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• Highly Qualified Faculty of India with renowned degrees – Chartered
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• He has also completed training in SAP (an ERP), a preferred so ware used worldwide by
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• First CFA of Madhya Pradesh who cleared all the 3 levels of CFA in Year 2008
• 5 Years of prac cal experience in esteemed organiza ons at various places – Bangalore
(India), Mumbai (India), Kingston (Jamaica), San Juan (Puerto Rico) , Chicago (USA).
• Only Faculty with prac cal Interna onal exposure to most of the Financial Management
and Cost Management topics such as Deriva ves trading, Fundamental & Technical
analysis of Stock Markets, Por olio Management, Research Reports and stock
recommenda ons, Capital Budge ng, Mergers & Acquisi ons, Forex transac ons,
Standard Cos ng, Manufacturing Resources Planning, Decision Making, Transfer Pricing
etc.
• Completed Corporate training in & operated world renowned systems to monitor and
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STRATEGIC COST MANAGEMENT &
PERFORMANCE EVALUATION
[COST]
The Best & The Most Comprehensive Notes for CA FInal
CHAPTER - 01 CHAPTER - 02
STRATEGIC
PRICING
ANALYSIS OF
DECISIONS
OPERATING INCOME
01 16
CHAPTER - 03
DIVISIONAL
TRANSFER
PRICING
24
Leaders in CA Final SCMPE (COST) & SFM

From the Desk of CA Praveen Khatod
Steve Jobs, a child born to an unmarried couple who gave him up for adoption as soon as he was
born, was one of the most respected entrepreneurs and inventors of his time. In 1976, he
founded Apple Inc. As Apple grew, Steve Jobs brought in
John Sculley, a more experienced CEO, to run the
company. In 1985, following a long power struggle with
Sculley, Jobs was fired from his own company. During
this time he started a new company called NeXT and
another company called Pixar. Pixar went on to create
the first computer-animated film, Toy Story. 12 years
later, Apple bought NeXT and Jobs returned to Apple as
the head of the company. Under his renewed leadership
Apple successfully developed the iMac, the iPod, the
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multi-year pace and making his company the highest
valued company in the world.
Steve Jobs story teaches us that if you want to be successful CA, CFA (USA), CPA (USA)
as bad as you want to breathe then you will be successful. PRAVEEN KHATOD
Always believe in yourself. You have the ability to do any kind of work whatever it is easy or
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change the world. You have a big responsibility to make the world better. I know you can do this
very well.
Be a good human who helps everyone. Be a good partner, a good friend, a good soul who is honest,
trustworthy and responsible. Happiness will find you !
Just remember there is someone out there who is more than happy with less than what you have !
T a r g e t i n g 100 Marks i n SFM . . .
Leaders in CA Final SCMPE & (COST) SFM

STRATEGIC
ANALYSIS OF
OPERATING INCOME

STRATEGIC
ANALYSIS OF
OPERATING INCOME
MANUFACTURING CYCLE EFFICIENCY
Question-1
Queenstown Furniture (QF) manufactures high-quality wooden doors within the forests of Queenstown
since 1952. Management is having emphasize on crea vity, engineering, innova on and experience to
provide customers with the door they desire, whether it is a standard design or a one-of-a-kind custom door.
The following informa on pertains to opera ons during April:
Processing me 9.0 hrs.* Wai ng me 6.0 hrs.*
Inspec on me 1.5 hr.* Move me 7.5 hrs.*
Units per batch 60 units
(*) average me per batch
Required
COMPUTE the following opera onal measures:
(i) Average non-value-added me per batch
(ii) Average value added me per batch
(iii) Manufacturing cycle efficiency
(iv) Manufacturing cycle me [Study Material]
Solu on:
(i) Average Non Value Added Time per batch

= Inspec on Time + Wai ng Time + Move Time
= 1.5 hr. + 6.0 hrs. + 7.5 hrs.
= 15 hrs
(ii) Average Value Added Time per batch

= Processing Time
= 9 hrs
1
CA, CFA (USA), CPA (USA) PRAVEEN KHATOD - Best Faculty in India for SCM (COST) & SFM
STRATEGIC ANALYSIS OF OPERATING INCOME
(iii) Manufacturing Cycle Efficiency

Processing Time
Processing Time + Inspection Time + Waiting Time + Move Time
9.0 hrs
=
9.0 hrs. + 1.5 hr. + 6.0 hrs. + 7.5 hrs.
= 37.5%
(iv) Manufacturing Cycle Time

Total Production Time
Units per Batch
24 hrs
=
60 units
= 0.40 hrs. per unt
COMPREHENSIVE - CASE SCENARIO
Question-2
Melody is a manufacturer of musical instruments. The company specializes in manufacture of Piano and
Electronic Keyboard instruments. They are both labour-intensive products. Therefore, Melody follows
absorbed its produc on overheads based on direct labour hours.
Piano
Melody's Pianos are of very high quality. Client patronage include professional Piano musicians. Some of
these instruments are sold in its standard form. However, musicians par cularly the concert players require
their pianos to be customized to certain specifica ons. Customiza on primarily relates to the acous c
quality of the piano sound. Quality of sound is of paramount importance to musicians as it determines the
power and warmth of tone. Each musician has a preference to achieve a special quality of sound. Therefore,
no two customized Pianos can be the same. Due to its reputa on, Melody receives numerous requests for
customiza on from its customers. Ability to provide customiza on service sets Melody apart from its
compe tors.
Customiza on requires the services of professional cra smen. They are hired as subcontractors for such
work based on the need. These cra smen perform their services within the factory premises. For this a
special work, space is maintained by Melody. Melody charges its customers extra for subcontrac ng cost
plus 10%. This would cover the actual cost of subcontrac ng and any incidental overheads incurred. The
Board of Melody accepts that this method of billing is very simplis c. It is unsure if the company is recovering
the en re cost of providing this customiza on service.
2
Electronic Keyboard Instruments

These are instruments manufactured by Melody are home Keyboards that are targeted at young music
enthusiasts who are beginning to learn music. They come in standard sizes, comprised of standard
components. No customiza ons are done to Keyboards.
As a performance management expert, the Board wants your advice. The extract below provides the most
recent management accounts for the Piano and Keyboard Division.
Figures in ₹
Sr. No. Par culars Piano Keyboard Total
1. Number of items manufactured 1,000 10,000
2. Sale Price per unit 2,50,000 15,000
3. Revenue 25,00,00,000 15,00,00,000 40,00,00,000
4. Materials 7,50,00,000 3,75,00,000 11,25,00,000
5. Direct Labour 8,00,00,000 6,75,00,000 14,75,00,000
6. Subcontrac ng Cost 3,75,00,000 - 3,75,00,000
7. Produc on Overheads 4,50,00,000 65,00,000 5,15,00,000
8. Total Cost of Produc on (4 + 5 +6 + 7) 23,75,00,000 11,15,00,000 34,90,00,000
9. Gross Profit (3 - 8) 1,25,00,000 3,85,00,000 5,10,00,000
Produc on Overheads Figures in ₹

Par culars Amount
Inspec on and Tes ng 3,45,00,000
Space Maintenance Cost for Subcontrac ng Work 50,00,000
(rent, u li es, 2 support staff to maintain storage)
Other Produc on Overheads 1,20,00,000
(rest of the u li es, rent, salary of support staff at storage)
Required
(i) DISCUSS the difference in treatment of produc on overheads under absorp on cos ng and ac vity
based cos ng.
(ii) LIST the steps to implement ac vity based cos ng within Melody.
(iii) ASSESS whether ac vity based cos ng would be suitable for the Piano and Keyboard Divisions.
(iv) ADVISE Melody about the ac vity based management and ways to improve business performance.
3
Solu on:
(i) Product cost under absorp on cos ng method includes all manufacturing costs that are incurred to
produce a product {direct material, labour, and overheads (both fixed and variable)}. The alloca on of
overhead is determined by a single cost driver based on volume of produc on (popular ones are
machine hours or direct labour hours). This driver is applied to the en re produc on overhead to arrive
at the produc on overhead rate. For example, in the given problem, labour hours are being used to
allocate overheads to Pianos and Keyboards. All produc on overheads are allocated to products based
on this driver irrespec ve of whether this resource was used by the product or not. For example,
produc on overheads include maintenance cost rela ng to space for subcontrac ng work. This cost
is incurred for the manufacture of Piano alone. This por on of the maintenance cost gets clubbed with
other produc on costs. Eventually, an overhead absorp on rate is calculated using the ra o direct
labour hours for each product. Absorp on cos ng would ignore the fact that the manufacture of
Keyboards does not u lize the space allocated for subcontrac ng work. This skews the product cos ng
by erroneously infla ng the cost of Keyboards, some por on of the cost of manufacturing Pianos
passes onto the product cost for Keyboards. Applica on of a single cost driver may not be the most
appropriate way of alloca ng costs between products. For example, in the given problem, factory rent
that is clubbed with total overheads and applied to the product cost as part of the overhead rate.
Absorp on cos ng ignores that direct labour may not be the most appropriate basis to allocate factory
rent overhead to the products.
Ac vity based cos ng iden fies the cost of each ac vity and assigns costs to units produced based on
the number of ac vi es used by each unit. Instead of being clubbed as a single overhead cost, costs for
each ac vity are captured in their respec ve cost pools. The most appropriate cost driver is selected.
Cost drivers could be volume based (machine hours / direct labour) or transac on based (# of purchase
orders). This cost driver is used as the basis to allocate costs to various products based on the u liza on
of the resource related to that ac vity.
Overhead costs are assumed to be variable, determined (or driven) by the selected cost driver. Here,
the cost of maintaining space for subcontrac ng relates en rely to the manufacture of Pianos. Using
ABC method, this cost will be allocated only to Piano products since alloca on is now based on
u liza on of the resource to manufacture the product. Again, under this method, factory rent could
have space u liza on as the cost driver. Therefore, using ABC method, the alloca on of rent overhead
to the products will be made on a more logical basis as compared to absorp on cos ng.
To conclude, product cos ng using absorp on cos ng is rela vely simpler, a method regularly followed
for financial accoun ng purpose. Product cos ng using ABC method results in more detailed yet
accurate figures. It highlights the cost / benefit of various ac vi es that helps management focus on
elimina ng non-value added ac vi es.
4
(ii) Implementa on of ABC Method within Melody would include the following steps:
1. Ac vity Mapping: Produc on process has to be first broken down into various ac vi es. Based on
their nature, ac vi es must then be clubbed to form ac vity pools. Ac vity pools must then e in
with the products or services.
2. Cost Pools: Overheads costs are then iden fied to each ac vity pools. This gives the cost pool for
each category of ac vity.
3. Cost Driver: Iden fy the ac vity that bring about the cost. For example, space u liza on would be
a standard cost driver for factory rent. Cost drivers could be volume based or transac on based.
4. Overhead Rate: Once the cost pool and cost driver are iden fied, the cost per unit of cost driver
(overhead rate) is determined.
5. Overhead Cost Alloca on: Depending on how much of the resource (cost driver) the product
u lizes, the cost is allocated accordingly to that product.
6. Product Cost: The allocated overhead cost is added to the cost of direct materials and labour to
arrive at the full cost of produc on for the unit.
(iii) Appropriateness of ABC Method for the Keyboard and Piano Divisions
The Piano Division receives numerous requests for customiza on from its customers. While it
produces only 1,000 Pianos in a year, no two customiza ons are the same. Therefore, the range of
Pianos manufactured by Melody can be considered varied. Produc on overheads cost, including
subcontrac ng work, form 35% of the total produc on cost. ((₹ 3,75,00,000 + ₹ 4,50,00,000)/ ₹
23,75,00,000). Therefore, overheads form a substan al por on of product cost. Due to the variety in
customiza on, it is important to price each customiza on at a rate that will yield an acceptable profit
margin to Melody. To do this, manufacturing process has to be segregated into various ac vi es and
cost pools. Depending on u liza on of resources related to each ac vity, each Piano can be sold at an
appropriate price. If a Piano requires more of a resource from an ac vity, this can be included in the
product cost and factored into the selling price, such that even with customiza on an acceptable profit
margin can be earned. Thus, ABC method can help Melody arrive at a more accurate cost of produc on
as compared to absorp on cos ng.
While, overhead cost is one aspect of ABC analysis, the other informa on that an organiza on gets
from this framework is that it can iden fy the ac vi es that add value to the product. At the same me,
non-value adding services can be iden fied (for example storage) and measures can be taken to
minimize them. This helps it partner be er with its customers and gain a compe ve edge.
5
The Keyboard Division produces 10,000 Keyboards annually, all sold as a standard product with no
customiza on. Ac vi es are standardized, with no varia on in the process between the Keyboards.
Produc on overheads form only 6% of total cost of produc on. (₹65,00,000 / ₹11,15,00,000).
Implementa on of ABC method is me consuming and complex. Here, due to the standardized nature
of produc on and low quantum of produc on overheads, ABC method may not be jus fied for the
me and effort involved. In this case, absorp on cos ng may seem to be a more prac cal approach to
arrive at product price.
(iv) Ac vity Based Management to help Melody improve business performance
Ac vity based management can help Melody to meet the customer needs while using the lowest
possible resource or cost. ABM can be used at an opera onal or strategic level.
(i) Product Pricing

This would be especially in case of the Piano Division. As explained above, ABC method would enable
Melody calculate a more accurate cost of produc on for each Piano. Currently, the cost of
subcontrac ng work used for customizing Pianos is ₹ 3,75,00,000. This is being charged to the
customers with a 10% mark-up to cover for any incidental overhead. However, this is very simplis c. As
such the mark-up that can be earned under this method will be ₹ 37,50,000. However, the cost of
maintenance of the area for subcontrac ng work is higher at ₹ 50,00,000. Therefore, it can be
concluded that Melody is not recovering the en re por on of the incidental overheads incurred by
providing the subcontrac ng work.
By iden fying the cost pools rela ng to the subcontrac ng work, Piano Division can determine that it is
making a loss on the subcontract work as a whole. It could therefore adjust the price of customized
Pianos such that it earns an acceptable margin on each sale. This is at an opera onal level. At a strategic
level, Melody can determine which type of customiza ons are most profitable. Customiza ons that
are not very frequent, too complex, and costly may be avoided as it takes away resources from Melody
in terms of labour, space etc. At the same me, careful considera on should be given to such decisions
since it is this customiza on service that gives Melody an edge over other compe tors. Therefore,
Melody should take decisions that help it balance the customer base, while keeping the costs low and
processes as standardized as possible.
(ii) Analysis of Ac vi es
Implementa on of ABC method forces the company to take a more detailed look at its ac vi es that
comprise of its manufacturing process. It may be found that certain ac vi es can be performed in
more efficient manner. Also, ac vi es can be iden fied as those that add value to the product and
those that are not value adding. For example, in the given example, storage is not a value adding
ac vity. Melody can work on a system where it op mizes the produc on process such that storage
requirements are lower. The inventory turnover of Piano can also be improved, since quicker the Piano
is shipped to the customer, lower the space requirement. Inspec on is another non- value adding
ac vity. For example, Melody switch to a standardized procurement system for its raw materials from
reputed suppliers. While it may be a costlier op on, this may lead to lower defects in the product,
therefore requiring lesser need for inspec on.
6
(iii) Performance Measurement

Employee resource should be used more towards value adding ac vi es. Proper training would be
required to ensure acceptable quality of work. This would automa cally reduce non-value adding
ac vi es like rework, idle me, and inspec on. There has to be proper informa on system in place that
captures such data. This is facilitated through the implementa on of ABC cos ng method and use of
ABM. However, to have a successful system, senior management need to be commi ed to this model,
proper communica on and training has to be given to employees. To implement such a performance
system the management has to commit sufficient me and effort. Cost benefit considera ons of
having such systems should also be taken into considera on. To conclude, implemen ng ABM should
not take up produc ve me of employees and become a non- value ac vity in itself!
Question-3
Jigyasa India Ltd. (JIL) has 30 retail stores of uniform sizes 'Fruity & Sweety Retails' across the country. Mainly
three products namely Bu er Jelly, 'Fruits & Nuts' and 'Icy Cool are sold through these retail stores. JIL
maintains stocks for all retail stores in a centralised warehouse. Goods are released from the warehouse to
the retail stores as per requisi on raised by the stores. Goods are transported to the stores through two
types of vans i.e. normal and refrigerated. These vans are to be hired by the JIL.
Costs per month of JIL are as follows:

(₹)
Warehouse Costs:
Labour & Staff Costs 27,000
Refrigera on Costs 1,52,000
Material Handling Costs 28,000
Total 2,07,000
Head Office Cost
Salary & Wages to Head Office Staff 50,000
Office Administra on Costs 1,27,000
Total 1,77,000
Retail Stores Costs:
Labour Related Costs 33,000
Refrigera on Costs 1,09,000
Other Costs 47,000
Total 1,89,000
7
Average transporta on cost of JIL per trip to any retail stores are as follows:
Normal Van ₹ 3,200
Refrigerated Van ₹ 4,900
The Chief Financial Manager asked his Finance managers to calculate profitability based on three products
sold through Fruity & Sweety retail stores rather than tradi onal method of calcula ng profitability.
The following informa on regarding retail stores are gathered:

Bu er Jelly Fruits & Nuts Icy Cool
No. of Cartons per cubic metre (m³) 42 28 40
No. of Items per cartons (units) 300 144 72
Sales per month (units) 18,000 4,608 1,152
Time in Warehouse (in months) 1 1.5 0.5
Time in Retail Stores (in months) 1 2 1
Selling Price per unit (₹) 84 42 26
Purchase Price per unit (₹) 76 34 22
Bu er Jelly and Icy-Cool are required to be kept under refrigerated condi ons.
Addi onal informa on:
Total Volume of All Goods Sold per month 40,000 m³
Total Volume of Refrigerated Goods Sold per month 25,000 m³
Carrying Volume of each van 64 m³
Required
CALCULATE the Profit per unit using Direct Product Profitability (DPP) method.
[Study Material]
8
Solu on:
Direct Product Profitability (DDP) Statement

(Amount in ₹)
Bu er Jelly Fruits & Nuts Icy Cool
Selling Price per unit 84.00 42.00 26.00
Less: Purchase Price per unit 76.00 34.00 22.00
Gross Profit ...(A) 8.00 8.00 4.00
Direct Product Costs:
Warehouse Costs per m³ [W.N.-1] 7.46 2.07 3.73
Retail Stores Costs per m³ [W.N.-2] 6.36 4.00 6.36
Transporta on Costs [W.N.-3] 76.56 50.00 76.56
Total DPP costs per m³ 90.38 56.07 86.65
Items per m³ [W.N.-4] 12,600 4,032 2,880
Cost per items ...(B) 0.007 0.014 0.030
Direct Product Profit ...(A)-(B) 7.993 7.986 3.97
Working Notes
(1) Warehouse Related Costs

General Costs (₹) Cost Related With
Refrigerated Goods (₹)
Labour & Staff Costs 27,000 —
Refrigera on Costs — 1,52,000
Material Handling Costs 28,000 —
Total 55,000 1,52,000
Volume of Goods Sold 40,000 m³ 25,000 m³
Cost per m³ per month 1.38 6.08
9
Products Time in Warehouse Cost per m³ per month (₹) Total Cost (₹)
Bu er Jelly 1 Month 7.46 7.46
(1.38 + 6.08)
Fruits & Nuts 1.5 Months 1.38 2.07
Icy - cool 0.5 Months 7.46 3.73
(1.38 + 6.08)
(2) Retail Stores Related Costs

General Costs Cost Related with
(₹) Refrigerated Goods (₹)
Labour Related Costs 33,000 —
Refrigera on Costs — 1,09,000
Other Costs 47,000 —
Total 80,000 1,09,000
Volume of Goods sold 40,000 m³ 25,000 m³
Cost per m³ per month 2.00 4.36
Products Time in Retail Stores Cost per m³ per month Total Cost
Bu er Jelly 1 Month ₹ 6.36 ₹ 6.36
(₹ 2.00 + ₹ 4.36)
Fruits & Nuts 2 Months ₹ 2.00 ₹ 4.00
Icy - Cool 1 Months ₹ 6.36 ₹ 6.36
(₹ 2.00 + ₹ 4.36)
(3) Transpota on Costs

Normal Van Costs Refrigerated Van Costs
Cost per trip ₹ 3,200 ₹ 4,900
Volume of Van 64 m³ 64 m³
Cost per m³ per trip ₹ 50.00 ₹ 76.56
10
(4) No. of Items per M³

Products No. of No. of Items per No of Items per m³
Cartons (m³) Cartons (units)
Bu er Jelly 42 300 12,600
(42 x 300)
Fruits & Nuts 28 144 4,032
(28 x 144)
Icy - Cool 40 72 2,880
(40 x 72)
Question-4
Bookmark LLP is a publishing firm that started opera ons very recently. The firm has published "Advanced
Learner's Dic onary" this first year, that have been sold to 3 distributors PER, MGH and WLY. The firm's
financials reflect profits in its first year of opera ons. The management is pleased with the results. However,
they are interested in finding out how profitable each customer is. This would help them formulate their
sales strategy.
Par culars PER MGH WLY
Sales units p.a. 1,000 950 1,250
Sales price (gross) 250 250 250
Payment terms 3/10 net 30 net 30 3/10 net 30
Sales returns 0.5% 0% 10%
Delivery terms FOB des na on FOB des na on FOB shipping point
In order to get market share, PER and WLY have been extended credit terms to avail discount if payment is
made within 10 days. Customer MGH does not have much bargaining power and hence has been allowed
only 30 days' credit period without any benefit of availing discount for early payment. Both PER and WLY
have made payments within 10 days to avail of the discount extended.
On the cost front, variable cost of goods sold a ributable to the net sales to customers PER, MGH and WLY
are ₹ 1,50,000, ₹ 1,42,500, and ₹ 1,87,500 respec vely. Key metrics of customer assignable marke ng,
administra ve and distribu on costs are as below:
11
Ac vity Ac vity Driver No of Units of Ac vity Driver Cost

Driver
Rate (₹)
PER MGH WLY
Order taking and processing # of orders 4 2 15 300
Expedited / rush orders # of orders 1 - 5 250
Delivery costs # distance in km. 100 50 - 80
Sale return processing # of returns 1 - 8 150
Billing cost # of invoices 4 2 15 50
Customer visit # of visits 1 - 5 800
Inventory carrying cost* # 1 per unit 1,000 950 1,250 10
* Assume no opening and closing stock
Fixed cost that are not assignable to any customer is ₹ 1,00,000 p.a.
Required
(i) PREPARE the customer wise profitability statement as also the overall profitability statement of
Bookmark LLP.
(ii) RECOMMEND a strategy for Bookmark LLP regarding its customers.

[RTP May 2018, Study Material]
12
Solu on:
(i) Customer Wise Profitability Statement and Overall Profitability Statement

SN. Par culars PER MGH WLY Total ₹
A Sales (net proceeds) - Table 1 241,288 237,500 272,812 751,600
B Variable Cost of Goods Sold 1,50,000 1,42,500 1,87,500 4,80,000
C Assignable- Marke ng and Administra on
Cost- Table 2
• Order Taking and Processing 1,200 600 4,500 6,300
• Sale Return Processing 150 - 1,200 1,350
• Billing Cost 200 100 750 1,050
• Customer Cost 800 - 4,000 4,800
Total Assignable Marke n and 2,350 700 10,450 13,500
Administra on cost
D Assignable- Distribu on Cost - Table 2
• Expedited / Rush Orders 250 - 1,250 1,500
• Delivery Costs 8,000 4,000 - 12,000
• Inventory Carrying Cost 10,000 9,500 12,500 32,000
Total Assignable Distribu on Cost 18,250 13,500 13,750 45,500
E Non- Assignable Fixed Cost - - - 100,000
F Total Costs (B+C+D+E) 170,600 156,700 211,700 639,000
B Net Profit (Step A - F) 70,688 80,800 61,112 112,600
H Profit % of Sales (G / A) 29% 34% 22% 15%
13
Workings
Table 1: Customer Sales Analysis - Revenue Analysis All figures in ₹

Par culars PER MGH WLY Total ₹
Sales {Sale Units x Sale Price (gross)} 2,50,000 2,37,500 3,12,500 8,00,000
Less: Sale Return (Step 1 x Return%) 1,250 - 31,250 32,500
Net Sales 2,48,750 2,37,500 2,81,250 7,67,500
Less: Cash Discount 7,462 - 8,438 15,900
Net Proceeds 2,41,288 2,37,500 2,72,812 7,51,600
Final Collec ons vs Original Sale 97% 100% 87% 94%
Table 2: Assignable Marke ng, Administra ve and Distribu on Costs All figures in ₹
Par culars PER MGH WLY Total
Order Taking and Processing 1,200 600 4,500 6,300
(# of orders x cost per order)
Expedited / Rush Orders 250 - 1,250 1,500
(# of orders x cost per order)
Delivery Costs 8,000 4,000 - 12,000
(Distance in km. x cost per km )
Sale Return Processing 150 - 1,200 1,350
(# of returns x cost per return)
Billing Cost 200 100 750 1,050
(# of invoices x cost per invoice)
Customer visits 800 - 4,000 4,800
(# of customer visits x cost per visits )
Inventory Carrying Cost 10,000 9,500 12,500 32,000
(# of units x inventory carrying cost p.u.)
14
(ii) Customer strategy: It can be seen that Bookmark LLP has an overall profit of ₹ 112,600 or 15% of sales.
While the performance is good, the firm's management has to analyze customer wise profitability.
(a) WLY is the largest customer in terms of units sold. However, Table 1 above shows that sale returns
at 10% is unusually large compared to other customers. Bookmark LLP has to inves gate why the
returns are of such large quan ty. Possibly, there could be communica on gap between the firm
and WLY. Possible non-conformity in goods delivered has resulted in returns. Only 87% of the
original sale value is being collected. The root cause of the problem has to be iden fied and
rec fied. This will also reduce the sale return processing costs.
(b) WLY has placed many rush orders, which requires Bookmark LLP to ship these orders
immediately, using costlier means of transporta on. Currently, there is no charge for shipping
rush orders. In order to deter WLY from repeatedly placing rush orders, Bookmark LLP can charge
the customer for shipping such orders beyond a threshold number of orders. Say rush orders
beyond 2 orders will be charged to the customer.
(c) WLY has placed 15 orders for 1,250 units. Compara vely, PER and MGH placed 4 and 2 orders for
approximately 1,000 units each. WLY can be requested to place fewer orders with larger quan ty
per order, in order to op mize ordering cost.
(d) Being the largest customer, WLY has 5 sale visits from Bookmark LLP, which is more than the other
2 customers. Priced at ` 800 per visit, this is very costly. At the same me, WLY is yielding the least
profit. Therefore, Bookmark LLP should reassess if resources can be reallocated to the other two
more profitable customers. That may encourage more sales from higher yielding customers.
(e) Since WLY seems to need more hand-holding in terms of more sales visits as well as higher rush
orders, Bookmark LLP may assess if it wants to discon nue or reduce business. Alterna vely, it
may reassign these resources towards exis ng or newer customers to get be er profitability.
However, if WLY can be migrated to a higher profitability, Bookmark LLP need not lose out its
market share.
(f) Customer MGH is the most profitable yielding 34% return over sales, although in terms of
'Advanced Learner's Dic onary' ordered, it is the smallest of the three. Bookmark LLP can assess
if it can extend some discount, in order to encourage more sales. Currently, Customer MGH does
not get any discount.
(g) Bookmark LLP can assign more sales visits to Customer PER and MGH to encourage them
purchase more as well as provide high quality customer service.
15
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PRICING
DECISIONS

PRICING
DECISIONS
Question-1
Recommend the Pricing Strategy to be adopted with reference to the following situa ons. You are not
required to explain the reasons for your answer.
a. Star Coffee Shop follows the prac ce of keeping the price of its coffee or service ar ficially high in order
to encourage favourable percep ons among buyers, based solely on the price.
b. Sky TV gave away their satellite dishes for free in order to set up a market for them.
c. Princeton Hotels Ltd. follows a compe ve pricing method under which it tries to keep its price at an
average level charged by the Industry.
d. Eddisson Enterprises has piled up stocks in large quan es and the market price has fallen.
e. Acqua LLP follows a new product pricing strategy through which company makes profitable sales by
selling out few units.
f. X Ltd. produces Product X a revolu onary product and as a reward for innova on and for taking first
ini a ve which pricing strategy should X Ltd. adopt?
g. An established company has recently entered the sta onery market segment and launched quality
paper for prin ng at home and office.
h. D is a perishable item, with more than 80% of its shelf life is over.
[(8 Marks) CA Final June 2019]
17
PRICING DECISIONS
Question-2
Aditya Heavy Engineering Ltd. (AHEL) produces its only product A7. To manufacture a unit of A7, variable cost
of ₹ 2,20,000 is incurred. Market research has indicated that at a selling price of ₹ 5,10,000 no order will be
received, but the demand for A7 will be increased by two units with every ₹ 5,000 reduc on in the unit selling
price below ₹ 5,10,000.
Required:
To determine the unit selling price for A₇ that will maximize the profit of AHEL.
Solu on:
We assume that: Selling Price per unit of A₇ is 'P', and Quan ty Demanded is 'Q'
The Marginal Cost of a unit of A₇ is ₹ 2,20,000
Price Equa on for 'A₇'
P = a – bQ
P = 5,10,000 – (5,000 / 2) × Q
Revenue (R) = Q × [5,10,000 – 2,500 × Q]
= 5,10,000 Q – 2,500 Q2
Marginal Revenue (MR) = a – 2bQ
= 5,10,000 – 2 × (5,000 / 2) × Q
= 5,10,000 – 5,000 Q
Marginal Cost (MC) = 2,20,000
Profit is Maximum where Marginal Revenue (MR) equals to Marginal Cost (MC)
5,10,000 – 5,000 Q = 2,20,000
Q = 58 units
By Pu ng the Value of 'Q' in Price Equa on, Value of 'P' is Obtained

P = 5,10,000 – (5,000/ 2) × Q
= 5,10,000 – 2,500 × 58 units
= 3,65,000
At Selling Price of ₹ 3,65,000 AHEL's Profit will be Maximum.
18
PRICING DECISIONS
LEARNING CURVE METHOD OF PRICING
Question-3
The following informa on is provided by a firm. The factory manager wants to use appropriate average
learning rate on ac vi es, so that he may forecast costs and prices for certain levels of ac vity:-
(i) A set of very experienced people feed data into the computer for processing inventory records in the
factory. The manager wishes to apply 80% learning rate on data entry and calcula on of inventory.
(ii) An opera on uses contract labour. The contractor shi s people among various jobs once in two days.
The labour force performs one task in 3 days. The manager wants to apply an average learning rate for
these workers.
(iii) A labour intensive sculpted product is carved from the metal provided to the staff. The metal is sourced
from different suppliers since it is scarce. The alloy composi on of the input metal is quite different
among the suppliers.
(iv) Pieces of hand-made furniture are assembled by the company in a far-off loca on. The labourers do
not know anything about the final product which u lizes their work. As a ma er of further precau on,
rota on of labour is done frequently.
(v) Skilled workers have been employed for a long me. The company has adequate market for the cra
pieces done by these experts.
You are required to advise to the manager with reasons on the applicability of the learning curve theory on
the above informa on.
Question-4
DK Interna onal is developing a new product. During its expected life, 16,000 units of the product will be sold
for ₹ 102 per unit.
Produc on will be in batches of 1,000 units throughout the life of the product.
The direct labour cost is expected to reduce due to the effects of learning for the first eight batches
produced. Therea er, the direct labour cost will remain constant at the same cost per batch as in the 8
batch.
The direct labour cost of the first batch of 1,000 units is expected to be ₹ 55,000 and a 90% learning effect is
expected to occur. The direct material and other non-labour related variable costs will be ₹ 50 per unit
throughout the life of the product.
There are no fixed costs that are specific to the product.

. .
The learning index for a 90% learning curve = - 0.152; 8-⁰ ¹⁵² = 0.729; 7-⁰ ¹⁵² = 0.744
19
PRICING DECISIONS
Required:
(i) Calculate the expected direct labour cost of the 8th batch.
(ii) Calculate the expected contribu on to be earned from the product over its life me.
(iii) Calculate the rate of learning required to achieve a life me product contribu on of ₹ 5,00,000,
assuming that a constant rate of learning applies throughout the product's life.
[(10 Marks), CA Final May 2019]
Solu on:
(i) Total Direct Labour Cost for first 8 batches based on learning curve of 90% (When the direct labour cost
for the first batch is ₹ 55,000)
The usual learning curve modal is

y = ax
Where
y = Average Direct Labour Cost per batch for x batches
a = Direct Labour Cost for first batch
x = Cumula ve No. of batches produced
b = Learning Coefficient /Index
- .
y = ₹ 55,000 x (8) ⁰ ¹⁵²
= ₹ 55,000 x 0.729
= ₹ 40,095
Total Direct Labour Cost for first 8 batches

= 8 batches x ₹ 40,095
= ₹ 3,20,760
Total Direct Labour Cost for first 7 batches based on learning curve of 90% (when the direct labour cost
for the first batch is ₹ 55,000)
- .
y = ₹ 55,000 x (7) ⁰ ¹⁵²
= ₹ 55,000 x 0.744
= ₹ 40,920
Total Direct Labour Cost for first 7 batches

= 7 batches x ₹ 40,920
= ₹ 2,86,440
Direct Labour Cost for 8 batch

= ₹ 3,20,760 — ₹ 2,86,440
= ₹ 34,320
20
PRICING DECISIONS
(ii) Statement Showing "Life Time Expected Contribu on"

Par culars Amount (₹)
Sales (₹ 102 x 16,000 units) 16,32,000
Less: Direct Material and Other Non Labour Related Variable Costs 8,00,000
(₹ 50 x 16,000 units)
Less: Direct Labour * 5,95,320
Expected Contribu on 2,36,680
(*) Total Labour Cost over the Product's Life

= ₹ 3,20,760 + (8 batches x ₹ 34,320)
= ₹ 5,95,320
(iii) In order to achieve a Profit of ₹ 5,00,00,000 the Total Direct Labour Cost over the Product's Life me
would have to equal ₹ 3,32,000.
Statement Showing "Life Time Direct Labour Cost"
Par culars Amount (₹)
Sales (₹ 102 x 16,000 units) 16,32,000

Less: Direct Matrial and Other Non Labour Variable Costs 8,00,000
(₹ 50 x 16,000 units)
Less: Desired Life Time Contribu on 5,00,000
Direct Labour 3,32,000
Average Direct Labour Cost per batch for 16 batches is ₹ 20,750 (₹ 3,32,000 / 16 batches).
Total Direct Labour Cost for 16 batches based on learning curve of r% (when the direct labour cost for
the first batch is ₹ 55,000)
y = ₹ 55.000 x (16)
₹ 20,750 = ₹ 55,000 x (16)
0.3773 = (16)
log 0.3773 = b x log 2⁴
log 0.3773 = b x 4 log 2
log r ö
log 0.3773 = ç ÷ x 4 log 2
è log 2 ø
log 0.3773 = log r⁴
0.3773 = r⁴
4
r 0.3773
r = 78.37%
21
PRICING DECISIONS
Alterna ve
In order to achieve a contribu on of ₹ 5,00,000, the total labour cost over the product's life me would have
to be ₹ 8,32,000 - ₹ 5,00,000 = ₹ 3,32,000. This equals an average batch cost of ₹ 3,32,000/16 = ₹ 20,750/-.
This represents ₹ 20,750/ ₹ 55,000 = 37.73% of the cost of the first batch.
16 batched represent 4 doublings of output.
Therefore, the rate of learning required = 4

0.3773 = 78.37%
CASE SCENARIO
Question-5
Netcom Ltd. manufactures and sells a number of products. All of its products have a life cycle of less than one
year. Netcom Ltd. uses a four stage life cycle model (Introduc on, Growth, Maturity and Decline).
Netcom Ltd. has recently developed an innova ve product. It was decided that it would be appropriate to
adopt a market skimming pricing policy for the launch of the product.
However, Netcom Ltd. expects that other companies will try to join the market very soon.
This product is currently in the Introduc on stage of its life cycle and is genera ng significant unit profits.
However, there are concerns that these current unit profits will not con nue during the other stages of the
product's life cycle.
Required
EXPLAIN, with reasons, the changes, if any, to the unit selling price and the unit produc on cost that could
occur when the products move from the previous stage into each of the following stages of its life cycle:
(i) Growth
(ii) Maturity
[Study Material]
22
PRICING DECISIONS
Solu on:
Growth Stage
Compared to the introduc on stage the likely changes are as follows:
Unit Selling Prices:

These are likely to be reducing for a number of reasons:
• The product will become less unique as compe tors use reverse engineering to introduce their
versions of the product.
• Netcom may wish to discourage compe tors from entering the market by lowering the price and
thereby lowering the unit profitability.
• The price needs to be lowered so that the product becomes a rac ve to different market segments
thus increasing demand to achieve the growth in sales volume.
Unit Produc on Costs:

These are likely to reduce for a number of reasons:
• Direct materials are being bought in larger quan es and therefore Netcom may be able to nego ate
be er prices from its suppliers thus causing unit material costs to reduce.
• Direct labour costs may be reducing if the product is labour intensive due to the effects of the learning
and experience curves.
• Other variable overhead costs may be reducing as larger batch sizes reduce the cost of each unit.
• Fixed produc on costs are being shared by a greater number of units.
Maturity Stage
Compared to the growth stage the likely changes are as follows:
Unit Selling Prices:

These are unlikely to be reducing any longer as the product has become established in the market place. This
is a me for consolida on and whilst there may be occasional offers to tempt customers to buy the product
the selling price is likely to be fairly constant during this period.
Unit Produc on Costs:

Direct material costs are likely to be fairly constant in this phase and may even rise as the quan es required
diminish compared to those required in the growth stage with the consequen al loss of nego a ng power in
late maturity stage.
Direct labour costs are unlikely to be reducing any longer as the effects of the learning and experience curves
have ended. Indeed the workers may have started working on the next product so that their a en on
towards this product has diminished with the result that these costs may increase.
Overhead costs are likely to be similar to those of the end of the growth phase as op mum batch sizes have
been established and are more likely to be used in this maturity stage of the product life cycle where demand
is more easily predicted.
23
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DIVISIONAL
TRANSFER
PRICING

DIVISIONAL
TRANSFER
PRICING
Question-1
Division A is a profit centre which produces three products X, Y & Z. Each product has an external market:-
Par culars X Y Z
Maximum external sales 800 units 500 units 300 units
External market price per unit ₹ 96 ₹ 92 ₹ 80
Variable cost of produc on in division A ₹ 33 ₹ 24 ₹ 28
Labour hours required per unit in division A 6 8 4
Product Y can be transferred to Division B, but the maximum quan ty that can be required for transfer is 300
units of Y. Instead of receiving transfer of product Y from Division A, Division B could buy similar product in
the open market at a slightly cheaper price of ` 45 per unit.
(i) What should the Transfer Price be for each unit for 300 units of Y, if the total labour hours available in
Division A are:
(a) 13,000 hours
(b) 8,000 hours
(c) 12,000 hours?
(ii) Indicate the transfer pricing range that can promote goal congruence.
[Study Material]
25
DIVISIONAL TRANSFER PRICING
Solu on:
Division A has two type of clientele, external customers and Division B. Capacity in Division A is defined by
the number of labor hours available for produc on.
The total hours needed to meet external demand is 10,000 hours as explained below:
Statement of Hours Needed for External Sales

External Sales Qty Hours p.u. Total Hours Needed
X 800 6 4,800
Y 500 8 4,000
Z 300 4 1,200
Hours Needed for External Sales 10,000
Case 1: When 13,000 hours are available, a er mee ng the external demand requiring 10,000 hours,
Division A will have surplus capacity of 3,000 hours.
Hours needed to produce 300 units of Y = 300 × 8 hours = 2,400 hours. Since Division A has surplus capacity, it
can meet the demand of Division B also without curtailing its external sales. Hence, there is no opportunity
cost on account of lost contribu on.
Transfer price range:
Minimum Transfer Price p.u.

= Marginal Cost of Produc on p.u. of Y = ₹ 24.
Maximum Transfer Price

= Lower of Net Marginal Revenue and the External Buy-in Price
The Maximum Transfer Price would be the External Procurement Price for Division B = ₹ 45 p.u.
Note: Addi onal cost informa on related to Division B would be needed to calculate net marginal revenue.
Case 2: When 8,000 hours are available, Division A has limited capacity as explained below.
The total hours needed for external sales is 10,000 and those need for internal transfer is 2,400 hours. In all,
12,400 hours are needed, when only 8,000 hours are available. There is a shor all of 4,400 hours. Capacity is
hence limited.
Therefore, labor hours have to be u lized op mally. This is determined by calcula ng the contribu on per
hour from sale each product that is sold externally. It determines how valuable each hour is product wise.
26
Statement of Product Wise Contribu on per hour

Sr. No. Par culars X Y Z
1 Selling Price p.u. 96 92 80
2 Less: Variable Cost p.u. 33 24 28
3 = 1-2 Contribu on p.u. 63 68 52
4 Labour hours needed p.u. 6 8 4
5 = 3/4 Contribu on per hour 10.50 8.50 13.00
6 Ranking high to low II III I
Product Z gives the maximum contribu on per hour, hence ranked 1. Product X and Y follow at rank 2 and 3
respec vely. This is the basis to allocate limited hours for op mal produc on in Division A.
The en re demand of Product Z will be produced first. This requires 1,200 hours. Out of the balance 6,800
hours, Product X will require 4,800 hours. This leaves a balance of 2,000 hours for Product Y. Product Y
requires 8 hours p.u. Hence maximum produc on of product Y = 2,000 hours / 8 = 250 units.
Statement of Op mum Mix

Total Hours Available 8,000
Priority External Sales Qty Hours p.u. Total Hours Needed Remaining Hours
1 Z 300 4 1,200 6,800
2 X 800 6 4,800 2,000
3 Y 250 8 2,000 -
Total Hours Needed for External Sales 8,000
If Division A accepts to produce 300 units of Y for Division B, the total hours required for internal sales would
be 2,400 hours. This can be catered to by curtailing its external sales. 2,000 hours from produc on of
external sales of Product Y is first diverted and the balance 400 hours are diverted from produc on of
Product X. Hence this results in lost contribu on, an opportunity cost that has to be included in transfer
pricing.
Contribu on Lost from Reduced External Sales

= Product Y (2000 hours × contribu on per hour of ₹ 8.5) + Product X (400 hours × contribu on per hour of
₹ 10.5)
= ₹ 17,000 + ₹ 4,200
= ₹ 21,200
27
On a per unit basis, lost contribu on works out to 21,200 / 300 units = ₹ 70.66
Therefore, Transfer Price
= Marginal Cost p.u. + Contribu on Lost from Reduced External Sales
= ₹ 24 + ₹ 70.66
= ₹ 94.66
Since Division B can source at 45, it would be cheaper to purchase the component from outside.
Case 3: When 12,000 hours are available, Division A has limited capacity as explained below.
The total hours needed for external sales is 10,000 and those need for internal transfer is 2,400 hours. In all,
12,400 hours are needed, when only 12,000 hours are available. There is a shor all of 400 hours. Capacity is
hence limited.
Therefore, labor hours have to be u lized op mally. Again, as explained in Case 2, this is determined by
calcula ng the contribu on per hour from sale each product that is sold externally. Referring to the table
above, Contribu on per hour is X: ₹ 10.5; Y: ₹ 8.5 and Z: ₹ 13. Accordingly, produc on wise Z will be given first
priority, followed by X and then Y.
The en re demand of Product Z will be produced first. This requires 1,200 hours. Out of the balance 10,800
hours, Product X will require 4,800 hours. This leaves a balance of 6,000 hours for Product Y. Product Y
requires 8 hours p.u. External sales of product require 4,000 hours (500 units × 8 hours p.u.).
Statement of Op mum Mix

Total Hours Available 8,000
Priority External Sales Qty Total Hours Needed Remaining Hours
1 X 300 1,200 10,800
2 Y 800 4,800 6,000
3 Z 500 4,000 2,000
Total Hours Needed for External Sales 10,000
This leaves 2,000 hours available for produc on of 300 units of Y to be sold to Division B. These 300 units will
require 2,400 hours (300 units × 8 hours p.u.). Hence, there is a shor all of 400 hours to meet this internal
demand. This shor all of 400 hours will be made up with diver ng hours earmarked for external sale of
Product Y (Rank 3 as explained in the table above). Loss of contribu on on account of curtailed sales would
then be built into the transfer price.
28
Contribu on Lost by Diver ng 400 hours from Product Y for External Sales
= 400 hours × contribu on per hour
= 400 hours × ₹ 8.5
= ₹ 3,400.
On a per unit basis,
= 3,400 / 300 units
= ₹ 11.33
Therefore, Transfer Price
= Marginal Cost p.u. + Contribu on Lost from Reduced External Sales
= ₹ 24 + ₹ 11.33
= ₹ 35.33
Division B can source this at ₹ 45 p.u. from outside. Hence transfer price can be in the range ₹ 35.33 to ₹ 45.
Question-2
Division A produces goods at a cost of ` 10 p.u. and transfers the goods to Division B which has addi onal
costs of ` 5 p.u. Division B sells externally at ` 16 p.u. The company has a policy of se ng transfer prices at
cost + 20%.
Calculate:
(i) Profit of each division and the overall profit the company made.
(ii) Write a brief analysis of the results. [Study Material]
Solu on:
(i) Division Wise Profitability Statement: Summarizing the informa on from the ques on, the division
wise profitability statement will be as below:
Sr. No. Par culars Division A Division B Company
1 Own Cost - 10 -5 - 15
2 Transfer-in Price 0 - 12 0
3=1+2 Total Cost - 10 - 17 - 15
4 Revenue 12 16 16
(i) Transfer Price of Division A
(Cost 10 + 20%)
(ii) Selling Price of Division B
5=4-3 Profit 2 -1 1
Profit Split between Divisions
29
Note
Transfer price of ` 12 does not affect the overall company profits since they get eliminated at the me
of consolida on. These records are useful for internal evalua on purposes and may not involve actual
cash se lement. Therefore, transfer- pricing methodology would greatly influence each division's
financials, thereby underlining the need to have an accurate measurement system
(ii) Analysis of the Results: As shown above, Division A shows a profit of 2 while Division B shows a loss of 1.
Division A that incurs 2/3rd of the cost while Division B incurs only 1/3rd of it. The net profit margin for
the product is 6.7% (1/ 15) while the internal mark-up that Division A charges is 20%. Therefore,
Division A will always make a profit. Division B is bearing internal mark-up at a much higher rate than
the mark-up it can charge its customers. Therefore, it will always be a loss-making unit.
Behavioural Consequences
Manager of Division B could get demo vated since performance of the unit is affected by a higher
internal mark-up. Moreover, since the manager of Division A will always make a profit under this
method, efforts may not be taken to make costs efficient. The management can take steps to review
the following:
(i) Is the transfer pricing policy of cost plus 20% jus fied? If so, should the pricing policy for
external customers be revised?
(ii) What share of Division A's costs are controllable? Is it possible for Division A to take measures
for cost efficiencies and charge Division B a lower amount?
(iii) Alterna vely, should Division B be allowed to source the component from outside?
30
Question-3
Global Mul na onal Ltd. (GML) has two Divisions 'Dx' and 'Dz' with full profit responsibility. The Division 'Dx'
produces Component 'X' which it sells to 'outside' customers only. The Division 'Dz' produces a product
called the 'Z' which incorporates Component 'X' in its design. 'Dz' Division is currently purchasing required
units of Component 'X' per year from an outside supplier at market price.
New CEO for Indian Opera ons has explored that 'Dx' Division has enough capacity to meet en re
requirements of Division 'Dz' and accordingly he requires internal transfer between the divisions at marginal
cost from the overall company's perspec ve.
Manager of Division 'Dx' claims that transfer at marginal cost are unsuitable for performance evalua on
since they don't provide an incen ve to the division to transfer goods internally. He stressed that transfer
price should be 'Cost plus a Mark-Up'.
New CEO worries that transfer price suggested by the manager of Division 'Dx' will not induce managers of
both Divisions to make op mum decisions.
Required:
You are requested to help him out of the problem. [Study Material]
OR
Discuss transfer pricing methods to overcome performance evalua on conflicts. [MTP May 2018]
Solu on:
To overcome the op mum decision making and performance evalua on conflicts that can occur with
marginal cost-based transfer pricing following methods has been proposed:
Dual Rate Transfer Pricing System

“With a 'Dual Rate Transfer Pricing System' the 'Receiving Division' is charged with marginal cost of the
intermediate product and 'Supplying Division' is credited with full cost per unit plus a profit margin”.
Accordingly Division 'Dx' should be allowed to record the transac ons at full cost per unit plus a profit
margin. On the other hand Division 'Dz' may be charged only marginal cost. Any inter divisional profits can be
eliminated by accoun ng adjustment.
Impact:
− Division 'Dx' will earn a profit on inter-division transfers.
− Division 'Dz' can chose the output level at which the marginal cost of the product 'X' is equal to the net
marginal revenue of the product 'Z'.
31
Two Part Transfer Pricing System

“The 'Two Part Transfer Pricing System' involves transfers being made at the marginal cost per unit of output
of the 'Supplying Division' plus a lump-sum fixed fee charged by the 'Supplying Division' to the 'Receiving
Division' for the use of the capacity allocated to the intermediate product.”
Accordingly Division 'Dx' can transfer its products to Division 'Dz' at marginal cost per unit and a lump-sum
fixed fee.
Impact:
− 'Two Part Transfer Pricing System' will inspire the Division 'Dz' to choose the op mal output level.
This pricing system also enable the Division 'Dx' to obtain a profit on inter-division transfer.
Question-4
Standard Corpora on Inc. (SCI) is a US based mul na onal company engaged in manufacturing and
marke ng of Printers and Scanners. It has subsidiaries spreading across the world which either
manufactures or sales Printers and Scanners using the brand name of SCI.
The Indian subsidiary of the SCI buys an important component for the Printers and Scanners from the
Chinese subsidiary of the same MNC group. The Indian subsidiary buys 1,50,000 units of components per
annum from the Chinese subsidiary at CNY (¥) 30 per unit and pays a total custom duty of 29.5% of value of
the components purchased.
A Japanese MNC which manufactures the same component which is used in the Printer and Scanners of SCI,
has a manufacturing unit in India and is ready to supply the same component to the Indian subsidiary of SCI
at ₹ 320 per unit.
The SCI is examining the proposal of the Japanese manufacturer and asked its Chinese subsidiary to present
its views on this issue. The Chinese subsidiary of the SCI has informed that it will be able to sell 1,20,000 units
of the components to the local Chinese manufactures at the same price i.e. ¥ 30 per unit but it will incur
inland taxes @ 10% on sales value. Variable cost per unit of manufacturing the component is ¥ 20 per unit.
The Fixed Costs of the subsidiaries will remain unchanged.
The Corpora on tax rates and currency exchange rates are as follows:
Corpora on Tax Rates Currency Exchange Rates
China 25% 1 US Dollar ($) = ` 61.50
India 34% 1 US Dollar ($) = ¥ 6.25
USA 40% 1 CNY (¥) = ` 9.80
32
Required:
(i) PREPARE a financial appraisal for the impact of the proposal by the Japanese manufacturer to supply
components for Printers and Scanners to Indian subsidiary of SCI. [Present your solu on in Indian
Currency and its equivalent.]
(ii) IDENTIFY other issues that would be considered by the SCI in rela on to this proposal.
(Note: While doing this problem use the only informa on provided in the problem itself and ignore the actual
taxa on rules or trea es prevails in the above men oned countries)
[Study Material]
Solu on:
(i) Impact of the Proposal by the Japanese Manufacturer to Supply Components for Printers and Scanners
to the Indian Subsidiary of the SCI.
On Indian Subsidiary of SCI

Par culars Amount (`)
Cost of Purchase from the Chinese Manufacturer:
Invoiced Amount {(1,50,000 units × ¥ 30) × ` 9.80} 4,41,00,000
Add: Total Custom Duty (` 4,41,00,000 × 29.5%) 1,30,09,500
Total Cost of Purchase from the Chinese Manufacturer …(A) 5,71,09,500
Cost of Purchase from Japanese Manufacturer in India:
Invoice Amount (1,50,000 units × ` 320) 4,80,00,000
Total Cost of Purchase from Japanese Manufacturer in India …(B) 4,80,00,000
Savings on Purchase Cost Before Corporate Taxes …(A) – (B) 91,09,500
Less: Corporate Tax @34% 30,97,230
Savings a er Corporate Taxes 60,12,270
33
On Chinese Subsidiary of SCI

Loss of Contribu on 29,40,000
[{(1,50,000 – 1,20,000 units) × ¥ (30 – 20)} × ` 9.80]
Add: Inland taxes on Local Sale - Chinese Manufacturer 35,28,000
[{(1,20,000 units × ¥ 30) × 10%} × ` 9.80]
Total Loss Before Corporate Taxes 64,68,000
Less: Tax Savings on the Losses (` 64,68,000 × 25%) 16,17,000
Net Loss a er Corporate taxes 48,51,000
On SCI Group
Saving from Indian Subsidiary 60,12,270
Loss from Chinese Subsidiary 48,51,000
Net Benefit to SCI Group 11,61,270
From the above analysis it can be seen that the proposal from the Japanese manufacturer in India is
beneficial for the SCI as it give a net benefit of ₹ 11,61,270.
(ii) The SCI need to consider various other issues before reaching at a final decision of accep ng the
proposal of the Japanese manufacturer in India. The few sugges ve issues that should be considered
are as follows:
- The longevity of the proposal of the Japanese manufacturer: Whether Japanese manufacturer
will supply the components in the future also. For this purpose a long term agreement between
the Indian Subsidiary of SCI and Japanese manufacturer in India needs to be entered.
- Certainty of the fiscal policy in India: The Japanese manufacturer will not be able to supply the
component at the present price if the fiscal policy of India will change in the future.
- Repatria on of Profit earned in India: Though the Indian subsidiary is making profit but it
depends on the Government policy on the repatria on of profit from India to USA.
- Opera ng Condi ons in China: The SCI has to make sure that the Chinese subsidiary is opera ng
profitably and able to use the spare capacity in the future as well.
- The fiscal policy in China: If the Government of China liberalize its fiscal policies in China in future
then the manufacturing cost will be cheaper than the today's cost.
- Movements in Exchange Rates.
Apart from above sugges ve points the foreign rela ons and other tax trea es and accords should also
be kept in considera on.
34
Question-5
Great Vision manufactures a wide range of op cal products including lenses and surveillance cameras.
Division 'A' manufactures the lenses while Division 'B' manufactures surveillance cameras. The lenses that
Division 'A' manufactures is of standard quality that has a number of applica ons. Due to huge demand in
the market for its products Division 'A' is opera ng at full capacity. It sells its lenses in the open market for `
140 per lens, the variable cost of produc on for each lens is ` 110, while the total cost of produc on is ` 125
per lens.
The total produc on cost of a camera by Division 'B' is ` 400 each. Currently Division 'B' procures lens from
foreign vendors, the cost per lens would be ` 170 each. The management of Great vision has proposed that
to take advantage of in-house produc on capabili es and consequently the procurement cost of the lens
would reduce. It is proposed that Division 'B' should buy an average of 5,000 lenses each month from
Division 'A' at ` 120 per lens. The es mate cost of a surveillance camera is as below:
Other components purchased from external vendors ` 150
Cost of lens purchased from Division 'A' ` 120
Other variable costs ` 30
Fixed overheads ` 50
Total cost of a camera ` 350
Each surveillance camera is sold for ` 410. The margin for each camera is low since compe on in the market
is high. Any increase in the price of a camera would reduce the market share. Therefore, Division 'B' cannot
pay Division 'A' beyond ` 120 per lens procured.
Great vision's management uses Return on investments (ROI) as a scale to measure the divisional
performance and marginal cos ng approach for decision making.
Required:
(i) ANALYZE the behavioural consequences of each division when Division 'A' supplies lenses to Division
'B' at ` 120 per lens? Substan ate your answer based on the informa on given in the problem.
(ii) ANALYZE if it would be beneficial to the company as a whole for Division 'A' to supply the lenses to
Division 'B' at ` 120 per lens.
(iii) Do you feel that the divisional managers should accept the inter-divisional transfers in principle? If yes,
CALCULATE the range of transfer price?
(iv) ADVISE alternate transfer pricing models that the chief execu ve of the company can consider in order
to change the a tude of the divisional heads if they are against the transfer pricing policy.
(v) CALCULATE the range of transfer price, if Division 'A' has excess capacity and can accommodate the
internal requirement of 5,000 lens per month within the current opera ons
[RTP Nov 2018, Study Material]
35
Solu on:
(i) Analysis of Behavioural Consequences

Division 'A' has huge demand for its lenses enabling it to operate at full capacity. External sales yield a
contribu on of ` 30 per lens sold (selling price of ` 140 less variable cost of ` 110 per lens). Likewise,
each sale yields a profit ` 15 per lens (selling price of ` 140 less cost of produc on ` 125 per lens). This
yields an ROI of 12% (profit of ` 15 per lens over a cost investment of ` 125 per lens).
If Division 'A' sells lens to Division 'B' at ` 120 per lens, it contribu on reduces to ` 10 per lens (transfer
price ` 120 less variable cost ` 110) while overall it shows a loss of ` 5 per lens (transfer price ` 120 less
total cost of produc on is ` 125 per lens). The loss of ` 5 per lens is on account of (i) only par al recovery
of fixed cost of produc on and (ii) opportunity cost in the form of loss of profit from external sales. This
would therefore result in lower divisional profit for Division 'A'.
Consequently, the manager of Division 'A' would not accept the transfer price of ` 120 per lens. Lower
profitability due to internal sales may demo vate the division. Due to the benefits of internal
procurement, the management of Great vision may want to increase the capacity of Division 'A' or
infuse more investment to expand its opera ons. However, due to inability to recover fixed costs in its
en rety from internal sales the ROI of the division is impacted, therefore divisional performance would
be perceived to be lower. Therefore, it may oppose decisions as this would lead to higher fixed costs. At
an overall level, such opposi on may be detrimental to the company, leading to sub op miza on of
resources.
The current total cost of produc on for Division 'B' is ` 400 per camera. Each sale yields a profit of ` 10
per camera (Selling price ` 410 less total cost of produc on ` 400 per camera). Therefore, the current
ROI is 2.50% (profit of ` 10 over cost investment of ` 400 per camera). If the lens is procured from
Division 'A' at ` 120 per lens, Division 'B' can get a benefit of ` 50 per camera due to lower procurement
cost. If lenses are procured from Division 'A', referring to the cost es mate given in the problem,
Division 'B' can earn a contribu on of ` 110 per lens sold (sale price of ` 410 per camera less variable
cost of ` 300 per camera) and a profit of ` 60 per camera (sale price of ` 410 per camera less total cost of
produc on of ` 350 per camera). Therefore, ROI improves to 17.14% (profit of ` 60 over cost
investment of ` 350 per camera). By procuring the lenses internally, the profit of the division improves
substan ally. Consequently, the manager of Division 'B' would accept the transfer price of ` 120 per
camera.
36
(ii) Analysis of Overall Benefit to the Company (from internal transfer)

While calcula ng the benefit to the company, the fixed cost of each division is ignored. It is also given in
the problem, that only marginal cost (variable cost) is considered for decision making.
As explained above, each external sale yields a contribu on of ₹30 to Division 'A'. The lost contribu on
each month from diversion of external sales of Division ;A' towards internal transfer to Division 'B' =
5,000 units x ` 30 per lens = ` 150,000 per month. This is an opportunity cost to the company.
The current procurement price for Division 'B' is ` 170 per lens. The same lens can be manufactured at `
110 (variable cost) by Division 'A'. Therefore, cost of produc on reduces by ₹60 for the company.
Savings in procurement cost = 5,000 units x ` 60 per lens = ` 300,000 per month. This is a savings to the
company.
Therefore, the net benefit to the company at an overall level = ` 1,50,000 per month.
Please note that the internal transfer price affects profitability of individual division but does not affect
the company's overall profitability.
(iii) Range of Transfer Price

As explained above, the company gets a net benefit of ` 150,000 per month by procuring the lenses
internally. Therefore, the divisional managers should accept the transfer pricing model. At the same
me, neither division should be at a loss due to this arrangement. When the transfer price is ` 120 per
lens, Division 'A' bears the loss, which will impact assessment of the division's performance. Therefore,
an acceptable range for transfer price should be worked out. This can be done as below:
When the supplying division operates at full capacity, the range for transfer pricing would be-
(a) Minimum transfer price = Marginal Cost p.u. + Opportunity Cost p.u.
Since the supplying division is opera ng at full capacity, it has no incen ve to sell the goods to the
purchasing division at a price lower than the market price. If the internal order is accepted,
capacity is diverted towards this sale. Hence the supplying division would addi onally charge the
lost contribu on from external sales that had to be curtailed. By doing so, the division will be
indifferent whether the sale is an external or internal one.
Therefore, the minimum transfer price (which would be set by Division 'A', the supplier) =
marginal cost per lens + opportunity cost per lens = ` 110 + ` 30 per lens = ` 140 per lens. In other
words, the minimum transfer price would be the external sale price of each lens.
37
(b) Maximum transfer price = Lower of net marginal revenue and the external buy-in price.
The maximum transfer price (which would be determined by Division 'B', the procurer) = lower of
net marginal revenue and the external buy-in price.
Net marginal revenue would be the revenue per one addi onal sale. Net marginal revenue per
camera = marginal revenue — marginal cost (i.e. variable cost excluding the cost of the lens) to
Division 'B' = ` 410 - ` (150+30) = ` 410 - ` 180 = ` 230 per camera. This is the maximum price that
Division 'B' can pay for the lens, without incurring any loss. As men oned before, fixed cost is
ignored for this analysis.
The current external procurement price is ` 170 per lens.
Therefore, the maximum price that Division 'B' would be willing to pay = lower of net marginal
revenue (` 230 per camera) or external procurement cost (` 170 per lens). Therefore, Division 'B'
would pay a maximum price, equivalent to the current external price of ` 170 per lens. It will not
pay Division 'A', price more than the external market price for a lens.
Therefore, the acceptable range for transfer price would range from a minimum of ` 140 per lens and
maximum of ` 170 per lens. The managers may be given autonomy to nego ate a mutually acceptable
transfer price between this range.
(iv) Advise on Alterna ve to Current Transfer Pricing System
Other alterna ve transfer pricing models that can be considered are:

Dual Pricing
The supplying division, Division 'A', records transfer price by including a normal profit margin thereby
showing reasonable revenue. At the current market price per lens, transfer price for Division A would
be ` 140 per lens. The purchasing division, Division 'B', records transfer price at marginal cost thereby
recording purchases at minimum cost. As per the current produc on cost, the transfer price for
Division 'B' would the variable cost incurred by Division 'A' to manufacture one lens, that is ` 110 per
lens. This allows for be er evalua on of each division's performance. It also improves co-opera on
between divisions, promo ng goal congruence and reduc on of sub-op miza on of resources.
Drawbacks of dual pricing include:
(a) It can complicate the records, thereby may result in errors in the company's overall records.
(b) Profits shown by the divisions are ar ficial and need to be used only for internal evalua ons.
38
Two Part Pricing System

Here, transfer price = marginal cost of produc on + a lump-sum charge (two part to pricing). While
marginal cost ensures recovery of addi onal cost of produc on related to the goods transferred, lump-
sum charge enables the recovery of some por on of the fixed cost of the supplying division. Therefore,
while the supplying division can show be er profitability, the purchasing division can purchase the
goods a lower rate compared to the market price.
The proposed transfer price of ` 120, is a two-part price that enables Division 'A' to recover the
marginal cost of produc on of a lens as well as por on of the fixed cost. However, as explained in part
(i) above, this price is insufficient to provide a reasonable return to Division 'A'. Therefore, the
management of Great vision along with the divisional managers have to nego ate a price that is
reasonable to Division 'A' while not exceeding the current procurement price of ` 170 per lens for
Division 'B'. As explained in part (iii) of the solu on, in the given case, the range of ` 140 to ` 170 per
lens, would help resolve this conflict.
(v) Range of Transfer Price where Division 'A' has excess capacity
When the supplying division has excess capacity, the range for transfer pricing would be
(a) Minimum transfer price (determined by Division 'A') = marginal cost per lens = ` 110 per lens. This
ensures that the Division 'A' is able to recoup at least its addi onal outlay of ` 110 per lens
incurred on account of the transfer. Fixed cost is a sunk cost hence ignored. Since capacity can be
u lized further, it would be op mum for Division 'A' to charge only the marginal cost for internal
transfer. Division 'B' gets the advantage ge ng the goods at a lower cost than market price.
(b) Maximum transfer price (determined by Division 'B') = Lower of net marginal revenue and the
external buy-in price. As explained in part (iii) above, this would be lower of net marginal revenue
of ` 230 per camera or external buy-in price of ` 170 per lens, Therefore, the maximum transfer
price would be ` 170, the external market price beyond which Division 'B' will be unwilling a
higher price to Division 'A'.
Hence, when Division 'A' has excess capacity, the minimum transfer price would be ` 110 per lens
while the maximum transfer price would be ` 170 per lens.
39
@khatodpraveen
@jainpraveen17
@praveenkhatod
CA Final – SCMPE [COST]
STANDARD COSTING
May 2018 Nov 2018 May 2019 Nov 2019 May 2020 Average
20 Marks 10 Marks 20 Marks 10 Marks Exams Not Held 15 Marks
CA, CFA(USA), CPA(USA)

PRAVEEN KHATOD
Interpretation,
Basic Variances
Interdependency,
- Material
Investigation &
- Labour
Reporting of Variances
2
- Variable Overheads
- Fixed Overheads
- Sales
1 Standard
Costing
Advanced Variances
Reconciliation Statement
3 4
+91 88892 46468, 62 66 55 33 42 STANDARD COSTING
Budget Actual
FINANCIAL
Particulars Per Unit Total Computation Total
INFORMATION
No. of Units 10000 11000
Sales ₹ 180 x 10000 1800000 ₹ 175 x 11000 1925000
Less: Variable Cost
Material
- Strawberry 0.4 Kgs @ ₹ 100 per kg 400000 4800 Kgs @ ₹ 105 504000
(denoted by RM A)
- Milk 0.6 Kgs @ ₹ 40 per kg 240000 6400 Kgs @ ₹ 41 262400

(denoted by RM B)
Labour
- Skilled 1 Hr @ ₹ 30 per hour 300000 11800 Hrs @ ₹ 32 ph 377600
- Unskilled 2 Hrs @ ₹ 20 per hour 400000 22300 Hrs* @ ₹ 21 ph 468300

(*Includes 100 Idle Hours)
VOH 3 Hrs @ ₹ 5 per hour 150000 187000
Contribution 310000 125700
Fixed Costs Budg Days = 25 days 60000 Actual Days = 24 days 75000
Budg No. of workers = 150 Actual Hrs per day/
Budg Hrs per day/worker = 8 Hrs worker = 7 Hrs
Profit 250000 50700
Points to Remember:
1. Budgeted Cost Vs. Standard Cost
[Budgeted Units x Budgeted Cost pu] [Actual Units x Budgeted Cost pu]
2. Total Budgeted Cost = Total Standard Cost
3. Budgeted Cost pu = Standard Cost pu
1
CA, CFA (USA), CPA (USA) PRAVEEN KHATOD - Best Faculty in INDIA for SFM & SCMPE (COST)
Material Cost Variance

Standard Material Cost – Actual Material Cost
MATERIAL SQ x SP – AQ x AP
COST RM A: 4400 Kgs x ₹ 100 – 4800 Kgs x ₹ 105 = ₹ 64000 A
VARIANCE RM B: 6600 Kgs x ₹ 40 – 6400 Kgs x ₹ 41 = ₹ 1600 F
= ₹ 62400 Adverse or Adv or A
Material Price Variance Material Usage Variance

Impact of Actual Price paid being more/less Impact of Actual RM Consumption being more
than Standard on Actual Quantity / less than Std Consumption at Std. Price
(SP – AP) x AQ or AQ x SP – AQ x AP (SQ – AQ) x SP
RM A: (₹ 100 - ₹ 105) x 4800 Kgs = ₹ 24000 A RM A: (4400 - 4800) x ₹ 100 = ₹ 40000 A
RM B: (₹ 40 - ₹ 41) x 6400 Kgs = ₹ 6400 A RM B: (6600 - 6400) x ₹ 40 = ₹ 8000 F
= ₹ 30400 A = ₹ 32000 A
Material Mix Variance Material Yield or Sub-Usage Variance

Impact of not maintaining the Standard Had there been no error in mix then how
mix ratio much Usage Variance would have been
(RAQ – AQ) x SP (SQ – RAQ) x SP
RM A: (4480 - 4800) x ₹ 100 = ₹ 32000 A RM A: (4400 - 4480) x ₹ 100 = ₹ 8000 A
RM B: (6720 - 6400) x ₹ 40 = ₹ 12800 F RM B: (6600 - 6720) x ₹ 40 = ₹ 4800 A
= ₹ 19200 A = ₹ 12800 A
Points to Remember:
1. Standard Price' means Standard Price per unit of RM (Not per unit of FG)
2. Material Price Variance Vs. Material Purchase Price Variance
MPV = (SP-AP) x AQ Consumed MPPV = (SP-AP) x Purchase Qty
[aka Partial Plan] [aka Single Plan]
Note: If Question is silent / No Note: In this case, MCV can't be
hints for Single Plan are given calculated directly.
then this is the default MCV = MPPV + MUV
assumption
2
3. How to incorporate effect of Normal Loss % 4. Equivalent Production

Suppose, Input of RM A & B is Concept applicable when in addition to AO,
RM A : 0.55 Kg info about WIP is also given
RM B : 0.70 Kg
Total Input 1.25 Kgs Output = 1 Kg
NL as a % of Input NL as a % of Output Op WIP = 3000 Units Units Completed

NL = 20% of Input NL = 25% of Output [60% Complete] = 8000 Units
AQ = Given in the Question AQ = Given in the Question

SQ = 11000 / 80% = 13750 SQ = 11000 + 25% = 13750
Split between A & B in the ratio of 0.55:0.70 Split between A & B in the ratio of 0.55:0.70
0.55 0.55 Units Introduced Cl WIP = 5000 Units
SQ of A : 13750 x = 6050 Kgs SQ of A : 13750 x = 6050 Kgs = 10000 Units
1.25 1.25 [30% Complete]
0.70 0.70
SQ of B : 13750 x = 7700 Kgs SQ of B : 13750 x = 7700 Kgs
1.25 1.25
Alternative Method: Opening WIP 3000 Units x 40% (remaining 1200 Units
RM A: completion done in the current
Output Input period)
∵ 1 Kgs requires 0.55 Kgs Units Introduced 5000 Units x 100% 5000 Units
∴ 11000 Kgs would need 11000 x 0.55 = 6050 Kgs & Completed
1
RM B: Similarly, 11000 x 0.70 = 7700 Kgs Closing WIP 5000 Units x 30% (completed in the 1500 Units
1 current period)
Equivalent Production 7700 Units
Now AO = 8000 ; Correct AO = 7700 Units for Variance calculation

purpose
3
Labour Cost Variance

Standard Labour Cost – Actual Labour Cost
LABOUR SH x SR – AHP x AR
COST Sk: 11000 Hrs x ₹ 30 – 11800 Hrs x ₹ 32 = ₹ 47600 A
VARIANCE Unsk: 22000 Hrs x ₹ 20) x 22300 Hrs x ₹ 21 = ₹28300 A
= ₹ 75900 A
Labour Rate Variance Labour Idle Time Variance Labour Efficiency Variance
(SR – AR) x AHP Idle Time means [Wages Paid ✔ Output ✖] (SH – AHW) x SR
Sk: (₹ 30 - ₹ 32) x 11800 Hrs = ₹ 23600 A It is calculated so that it doesn't hide in LEV Sk: (11000 – 11800 Hrs) x ₹ 30 = ₹ 24000 A
Unsk: (₹ 20 - ₹ 21) x 22300 Hrs = ₹ 22300 A (AHW – AHP) x SR Unsk: (22000 – 22200 Hrs) x ₹ 20 = ₹ 4000 A
= ₹ 45900 A Sk: (11800 – 11800 Hrs) x ₹ 30 = ₹ 0 = ₹ 28000 A
Unsk: (22200 – 22300 Hrs) x ₹ 20 = ₹ 2000 A
= ₹ 2000 A
Labour Mix or Gang Composition Variance Labour Sub-efficiency Variance

(RAHW – AHW) x SR (SH – RAHW) x SR
Sk: (11333 - 11800) x ₹ 30 = ₹ 14010 A RM A: (11000 - 11333) x ₹ 30 = ₹ 9990 A
Unsk: (22667 - 22200) x ₹ 20 = ₹ 9340 F RM B: (22000 - 22667) x ₹ 20 = ₹ 13340 A
= ₹ 4670 A = ₹ 23330 A
Points to Remember:
1. Standard Hours -> 'Workers have produced 800 Standard Hrs' means Std Hrs for AO are 800 hrs
2. LITV will ALWAYS be Adverse since it tracks Abnormal Idle Hrs
4
VARIABLE Before calculation VOH Variance, calculate below two Absorption Rates:
OVERHEADS 1. VOH Rate per hour = Budgeted VOH / Budgeted Hrs = ₹ 150000 / 30000 Hrs = ₹ 5 ph
COST 2. VOH Rate per Unit = Budgeted VOH / Budgeted Units = ₹ 150000 / 10000 Units = ₹1 5 pu
VARIANCE
Variable Overheads Cost Variance
Absorbed VOH – Actual VOH
AO x SRpu – AVOH
SH for AO x SRph - AVOH
11000 Units x ₹ 15pu – ₹ 187000
or 33000 hrs x ₹ 5ph – ₹ 187000
= ₹ 22000 A
VOH Expenditure Variance VOH Utilization/ Efficiency Variance

(SRph – ARph) x AH or (SH – AH) x SRph
AH x SR - AVOH (33000 – 34000 Hrs) x ₹ 5
34000 Hrs x ₹ 5 ph - ₹ 187000 = ₹ 5000 A
= ₹ 17000 A
Points to Remember:
1. Although No. of Hrs for VOH = No. of Hrs for labour (unless otherwise specified)
2. But Labour SRph = VOH SRph. Remember to pick correct SRph.
3. If Question is silent then use AHW not AHP (because it is deemed that most of the VOH are incurred only when Production is done)
6
FIXED Before calc FOH Variance, Calculate below three Absorption Rates:
OVERHEADS - FOH Rate Per Day = BFOH / BD = ₹ 60000 / 25 = ₹ 2400 per day
COST - FOH Rate Per Hour = BFOH / BH = ₹ 60000 / 30000 = ₹ 2 ph
VARIANCE - FOH Rate Per Unit = BFOH / BO = ₹ 60000 / 10000 = ₹ 6 pu
Fixed Overheads Cost Variance
Absorbed FOH – Actual FOH
AO x SRpu – AFOH
SH for AO x SRph - AFOH
11000 Units x ₹ 6pu – ₹ 75000
33000 hrs x ₹ 2 ph - ₹ 75000
= ₹ 9000 A
FOH Expenditure Variance FOH Volume Variance

Shows error in Estimating FOH while preparing Impact on OH recovery due to More/ Less
Budgets Production than Budgeted
BFOH – AFOH (AO – BO) x SRpu or Absorbed FOH - BFOH
= ₹ 60000 - ₹ 75000 (11000 - 10000) x ₹ 6pu
= ₹ 15000 A = ₹ 6000 F
FOH Calendar Variance FOH Capacity Variance FOH Efficiency Variance

Effect of Working for More/ Less No. of Effect of Under/ Over Utilization of Capacity Same as Labour Efficiency
Days than Budgeted (Actual Hours – Possible Hours) x SR per hour (SH - AH) x SR per hour
(Actual Days – Budgeted Days) x SR per day in Actual Days (33000 - 34000) x ₹ 2 ph
Sk: (24 – 25 days) x ₹ 2400 34000 hrs – (24 days x 1200 Hours) x ₹ 2 ph = ₹ 2000 A
= ₹ 2400 A = ₹ 10400 F
Points to Remember:
1. If Actual Days & Budgeted Days are Not given in the Exam, then AD=BD. Consequently,
- FOH Calendar Var = 0
- FOH Cap Var = (AH-BH) x SRph
2. Total Cost Variances are ALWAYS calculated by comparing Standard Cost Vs. Actual Cost
3. If Question is silent then use AHW not AHP
4. Even if Budgeted & Actual Units are same (i.e. FOH Volume Variance = 0) still further analyse into
FOH Calendar, Capacity & Efficiency Variance.
7
Calculate FOH Ratios in the above case ?

FOH
FOH Volume Ratio = Actual Output ÷ Budgeted Output = 11000 ÷ 10000 = 110%
RATIOS
FOH Calendar Ratio = Actual Days ÷ Budgeted Days = 24 ÷ 25 = 96%
FOH Capacity Ratio = Actual Hours ÷ Possible Hours = 34000 ÷ 28800 = 118.06%
FOH Efficiency Ratio = Standard Hours ÷ Actual Hours = 33000 ÷ 34000 = 97.06%
Points to Remember:
1. To Calculate Ratios, simply use “÷” instead of “-“.
2. To Reconcile Ratios, simply use “x” instead of “+”
Reconcile above Ratios ?

FOH Volume Ratio = FOH Calendar Ratio X FOH Capacity Ratio X FOH Efficiency Ratio
= 96% x 118.06% x 97.06%
= 110%
8
SALES Two Approaches – (A) Turnover Approach (B) Margin Approach

VARIANCE
(A) TURNOVER Approach
Total Sales Variance

Actual Sales – Budgeted Sales
AQ x AP – BQ x SP
11000 Units x ₹ 175 – 10000 Units x ₹ 180
= ₹ 125000 Favorable or Fav or F
Sales Price Variance Sales Volume Variance

(AP – SP) x AQ or AQ x AP – AQ x SP (AQ – BQ) x SP
(₹ 175 - ₹ 180) x 11000 Units (11000 - 10000) x ₹ 180
= ₹ 55000 A = ₹ 180000 F
Sales Mix Variance Sales Quantity or Sub-Volume Variance

(AQ – RAQ) x SP (RAQ – BQ) x SP
here,
SP means Standard Selling Price, Alternative term is Budgeted Selling Price (BP)
9
(B) MARGIN Approach – (i) Net Profit per unit OR (ii) Contribution per unit
[If Co. is following Absorption Costing] [If Co. is following Marginal Costing]
If Budgeted Profit per unit is used: Total Sales Margin Variance

AQ x AM – BQ x SM
11000 Units x ₹ 20 – 10000 Units x ₹ 25
= ₹ 30000 A
Sales Margin Price Variance Sales Margin Volume Variance

(AM – SM) x AQ or AQ x AM – AQ x SM (AQ – BQ) x SM
(₹ 20 - ₹ 25) x 11000 Units (11000 - 10000) x ₹ 25
= ₹ 55000 A = ₹ 25000 F
If Budgeted Contribution per unit is used: Total Sales Margin Variance

AQ x AM – BQ x SM
11000 Units x ₹ 26 – 10000 Units x ₹ 31
= ₹ 24000 A

(₹ 26 - ₹ 31) x 11000 Units (11000 - 10000) x ₹ 31
= ₹ 55000 A = ₹ 31000 F
here,
SM means Standard Margin, Alternative term is Budgeted Margin (BM)
Points to Remember:
1. BM means Budgeted Margin (Budgeted SP – Budgeted Cost pu)
2. AM means Actual Margin (Actual SP – Budgeted Cost pu). Do not make the mistake of deducting Actual Cost pu because Sales Department is
responsible only for Actual Sales Volume & Actual Selling Price but not for Actual Cost.
3. ALWAYS, SPV = SMPV because Standard Cost remaining constant, Difference in Contribution pu (or Profit pu) will be the same as Diff in SPpu
4. SMVV = SVV x Budg NP Ratio (If Absorption Costing) | SMVV = SVV x Budg PVR (If Marginal Costing)
Note: This relationship holds good only in case of Individual Products. Don't use on Aggregate Variance of Two or more products.
5. In Variable Cost Variances (M,L,VOH), ALWAYS Standard Data on LHS & Actual Data on RHS
6. In Sales Variances, ALWAYS Actual Data on LHS & Standard Data on RHS
10
What if, in above case, Company also sells one more Product viz Guava Milk Shake
Budget Actual
Units SP VC Units SP VC
Strawberry Milk Shake 10000 180 149 11000 175 164

[rounded off]
Guava Milk Shake 5000 100 81 4500 90 83

Calculate Sales Variance using Contribution Approach
Working Note BM AM
Strawberry 31 26
Total Sales Margin Variance
Guava 19 9 Actual Sales – Budgeted Sales
AQ x AM – BQ x SM
Strawberry: 11000 Units x ₹ 26 – 10000 Units x ₹ 31 = ₹ 24000 A
Guava: 4500 Units x ₹ 9 – 5000 Units x ₹ 19 = ₹ 54500 A
= ₹ 78500 A

Strawberry: (₹ 26 - ₹ 31) x 11000 Units = ₹ 55000 A Strawberry: (11000 - 10000) x ₹ 31 = ₹ 31000 F
Guava: (₹ 9 - ₹ 19) x 4500 Units = ₹ 45000 A Guava: (4500 - 5000) x ₹ 19 = ₹ 9500 A
= ₹ 100000 A = ₹ 21500 F
Sales Margin Mix Variance Sales Margin Quantity or Sub-Volume Variance

(AQ – RAQ) x SM (RAQ – BQ) x SM
Strawberry: (11000 - 10333) x ₹ 31= ₹ 20677 F Strawberry: (10333 - 10000) x ₹ 31 = ₹ 10323 F
Guava: (4500 - 5167) x ₹ 19 = ₹ 12673 A Guava: (5167 - 5000) x ₹ 19 = ₹ 3173 F
= ₹ 8004 F, say ₹ 8000 F = ₹ 13496 F, say ₹ 13500 F
11
MARKET SIZE
Let’s Dive Deeper
&
Budget Actual SHARE
3.6%
5% Budget Particulars Actual 8.8%
10%
10000 Strawberry 11000
5000 Guava 4500
15000 Total 15500

85%
100000 Industry Size 125000 87.6%
Other Companies Strawberry Guava

Other Companies Strawberry Guava
Market Size Variance & Market Share Variance (based on Contribution Margin Approach)
Market Size Variance = (Actual Industry Sales Quantity in units – Budgeted Industry Sales Quantity in units) x Budgeted Market Share % x
(Average Budgeted Margin per unit)
= (125000 – 100000) x 15% x ₹ 27*
= ₹ 101250 F
Market Share Variance = (Actual Market Share % - Budgeted Market Share %) x (Actual Industry Sales Quantity in units) x (Average Budgeted
Margin per unit)
= (12.4% - 15%) x 125000 x ₹ 27*
= ₹ 87750 A
Points to Remember
Market Size and Market Share are further classification of Sales Qty Variance (not Sales Volume Variance)
12
INTERPRETATION
OF
VARIANCES
TYPE REASONS CORRECTIVE ACTION
Material Price Use of Different Supplier; Change in Order Size; Emergency Purchase at Right point of time; Proper
Purchases – Inappropriate Inventory Control; Efficiency/ Inefficiency Negotiation; Price check at regular intervals
in Buying Process;
Material Usage Inferior/ Better Quality Material; Quality Control System; Poor Regular Inspection; Training Workers; Efficient
Inspection; Careless Material Handling; Pilferage; Changes in Wastage Production methods
Rate, Material Mix, Production Method, Design
Labour Rate Unexpected Increase in Wage-rates; Overtime; Change in Labour Proper Job allocation according to capabilities
composition – More/ Less Experienced; Bonus Payment
Labour Efficiency Workforce Mix; Learning Curve impact; Poor Supervision; Resource Proper Planning/ Scheduling; Training Workers;
Shortages; Inferior RM Quality; Poor working conditions; Improper Healthy working environment; Deadlines
Scheduling; New Machinery/ Production Method/ Design
Manufacturing Overheads Improper Planning; Reduction in Sales; Breakdowns; Power failures; Efficient Planning for better capacity utilization
Labour trouble
Selling & Distribution Increase in Delivery Cost/ Stock holding period Introduction of Operating Costing; Cost Ratios
Overheads
Sales Price Variance Higher Discounts; Low price during marketing campaign; Market/ Proper Pricing Strategies/ Methods/ Negotiations
Economic conditions; Poor performance by Sales Personnel
Sales Volume Variance Successful/ Unsuccessful Direct Selling/ Marketing efforts; Change Sales Quotas/ Targets
in Customer Preferences; Lost sales due to Production difficulties;
Change in Price
13
INTERDEPENDENCY
BETWEEN
VARIANCES
Action Result Reaction Result
Cheaper/ Poor Quality RM Favourable MPV More RM Wastage Adverse MUV
More Skilled Labour Adverse LRV Higher Productivity Favourable LEV
Cheaper Labour Mix Favourable LMV Lower Productivity Adverse L Sub-Eff V
Labour trying to improve Favourable LEV More Bonus Adverse LRV

productivity to get bonus More RM Wastage Adverse MUV
Cutting Sales Price Adverse SPV Higher Sales Demand Favourable SVV
& Vice-versa
14
INTERPRETATION [Source: ICAI Study Material]

Question
OF
VARIANCES
Natural Spices manufactures and distributes high-quality spices to gourmet food shops and top quality restaurants. Gourmet and high-end restaurants pride
themselves on using the freshest, highest-quality ingredients.
Natural Spices has set up five state of the art plants for meeting the ever- growing demand. The firm procures raw material directly from the centers of
produce to maintain uniform taste and quality. The raw material is first cleaned, dried and tested with the help of special machines. It is then carefully
grounded into the finished product passing through various stages and packaged at the firm's ultraclean factory before being dispatched to customers.
The following variances pertain to last week of operations, arose as a consequence of management's decision to lower prices to increase volume.
Sales Volume Variance 18,000 (F)
Sales Price Variance 14,000 (A)
Purchase Price Variance 10,000 (F)
Labour Efficiency Variance 11,200 (F)
Fixed Cost Expenditure Variance 4,400 (F)
Required
(i) IDENTIFY the 'Critical Success Factors' for Natural Spices.
(ii) EVALUATE the management's decision with the 'Overall Corporate Strategy' and
'Critical Success Factors'.
(iii) INTERPRET the Variances
15
Solution:
(i) Gourmet and high-end restaurants recognises Natural Spices on the basis of its high quality of spices. Therefore, quality is most critical success factor
of Natural Spices. There are other factors which cannot be ignored such as price, delivery options, attractive packing etc. But all are secondary to the
quality.
(ii) Deliberate action of cutting price to increase sales volume indicates that firm is intending to expand its market to retail market and street shops which
is price sensitive.
Purchase Price Variance is clearly indicating that firm has purchased raw material at lower price which may be due to buying of lower quality of material.
Similarly, positive Efficiency Variance is indicating cost cutting and stretching resources.
It appears that firm is intending to expand its market to retail market and street shops by not only reducing the price but also compromising its quality
which is opposing its current strategy of high quality.
Management should monitor the trends of variances on regular basis and take appropriate action in case of evidence of permanent decline in quality.
Here, customer feedback is also very important. The company should stick to its Overall Corporate Strategy of maintaining high quality, else it may lose
its existing customers.
If the Company wants to capture the price sensitive market (i.e. lower segment), then it should form another division or a subsidiary company for this
purpose, so that its present market remains unaffected.
(iii) Favourable sales volume variance and adverse price variance is an indication that the company is able to achieve growth in sales volume but at reduced
sales prices.
Favourable Purchase Price Variance is clearly indicating that firm has purchased raw material at lower price which may be due to buying of lower quality
of material. Similarly, Favourable Labour Efficiency Variance is indicating cost cutting and stretching resources.
Fixed OH Expenditure Variance is also Favourable, which indicates that either the company is able to control the cost over its budgeted cost or it has
curtailed some essential costs required to ensure compliance with quality.
16
FORMAT OF RECONCILIATION STATEMENT/ OPERATING STATEMENT/ FINANCIAL CONTROL REPORT

Particulars Absorption Costing Marginal Costing
Profit Route Budgeted Profit Standard Profit Budgeted Profit

to Actual Profit to Actual Profit to Actual Profit
Budgeted / Standard Profit Xxxx Xxxx Xxxx
Add/ (Less): Effect of Variances
Sales Margin Volume Variance ✔ NA ✔
Sales Margin Price Variance/ Sales Price Var ✔ ✔ ✔
Material Cost Variance ✔ ✔ ✔

- MPV
- MMV
- MYV
} MUV
Labour Cost Variance ✔ ✔ ✔
- LRV
- LITV
- LMV
- L Sub-EV
} LEV
Variable OH Cost Variance ✔ ✔ ✔

- VOH Exp V
- VOH Utilization V
FOH Cost Variance

- FOH Exp V ✔ ✔ ✔
- FOH Cal V
-
-
FOH Cap V
FOH Eff V
} FOH Vol V ✔ ✔ NA
Actual Profit Xxxx Xxxx Xxxx
18
Particulars Absorption Costing Marginal Costing
Profit Route Budgeted Profit Standard Profit Budgeted Profit

to Actual Profit to Actual Profit to Actual Profit
Budgeted/ Standard Profit 250000 275000 250000
Add/ (Less): Effect of Variances
Sales Margin Volume Variance 25000 F NA 31000 F
Sales Margin Price Variance/ Sales Price Var 55000 A 55000 A 55000 A
Material Cost Variance

- MPV 30400 A 30400 A 30400 A
- MMV 19200 A 19200 A 19200 A
- MYV } MUV 12800 A 12800 A 12800 A
Labour Cost Variance

- LRV 45900 A 45900 A 45900 A
- LITV 2000 A 2000 A 2000 A
- LM 4670 A 4670 A 4670 A
- LSub-EV
} LEV 23330 A 23330 A 23330 A
Variable OH Cost Variance

- VOH Exp V 17000 A 17000 A 17000 A
- VOH Utilization V 5000 A 5000 A 5000 A
FOH Cost Variance

- FOH Exp V 15000 A 15000 A 15000 A
- FOH Cal V 2400 A 2400 A NA
-
-
FOH Cap V
FOH Eff V
} FOH Vol V 10400 F
2000 A
10400 F
2000 A
NA
NA
Actual Profit 50700 50700 50700
19
INVESTIGATION
OF
VARIANCES
It is not fruitful to investigate each & every Variance since it involves resources, efforts & cost !
“Interpretation may suggest possible cause of variances but investigation must arrive at definite conclusions about the cause of the variance so that action
to correct the variance can be effective.”
5 Factors to be considered Before Investigating Variance
Size Ignore Small Variations; Establish limits above which to investigate
Type of Variance More focus on Adverse Variances
Cost Cost of Investigation < Benefits associated with Investigation
Pattern in Variance Variance seen worsening over time then Investigation is needed
Budgetary Process If Budgetary Process is Uncontrollable & Unrealistic then re-evaluate the
budgetary process (rather than Investigating Variance)
Method Used for Investigating Variance

Simple Rule of Thumb Model -> Investigate if Variance > than
(i) Certain Absolute Amount
(ii) Certain % of Total Cost
Statistical Decision Model ->
(i) Determining Probabilities
Investigate if,
PB > C
Here,
P is the probability that the process is 'Out of Control'
B is the benefit associated with returning the process to its 'In-Control' state.
C is the cost of conducting an investigation
20
Example:
Let us assume that the incremental cost of investigating the variance is ₹ 25. The estimated benefit B from investigating a variance and taking corrective
action is ₹ 100.
Investigate if
P > 25/ 100 or 0.25
Now how to find the Probability that a particular process is ‘Out of Control’
Let's go further,
Standard Time for a particular Process = 2.5 Hours
Standard Deviation = 15 mins or 0.25 Hours
Actual Time Taken = 3 Hours (say, 3000 Hrs for output of 1000 Units)
Find the probability of taking time more than 3 Hours when process is in-control ?
0.0228
Probability
2σ
2.5 hrs 3 hrs

Time taken (hrs.)
x-μ
Z =
σ
3.00 - 2.50
Z =
0.25
Z = 2.0
P (Z = 2.0) = 0.4772 (between '0' & Z) or 0.9772 (Cumulative Value Up to Z)
Probability of taking more than 3 hours when process is in-control = 1-0.9772 = 0.0228 or 2.28%
The probability of the process being 'Out of Control' is one minus the probability of being 'In Control'.
Thus, P = (1 - 0.0228) = 0.9772 or 97.72%
We ascertained that the variance should be investigated if the probability that the process is 'Out of Control' is > 0.25. The process should therefore be
investigated.
21
(ii) Statistical Control Charts

Can be used to monitor Variances.
For example, if control limits are set based on 2σ from the mean then this would show 4.55% (100% - 95.45%) of future observations would result from pure
chance when the process is under control. Therefore, there is a high probability that an observation outside the 2σ control limits is out of control.
Usage Usage Usage
Project A Project B Project C
µ + 2σ µ + 2σ µ + 2σ
µ+σ µ+σ µ+σ
µ µ µ
µ+σ µ+σ µ+σ
µ + 2σ µ + 2σ µ + 2σ
1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
For Project A the process is deemed to be For Project B the last two observations With Project C, the observations would not
in control because all observations fall suggest that the project is out of control. prompt an investigation because all the
within the control limits. Therefore, both observations should be observations are within the control limits.
investigated. However, the last six observations show a
gradually increasing usage in excess of the
mean, and the process may be out of
control. Statistical procedures that
consider the trend in recent usage as well
as daily usage can also be used.
REPORTING OF VARIANCES
- Behavioral Issues- Short-termism, Sub-optimal behavior such as Budget Slacks
- Ethics - Favorable Cost Variance in Hospitals
22
ADVANCED
VARIANCES 4 5
Variance
Learning
Analysis
Curve
&
3 Impact on
Throughput Variance
6
Variances
Accounting Analysis in
Relevant Advanced
Cost Manufacturing
Approach Environment/
High-Technology
Firms
Variance ADVANCED Variance
2 Analysis in VARIANCES Analysis in

Service Industry
7
ABC
Planning & Variance

Operational Analysis in
Variances Public Services
1 8
23
1. Planning & Operational Variances

Let us say, due to bad weather, Strawberry crop decimated leading to supply shortage. Purchase Manager has to look for alternative sources with slightly
cheaper quality (leading to 5% more quantity usage) & still pay a higher price by 2% ?
Calculate MCV under approach that classifies Total Variance into Planning & Operational Elements ?
Material Cost Variance Original Standard Revised Standard Actual
Standard Material Cost – Actual Material Cost
SQ x SP – AQ x AP Qty Price Qty Price Qty Price
RM A: 4400 Kgs x ₹ 100 – 4800 Kgs x ₹ 105 = ₹ 64000 A
4400 100 4620 102 4800 105
RM B: 6600 Kgs x ₹ 40 – 6400 Kgs x ₹ 41 = ₹ 1600 F
= ₹ 62400 Adverse or Adv or A 6600 40 6600 40 6400 41
Planning Variance Operational Variance

Original Standard Vs. Revised Standard Revised Standard Vs. Actual
SQ x SP – RSQ x RSP RSQ x RSP – AQ x AP
RM A: 4400 x ₹ 100 - 4620 x ₹ 102 = ₹ 31240 A RM A: 4620 x ₹ 102 - 4800 x ₹ 105 = ₹ 32760A
RM B: 6600 x ₹ 40 - 6600 x ₹ 40 = ₹ 0 RM B: 6600 x ₹ 40 - 6400 x ₹ 41 = ₹ 1600 F
= ₹ 31240 A = ₹ 31160 A
Material Price Variance Material Usage Variance Material Price Variance Material Usage Variance
(SP – RSP) x RSQ (SQ – RSQ) x SP (RSP – AP) x AQ (RSQ – AQ) x RSP
RM A: (₹ 100 - ₹ 102) x 4620 RM A: (4400 - 4620) x ₹ 100 RM A: (₹ 102 - ₹ 105) x 4800 RM A: (4620 - 4800) x ₹ 102 = ₹
= ₹ 9240 A = ₹ 22000 A = ₹ 14400 A 18360 A
RM B: (₹ 40 - ₹ 40) x 6600 = ₹ 0 RM B: (6600 - 6600) x ₹ 40 = ₹ 0 RM B: (₹ 40 - ₹ 41) x 6400 RM B: (6600 - 6400) x ₹ 40 = ₹
= ₹ 9240 A = ₹ 22000 A = ₹ 6400 A 8000 F
= ₹ 20800 A = ₹ 10360 A
Points to Remember
1. Under Planning Variance, since we compare ‘Std’ Vs. ‘Revised Std’. instead of ‘Actual’. So simply replace AQ & AP by RSQ & RSP
2. Under Operational Variance, since we compare ‘Revised Std’ instead of ‘Std’. Vs. ‘Actual’. So simply replace SQ & SP by RSQ & RSP
3. Planning Variance are generally deemed Uncontrollable. However, failure by Planning Team in anticipating correct market trends indicates faulty standard
setting and should be classified as Controllable portion of Planning Variance.
4. Market Size Variance is a case of Planning Variance and Market Share Variance is a case of Operational Variance.
Note: Similarly, Planning & Operational Variances can be calculated for other Elements of Cost.
24
Question Source: ICAI Exam CA Final June 2019 (10 Marks)
GRV is a chemical processing company that produces sprays used by farmers to protect their crops. One of these sprays ₹Agrofresh' is made by using either
chemical A or chemical B. To produce one litre of Agrofresh spray they have the option to use either 12 litres of chemical A or 12 litres of chemical B. During
the financial year, the purchase department of GRV has planned to use chemical B as it appeared that it would be the cheaper of the two and their plans were
based on a cost of chemical B of ₹ 15 per litre.
Due to subsequent market movement during the year the actual prices changed and if the concerned department had purchased efficiently, the cost would
have been
Chemical A ₹ 15.40 per litre
Chemical B ₹ 16.00 per litre
Production of Agrofresh spray was 1000 litres and the usage of chemical B was 12800 litres at a cost of ₹ 2,09,920.
You are the CEO of GRV and the Management Accountant has sent to you the following suggestions through e-mail:
"I feel that in our particular circumstances the traditional approach to variance analysis is of little use as for some of our products we can utilize one of
several equally suitable chemicals and we always plan to use such chemical which will lead to cheapest production costs. However due to sharp market
movements, we are frequently trapped by the sharp price changes which lead to the choice of expensive alternative at the end."
To check the reality in the content of the mail, your CEO asked you, the Cost Accountant of the company:
(i) to calculate the material variances for Agrofresh by using
- Traditional Variance Analysis
- Planning and Operational Variances
(ii) to analyse how planning and operational variances approached the variances.
(iii) to analyse how the advanced variances are useful to your organisation.
25
Solution:
(a) (i) Traditional Variances

Usage Variance = (12,000 lt. – 12,800 lt.) × ₹ 15.00
= ₹ 12,000 (A)
Price Variance = (₹ 15.00 – ₹ 16.40) × 12,800 lt.
= ₹ 17,920 (A)
Total Variance = ₹ 12,000 (A) + ₹ 17,920 (A)
= ₹ 29,920 (A)
Operational Variances
Usage Variance = (12,000 lt. – 12,800 lt.) × ₹ 16.00
= ₹ 12,800 (A)
Price Variance = (₹ 16.00 – ₹ 16.40) × 12,800 lt.
= ₹ 5,120 (A)
Total Variance = ₹ 12,800 (A) + ₹5,120 (A)
= ₹ 17,920 (A)
Planning Variances
Controllable Variance = (₹ 15.40 – ₹ 16.00) × 12,000 lt.
= ₹ 7,200 (A)
Uncontrollable Variance = (₹ 15.00 – ₹15.40) × 12,000 lt.
= ₹ 4,800 (A)
Total Variance = ₹ 7,200 (A) + ₹ 4, 800 (A)
= ₹ 12,000 (A)
Reconciliation = ₹ 17,920 (A) + ₹ 12,000 (A)
= ₹ 29,920 (A)
Direct Material Usage Operational Variance using Standard Price, and the Direct Material Price Planning Variance based on Actual Quantity
can also be calculated. This approach reconciles the Direct Material Price Variance and Direct Material Usage Variance calculated in part.
26
(ii) Traditional variance analysis is applied based on the assumption that whole of the variance is due to operational deficiencies and the planning
associated with setting the original standard is perfectly correct. But this assumption is not practical. When the conditions are volatile and
dynamic, traditional variances need to be analysed into planning and operational variances. Planning variances try to explain the extent to which
the original standard needs to be adjusted to reflect changes in operating conditions between the current situation and that imagined when the
standard was originally derived. Planning variances are generally not controllable and may need to revise to cater the changes due to
environmental/ technological changes at a later stage. In certain situation planning variances can be considered controllable as well. Whereas
operational variances explain the extent to which adjusted standards have been achieved. Operational variances are calculated after the
planning variances have been established and are thus a realistic way of assessing performance. So, it indicates a reality check of traditional
variance analysis. In GRV, as per traditional approach total variances are ₹ 29,920 (adverse), out of which ₹ 17,920 (adverse) accounts for total
operational variance and ₹ 12,000 (adverse) is for total planning variance. It is necessary to analyse planning variances further. The planning
variance of ₹ 12,000 (adverse) can be divided into an uncontrollable adverse variance of ₹ 4,800 and a controllable adverse variance of ₹ 7,200.
Similarly, total operational variance can be sub classified as adverse price variance of ₹ 5,120 and adverse usage variance of ₹ 12,800. This
analysis gives a clearer indication of the inefficiency of the purchasing function by the concerned department. Performance of the staff of the
purchasing department should be evaluated/rewarded/ based on variances which are controllable. If an adverse uncontrollable variance of ₹
4,800 is reported in the performance reports this is likely to lead to dysfunctional motivation effects to the purchase department.
(iii) In today's cutthroat competition managers must react quickly and accurately to the changes in technology, price fluctuation, consumer tastes,
laws and regulations, economic conditions, political conditions, and international conditions etc. which are changing rapidly and dramatically.
Accordingly, management accountant should be able to provide necessary inputs by a proper analysis of the things that pertains to his/her area
like effect of changes in price. The unique features of advanced variance analysis are that, it considers different market conditions and
changes in the dynamic environment.
Moreover, advanced variances classify variances into controllable and uncontrollable variances and helps the management to find out reasons
for adverse variances so that corrective action can be taken. Similarly, if any adverse variances have arrived, because of changes in the market
condition like inflation, it has to be differentiated from the other variances.
27
2. Variance Analysis in ABC

Applicability - If Company has adopted ABC Approach for Budgeting & Recording Oh’s
Direct Cost (M,L) -> Same

Sales -> Same
VOH & FOH -> are clubbed together as Activity Cost and Activity-wise Variances are calculated
Let us say, in our Example, one of the Overheads Cost is related to Machine Setup Activity. (Cost Driver: No. of Machine Setup Hours)
Activity: Machine Setup Budgeted Actual

Budgeted No. of Setups = = 20 Setups
No. of Units 10000 11000 500
25000
Activity Cost ₹ 25000 ₹ 28000 ABC Rate per Setup = = ` 1250 per Setup
20
25000
Standard Batch Size 500 Units ABC Rate per Setup hour =
60 Setup Hrs
Setup Hours 3 Hrs per Setup 70 Hours (total) = ` 416.67 per Setup hr
Machine Setup Activity Cost Variance

Standard Activity Cost – Actual Activity Cost
Std No. of Setups for AO x ABC Rate per Setup – Actual Activity Cost
Or Std No. of Setup Hrs for AO x ABC Rate ph - Actual Activity Cost
22 Setups x ₹ 1250 per Setup – ₹ 28000
Or 66 Setup Hrs x ₹ 416.67 - ₹ 28000
= ₹ 500 A
Activity Expenditure Variance Activity Efficiency Variance

Cost impact of paying more/ less than standard for actual activities Cost Impact of undertaking activities more/ less than standard
undertaken (Std No. of Setup Hrs – Actual Setup Hrs) x ABC Rate per Setup Hr
(SR per Setup Hour – AR per Setup Hour) x Actual No. of Setup Hours (66 – 70 Hrs) x ₹ 416.67
₹ 416.67 Hrs x70 Hrs - ₹ 28000 = ₹ 1667 A
= ₹ 1167 F
Points to Remember
1. Simply think about VOH Cost Variance & Rename it as Activity Variance
28
3. Relevant Cost Approach to Variance Analysis

Used when Company has some inputs as Key Factor
Let us say, in our Example, availability of Strawberry is a limiting factor.
Particulars Budget Actual
No. of Units 10000 8000
SP ₹ 180 ₹ 180
Less: VC ₹ 40 ₹ 50
- Strawberry (RM A) [0.4 Kgs @ ₹ 100 per kg] [0.5 Kgs @ ₹ 100 per kg]
Contribution pu ₹ 140 ₹ 130
Total Contribution ₹ 1400000 ₹ 1040000

Limited Qty of Strawberry available = 4000 Kgs
Calculate Variance under (i) Traditional Approach & (ii) Relevant Cost Approach
Variance Traditional Approach
MPV (₹100 - ₹ 100) x 4000 Kgs = ₹0
MUV (3200 kgs – 4000 kgs) ₹ 100 = ₹ 80000 A
SPV (₹180 - ₹ 180) x 8000 Units = ₹0
SMVV (8000 – 10000) x ₹ 140 = ₹ 280000 A
Variance Relevant Cost Approach Conclusion
MPV (₹100 - ₹ 100) x 4000 Kgs = ₹0 Same
MUV ₹ 80000 A + ₹ 280000 A = ₹ 360000 A Acquisition Cost + Opportunity Cost

[MUV under Traditional Approach + SMVV to the extent of loss
of Sales on account of mis-utilization of scarce resources)
SPV (₹180 - ₹ 180) x 8000 Units = ₹0 Same
SMVV ₹0 Reduction in Sales Volume due to the mistake of Sales Department

Points to Remember:
1. Under Relevant Cost Approach, we follow the principles of Marginal Costing (not Absorption Costing) i.e. we use Contribution pu instead of Profit pu
2. Under Relevant Cost Approach only Usage & Efficiency Variances changes. Price & Rate Variances are calculated in the same manner as under Traditional
Approach.
29
Learning Curve
4. Learning Curve Impact on Variances
It is important to take the result of decline in labour hours & costs into account in setting standards. Standard Costing
Question Source: ICAI Study Material
City International Co. is a multiproduct firm and operates standard costing and budgetary control system. During the month of June firm launched a new
product. An extract from performance report prepared by Sr. Accountant is as follows:
Particulars Budget Actual
Output 30 units 25 units
Direct Labour Hours 180.74 hrs 118.08 hrs.
Direct Labour Cost ₹ 1,19,288 ₹ 79,704
Sr. Accountant prepared performance report for new product on certain assumptions but later on he realized that this new product has similarities with
other existing product of the company. Accordingly, the rate of learning should be 80% and that the learning would cease after 15 units. Other budget
assumptions for the new product remain valid.
The original budget figures are based on the assumption that the labour has learning rate of 90% and learning will cease after 20 units, and thereafter the
time per unit will be the same as the time of the final unit during the learning period, i.e. the 20th unit. The time taken for 1st unit is 10 hours.
Required
Show the variances that reconcile the actual labour figures with revised budgeted figures in as much detail as possible.
Note:
The learning index values for a 90% and a 80% learning curve are -0.152 and -0.322 respectively.
[log 2 = 0.3010, log 3 = 0.47712, log 5 = 0.69897, log 7 = 0.8451, antilog of 0.6213 = 4.181, antilog of 0.63096 = 4.275]
30
Time required for 25 units based on revised learning curve of 80% (when the
Solution: time required for the first unit is 10 hours)
Working Note Total time for first 15 units = 62.72 hrs
Total time for next 10 units = 28.70 hrs [(62.72 – 59.85) hours x 10
The usual learning curve model is units]
b Total time for 25 units = 62.72 hrs + 28.70 hrs
y = ax = 91.42 hours
Where W.N.2
y = Average time per unit for x units Computation of Standard and Actual Rate
a = Time required for first unit
x = Cumulative number of units produced
b = Learning coefficient
W.N.1
Time required for first 15 units based on revised learning curve of 80%
when the time required for the first unit is 10 hours)
-0.322 W.N.3
y = 10 x (15)
Computation of Variances
log y = log 10 - 0.322 x log 15
Labour Rate Variance = Actual Hrs (Std. Rate – Actual Rate)
log y = log 10 - 0.322 log (5 x 3)
= 118.08 hrs (₹ 660.00 – ₹ 675.00)
log y = log 10 - 0.322 [log 5 + log 3]
= ₹ 1,771.20 (A)
log y = 1 - 0.322 [0.69897 + 0.47712]
Labour Efficiency Variance = Std. Rate (Std. Hrs – Actual Hrs)
log y = 0.6213
= ₹ 660 (91.42 hrs – 118.08 his)
y = antilog of 0.6213
= ₹ 17,595.60 (A)
y = 4.181 hours
Total time for 15 units = 15 units x 4.181 hours Statement of Reconciliation (Actual Figures Vs Budgeted Figures)
= 62.72 hours
Particulars ₹
Time required for first 14 units based on revised learning curve of 80%
Actual Cost 79,704.00
(when the time required for the first unit is 10 hours)
0.322
y = 10 x (14)- Less: Labour Rate Variance (Adverse) 1,771.20
log y = log10 - 0.322 x log 14
Less: Labour Efficiency Variance (Adverse) 17,595.60
log y = log10 - 0.322 x log (2 x 7)
log y = log10 - 0.322 x [log 2 + log 7] Budgeted Labour Cost (Revised)* 60,337.20
log y = 1 - 0.322 x [0.3010 + 0.8451]
log y = 0.63096 Budgeted Labour Cost (Revised)*
y = antilog of 0.63096 = Std. Hrs. x Std. Rate
y = 4.275 hrs = 91.42 hrs. x ₹ 660
Total time for 14 units = 14 units x 4.275 hrs = 60,337.20
= 59.85 hrs
31
5. Variance Analysis & Throughput Accounting
Traditional System: Focuses on Efficiency & Cost of operation of each part of the manufacturing system by having long manufacturing rounds and buying in
large quantities.
Throughput Accounting System: Focuses on the Entity as a whole. For example, when a terminal upstream from the constrained resource runs out of work, a
manager functioning under throughput accounting system will shut it down in order to avoid the formation of an unnecessary level of work-in-process
inventory. But this will result into a negative labour efficiency variance, since the terminal's staff is not actively producing anything.
Emphasis is on tracking variations in the size of the inventory buffer placed before the constrained resource, to confirm that the constraint is never halted
due to an inventory shortage.
32
6. Variance Analysis in Advanced Manufacturing Environment/ High-Technology Firms
[High-Tech Firms like Audio Technology, Automotive, Computer Engineering, Electrical and Electronic Engineering, Information Technology, Medical
devices, Nanotechnology, Semiconductors, Telecommunication etc.]
Ø A large part of manufacturing process is computerized. resulting in Less Direct

Ø Many costs that once were largely variable have become Labour & More Overheads ü Labour Variances are No longer meaningful
fixed. ü Two largest Variable Costs are Direct Materials &
Ø Manufacturing Labour consists of Highly skilled experts/ Variable Manf OH, say, Power to operate Machines
programmers are largely committed costs
7. Variance Analysis in Service Industry
[example accountants, solicitors, dentists, hairdressers, transport companies and hotels]
traditional variance analysis of overheads

does not deliver very useful information for
Ø Major portion of their cost is comprised of
overheads control purposes
overhead expenses rather than production ü Use ABC Approach
expenses
8. Variance Analysis in Public Services

[e.g. street cleaning, Garbage Collection]
Ø Unique nature of Unit of Service e.g. No. of Visits, No of Hrs worked

Ø Timing Differences (some costs are not incurred evenly over the year)
Ø Actual Expenditure may need modification on account of Trade Payables, Accruals etc.
33

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Follow us to know latest Exam STRATEGIC COST

CA, CFA (USA),

• Unique techniques to make understand the formulas

• His logical explana on of concepts and presenta on style is

CA, CFA (USA), CPA (USA)

Alpha Academy may be reached @

Leaders in CA Final SCMPE (COST) & SFM

T a r g e t i n g 100 Marks i n SFM . . .

Leaders in CA Final SCMPE & (COST) SFM

Leaders in CA Final SCMPE (COST) & SFM

MANUFACTURING CYCLE EFFICIENCY

(i) Average Non Value Added Time per batch

(ii) Average Value Added Time per batch

(iii) Manufacturing Cycle Eﬃciency

(iv) Manufacturing Cycle Time

= 0.40 hrs. per unt

COMPREHENSIVE - CASE SCENARIO

Electronic Keyboard Instruments

Produc on Overheads Figures in ₹

(iv) Ac vity Based Management to help Melody improve business performance

(i) Product Pricing

(iii) Performance Measurement

Costs per month of JIL are as follows:

The following informa on regarding retail stores are gathered:

Direct Product Proﬁtability (DDP) Statement

(1) Warehouse Related Costs

(2) Retail Stores Related Costs

(3) Transpota on Costs

(4) No. of Items per M³

Ac vity Ac vity Driver No of Units of Ac vity Driver Cost

(ii) RECOMMEND a strategy for Bookmark LLP regarding its customers.

(i) Customer Wise Proﬁtability Statement and Overall Proﬁtability Statement

Table 1: Customer Sales Analysis - Revenue Analysis All ﬁgures in ₹

Leaders in CA Final SCMPE (COST) & SFM

By Pu ng the Value of 'Q' in Price Equa on, Value of 'P' is Obtained

LEARNING CURVE METHOD OF PRICING

There are no ﬁxed costs that are speciﬁc to the product.

[(10 Marks), CA Final May 2019]

The usual learning curve modal is

Total Direct Labour Cost for ﬁrst 8 batches

Total Direct Labour Cost for ﬁrst 7 batches

Direct Labour Cost for 8 batch

(ii) Statement Showing "Life Time Expected Contribu on"

(*) Total Labour Cost over the Product's Life

Sales (₹ 102 x 16,000 units) 16,32,000

16 batched represent 4 doublings of output.

Therefore, the rate of learning required = 4

Unit Selling Prices:

Unit Produc on Costs:

Unit Selling Prices:

Unit Produc on Costs:

Leaders in CA Final SCMPE (COST) & SFM

Statement of Hours Needed for External Sales

Transfer price range:

Minimum Transfer Price p.u.

Maximum Transfer Price

Statement of Product Wise Contribu on per hour

Statement of Op mum Mix