term profit objectives and projected volume of sales. On deducting target profit margin from target selling price, target cost is determined. Estimate the actual cost of the product: Actual cost of the product may be determined after taking into account the design specifications, material cost and other costs required to produce the product. Comparison of estimated cost with actual cost: In case the estimated cost of the product is higher than that of the target cost of the product then the concern should resort to cost reduction methods involving the use of Value Engineering / Value Analysis tools. (refer complete Value Engineering Process in Activity Based Costing) Steps involved in implementing a Target Costing System Create a Project Charter: Project Charter is a document, approved by top management that describes its goals and what it is authorized to do. This Charter is based on the corporate mission statement and related goals. Written approval of Project Charter by the top management provides the target costing effort with a strong basis of support and direction in all subsequent efforts. Obtain a Management Sponsor: Management Sponsor is an individual belonging to top management. His role will be to support the initiative in all respects, to obtain funding, to co- ordinate with other members of top management, to eliminate problems in a timely manner. Obtain a Budget: The funding should be based on a formal allocation of money through the corporate budget. The fund should be given unreservedly to the target costing effort. Assign a Strong Team Manager: The Target Costing Team involves the active participation of many members with diverse backgrounds. A strong Team Manager is required to bring the 140 CU IDOL SELF LEARNING MATERIAL (SLM)
group together as a smooth functioning team focused on key objectives. He should be skilled in dealing with management, the use of project tools and working with a diverse group of people. This manager should be a full-time employee, so that his or her complete attention can be directed towards the welfare of the project. Enrol Full-time Participants: It is essential that the members of the team be devoted to it full- time rather than trying to fulfil other commitment elsewhere in the company at the same time. They should have a single focus on ensuring the success of the target- costing program. Use Project Management Tools: Target costing can be a highly complex effort especially for high-cost products with many features and components. The team should use all available project management tools, such as Microsoft Project (for tracking the completion of specific tasks), a company database containing various types of costing information and a variety of product design tools. Advantages of Target Costing: Innovation: It reinforces top-to-bottom commitment to process and product innovation and is aimed at identifying issues to be resolved. Competitive Advantage: It enables a firm to achieve competitive advantage over other firms in the industry. The firm, which achieves cost reduction targets realistically, stands to gain in the long run. Market Driven Management: It helps to create a company’s competitive future with market- driven management for designing and manufacturing products that meet the price required for market success. Real Cost Reduction: It uses management control systems to support and reinforce manufacturing strategies and to identify market opportunities that can be converted into real savings to achieve the best value rather than simply the lowest cost. Problems with Target Costing The development process can be lengthened to a considerable extent since the design team may require a number of design iterations before it can devise a sufficiently low-cost product that meets the target cost and margin criteria. A large amount of mandatory cost cutting can result in finger-pointing in various parts of the company, especially if employees in one area feel they are being called on to provide a disproportionately large part of the savings. Representatives from number of departments on the design team can sometimes make it more difficult to reach a consensus on the proper design. 12.3 LIFE CYCLE COSTING Life cycle costing, aims at cost ascertainment of a product, project etc. over its projected life. It is a system that tracks and accumulates the actual costs and revenues attributable to cost object from its inception to its abandonment. Product Life Cycle 141 CU IDOL SELF LEARNING MATERIAL (SLM)
Product life cycle is a pattern of expenditure, sale level, revenue and profit over the period from new idea generation to the deletion of product from product range. Product life cycle spans the time from initial R&D on a product to when customer servicing and support is no longer offered for the product. For products like motor vehicles this time span may range from 5 to 7 years. For some basic pharmaceuticals, the time span may be 7 to 10 years. In case of cameras, photocopying machines etc. the life is more than 100 years. Phases in product life cycle The four identifiable phases in the Product Life Cycle are (a) Introduction (b) Growth (c) Maturity and (d) Decline. Product Life Cycle Costing It is an approach used to provide a long-term picture of product line profitability, feedback on the effectiveness of life cycle planning cost data to clarify the economic impact of alternatives chose in the design, engineering phase etc. It is also considered as a way to enhance the control of manufacturing costs. The thrust of product life cycle costing is on the distribution of costs among categories changes over the life of the product, as does the potential profitability of a product. Hence it is important to track and measure costs during each stage of a product’s life cycle. Features / Characteristics of Product Life Cycle Costing: Product life cycle costing is important due to the following features: Product life cycle costing involves tracing of costs and revenues of each product over several calendar periods throughout their entire life cycle. Costs and revenues can be analysed by time periods, but the emphasis is on costs and revenue accumulation over the entire life cycle for each product. Product life cycle costing traces research and design and development costs, incurred to individual products over their entire life cycles, so that the total magnitude of these costs for each individual product can be reported and compared with product revenues generated in later periods. Life cycle costing therefore ensures that costs for each individual product can be reported and compared with product revenues generated in later periods. Hence, the costs are made more visible. Benefits of Product Life Cycle Costing: The benefits of product life cycle costing are summarized as follows: The product life cycle costing results in earlier actions to generate revenue or to lower costs than otherwise might be considered. There are a number of factors that need to the managed in order to maximize return on a product. Better decisions should follow from a more accurate and realistic assessment of revenues and costs, at least within a particular life cycle stage. 142 CU IDOL SELF LEARNING MATERIAL (SLM)
Product life cycle thinking can promote long-term rewarding in contract to short-term profitability rewarding. Importance of Product Life Cycle Costing: Product Life Cycle Costing is considered important due to the following reasons: Time based analysis: Life cycle costing involves tracing of costs and revenues of each product over several calendar periods throughout their life cycle. Costs and revenues can be analysed by time periods. The total magnitude of costs for each individual product can be reported and compared with product revenues generated in later periods. Overall Cost Analysis: Production costs are accounted and recognized by the routine accounting system. However non-production costs like R&D, design, marketing, distribution, customer service etc. are less visible on a product-by-product basis. Product Life Cycle Costing focuses on recognizing both production and non-production cost. Pre-production Costs analysis: The development period for R&D and design is long and costly. A high percentage of total product costs may be incurred before commercial production begins. Hence, the company needs accurate information on such costs for deciding whether to continue with the R&D or not. Effective Pricing Decisions: Pricing Decisions, in order to be effective, should include market consideration on the one hand and cost considerations on the other. Product Life Cycle Costing and Target Costing help analyse both these considerations and arrive at optimal price decisions. Better Decision Making: Better decisions should follow from a more accurate and realistic assessment of revenues and costs, at least within a particular life cycle stage. Long Run Wholistic view: Product life cycle thinking can promote long-term rewarding in contrast to short-term profitability rewarding. It provides an overall framework for considering total incremental costs over the entire life span of a product, which in turn facilitates analysis of parts of the whole where cost effectiveness might be improved. Life Cycle Budgeting: Life Cycle Budgeting, i.e. Life Cycle Costing with Target Costing principles, facilitates scope for cost reduction at the design stage itself. The Company stands to benefit since costs are avoided before they are committed or locked in. Review: Life Cycle Costing provides scope for analysis of long term picture of product line profitability, feedback on the effectiveness of life cycle planning and cost data to clarify the economic impact of alternatives chosen in the design, engineering phase etc. 12.4 KAIZEN COSTING Kaizen Costing refers to the ongoing continuous improvement program that focuses on the reduction of waste in the production process, thereby further lowering costs below the initial targets specified during the design phase. It is a Japanese term for a number of cost reduction steps that can be used subsequent to issuing a new product design to the factory floor. The 143 CU IDOL SELF LEARNING MATERIAL (SLM)
initial VE review may not be complete and perfect in all costs aspects. There may be further chances of waste reduction, cost and time reduction and product improvement. Such continuous cost reduction technique is call as Kaizen Costing. The review of product costs under the target costing methodology is not reserved just for the period up to the completion of design work on a new product. On the contrary, there are always opportunities to control costs after the design phase is completed, though these opportunities are fewer than during the design phase. Kaizen Costing Process: Activities in kaizen costing include elimination of waste in production, assembly and distribution processes, as well as the elimination of work steps in any of these areas. Thus kaizen costing is really designed to repeat many of the value engineering steps for as long as a product is produced, constantly refining the process and thereby stripping out extra costs at each stage. Savings from Kaizen Costing: The cost reductions resulting from kaizen costing are much smaller than those achieved with value engineering. But these are still significant since competitive pressures are likely to force down the price of a product over time, and any possible cost savings allow a company to still attain its targeted profit margins Mille continuing to reduce cost. Multiple Versions of Products - Continuous Kaizen Costing: Multiple improved versions of products can be introduced to meet the challenge of gradually reducing costs and prices. The market price of products continues to drop over time, which forces a company to use both target and kaizen costing to reduce costs and retain its profit margin. However, prices eventually drop to the point where margins are reduced, which forces the company to develop a new product with lower initial cost and for which kaizen costing can again be used to further reduce costs. This pattern may be repeated many times as a company forces its costs down through successive generations of products. The exact timing to switch to a new product is easy to determine well in advance since the returns from kaizen costing follow a trend line of gradually shrinking savings. Since prices also follow a predictable downward track, plotting these two trend lines into the future reveals when a new product version must be ready for production. 12.5 JUST IN TIME A JIT approach is a collection of ideas and philosophy that streamline a company’s production process activities to such an extent that waste of all kind viz. material and labour is systematically driven out of the process. Just in Time technique enables a company to ensure that it receives products / spare parts / materials from its suppliers on the exact date and at the exact time when they are needed. The steps involved are: Supplier Evaluation: The Purchasing Department must evaluate and investigate every supplier and eliminate those who could not keep up with the delivery dates. 144 CU IDOL SELF LEARNING MATERIAL (SLM)
Supplier Assistance: The engineering staff must visit supplier sites and examine their processes, not only to see if they can reliably ship high-quality parts but also to provide them with engineering assistance to bring them up to a higher standard of product. Supplier Information System: The firm must install a system, which is as simple as a fax machine or as advanced as an electronic data interchange system or linked computer systems, that communicates with suppliers as to exactly how much of specified parts are to be sent to the company. Direct Delivery: Deliveries should be sent straight to the production floor for immediate use in manufactured products, so that no time spent in inspecting the parts for defects. Drivers, who bring supplies of materials, drop them off at the specific machines that will use the materials first. Benefits associated with JIT system Reduction in Inventory levels: Unnecessary piling up of Raw Materials, WIP and finished goods are avoided. The focus is on production and purchase as per the firm’s requirements. Under a JIT system, the amount of inventory retained in a company drops continuously as under: Raw materials inventory is reduced because suppliers deliver only small quantities of parts as and when they are needed. Work-in-progress inventory drops because the conversion to machine cells and the use of Kanban cards greatly reduces the need to pile up inventory between machines. Finished goods inventory drops because inventories are allowed to build up only if a company experiences high seasonal sales. Reduction in Wastage of Time: The key focus of any JIT system is on reducing various kinds of wastage of time, so that the entire production process is concentrated on the time spent in actually producing products. By reducing wastage of time, the firm effectively eliminates activities that do not contribute to the value of a product which in turn reduces the costs associated with them. Time reduction can be achieved in the following manager. Inspection Time: All inspection time is eliminated from the system as operators conduct their own quality cheeks. Suppliers’ assistance and quality checks at supplier’s factory eliminate the need for separate inspection or QC department in the firm. Handling Time: All movement, which involves shifting inventory and work in process throughout the various parts of the plant, can be eliminated by clustering machines together in logical groupings called Working Cells Queue Time: Queue time is eliminated by not allowing inventory to build up in front of machines. Kanban cards serve this purpose. Storage Time: Clearing out excessive stocks of inventory and having suppliers deliver parts only as and when needed eliminates Storage time. 145 CU IDOL SELF LEARNING MATERIAL (SLM)
Reduction in Scrap Rates: There will be sharp reductions in the rates of defectives or scrapped units. The workers themselves identify defects and take prompt action to avoid their recurrence. 12.6 BACKFLUSH COSTING Traditional, normal and standard costing systems use the sequential tracking method for accounting costs. This involves recording journal entries in the same order as transactions occur, i.e. purchase, issue of materials, production, overheads absorption etc. Such systems are required in those manufacturing environments where inventory / WIP values are large. An alternative approach to sequential tracking is Backflush Costing. It is a costing system that omits recording some or all of the journal entries relating to the cycle from purchase of direct materials to the sale of finished goods. The journal entries for the subsequent stages use normal or standard costs to work backward to flush out the cost in the cycle for which the journal entries were omitted earlier. Since JIT systems operate in modern manufacturing environment characterized by low inventory and WIP values, usually also associated with low-cost variances, the use of backflush costing is ideal when compared to sequential tracking method. However, the following issues must be corrected before effective implementation of Backflush Costing: Accurate Production reporting: The total production figure entered into the system must be absolutely correct, or else the wrong component types and quantities will be subtracted from stock. This is a particular problem when there is high turnover or a low level of training to the production staff that records this information. Proper Scrap reporting: All abnormal scrap must be diligently tracked and recorded. Otherwise, these materials will fall outside the backflushing system and will not be charged to inventory. Since scrap can occur anywhere in a production process, lack of attention by any of the production staff can result in an inaccurate inventory. 12.7 STRATEGIC COST MANAGEMENT Lot tracing: Lot tracing is impossible under backflushing system. It is required when a manufacturer need to keep records of which production lots were used to create a product, in case all the items in a lot must be recalled. Only a picking system can adequately record this information. Some computer systems allow picking and backflushing system to coexist. Inventory accuracy: The inventory balance may be too high at all times because the backflushing transaction that relieves inventory usually does so only once a day, during which time other inventory is sent to the production process. This makes it difficult to 146 CU IDOL SELF LEARNING MATERIAL (SLM)
maintain an accurate set of inventory records in the warehouse. The success of backflushing system is directly related to a company’s willingness to invest in a well-paid, experienced well-educated production staff that undergoes little turnover. Business process re-engineering (Value Engineering) Business process re-engineering involves examining business processes, current operations of organization and if possible, making substantial changes to current organizational operations. It means that apart from segregating all the activities into Value Added and Non Value Added Activities, and eliminating all Non Value added activities from the process, one should also consider, whether there is any better way of doing all the value added activities. In value engineering process, we try to find out better ways of doing all the activities so that cost control and cost reduction can be done effectively. For example purchase of materials is a business process consisting of activities such as purchase requisition, identifying suppliers, preparing purchase orders, mailing purchase orders and follow up. The process can be re- engineered by sending the production schedule direct to the suppliers and entering into contractual agreement to deliver materials according to the production schedule. 12.8 SUMMARY Just in time is an approach of ideas that streamlines the production process to Such an extent where all wastages of time labour and money is driven out of the system Life cycle costing is a pattern of expenditure, sales level, revenue and profits over the period from new idea generation to the deletion of the product from range of products. Target costing is defined as a structured approach in determining the cost at which a proposed product with specified functionality and quality must be produced, to generate a desired level of profitability at its anticipated selling price Kaizen costing: It refers to the ongoing continuous improvement program that focuses on the reduction of waste in the production process, thereby further lowering cost below the initial targets specified during the design phase. It is a Japanese term for a number of cost reduction steps that can be used, subsequent to issuing a new design to the factory floor. Backflush costing is a product costing system generally used in a just-in-time (JIT) inventory system. In short, it is an accounting method that records the costs associated with producing a good or service only after they are produced, completed, or sold 12.9 KEYWORDS JIT-Just in time VE- Value Engineering PLC- Product Life cycle cost 147 CU IDOL SELF LEARNING MATERIAL (SLM)
12.10LEARNING ACTIVITIES Learn how the concept relating to JIT helped heavy motorcycle manufacturer overcome competition ___________________________________________________________________________ ___________________________________________________________________________ 12.11 UNIT END QUESTIONS A.Descriptive Questions Short Questions 1. Discuss the advantages of target costing 2.what do you understand by product life cycle 3.Briefly explain about the concept of just in time 4.Write a short note about value analysis and value engineering Long Questions 1.What is target costing discuss it advantages and disadvantages 2.Discuss in detail the steps involved in implementation of just in time 3.What is product life cycle and discuss its advantages B. Multiple choice Questions Which of the following is not a term normally used in value analysis? a. Resale value b. Use value c. Esteem value d. Cost value 2. Which of the following is not suitable for a JIT production system? a. Batch production b. Jobbing production c. Process production d. Service production 3. Which of the following is NOT a method of transfer pricing? a. Cost plus transfer price b. Internal price transfer price c. Market-based transfer price d. Two-part transfer price 148 CU IDOL SELF LEARNING MATERIAL (SLM)
4. When is market skimming pricing appropriate? a. If demand is very elastic b. If the product is new and different c. If there is little chance of achieving economies of scale d. If demand is inelastic 5. Which of the following is a recognised method of arriving at the selling price for the products of a business? (A) Life cycle pricing (B) Price skimming (C) Penetration pricing (D) Target costing a. (A) and (B) only b. (A), (B) and (C) only c. (B) and (C) only d. (A), (C) and (D) only Answers 1-a 2-a 3-b 4-b 5- b 12.12REFERENCES Text Books: T1 V.K. Saxana & C.D. Vashist, Advanced Cost of Management Accounting, Sultan Chand & Sons, New Delhi, 1998. T2 Advanced Management Accounting By Ravi M.Kishore – Taxman Publication Reference Books: R1 Dr.Manmohan & S.N.Goyal, Principles of Management Accounting Shakithabhavan Publication, Agra. R2 Kaplan & Atkinson, Advanced Management Accounting, Prentice Hall of India – 1999 149 CU IDOL SELF LEARNING MATERIAL (SLM)
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