(iii) Capacities of individual or interrelated production or operation Centres (iv) Operational constraints or capacity of critical machines or equipment (v) Number of shifts or machine hours or man hours Normal Capacity: Normal capacity is determined after suitable adjustments to the Installed Capacity. The adjustments may be of the following nature: (i) Time lost due to scheduled preventive or planned maintenance (ii) Number of shifts or machine hours or man hours (iii) Holidays, normal shut down days, normal idle time (iv) Normal time lost in batch change over CAS-3: COST ACCOUNTING STANDARD ON “PRODUCTION AND OPERATION OVERHEADS” This standard deals with the principles and methods of determining the Production or Operation Overheads. This standard deals with the principles and methods of classification, measurement and assignment of Production or Operation Overheads, for determination of the cost of goods produced or services provided and for the presentation and disclosure in cost statements. Objectives The objective of this standard is to bring uniformity and consistency in the principles and methods of determining the Production or Operation Overheads with reasonable accuracy. Scope This standard shall be applied to cost statements, which require classification, measurement, assignment, presentation and disclosure of Production or Operation Overheads including those requiring attestation. Disclosures The cost statements shall disclose the following: 1. The basis of assignment of Production or Operation Overheads to the cost objects 2. Production or Operation Overheads incurred in foreign exchange 3. Production or Operation Overheads relating to resources received from or supplied to related parties 4. Any Subsidy, Grant, Incentive or any amount of similar nature received or receivable reduced from Production or Operation Overheads 5. Credits or recoveries relating to the Production or Operation Overheads 6. Any abnormal cost not forming part of the Production or Operation Overheads 7. Any unabsorbed Production or Operation Overheads CAS-4: Cost Accounting Standard on Cost of Production for Captive Consumption Cost Accounting Standard 4 (CAS-4) was issued to specify the principles for determination of cost of production for valuation of goods meant for captive consumption, 51 CU IDOL SELF LEARNING MATERIAL (SLM)
as required under the Central Excise Valuation (Determination of Price of Excisable Goods) Rules 2000. CBEC, vide circular No. 692/8/2003- CX dated 13-2-2003 had clarified that in case of captive consumption, cost calculation should be as per CAS-4 only. With the introduction of Goods and Services Tax [GST] with effect from July 1, 2017, the concept of ‘captive consumption’ is no more relevant for computing the tax incidence. However, the concept of cost of production or manufacture is relevant under the GST laws where the value of supply of goods or services or both are determined based on cost. Objective The objective of this Standard is to bring uniformity and consistency in the principles and methods of determining the cost of production or acquisition or supply of goods or provision of services as required under the provisions of GST Acts/Rules. Scope This standard should be applied to cost statements which require classification, measurement, assignment, presentation, and disclosure of related costs for determination of the following under the relevant provisions of GST Acts/Rules. (i) Determination of cost of production of goods. (ii) Determination of cost of acquisition of goods; (iii) Determination of cost of supply of goods. (iv) Determination of cost of provision/supply of services; and (v) Determination of value of supply of goods or services as per open market value or as per goods or services of like kind and quality. CAS-5: Cost Accounting Standard on Determination of Average Cost of Transportation The Cost Accounting Principles for tracing/identifying an element of cost, its allocation/apportionment to a product or service are well established. Transportation Cost is an important element of cost for procurement of materials for production and for distribution of product for sale. Therefore, Cost Accounting Records should present transportation cost separately from the other cost of inward materials or cost of sales of finished goods. The Finance Act 2003 also specifies the certification requirement of Transportation Cost for claiming deduction while arriving at the assessable value of excisable goods cleared for home consumption/ export. There is a need to standardize the record keeping of expenses relating to transportation and computation of Transportation Cost. Objective (a) To bring uniformity in the application of principles and methods used in the determination of averaged/equalized Transportation Cost (b) To prescribe the system to be followed for maintenance of records for collection of cost of transportation, its allocation/apportionment to cost centres, locations or products 52 CU IDOL SELF LEARNING MATERIAL (SLM)
(c) To provide transparency in the determination of cost of transportation Scope This standard should be applied for calculation of cost of transportation required under any statute or regulations or for any other purpose. For example, this standard can be used for : (a) Determination of average transportation cost for claiming the deduction for arriving at the assessable value of excisable goods (b) Insurance claim valuation (c) Working out claim for freight subsidy under Fertilizer Industry Coordination Committee (d) Administered price mechanism of freight cost element (e) Determination of inward freight costs included or to be included in the cost of purchases attributable to the acquisition (f) Computation of freight included in the value of inventory for accounting on inventory or valuation of stock hypothecated with Banks / Financial Institution ...etc. CAS-6: Cost Accounting Standard on Material Cost [Limited Revision 2017] This standard deals with principles and methods of determining the Material Cost. Material for the purpose of this standard includes raw materials, process materials, and additives, manufactured / bought out components, sub-assemblies, accessories, semi- finished goods, consumable stores, spares and other indirect materials. This standard does not deal with Packing Materials as a separate standard is being issued on the subject. This standard deals with the principles and methods of classification, measurement and assignment of Material Cost, for determination of the Cost of product or service, and the presentation and disclosure in cost statements. Objective The objective of this standard is to bring uniformity and consistency in the principles and methods of determining the Material Cost with reasonable accuracy. Scope This standard should be applied to Cost Statements which require classification, measurement, assignment, presentation and disclosure of Material Costs including those requiring attestation. CAS-7: Cost Accounting Standard on Employee Cost [Limited Revision 2017] This standard deals with the principles and methods of determining the Employee Cost. This standard deals with the principles and methods of classification, measurement and assignment of Employee Cost, for determination of the cost of product or service and the presentation and disclosure in Cost Statements. Objective The objective of this standard is to bring uniformity and consistency in the principles and methods of determining the Employee Cost with reasonable accuracy. Scope 53 CU IDOL SELF LEARNING MATERIAL (SLM)
This standard should be applied to cost statements which require classification, measurement, assignment, presentation and disclosure of Employee Cost including those requiring attestation. CAS-8: Cost Accounting Standard on Cost of Utilities [Limited Revision 2017] This standard deals with the principles and methods of determining the Cost of Utilities. This standard deals with the principles and methods of classification, measurement and assignment of Cost of Utilities, for determination of the cost of product or service and the presentation and disclosure in Cost Statements. Objective The objective of this standard is to bring uniformity and consistency in the principles and methods of determining the Cost of Utilities with reasonable accuracy. Scope This standard shall be applied to cost statements which require classification, measurement, assignment, presentation and disclosure of Cost of Utilities including those requiring attestation. For determining the cost of production to arrive at an assessable value of excisable utilities used for captive consumption, Cost Accounting Standard 4 on Cost of Production for Captive Consumption (CAS 4) shall apply. This standard shall not be applicable to the organizations primarily engaged in generation and sale of utilities. This standard does not cover issues related to the ascertainment and treatment of carbon credits, which shall be dealt with in a separate standard. CAS-9: Cost Accounting Standard on Packing Material Cost [Limited Revision 2017] This standard deals with the principles and methods of determining the Packing Material Cost. This standard deals with the principles and methods of classification, measurement and assignment of Packing Material Cost, for determination of the cost of product, and the presentation and disclosure in Cost Statements. Packing Materials for the purpose of this standard are classified into primary and secondary packing materials. Objective The objective of this standard is to bring uniformity and consistency in the principles and methods of determining the packing material cost with reasonable accuracy. Scope This standard should be applied to cost statements, which require classification, measurement, assignment, presentation and disclosure of Packing Material Cost including those requiring attestation. CAS-10: Cost Accounting Standard on Direct Expenses [Limited Revision 2017] This standard deals with the principles and methods of determining the Direct Expenses. This standard deals with the principles and methods of classification, measurement and assignment of Direct Expenses, for determination of the cost of product or service, and the presentation and disclosure in Cost Statements. 54 CU IDOL SELF LEARNING MATERIAL (SLM)
Objectives The objective of this standard is to bring uniformity and consistency in the principles and methods of determining the Direct Expenses with reasonable accuracy. Scope This standard should be applied to Cost Statements, which require classification, measurement, assignment, presentation and disclosure of Direct Expenses including those requiring attestation. CAS-11: Cost Accounting Standard on Administrative overheads [Limited Revision 2017] This standard deals with the principles and methods of determining the Administrative Overheads. This standard deals with the principles and methods of classification, measurement and assignment of Administrative Overheads, for determination of the cost of product or service, and the presentation and disclosure in Cost Statements. Objective The objective of this standard is to bring uniformity and consistency in the principles and methods of determining the Administrative Overheads with reasonable accuracy. Scope The standard should be applied to Cost Statements, which require classification, measurement, assignment, presentation and disclosure of Administrative Overheads including those requiring attestation. CAS-12: Cost Accounting Standard on Repairs and Maintenance [Limited Revision 2017] This standard deals with the principles and methods of determining the Repairs and Maintenance Cost. This standard deals with the principles and methods of classification, measurement and assignment of Repairs and Maintenance Cost, for determination of the cost of product or service, and the presentation and disclosure in Cost Statements. Objective The objective of this standard is to bring uniformity and consistency in the principles and methods of determining the Repairs and Maintenance Cost with reasonable accuracy. Scope The standard should be applied to Cost Statements, which require classification, measurement, assignment, presentation and disclosure of Repairs and Maintenance Cost including those requiring attestation. CAS-13: Cost Accounting Standard on Cost of Service Cost Centre [Limited Revision 2017] 55 CU IDOL SELF LEARNING MATERIAL (SLM)
This standard deals with the principles and methods of determining Cost of Service Cost Centres. This standard covers the service cost centre and excludes utilities and repair & maintenance costs dealt with in CAS - 8 & CAS 12 respectively. This standard deals with the principles and methods of classification, measurement and assignment of Cost-of- Service Cost Centre, for determination of the cost of product or service, and the presentation and disclosure in Cost Statements. Objective The objective of this standard is to bring uniformity and consistency in the principles and methods of determining the Cost-of-Service Cost Centre with reasonable accuracy. Scope The standard should be applied to the preparation & presentation Cost Statements, which require classification, measurement and assignment, of Cost-of-Service Cost Centres including those requiring attestation. CAS-14: Cost Accounting Standard on Pollution Control Cost [Limited Revision 2017] This standard deals with the principles and methods of determining Pollution Control Cost. This standard deals with the principles and methods of classification, measurement and assignment of Pollution Control Costs, for determination of the cost of product or service, and the presentation and disclosure in Cost Statements. Objective The objective of this standard is to bring uniformity and consistency in the principles and methods of determining the Pollution Control Costs with reasonable accuracy. Scope The standard should be applied to Cost Statements, which require classification, measurement, assignment, presentation and disclosure of Pollution Control Costs including those requiring attestation. CAS-15: Cost Accounting Standard on Selling and Distribution Overheads This standard deals with the principles and methods of determining the Selling and Distribution Overheads. This standard deals with the principles and methods of classification, measurement and assignment of Selling and Distribution Overheads, for determination of the cost of sales of product or service, and the presentation and disclosure in cost statements. Objective The objective of this standard is to bring uniformity and consistency in the principles and methods of determining the Selling and Distribution Overheads with reasonable accuracy. Scope 56 CU IDOL SELF LEARNING MATERIAL (SLM)
This standard should be applied to cost statements, which require classification, measurement, assignment, presentation and disclosure of Selling and Distribution Overheads including those requiring attestation. CAS -16 : Cost Accounting Standard on Depreciation and Amortisation [Limited Revision 2017] This standard deals with the principles and methods of determining Depreciation and Amortisation Cost. This standard deals with the principles and methods of measurement and assignment of Depreciation and Amortisation for determination of the cost of product or service, and the presentation and disclosure in cost statements. Objective The objective of this standard is to bring uniformity and consistency in the principles and methods of determining the Depreciation and Amortisation with reasonable accuracy. Scope This standard shall be applied to cost statements which require measurement, assignment, presentation and disclosure of Depreciation and Amortisation, including those requiring attestation. CAS-17 : Cost Accounting Standard on Interest and Financing Charges [Limited Revision 2017] This standard deals with the principles and methods of determining Interest and Financing Charges. This standard deals with the principles and methods of classification, measurement and assignment of Interest and Financing Charges. Objective The objective of this standard is to bring uniformity and consistency in the principles ,methods of determining and assigning the Interest and Financing Charges with reasonable accuracy. Scope This standard should be applied to cost statements which require classification, measurement, assignment, presentation and disclosure of Interest and Financing Charges including those requiring attestation. This standard does not deal with costs relating to risk management through derivatives. CAS -18 : Cost Accounting Standard on Research and Development Costs This standard deals with the principles and methods of determining Research and Development Cost. This standard deals with the principles and methods of determining the Research, and Development Costs and their classification, measurement and assignment 57 CU IDOL SELF LEARNING MATERIAL (SLM)
for determination of the cost of product or service, and the presentation and disclosure in cost statements. Objective The objective of this standard is to bring uniformity and consistency in the principles and methods of determining the Research, and Development Costs with reasonable accuracy and presentation of the same. Scope This standard should be applied to cost statements that require classification, measurement, assignment, presentation and disclosure of Research, and Development Costs including those requiring attestation. CAS-19 : Cost Accounting Standard on Joint Costs This standard deals with the principles and methods of determining Joint Cost. The standard deals with the principles and methods of measurement and assignment of Joint Costs and the presentation and disclosure in cost statement. Objective The objective of this standard is to bring uniformity, consistency in the principles, methods of determining and assigning Joint Costs with reasonable accuracy. Scope The standard shall be applied to cost statements which require classification, measurement, assignment, presentation and disclosure of Joint Costs including those requiring attestation. CAS-20: Cost Accounting Standard on Royalty and Technical Know-How Fee [Limited Revision 2017] This standard deals with the principles and methods of determining the amount of Royalty and Technical Know-how Fee. This standard deals with the principles and methods of classification, measurement and assignment of the amount of Royalty and Technical Know-how Fee, for determination of the cost of product or service, and their presentation and disclosure in cost statements. Objective The objective of this standard is to bring uniformity and consistency in the principles and methods of determining the amount of Royalty and Technical Know-how Fee with reasonable accuracy. Scope This standard should be applied to cost statements, which require classification, measurement, assignment, presentation and disclosure of the amount of Royalty and Technical Know-how Fee including those requiring attestation. CAS-21 : Cost Accounting Standard on Quality Control [Limited Revision 2017] The standard deals with the principles and methods of measurement and assignment of Quality Control cost and the presentation and disclosure in cost statement. 58 CU IDOL SELF LEARNING MATERIAL (SLM)
Objective The objective of this standard is to bring uniformity, consistency in the principles, methods of determining and assigning Quality Control cost with reasonable accuracy. Scope The standards shall be applied to cost statements which require classification, measurement, assignment, presentation and disclosure of Quality Control cost including those requiring attestation. CAS – 22 : Cost Accounting Standard on Manufacturing Cost [Limited Revision 2017] This standard deals with the principles and methods of determining the Manufacturing Cost of excisable goods. This standard deals with the principles and methods of classification, measurement and assignment for determination of the Manufacturing Cost of excisable goods and the presentation and disclosure in cost statements. Objective The objective of this standard is to bring uniformity and consistency in the principles and methods of determining the Manufacturing Cost of excisable goods. Scope This standard should be applied to cost statements which require classification, measurement, assignment, presentation and disclosure of Manufacturing Cost of excisable goods. CAS 23 Cost Accounting Standard on Overburden Removal Cost [Limited Revision 2017] The standard deals with the principles and methods of measurement and assignment of Overburden Removal Cost and the presentation and disclosure in cost statements. Objective The objective of this standard is to bring uniformity, consistency in the principles, methods of determining and assigning Overburden Removal Cost with reasonable accuracy. Scope The standard shall be applied to cost statements which require classification, measurement, assignment, presentation and disclosure of Overburden Removal Cost including those requiring attestation. CAS 24 Cost Accounting Standard on Treatment of Revenue in Cost Statements [Limited Revision 2017] This standard deals with the principles and methods of classification, measurement, treatment and assignment of revenue and its presentation and disclosure in cost statements. Objective 59 CU IDOL SELF LEARNING MATERIAL (SLM)
The objective of this standard is to bring uniformity and consistency in the principles and methods for treatment of revenue in cost statements with reasonable accuracy. Scope This standard shall be applied to cost statements which require classification, measurement, treatment, assignment, presentation and disclosure of revenue including those requiring attestation. 4.5 SUMMARY CAS No Title Objective CAS 1 Classification of Cost For preparation of Cost CAS 2 Statements. CAS 3 Capacity Determination To bring uniformity and CAS 4 CAS 5 consistency in the principles CAS 6 and methods of CAS 7 determination of capacity with reasonable accuracy Production and Operation To bring uniformity and Overheads consistency in the principles and methods of determining the Production or Operation Overheads with reasonable accuracy Cost of Production for To determine the assessable Captive consumption value of excisable goods used for captive consumption Average (Equalized) Cost of To determine averaged / Transportation equalized transportation cost Material Cost To bring uniformity and consistency in the principles and methods of determining the Material Cost with reasonable accuracy in an economically feasible manner Employee Cost To bring uniformity and consistency in the principles and methods of determining 60 CU IDOL SELF LEARNING MATERIAL (SLM)
CAS 8 Cost of Utilities the Employee Cost with CAS 9 Packing Material Cost reasonable accuracy CAS 10 To bring uniformity and CAS 11 consistency in the principles CAS 12 and methods of determining CAS 13 the Cost of Utilities with CAS 14 reasonable accuracy To bring uniformity and consistency in the principles and methods of determining the Packing Material Cost with reasonable accuracy Direct Expenses To bring uniformity and consistency in the principles and methods of determining the Direct Expenses with reasonable accuracy Administrative Overheads To bring uniformity and consistency in the principles and methods of determining the Administrative Overheads with reasonable accuracy Repairs and Maintenance To bring uniformity and Cost consistency in the principles and methods of determining the Repairs and Maintenance Cost with reasonable accuracy Cost of Service Cost Centre To bring uniformity and consistency in the principles and methods of determining the Cost of Service Cost Centre with reasonable accuracy Pollution Control Cost To bring uniformity and consistency in the principles 61 CU IDOL SELF LEARNING MATERIAL (SLM)
and methods of determining the Pollution Control Costs with reasonable accuracy CAS 15 Selling and Distribution To bring uniformity and CAS 16 CAS 17 overheads consistency in the principles CAS 18 CAS 19 and methods of determining CAS 20 the selling and Distribution over- heads with reasonable accuracy Depreciation and To bring uniformity and Amortisation consistency in the principles and methods of determining the Depreciation and Amortisation with reasonable accuracy Interest and Financing To bring uniformity and Charges. consistency in the principles, methods of determining and assigning the Interest and Financing Charges with reasonable accuracy Research and Development To bring uniformity and Costs consistency in the principles and methods of determining the Research, and Development Costs with reasonable accuracy and presentation of the same. Joint Costs To bring uniformity and consistency in the principles and methods of determining the Joint Costs. Cost Accounting Standard To bring uniformity and on Royalty and Technical consistency in the principles Know- How Fee and methods of determining the amount of Royalty and Technical Know-how Fee 62 CU IDOL SELF LEARNING MATERIAL (SLM)
with reasonable accuracy CAS 21 Cost Accounting Standard To bring uniformity, CAS 22 CAS 23 on Quality Control consistency in the CAS 24 principles, methods of determining and assigning Quality Control cost with reasonable accuracy Cost Accounting Standard To bring uniformity and on Manufacturing Cost consistency in the principles and methods of determining the Manufacturing Cost of excisable goods Cost Accounting Standard To bring uniformity and on Overburden Removal consistency in the principles Cost and methods of determining and assigning Overburden Removal Cost including those requiring attestation Cost Accounting Standard To bring uniformity and on Treatment of Revenue in consistency in the principles Cost Statements and methods for treatment of revenue in cost statements with reasonable accuracy 4.6 KEY WORDS Normal capacity- It is the amount of production volume that can be reasonably expected over the long term Depreciation- It is the measure of wear and tear of an Asset Amortisation- Reduction in the Economic value of an Intangible Asset Finance charge- It is the total fee incurred by a borrower to access and use debt 4.7 LEARNING ACTIVITY 1. There are two types of packing material, primary and secondary discuss about the treatment of packing material in Cost Accounting? 63 CU IDOL SELF LEARNING MATERIAL (SLM)
________________________________________________________________________ ________________________________________________________________________ 4.8 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. What is the basic for cost classification as per CAS-1? 2. List the objective of CAS-4. 3. List the scope of CAS-2 4. Name 3 factors that should be disclosed in the cost statements as per CAS-3. Long Questions 1. Describe in detail the objectives and Functions of Cost Accounting Standards board 2. What are cost Accounting standards? Outline the scope of CAS 19 and CAS 20 B. Multiple choice Questions 1. CAS 21 stands for a. Capacity Determination b. Joint Cost c. Direct Expenses d. None of these. 2. CAS 13 stands for a. Joint Cost b. Interest and financing charges c. Employee Cost d. Cost of Service cost centre 3. Standard deals with the principles and methods of determining the manufacturing Cost of excisable goods a. CAS 12 b. CAS 15 c. CAS 22 d. CAS 2 4. Standards deals with determination of averages/ equalized transportation cost a. CAS 6 b. CAS 22 64 CU IDOL SELF LEARNING MATERIAL (SLM)
c. CAS 9 d. CAS 5 5. Standards deals with the principles and methods of determining depreciation and amortization cost a. CAS 9 b. CAS 12 c. CAS 15 d. CAS 16 Answer 1. (d), 2. (d), 3. (c), 4. (d), 5. (d) 4.9 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 65 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT - 5 INSTALLATION OF COST STRUCTURE 5.0 Learning Objectives 5.1 Installation of cost accounting system 5.2 Requisites of cost accounting system 5.3 Difference between Cost and Management accounting 5.4 Difference between Cost and Financial accounting 5.5 Summary 5.6 Keywords 5.7 Learning Activity 5.8 Unit End Questions 5.9 References 5.0 LEARNING OBJECTIVES After studying this unit students will be able to: Describe Installation of cost accounting system Analyse Requisites of cost accounting system Outline Meaning of Cost, management, and financial accounting 5.1 INSTALLATION OF COST SYSTEM OR COST ACCOUNTING SYSTEM Before installing a cost system proper care should be taken to study and considered all the aspects involved as otherwise the system will be a misfit and full advantages will not be realized from it. The following points should be looked into before installing a cost system:- The nature, method and stages of production, the number of varieties and the quantity of each product and such other technical aspects should be examined. It is to be seen how complex or how simple the production methods are and what is the degree of control exercised over them. The size, layout and organization of the factory should be studied. The methods of purchase, receipt, storage and issue of materials should be examined and modified wherever considered necessary. The wage payment methods should be studied. 66 CU IDOL SELF LEARNING MATERIAL (SLM)
The requirements of the management and the policy adopted by them towards cost control should be kept in view. The cost of the system to be installed should be considered. It is needless to emphasize that the installation and operation of system should be economic. The system should be simple and easy to operate. The system can be effectively run if it is appropriate and properly suited to the organization. Forms and records of original entry should be so designed as to involve minimum clerical work and expenditure. The system should be so designed that cost control can be effectively exercised. The system should incorporate suitable procedure for reporting to the various levels of management. This should be based on the principles of exception. 5.2 REQUISITES OF A GOOD COST ACCOUNTING SYSTEM There are certain essential features which a good Cost Accounting System should possess. These features are discussed below. The cost accounting system should be simple and practical. It should be able to meet the requirements of the organization. The data and information used by the cost accounting system should be authentic and accurate enough to present accurate reporting in order to facilitate the management for taking right decisions. There is a need for uniformity and consistency in classifying, treating and reporting cost data and information so that it can facilitate comparability of the results of the system. With a view to ensuring clarity of the results there should be integration of the cost accounting system with financial accounting, operation research, statistics, taxation etc. The cost accounting system should have enough flexibility in order to accommodate necessary amendments and modifications for the purpose of incorporating changes in technical, regulatory and other requirements. The management should be satisfied with the implementation of cost accounting system that facilitates the management in taking strategic business decisions. 67 CU IDOL SELF LEARNING MATERIAL (SLM)
5.3 DIFFERENCE BETWEEN COST AND MANAGEMENT ACCOUNTING BASIS OF COST ACCOUNTING MANAGEMENT COMPARISON ACCOUNTING Meaning The recording, classifying The accounting in which the both Information Type and summarizing of cost financial and non-financial Objective data of an organization is information are provided to Scope known as cost accounting. managers is known as Management Accounting. Specific Procedure Quantitative Quantitative and Qualitative. Recording Providing information to managers Planning Ascertainment of cost of to set goals and forecast strategies. Interdependency production. Impart and effect aspect of costs. Concerned with ascertainment, allocation, No distribution and accounting It gives more stress on the analysis aspects of cost. of future projections. Short range and long range planning Yes Records past and present data Short range planning Can be installed without Cannot be installed without cost management accounting. accounting. 5.4 DIFFERENCE BETWEEN COST AND FINANCIAL ACCOUNTING BASIS OF COST ACCOUNTING FINANCIAL COMPARISON ACCOUNTING 68 CU IDOL SELF LEARNING MATERIAL (SLM)
Meaning Cost Accounting is an Financial Accounting is an accounting system, through accounting system that captures Information type which an organization keeps the records of financial the track of various costs information about the business to Which type of cost is incurred in the business in show the correct financial used for recording? production activities. position of the company at a Users particular date. Valuation of Stock Records the information Records the information in Mandatory related to material, labour monetary terms. and overhead, which are used Time of reporting in the production process Only historical cost. Both historical and pre- determined cost Users of information provided by Information provided by the the financial accounting are cost accounting is used only internal and external parties like by the internal management creditors, shareholders, customers of the organization like etc. employees, directors, managers, supervisors etc. Cost or Net Realizable Value, whichever is less. At cost No, except for manufacturing Yes for all firms. firms it is mandatory. Details provided by cost Financial statements are reported accounting are frequently at the end of the accounting prepared and reported to the period. management. 5.5 SUMMARY Financial accounting, cost accounting and management accounting are distinct from each other. Management accounting is an integral part of management concerned with identifying, presenting and interpreting information used for: Formulating strategy; Planning and controlling activities; Decision taking; Optimizing the use of resources; Disclosure to shareholders and others external to the entity; 69 CU IDOL SELF LEARNING MATERIAL (SLM)
Disclosure to employees; Safeguarding assets. The tools and techniques of management accounting includes : Financial planning, Financial statement analysis, Marginal costing, Differential costing, Capital budgeting, Cash flow analysis, Standard costing Budgetary control, Techniques of linear programming, Statistical quality control, Investment chart, Sales and earning chart, etc. 5.6 KEY WORDS Financial Accounting: Financial accounting is a specific branch of accounting involving a process of recording, summarizing, and reporting the myriad of transactions resulting from business operations over a period. Management Accounting: Management accounting also is known as managerial accounting and can be defined as a process of providing financial information and resources to the managers in decision making. Management accounting is only used by the internal team of the organization, and this is the only thing which makes it different from financial accounting. 5.7 LEARNING ACTIVITY 1. Determine the Cost drivers in the following segment of activities a. Audit Firm b. Credit control c. Customer care operator d. Content writers ________________________________________________________________________ ________________________________________________________________________ 70 CU IDOL SELF LEARNING MATERIAL (SLM)
5.8 UNIT END QUESTIONS A.Descriptive Questions Short Questions 1. What is Financial Accounting? 2. What is Management Accounting? 3. Differentiate Cost Accounting and Management Accounting based on recording data 4. How does a good cost Accounting system help in cost reduction? 5. Differentiate cost and financial Accounting Long Questions 1. Difference between Cost and Management accounting 2. You have been asked to design a system of cost accounting for installation in a factory. 3. Describe the essentials that should be considered before you design such a system. 4. “Financial accounting treats costs very broadly while the cost accounting does this in much greater detail” Distinguish between financial and cost accounting. 5. Discuss requisites of a good cost Accounting System 6. Discuss about installation of Cost accounting System B. Multiple Choice Questions 1. HP petrol must maintain ________ wise cost Accounts. a. Unit wise b. Product wise c. Process wise d. None of these 2. Profit is the resultant of two varying factors _______________ and _______________. a. Sales cost b. Revenue , income c. Gain, Loss d. None of these 3. Advertisement agency follows ________ costing and Suggestive unit of cost is 71 ___________. a. Batch , No. of advertisements b. Operating , Units c. Job , Assignment CU IDOL SELF LEARNING MATERIAL (SLM)
d. None of these 4. Step(s) involved in cost control? a. Measure Actual performance b. Institute corrective action c. Measure adjusted performance d. Both A & B 5. Factor Influencing cost are called as a. Cost reduction b. Cost control c. Cost Driver d. Cost Accounting Answers 5-c 1-c 2-a 3-c 4-d 5.9 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 72 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT – 6 TOOLS FOR COST CONTROL STRUCTURE 6.0 Learning Objective 6.1 Introduction 6.2 Cost control – Features and aspects 6.2.1 Features 6.2.2 Aspects of Cost Control 6.2.3 Advantages cost control 6.2.4 Disadvantages of cost control 6.2.5 Examples of Cost Control 6.3 Techniques of cost control 6.4 Marginal Costing 6.5 Characteristics of Marginal Costing 6.6 Facts about Marginal Costing 6.7 Advantages and limitations of marginal Costing 6.8 Summary 6.9 Key words 6.10 Learning Activity 6.11 Unit End Questions 6.12 References 6.0 LEARNING OBJECTIVES After studying this unit students will be able to Explain meaning of cost control Learn about techniques of cost control Learn about Marginal costing Describe advantages and disadvantages of Marginal costing 6.1 INTRODUCTION Cost Control is the process of monitoring and regulating the expenditure of funds is known as cost control. In other words , it means to regulate/control the operating costs in a business firm. To exercise cost control, broadly the following steps should be observed: (a) Determine clearly the objective, i.e., pre-determine the desired results: The target cost and/ or targets of performance should be laid down in respect of each department or operation and these 73 CU IDOL SELF LEARNING MATERIAL (SLM)
targets should be related to individuals who, by their action, control the actual and bring them into line with the targets (b) Measure the actual performance: Actual cost of performance should be measured in the same manner in which the targets are set up, i.e. if the targets are set up operation-wise, and then the actual costs should also be collected operation-wise and not cost centre or department-wise as this would make comparison difficult. (c) Investigate into the causes of failure to perform according to plan; and (d) Institute corrective action 6.2 COST CONTROL – FEATURES AND ASPECTS 6.2.1 Features Cost control process involves setting targets and standards, ascertaining the actual performance, comparing the actual performance with standard, investigating the variances and taking corrective action. It aims at achieving the standard. It is a preventive function. In cost control, costs are optimized before they are incurred. It is generally applicable to items which have standards. It contains guidelines and directive management such as, how to do a thing. 6.2.2 Aspects of Cost Control 1) Planning: Initially a plan or set of targets is established in the form of budgets and standards. 2) Communication: The next step is to communicate the plan to those whose responsibility is to implement the plan. 3) Motivation: Motivation is defined as the process that initiates, guides and maintains goal-oriented behaviors. 4) Appraisal and Reporting: comparison has to be made with the predetermined targets and actual performance. Deficiencies are noted and discussion is started to overcome deficiencies. 5) Decision-making: Finally, corrective actions and remedial measures are taken or the set of targets are revised, depending upon the administration’s understanding of the problem. Main Areas of cost control like Materials, Labor, Overheads, Sales, Energy. 6.2.3 Advantages cost control It helps the firm to improve its profitability and competitiveness. It helps the firm in reducing its costs and thus reduce its prices. It is indispensable for achieving greater productivity. 74 CU IDOL SELF LEARNING MATERIAL (SLM)
If the price of the product is stable and reasonable, it can maintain higher sales and thus employment of work force. 6.2.4 Disadvantages of cost control Reduces the flexibility and process improvement in a company. Restriction on innovation. Requirement of skillful personnel to set standards. 6.2.5 Examples of Cost Control Use Skype to make domestic and international phone calls. Establish presence on social media sites such as Facebook and Twitter instead of newspaper, magazine, mail. Use electronic communication, cut down on print and paper communication. Outsource computer maintenance. Lease equipment. Share office or building space with another business 6.3 TECHNIQUES OF COST CONTROL Budgetary control, Standard costing, Inventory control, Ratio analysis, Variance analysis Ratio Analysis Definition: A ‘Ratio: is defined as an arithmetical/quantitative/numerical relationship between two numbers. Ratio analysis is a very important and age old technique of financial analysis. A tool used by individuals to conduct a quantitative analysis of information in a company's financial statements. Features of Ratio Analysis It is mainly used as an external standard, that is, for comparing performance with the other organization in the industry. Statistical yardstick that provides a measure of the relationship between two figures. It may be expressed in percentage terms as a proportion or as a rate. - Some of the most commonly used ratios for cost comparison are as follows: Sales / total assets Production costs / cost of sales Administration costs / cost of sales Sales / inventory Variance analysis 75 CU IDOL SELF LEARNING MATERIAL (SLM)
Definition: Variance is defined as the difference between the expected amount and the actual amount of costs or revenues. Variance analysis is the investigation of the difference between actual and planned behavior. For example, if you budget, for sales to be Rs.10,000/- and actual sales are Rs.8,000/-, variance analysis yields a difference of Rs.2,000/-. 6.4 MARGINAL COSTING In order to appreciate the concept of marginal costing, it is necessary to study the definition of marginal costing and certain other terms associated with this technique. The important terms have been defined as follows: 1. Marginal Costing: The ascertainment of marginal cost and of the effect on profit of changes in volume or type of output by differentiating between fixed costs and variable costs. 2. Marginal Cost: The amount at any given volume of output by which aggregate variable costs are changed if the volume of output is increased by one unit. In practice this is measured by the total variable cost attributable to one unit. Marginal cost can precisely be the sum of prime cost and variable overhead. Marginal Cost = Variable Cost = Direct Labour + Direct Material + Direct Expenses + Variable Overheads Note: In this context a unit may be a single article, a batch of articles, an order, a stage of production capacity, a process or a department. It relates to the change in output in particular circumstances under consideration. 3. Direct Costing: Direct costing is the practice of charging all direct cost to operations, processes or products, leaving all indirect costs to be written off against profits in the period in which they arise. Under direct costing the stocks are valued at direct costs, i.e., costs whether fixed or variable which can be directly attributable to the cost units. 4. Differential Cost: It may be defined as “the increase or decrease in total cost or the change in specific elements of cost that result from any variation in operations”. It represents an increase or decrease in total cost resulting out of: (a) Producing or distributing a few more or few less of the products; (b) a change in the method of production or of distribution; (c) an addition or deletion of a product or a territory; and (d) selection of an additional sales channel. 76 CU IDOL SELF LEARNING MATERIAL (SLM)
Differential cost thus includes fixed and semi-variable expenses. It is the difference between the total costs of two alternatives. It is an ad-hoc cost determined for the purpose of choosing between competing alternatives, each with its own combination of income and costs. 5. Incremental Cost: It is defined as, “the additional costs of a change in the level or nature of activity”. As such for all practical purposes there is no difference between incremental cost and differential cost. However, from a conceptual point of view, differential cost refers to both incremental as well as decremental cost. Incremental cost and differential cost calculated from the same data will be the same. In practice, therefore, generally no distinction is made between differential cost and incremental cost. One aspect which is worthy to note is that incremental cost is not the same at all levels. Incremental cost between 50% and 60% level of output may be different from that which is arrived at between 80% and 90% level of output. Differential cost or incremental cost analysis deals with both short-term and long-term problems. This analysis is more useful when various alternatives or various capacity levels are being considered. (will be discussed in the next chapter i.e., Budgets and Budgetary Control) 6. Contribution: Contribution or the contributory margin is the difference between sales value and the marginal cost [Contribution (C) = Sales (S) – Variable Cost]. It is obtained by subtracting marginal cost from sales revenue of a given activity. It can also be defined as excess of sales revenue over the variable cost. 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. 7. Key Factor: Key factor or Limiting factor is a factor which at a particular time or over a period limits the activities of an undertaking. It may be the level of demand for the products or services or it may be the shortage of one or more of the productive resources, e.g., labour hours, available plant capacity, raw material’s availability etc. Examples of Key Factors or Limiting Factors are: (a) Shortage of raw material. (b) Shortage of labour. (c) Plant capacity available. (d) Sales capacity available. (e) Cash availability 6.5 CHARACTERISTICS OF MARGINAL COSTING The technique of marginal costing is based on the distinction between product costs and period costs. Only the variables costs are regarded as the costs of the products while the 77 CU IDOL SELF LEARNING MATERIAL (SLM)
fixed costs are treated as period costs which will be incurred during the period regardless of the volume of output. The main characteristics of marginal costing are as follows: 1. All elements of cost are classified into fixed and variable components. Semi-variable costs are also analyzed into fixed and variable elements. 2. The marginal or variable costs (as direct material, direct labour and variable factory overheads) are treated as the cost of product. 3. Under marginal costing, the value of finished goods and work–in–progress is also comprised only of marginal costs. Variable selling and distribution are excluded for valuing these inventories. Fixed costs are not considered for valuation of closing stock of finished goods and closing WIP. 4. Fixed costs are treated as period costs and are charged to profit and loss account for the period for which they are incurred. 5. Prices are determined with reference to marginal costs and contribution margin. 6. Profitability of departments and products is determined with reference to their contribution margin. 6.6 FACTS ABOUT MARGINAL COSTING Some of the facts about marginal costing are depicted below Not a distinct method: Marginal costing is not a distinct method of costing like job costing, process costing, operating costing, etc., but a special technique used for managerial decision making. Marginal costing is used to provide a basis for the interpretation of cost data to measure the profitability of different products, processes and cost centres in the course of decision making. It can, therefore, be used in conjunction with the different methods of costing such as job costing, process costing, etc., or even with other techniques such as standard costing or budgetary control. Cost Ascertainment: In marginal costing, cost ascertainment is made on the basis of the nature of cost. It gives consideration to behaviour of costs. In other words, the technique has developed from a particular conception and expression of the nature and behaviour of costs and their effect upon the profitability of an undertaking. Decision Making: In the orthodox or total cost method, as opposed to marginal costing method, the classification of costs is based on functional basis. Under this method the total cost is the sum total of the cost of direct material, direct labour, direct expenses, manufacturing overheads, administration overheads, selling and distribution overheads. In 78 CU IDOL SELF LEARNING MATERIAL (SLM)
this system, other things being equal, the total cost per unit will remain constant only when the level of output or mixture is the same from period to period. Since these factors are continually fluctuating, the actual total cost will vary from one period to another. Thus, it is possible for the costing department to say one day that an item costs ₹20 and the next day it costs ₹18. This situation arises because of changes in volume of output and the peculiar behaviour of fixed expenses included in the total cost. Such fluctuating manufacturing activity, and consequently the variations in the total cost from period to period or even from day to day, poses a serious problem to the management in taking sound decisions. Hence, the application of marginal costing has been given wide recognition in the field of decision making. 6.7 ADVANTAGES AND LIMITATIONS OF MARGINAL COSTING Advantages 1. Simplified Pricing Policy: The marginal cost remains constant per unit of output whereas the fixed cost remains constant in total. Since marginal cost per unit is constant from period to period within a short span of time, firm decisions on pricing policy can be taken. If fixed cost is included, the unit cost will change from day to day depending upon the volume of output. This will make decision making task difficult. 2. Proper recovery of Overheads: Overheads are recovered in costing on the basis of pre-determined rates. If fixed overheads are included on the basis of pre-determined rates, there will be under- recovery of overheads if production is less or if overheads are more. There will be over- recovery of overheads if production is more than the budget or actual expenses are less than the estimate. This creates the problem of treatment of such under or over-recovery of overheads. Marginal costing avoids such under or over recovery of overheads. 3. Shows Realistic Profit: Advocates of marginal costing argues that under the marginal costing technique, the stock of finished goods and work-in-progress are carried on marginal cost basis and the fixed expenses are written off to profit and loss account as period cost. This shows the true profit of the period. 4. How much to produce: Marginal costing helps in the preparation of break-even analysis which shows the effect of increasing or decreasing production activity on the profitability of the company. 5. More control over expenditure: Segregation of expenses as fixed and variable helps the management to exercise control over expenditure. The management can compare the 79 CU IDOL SELF LEARNING MATERIAL (SLM)
actual variable expenses with the budgeted variable expenses and take corrective action through analysis of variances. 6. Helps in Decision Making: Marginal costing helps the management in taking a number of business decisions like make or buy, discontinuance of a particular product, replacement of machines, etc. 7. Short term profit planning: It helps in short term profit planning by B.E.P charts. Limitations 1. Difficulty in classifying fixed and variable elements: It is difficult to classify exactly the expenses into fixed and variable category. Most of the expenses are neither totally variable nor wholly fixed. For example, various amenities provided to workers may have no relation either to volume of production or time factor. 2. Dependence on key factors: Contribution of a product itself is not a guide for optimum profitability unless it is linked with the key factor. 3. Scope for Low Profitability: Sales staff may mistake marginal cost for total cost and sell at a price; which will result in loss or low profits. Hence, sales staff should be cautioned while giving marginal cost. 4. Faulty valuation: Overheads of fixed nature cannot altogether be excluded particularly in large contracts, while valuing the work-in- progress. In order to show the correct position fixed overheads have to be included in work-in-progress. 5. Unpredictable nature of Cost: Some of the assumptions regarding the behaviour of various costs are not necessarily true in a realistic situation. For example, the assumption that fixed cost will remain static throughout is not correct. Fixed cost may change from one period to another. For example salaries bill may go up because of annual increments or due to change in pay rate etc. The variable costs do not remain constant per unit of output. There may be changes in the prices of raw materials, wage rates etc. after a certain level of output has been reached due to shortage of material, shortage of skilled labour, concessions of bulk purchases etc. 6. Marginal costing ignores time factor and investment: The marginal cost of two jobs may be the same but the time taken for their completion and the cost of machines used may differ. The true cost of a job which takes longer time and uses costlier machine would be higher. This fact is not disclosed by marginal costing. 7. Understating of W-I-P: Under marginal costing stocks and work in progress are understated. 80 CU IDOL SELF LEARNING MATERIAL (SLM)
6.8 SUMMARY All elements of cost are classified into fixed and variable components. Semi- variable costs are also analysed into fixed and variable elements. The marginal or variable costs (as direct material, direct labour and variable factory overheads) are treated as the cost of product. Under marginal costing, the value of finished goods and work–in–progress is also comprised only of marginal costs. Variable selling and distribution are excluded for valuing these inventories. Fixed costs are not considered for valuation of closing stock of finished goods and closing WIP. Fixed costs are treated as period costs and are charged to profit and loss account for the period for which they are incurred. Prices are determined with reference to marginal costs and contribution margin. Profitability of departments and products is determined with reference to their contribution margin. 6.9 KEY WORDS 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. Contribution: Contribution or contribution margin is the difference between sales revenue and total variable costs irrespective of manufacturing or non- manufacturing. 6.10 LEARNING ACTIVITY What are the various cost control measures that are required in Hotel Industry? ________________________________________________________________________ ________________________________________________________________________ 81 CU IDOL SELF LEARNING MATERIAL (SLM)
6.11 UNIT END QUESTIONS A.Descriptive Questions Short Questions 1.Discuss the practical application of Marginal Costing. 2.Explain about the characteristics of Marginal Costing 3.What are the features of Cost control. 4.Discuss about the disadvantages of Cost control Long Questions 1.Elaborate about techniques of cost control 2. Write about advantages and limitations of Marginal costing B. Multiple choice Questions 1. Under marginal costing the cost of product includes: a. Prime costs only. b. Prime costs and variable overheads. c. Prime costs and fixed overheads. d. Prime costs and factory overheads. 2. Reporting under marginal costing is accomplished by: a. Treating all costs as period costs. b. Eliminating the work-in-progress inventory account. c. Matching variable costs against revenue and treating fixed costs as period costs. d. Including only variable costs in income statement. 3. Period costs are: a. Variable costs. b. Fixed costs. c. Prime costs. d. Overheads costs. 4. When sales and production (in units) are same then profit under: a. Marginal costing is higher than that of absorption costing. b. Marginal costing is lower than that of absorption costing. c. Marginal costing is equal to that of absorption costing. d. None of these 5. When sales exceed production (in units) then profit under: 82 a. Marginal costing is higher than that of absorption costing. CU IDOL SELF LEARNING MATERIAL (SLM)
b. Marginal costing is lower than that of absorption costing. c. Marginal costing is equal than that of absorption costing. d. None of these Answers 1.(b) 2. (c) 3. (b) 4. (c) 5. (a) 6.12 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 83 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT – 7 STANDARD COSTING STRUCTURE 7.0 Learning Objectives 7.1 Introduction 7.2 Meaning of Standard Costing 7.3 Salient features of Standard costing 7.4 Standard Costing 7.5 Purpose of Standard Costing 7.6 Historical or Actual Cost 7.7 Difference between Standard cost and Historical Cost 7.8 Importance of Standard cost 7.9 Establishing Standard costing System 7.10 Advantages of Standard Costing 7.11 Limitations of Standard Costing 7.12 Summary 7.13 Keywords 7.14 Learning Activity 7.15 Unit End Questions 7.16 References 7.0 LEARNING OBJECTIVES After studying this unit students will be able to State the meaning of Standard costing Learn about characteristics of Standard costing Analyse advantages and limitations of marginal costing Understand difference between standard cost and Historical cost 7.1 INTRODUCTION A standard costing system consists of the following four elements: 1. Setting standards for each operation. 2. Comparing actual with standard performance. 3. Analyzing and reporting variances arising from the difference between actual and standard performance. 4. Investigating significant variances and taking appropriate competitive action. 84 CU IDOL SELF LEARNING MATERIAL (SLM)
7.2 MEANING OF STANDARD COSTING Standard costing is a very important system of cost control. It is a system which seeks to control the cost of each unit or batch through determination in advance of what should be the cost and then its comparison with actual cost. Through carefully planned and accounting procedures, the difference between the actual and pre-determined costs are analyzed and then promptly reported upon to managers. The latter, in turn, take corrective and preventive action, as well as employ the data for planning, co-ordination and control. Standard costing “may be defined as a technique of cost accounting which compares the standard cost of each product or service with the actual cost to determine the efficiency of the operation, so that any remedial action may be taken immediately”. [Brown and Howard]. According to I.C.M.A. London, “Standard costing is the preparation and use of standard costs, their comparison with actual costs and the analysis of variances to their causes and points of incidence”. 7.3 SALIENT FEATURES OF STANDARD COSTING Following are the salient features of standard costing : (1) Setting of standards - standards for each element of cost, i.e. material, labour and overhead, are ascertained separately. (2) Measurement of actual costs. (3) Comparison of actual costs with pre-determined standards to determine variances. (4) Analysis of variances for the purpose of ascertaining the reasons of variances. (5) Reporting the variances to management and taking appropriate actions to correct them. Standard Costing and Budgetary Control Compared Standard costing and budgetary control both are closely interrelated. They both aim at the improvement of the system of managerial control. They both achieve the same objective of maximum efficiency and cost control by establishing pre-determined standards, comparing actual performance with the predetermined standard and taking necessary steps to improve the situation, where necessary. The nature of both of these techniques is forward looking. However, they differ in the following respects: 1. The scope of budgetary control is wider. It is an integrated plan of action a co-ordinated plan in respect of all functions of an enterprise. The scope of standard costing is limited to the operating level. Here too it is further linked to costs. Budgetary control is extensive whereas standard costing is intensive in its application. The budgets embrace revenues as well as costs and all functions and activities - sales, purchase, finance, capital expenditure, personnel etc. in addition to production whereas the coverage of standard costing is limited to costs only. 2. Budgetary control requires functional co-ordination whereas standard costing does not 85 CU IDOL SELF LEARNING MATERIAL (SLM)
require such co-ordination since it is possible -to think even of one aspect of cost. 3. It is possible to introduce the standard costing into the accounting routine itself. In such a case, the variances are given out by the accounting system itself. Budgetary control cannot be introduced into the accounting system. 4. In standard costing standards are based on technical assessment whereas budgetary targets are based on past actuals adjusted to future trends. The standards set up under standard costing are attainable level of performance whereas the actual expenditure should not normally exceed. Thus, they differ in approach. 5. Budgets are projection of final accounts while standard costs are projection of only cost accounts. 6. By nature, budgetary control emphasizes the forecasting aspect of the future operations while the scope and utility of standard costing is limited to only operating level of the concern. 7. In standard costing, variances are analyzed in details according to their originating causes and are revealed through different accounts whereas in budgetary control, the degree of variance analysis tends to be much less and variances are not revealed through the accounts but are revealed in total. Thus standard costing and budgetary control are two different aspects of the process of managerial control. But they both are complementary to each other and should be used simultaneously in order to achieve maximum efficiency and economy. It is often emphasized that budgetary control and standard costing cannot function independently. This opinion is supported by the fact that both methods use pre-determined costs for the coming period. Strictly speaking, this is not true but it is a fact that both function better in conjunction with each other. When standard costs have been determined, it is relatively easy to compute budgets for production costs and sales. With the use of standard costs, a budget becomes a summary of standards for all items of revenue and costs. On the other hand, in determining standard costs it is essential to ascertain the level of output for the period and this is much easier when budgeted level has been formulated. 7.4 STANDARD COSTING Standard costs are the basis of the system of standard costing. They are the pre-determined costs of manufacturing a single unit or a number of product units during a specific period in the immediate future. They are the planned costs of a product under current and/or anticipated operating conditions. Here is a definition of the term standard cost : The standard cost is a pre-determined cost which is calculated from management’s standards of efficient operation and the relevant necessary expenditure. Thus, it is clear from these definitions that standard costs represent the costs that should have been incurred under the expected circumstances. In a standard cost system, each unit 86 CU IDOL SELF LEARNING MATERIAL (SLM)
of product has a standard material cost, a standard labour cost, a standard overhead cost for each product centre. The total standard cost for the period under consideration is obtained by multiplying these standard unit costs by the number of units flowing through the cost centre in that period. 7.5 PURPOSE OF STANDARD COSTING Standard costs are used for : 1. Establishing budgets. 2. Controlling costs and motivating and measuring efficiencies. 3. Promoting possible cost reduction. 4. Simplifying costing procedures and expediting cost reports. 5. Assigning costs to materials, work-in-process and finished goods inventories. 6. Forming the basis for establishing bids and contracts and for setting selling prices. 7.6 HISTORICAL OR ACTUAL COSTS Historical costs are actual costs. They are recorded after they have been incurred. One major responsibility of cost accounting department is to record the different types of cost and ascertainment of actual cost of production total production cost as well as production cost per unit. 7.7 DIFFERENCE BETWEEN STANDARD COST AND HISTORICAL COST 1. The main difference between standard cost and historical cost is of recording them. Standard cost is a pre-determined cost while actual cost is an after-production recorded cost. Thus, standard cost is of forward nature while historical costs are actual and of historical nature. 2. Historical costs are actual costs which have been actually incurred while standard costs are reasonably attainable Ideal costs. 3. Historical costs relate to past, hence not useful for control purposes. On the other hand, standard costs relate to future, hence they are very useful in controlling the costs. 7.8 IMPORTANCE OF STANDARD COST Standard costs are very useful for managerial control and planning. The limitation of historical costing system in this respect has given the way to the wide-spread use of standard costs. Though the historical costs have their own value. They form the basis of financial accounting and reporting but they have certain serious drawback from the point of view of modern management. The main drawbacks are as follows: 87 CU IDOL SELF LEARNING MATERIAL (SLM)
1. Actual costs are received -very late. These data are available to the management after the expiry of accounting period and closing the accounts. Hence, the management cannot control them. 2. They do not provide any yardstick to ascertain the efficiency of the operations and performances. 3. They cannot become the basis of budgeting, planning and price determination because they are based on past situations. Standard costs are free from the above drawbacks and possess the following advantages : First, it is often simpler and requires less work than an actual cost system. It is economical in terms of time as well as money. Secondly, they provide yardsticks against which- actual costs are compared and ascertain efficiency or inefficiency of actual performances. Thirdly, they provide a valuable guidance to management in the formulation of price and production policies. Fourthly, they, being pre-determined costs, are useful in cost planning and budgetary control. Fifthly, the use of standard costs in the organization makes the people cost conscious, economical and efficient. It - assists in effective delegation of authority also. 7.9 ESTABLISHING STANDARD COSTING SYSTEM (1) Establishment of Cost Centres - According to I.C.M.A. London, a cost centre is “a location, person or item of equipment (or group of these) for which costs may be ascertained and used for the purposes of cost control”. A centre which relates to persons is referred to as a personal cost centre and one which relates to location or to equipment as an impersonal cost centre. The determination of a suitable and appropriate cost centre is very important for ascertainment and control of costs. There should be no overlapping in establishing cost centres. (2) Classification of Accounts : To introduce standard costing it is essential that accounts should be classified and integrated. The different accounts can be codified and different symbols can be used to facilitate speedy collection, communication and reporting. For example, following codes may be used for elements of cost : 0-10 Direct Materials 11-20 Direct Labour 21-25 Indirect Materials 26-30 Indirect Labour 31-40 Other Indirect Expenses (3) Setting of standards: One of the most important and difficult tasks in standard costing is setting of standards. “A standard is an ideal which it is anticipated can be attained over a 88 CU IDOL SELF LEARNING MATERIAL (SLM)
future period of time, normally in the next accounting year.” The success of standard costing system depends to a large extent on the genuineness, reliability and acceptance of these standards. The cost accountant, departmental heads, foremen and technical experts should work together in setting standards. Just like a budget committee, a committee should be formed to set standards. It is very essential to ascertain the type of standard used in setting of the standards. The following types of standards may be used : 1. Current Standard: Such standards are fixed on the basis of current conditions and remain in operation for a limited period in the sense that they are revised at regular intervals, the most common period being a year. 2. Basic Standard: This is a standard which is established and operated without revision for a number of years. This standard is fixed for long periods so as to help forward planning. Variances calculated on the basis of such standards will help in studying the trends in manufacturing costs over a long period of time. But this type of standards is not suitable for cost control. 3. Normal Standard : This standard is meant to smooth out fluctuations caused by seasonal and cyclical changes. This is defined by the Terminology as “the average standard which it is anticipated can be attained over a future period of time, preferably, long enough to cover one trade cycle”. It is difficult to follow such standards in practice because it is not possible to forecast performances with adequate accuracy for a long period of time. As such normal standards have little relevance for planning and cost control. 4. Establishing Standard Costs : After determining the type of standard to be used, the next step in this process is to determine the standard costs for each element of cost. As we know that there are mainly three elements of cost direct material, direct labour and overhead, hence standards should be fixed for each of them separately as follows: 5. Preparing Standard cost Card : Finally, a standard cost card should be prepared for each product or service incorporating standard established for each element of cost. This card will show the total and per unit standard cost of output. 7.10 ADVANTAGES OF STANDARD COSTING Standard costing is a very important managerial tool of cost reduction and cost control. The following are the possible advantages which can be derived by the management of an industrial concern by installing standard costing system: 1. Simplification of Cost Bookkeeping : Standard costing is simple and less complicated than historical costing. Standards set once for a product, continue for a long time. Once the standards are established, the records can be simplified and uniformity observed so that less is spent on clerical work. 89 CU IDOL SELF LEARNING MATERIAL (SLM)
2. Basis for Measuring Operating Performance : Standards set provide yardsticks against which actual costs are compared to ascertain efficiency or inefficiency of actual performances. 3. Cost Reduction and Control: By eliminating lost time, idle time, spoilage, material wastage and lost machine hours, cost control is affected. Standard costing provides information which is helpful in cost reduction. 4. Helpful in Budgeting : Standard costs are useful in planning and budgeting Standard costing is really linked with budgetary control. 5. Formulation of Production and Price Policies : Standard costing helps the management in the formulation of ideal production policy. For the purpose of fixing prices, it provides a lasting basis. Standard costs represent long-term estimates, cost and prices, therefore, can be fixed, on a long-term basis. 6. Promoting Cost consciousness and Efficiency : Standard costing makes all employees cost conscious because they know that their performance shall be compared with the pre- determined standards. Analysis of variances enables to assess manufacturing efficiency, fix the responsibility for inefficiencies and locate persons responsible for unfavorable variances. This brings about an improvement in efficiency and productivity all round specially if the system of rewards and punishment is also geared to the results. 7. Establishing Incentive Schemes: Standard costing provides the basis of incentive schemes because every incentive scheme is based on certain standards which can be determined easily, if the system of standard costing is in operation. It enables objective judgement of the people. 8. Facilitating Comparison : Standard costing enables cost comparisons for different products and departments. Besides, it also provides a basis for comparison between one period-and another specially when basic standards are used. 7.11 LIMITATIONS OF STANDARD COSTING Standard costing suffers from some limitations, possibly as a result of misunderstanding on the part of the managers. Possible limitations are as follows : (1) As the installation of standard costing requires high degree of skill, the technique of standard costing may not be appropriate to small concerns. Small concerns may not have expert staff capable of operating the system. Moreover, fixation of standards may prove costly for a small concern. (2) Exact divisions of variances into controllable and uncontrollable variances are a difficult task. (3) This system is not suitable for industries which produce non-standardized products, 90 CU IDOL SELF LEARNING MATERIAL (SLM)
and for jobs which change according to customers’ requirements. 7.12 SUMMARY Cost control is one of the objectives of cost management. Management of an organisation setups predetermined cost to compare the actual cost with the predetermined cost. Predetermined costs are standard costs used for cost control and performance evaluation. Standard cost is set on the basis of management’s estimation. Cost is estimated on the basis of technical specification provided by the engineering department or other expert such as production engineer Standard costs are divided into three main cost components, such as Direct Material Cost Direct Employee (Labour) Cost and Overheads 7.13 KEY WORDS Standard Cost: Standard cost is a pre-determined cost which shows in advance what each product should cost under the given situation. Standard Costing: Standard costing is a technique which uses standards for costs and revenue for the purpose of control through variance analysis. Standard Price: Standard price is a pre-determined price fixed on the basis of a specification of a product or service and of all factors affecting the price. Variance: The deviation of actual from standard is called variance. When actual cost is less than the standard cost, it is known as ‘favourable variance’. When actual cost is more than the standard cost, it is known as ‘unfavourable or adverse variance’. It is also referred to as a measure of dispersion defined as the mean squared deviation from the expected value 7.14 LEARNING ACTIVITY 1. Learn about the criticism levelled against standard costing system ________________________________________________________________________ ________________________________________________________________________ 7.15 UNIT END QUESTIONS 91 A.Descriptive Questions CU IDOL SELF LEARNING MATERIAL (SLM)
Short Questions 1.Discuss the process of setting standards. 2.Discuss the types of standards 3.Briefly discuss about limitations of standard costing Long Questions 1.Discuss the advantages and disadvantages about Standard costing system 2.What is standard costing? Explain briefly about Establishment of Standard cost? B. Multiple choice Questions 1. Under standard cost system the cost of the product determined at the beginning of production is its: a. Direct cost b. Pre-determined cost c. Historical cost d. Actual cost 2. The deviations between actual and standard cost is known as: a. Multiple analysis b. Variable cost analysis c. Variance analysis d. Linear trend analysis 3. The standard which is attainable under favourable conditions is: a. Theoretical standard b. Expected standard c. Normal standard d. Basic standard 4. The standard most suitable from cost control point of view is: a. Normal standard b. Theoretical standard c. Expected standard d. Basic standard Answers 1-b 2-c 3-a 4-c 92 CU IDOL SELF LEARNING MATERIAL (SLM)
7.16 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 93 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT – 8 RELEVANT COST INFORMATION AND SHORT-RUN MANAGERIAL DECISIONS STRUCTURE 8.0 Learning Objectives 8.1 Introduction 8.2 Relevant Costing and Costing for Decision Making 8.3 Relevant costing concepts 8.4 Summary 8.5 Keywords 8.6 Learning Activity 8.7 Unit End Questions 8.8 References 8.0 LEARNING OBJECTIVES After studying this unit students will be able to State the importance of Relevant costing Analyse its role in decision making Learn about different relevant costing concepts 8.1 INTRODUCTION Relevant cost is a managerial accounting term that describes avoidable costs that are incurred only when making specific business decisions. The concept of relevant cost is used to eliminate unnecessary data that could complicate the decision-making process. As an example, relevant cost is used to determine whether to sell or keep a business unit. The opposite of a relevant cost is a sunk cost, which has already been incurred regardless of the outcome of the current decision. 8.2 RELEVANT COSTING AND COSTING FOR DECISION MAKING In management accounting, notion of relevant costing has great significance because these costs are pertinent with respect to a particular decision. A relevant cost for a particular decision is one that transforms if an alternative course of action is taken. Relevant costs are also termed as differential costs. Studies have demonstrated that relevant costs will make a difference in a decision. A relevant cost only relates to a particular management decision and which will alter in the future as a result of that decision. Other theorists 94 CU IDOL SELF LEARNING MATERIAL (SLM)
described that relevant costs are future costs that will differ among alternatives. The main intent of relevant costing is to determine the objective cost of a business decision. An objective measure of the cost of a business decision is the degree of cash outflows that shall result from its execution. Relevant costing focuses on just that and overlooks other costs which do not influence the future cash flows. The fundamental principles of relevant costing are quite simple and managers can perhaps relate them to personal experiences involving financial decisions. It is stated in theoretical literature that relevant costing is a management accounting toolkit that assists management team to make decisions when they have to deal with some issues such as whether to buy a component from an external vendor or manufacture it in house?, Whether to accept a special order?, What price to charge on a special order?, Whether to discontinue a product line?, How to utilize the scarce resource optimally?. CIMA describes relevant costs as: \"the costs appropriate to a specific management decision\". A study of relevant costs and benefits assists to take wise decision. In order to meet the criteria for relevancy, a cost must have two criteria that include they affect the future and they differ among alternatives. Other group of theorists asserted that the relevant costs are applicable to decision. Costs are relevant, if they direct the executive towards the decision. It will be useful, if the costs are not only relevant but also precise. Relevance and accuracy are not alike concepts. Costs may be correct and irrelevant, costs may be incorrect but it can be relevant. Relevant information is the predicted future costs and incomes that will differ among the alternatives relevant information). Relevant costs are the costs which would change as a result of the decision under consideration, where as irrelevant costs are those which would remain unchanged by the decision. Therefore only relevant cost would be included in the investigative framework (Khan and Jain, 2008). A relevant cost is also defined as a cost whose amount will be affected by a decision being made. Management should believe only future costs and revenues that will differ under each alternative (Arora, 2008). Relevant costs are accepted future costs and relevant profits are expected future revenues that differ among the alternative course of action being considered (Hongren and Datar, 2008). In the arena of Management accounting, one feature of relevant cost is that they are future costs which have not been incurred. Hence the cost of material is relevant cost as long as the material not purchased because of deciding whether or not to purchase the material, one is to decide to sustain the cost or evade it. Therefore, all relevant costs are future costs. Whether particular costs and profits are relevant for decision making depends on decision circumstance and the options available. When selecting among different alternatives, manager must focus on the costs and revenues that differ across the decisions alternatives; these are relevant cost/revenues (Atkinson, et al, 2008). The relevance of cost to decision alternative is determined by situation. The facts and policies explain situation. It is established that historical cost is not relevant, only 95 CU IDOL SELF LEARNING MATERIAL (SLM)
future cost is relevant. All sunk costs are irrelevant (Allied Publishers, 1997). The following are relevant Costs: Differential cost: A differential cost is the difference in cost items under two or more decision alternatives distinctively two different projects or situations. Where same thing with the same amount appears in all alternatives, it is irrelevant. Differential costs must be compared to differential revenues. Incremental or marginal cost: Relevant costing is an incremental investigation which indicates that it considers only relevant costs that is costs that vary between alternatives and ignores sunk costs that is costs which have been incurred, which cannot be changed and therefore are inappropriate to the business situation. Incremental or marginal cost is a cost linked with producing an additional unit. Incremental cost must be compared with incremental revenues to take decision. Opportunity cost: It is cost of opportunity foregone. Whenever an organization decides to go for a particular project, it should not overlook opportunities for other projects. It should consider what alternative opportunities are there and which the best of these alternative opportunities is. Irrelevant costs: The reverse of a relevant cost is a sunk cost. A sunk cost is an expense that has already been made, and so will not change on a go-forward basis. Sunk costs are past costs. These cannot be changed with any future decision. Similarly, a cost which is identical in all decisions is immaterial. 8.3 RELEVANT COSTING CONCEPTS Make or Buy Decision Very often management is faced with the problem as to whether a part should be manufactured, or it should be purchased from outside market. Under such circumstances two factors are to be considered: (a) whether surplus capacity is available, and (b) the marginal cost. Illustrations The total cost of a manufactured component is as under: Prime cost Rs. 15 Fixed overhead Rs.4 Total cost Rs. 26 Variable overhead Rs. 7 96 CU IDOL SELF LEARNING MATERIAL (SLM)
The same part is available in the market at Rs.23. Should the firm make it or buy it? Solution If surplus capacity is available and will remain idle if the component is bought, the out-of- pocket expenses will be Rs. 23 per unit,Rs.1 more than the variable (relevant) cost of making component which is Rs.22 (Rs. 15 + Rs.7). Hence, it is economical to make it. However, if the firm is utilizing or can utilize the capacity in making some other part, which contributes, say Rs.4 per unit, the effective cost of buying the component will be Rs.19 (Rs.23 less Rs. 4 contribution from other product). In that case, it would be economical to buy the component at Rs.23 per unit from outside. The relevant computations for taking decision may be as follows: Make Per unit cost BuyBuy and use (Rs.) and leavecapacity Cost of making/buying capacity For other product Contribution from other— product idle (Rs.) Net relevant cost (Rs.) 4 — A firm needs a component in an assembly operation. If it wants to do the manufacturing itself, it will need to buy a machine for Rs. 4 lakhs which would last for 4 years with no salvage value. Manufacturing costs in each of the 4 years would be Rs 6 lakhs, Rs 7 lakhs, Rs8 lakhs and 10 lakhs, respectively. If the firm had to buy the component from a supplier the component would cost Rs 9 lakhs, Rs10 lakhs, Rs11 lakhs and Rs 14 lakhs respectively in each of the 4 years. However, the machine would occupy floor space which could have been used for another machine. This latter machine could be hired at no cost to manufacture an item, the sale of which would produce net cash flows in each of the 4 years of Rs 2 lakhs; it is impossible to find room for both the machines and there are no other external effects. The cost of capital is 10% and PV factor for each of the 4 years is 0.909, 0.826, 0.751 and 0.683 respectively. Should the firm make the component or buy from outside? Evaluation of Make or buy 97 CU IDOL SELF LEARNING MATERIAL (SLM)
Year Present valueWhen the Component isWhen the isComponent 0 factor at 10% manufactured bought 1 2 1.000 Cash outflow Present value Cash outflow Present value 3 4 4.000 — — 4 0.909 6+2 7.272 9 8.181 0.826 7+2 7.434 10 8.260 0.751 8+2 7.510 11 8.261 0.683 10 + 2 8.196 14 9.562 34.412 34.264 Saving in buying: Rs. 34.412 lakhs – Rs.34.264 lakhs = ₹ 0.148 lakh Thus it is beneficial to buy the component from outside. Note: The loss of Rs.2 lakhs cash inflow for each of the 4 years due to inability of the firm to operate another machine when it manufactures the component is to be treated as an opportunity cost. Product Mix Decision Many times, the management has to take a decision whether to produce one product or another instead. Generally, decision is made on the basis of contribution of each product. Other things being the same the product which yields the highest contribution is best one to produce. But, if there is shortage or limited supply of certain other resources which may act as a key factor like for example, the machine hours, then the contribution is linked with such a key factor for taking a decision. For example, in an undertaking the availability of machine capacity is limited, and the machine hours required for one unit of the two products are different. In such cases the contribution is to be linked with the machine hour and the product which yields the highest contribution per machine hour is to be preferred for taking decision. A firm’s operations are at present performed by hand. It has a proposal to install a new machine which can produce at a faster rate. Following information is available. Advise the management about the profitability of mechanization Production in units per hour Hand Machine Marginal cost per unit (Rs.) 1 2 Additional fixed cost per unit (Rs) 18 16 Total cost per unit (Rs) — 3 Selling price per unit (Rs) 18 19 24 24 98 CU IDOL SELF LEARNING MATERIAL (SLM)
Let us analyze the figures as under: Selling price per unit Hand Machine Less: Marginal cost per unit (Rs.) (Rs.) (including additional fixed cost) 24 24 Contribution per unit 18 19 Contribution per hour 6 5 6 10 If there is a great demand for the products, it is advisable to mechanize because the gross margin per hour is more when machine is used. If, however, there is idle capacity and there is an under- absorption of fixed overheads to the extent of Rs.3 per unit the total cost will be Rs.(19+ 3) = Rs. 22 leaving a contribution of Rs.2 per unit. The contribution per hour will, therefore, be Rs.4 which is less than that of obtaining under hand operation. Hence mechanization will not be advisable under these circumstances. Shut Down & Divestment Decision Very often it becomes necessary for a firm to temporarily close down the factory due to trade recession with a view to reopening it in the future. In such cases, the decision should be based on the marginal cost analysis. If the products are making a contribution towards fixed expenses or in other words if selling price is above the marginal cost, it is preferable to continue because the losses are minimized. By suspending the manufacture, certain fixed expenses can be avoided, and certain extra fixed expenses may be incurred depending up on the nature of the industry, say, for example, extra cost incurred in protecting the machinery. So the decision is based on as to whether the contribution is more than the difference between the fixed expenses incurred in normal operation and the fixed expenses incurred when the plant is shut down. In other words, the shutdown point is calculated by using the formula: Shut down point = (Total fixed cost – Shut down costs) ÷ Contribution per unit In case of decision rendering closure or shut down we consider the following points: 1. Current profit situation has to be maintained, so by analyzing the proposal of shut down or outsourcing if the current income is reduced then shut down will not be allowed unless the product or factory has reached at the end of its life cycle. 2. Avoidance of short-term loss may cause the loss of brand value in the market as well as loss of efficient employees. So in that case the business may be continued for better profit after the recession period. 99 CU IDOL SELF LEARNING MATERIAL (SLM)
3. In case of outsourcing proposal, we can also apply the differential cost concept i.e. saving in cost must be greater than or equal to out-sourcing fees payment. Here saving in cost i.e. cash inflow is computed from the concept of relevant cost i.e. by closing down we are saving variable cost of production, and discretionary fixed cost or shut down cost. This cash inflow further may be classified into two parts: 1. Saving in variable cost per time period i.e., Cash Inflow (CIF) per annum. 2. One time cash inflow following shut down i.e., sale of machine, sale of current stock of material etc. Total CIF or saving following shut down = one time CIF + CIF p.a. × life span of the proposal of outsourcing. If this total is greater than total outsourcing fees, then shutdown will take place other production will be continuing. Illustration No.1 Fixed expenses at 50% activity Rs.15,000 Fixed expenses when the factory is shut down Rs.10,000 Additional expenses in closing down Rs.1,000 Production at 50% activity = 5,000 units Contribution per unit ₹ 1 Solution (Rs.) A. If the plant is shut down the sunk costs or fixed expenses 11,000 B. If it is working at 50% activity the fixed expenses 15,000 C. Additional fixed expenses: [(B-A)] 4,000 D. Contribution (5,000 units Rs 1 p.u.) 5,000 By working at 50% activity the firm is able to recover the additional fixed expenses of Rs.4,000 and earn an extra contribution of Rs.1,000 towards shut down expenses. Hence it is advisable to continue production in the factory instead of closing it down. Illustration Universe Ltd. manufactures 20,000 units of ‘X’ in a year at its normal production capacity. The unit cost as to variable costs and fixed costs at this level are Rs.13 and Rs.4 respectively. Due to trade depression, it is expected that only 2,000 units of ‘X’ can be sold during the next year. The management plans to shut-down the plant. The fixed costs for the next year then are expected to be reduced to Rs.33,000. Additional costs of plant 100 CU IDOL SELF LEARNING MATERIAL (SLM)
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