Management

Accounting
CMA Inter
Divya Jadi Booti

CA Satish Jalan
 MANAGEMENT
ACCOUNTING
Divya Jadi Booti

CMA - Inter

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“Live as if you were to die tomorrow. Learn as if you were to live forever.”

Mahatma Gandhi

© SJC Institute LLP

This book shall not be reproduced or shared by photocopying, recording, or otherwise
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Preface
This is a compilation from the new syllabus of the Institute of Cost Accountants of India for
the subject of Management Accounting. Entire module of Institute has been covered in this
book. The effort has been made to structure the material for ease of conceptual learning. Some
solutions have been modified to keep them consistent with all other solutions and for others
we referred the solution given by the institute.
The explanation of all the solutions here, have been given in the class and it is very important
that this study material should not be referred in isolation, (i.e., without the class)
In exam, the paper comprises of three types of questions, based on - MCQ, Theories (Short
notes) and Practical Questions. You need to prepare the MCQ’s and detailed theories directly
from the institute material. Everything is important for your exam and comprehensive
preparation is required to pass the examination. Please remember that in order to get full
confidence in the subject, you have to solve this material at least 3 times after you’ve learnt
with us in the classes.
We have segregated here the topics as per the relevant concepts and have given immense
effort along with our team to ensure that there are limited errors in this book.
All due care has been taken to eliminate the errors. However, some errors may have gone
unnoticed and we would be happy if you bring it to our notice by sending us an email to care@
sjc.co.in
We would like to thank our editorial team (Sayantan, Anirban) for their consistent effort to help
me to bring this compilation for you.
Wish you All the Best and Happy Learning 

Satish Jalan
• Chartered Accountant (AIR - 27 in Inter)
• Company Secretary (AIR 3 - Inter, AIR 5 - Final)
• Chartered Management Accountant (CIMA, UK)
(AIR - I in Gateway)
• St. Xavier’s College Alumnus, Kolkata

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 Bird's Eye View
OF CHAPTERS ASKED IN PAST EXAMINATIONS

Sl
Chapter name Term
No.
Jun'23 Dec'23 Jun'24
1 Introduction to Management Accounting 6 7 7
2 Activity Based Costing 9 7 7
3 Decision Making Tools
Marginal Costing 15 7 28
Applications of Marginal Costing in Short Term Decision 7 21
Making
Transfer Pricing 8
4 Standard Costing and Variance Analysis 15 7 7
5 Forecasting, Budgeting and Budgetary Control 15 21 21
6 Divisional Performance Management 15 14 14
7 Resposibility Accounting 7 7
8 Decision Theory 15 7 7
Total 105 98 98
MCQ 25 30 30

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Content
Sl.
Chapters Page No. Weight
No.
SECTION A: INTRODUCTION TO MANAGEMENT ACCOUNTING
1. Introduction to Management Accounting 1.1 – 1.16
1.1 Conceptual Understanding 1.2
Relationship between Management Accounting and Cost
1.2 1.6
Accounting
Role of a Management Accountant in Modern Business
1.3 1.10
World
SECTION B: ACTIVITY BASED COSTING
2. Activity Based Costing 2.1 – 2.22
2.1 Traditional Cost System 2.2
2.2 Definition and Meaning of Activity Based Costing (ABC) 2.3
2.3 Steps in ABC System 2.4
2.4 Cost Pools and Cost Drivers 2.5
2.5 Merits and Demerits of ABC System 2.6
2.6 Activity Based Information and Decision Making 2.7
SECTION C: DECISION MAKING TOOLS
3. Marginal Costing 3.1 – 3.26
3.1 Concept 3.2
3.2 Cost-Volume-Profit Analysis 3.3
3.3 Break-Even Charts and Profit Charts 3.4
3.4 Multiple Product Break Even Analysis 3.6
3.5 Differential Cost Analysis 3.9
Marginal Costing Vs. Absorption Costing (advanced
3.6 3.11
applications)
Applications of Marginal Costing in Short Term Decision
4. 4.1 – 4.26
Making
4.1 Pricing Decision 4.3
4.2 Make or Buy decisions 4.5
4.3 Accept an Order or Reject 4.13
Optimum Utilization of Factors of Production [Limiting
4.4 4.16
Factor Analysis]

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 4.5 Replacement Decision 4.18
4.6 Evaluation of Alternative Choices 4.20
4.7 Subcontracting and Ancillarisation 4.22
4.8 Expansion of Business 4.23
4.9 Shutdown or Continue 4.24
5. Transfer Pricing 5.1 – 5.16
5.1 Concept 5.2
5.2 Methods and Techniques 5.4
5.3 Divisional Performance and Problem of Goal Congruence 5.5
Determination of Inter-departmental or Inter-company
5.4 5.7
Transfer Price
5.5 International Transfer Pricing 5.8
SECTION D: STANDARD COSTING AND VARIANCE ANALYSIS
6. Standard Costing and Variance analysis 6.1 – 6.32
6.1 Material and Labour Variances 6.2
6.2 Variable Overhead Variance 6.14
6.3 Fixed Overhead Variance 6.15
6.4 Sales Variance 6.20
6.5 Interpretation of Variances and Inferences Drawn 6.22
SECTION E: FORECASTING, BUDGETING AND BUDGETARY CONTROL
7. Forecasting, Budgeting and Budgetary Control 7.1 – 7.26
7.1 Introduction 7.2
7.2 Rationale for Budgets 7.3
7.3 General principles in the Budgetary process 7.4
7.4 Formulation of various types of Budgets 7.5
SECTION F: DIVISIONAL PERFORMANCE MEASUREMENT
8. Divisional Performance Measurement 8.1 – 8.26
Organisations with Multiple divisions, Benefits of
8.1 8.2
Decentralization
8.2 DuPont Analysis 8.3
Divisional Performance Measurement tools – ROI, Residual
8.3 8.5
Income
Economic Value Added – Definition, EVA Centre, EVA
8.4 8.8
Drivers
8.5 Introduction to Learning Curve 8.16
8.6 Balanced Score Card for Variable Pay Management 8.25

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SECTION G: RESPONSIBILITY ACCOUNTING
9. Responsibility Accounting 9.1 – 9.10
9.1 Concept of Cost, Revenue, Profit and Responsibility Centres 9.2
9.2 Preparation of Responsibility Report 9.8
SECTION H: DECISION THEORY
10. Decision Theory 10.1 – 10.22
10.1 Decision Making under Certainty 10.4
10.2 Decisions Making under Risk 10.5
10.3 Decision Making under Uncertainty 10.8
10.4 Decision Tree 10.15
11. Objectives 11.1 – 11.38

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 Introduction to Management Accounting


Chapter 1
Introduction to Management
Accounting

1.1 Conceptual Understanding

Relationship between Management Accounting and

1.2 Cost Accounting

Role of a Management Accountant in Modern

1.3 Business World

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 Introduction to Management Accounting
Conceptual Understanding

1.1
Conceptual Understanding

1 MTP Jun'23 Set 2

“The evolution of managerial accounting has been through four particular phases” – explain
the four phases. Also discuss the various tools and techniques that developed during each
particular phase clearly demarcating the contemporary techniques against the traditional
techniques. [7]

Four Phases, Tools and Techniques

Answer
Management accounting is an offshoot of financial accounting and has specific linkages with
cost accounting. Financial literature suggests that the beginning of management accounting is
linked with the requirement for accounting information to optimize economic resources during
the Industrial Revolution. The International Accounting Federation (IFAC, 1998) has described
the evolution of managerial accounting through four phases.
• First stage (prior to 1950s).
• Second stage (1950s – 1965)
• Third stage (1965 – 1985).
• Fourth stage (1985 – till date)
Explanation of four stages and faces are given below:
The first stage (prior to 1950) Cost determination and financial control, which is also referred
as the ‘classical era’ is the period where the focus was on cost determination and financial
control. At this stage, the development of managerial accounting was oriented to determining
costs and financial control of business processes. IFAC describes this period of Management
accounting as ‘the technical activity needed to achieve organizational objectives’. Managerial
accounting before the 1950s was mainly focused on determining the cost of the product.
The second stage (1950-1965) is referred as the age of information for management
planning and control.

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 Introduction to Management Accounting
Conceptual Understanding

During this period the main focus of managerial accounting was to provide information on
planning and control issues. This phase is characterized by the use of traditional account-
ing management techniques that support decision making and responsibility accounting.
Management accounting techniques such as: Standard Costs and Profitability Analysis were
introduced during this period. The second phase is described as ‘management activity, but in
the role of staff’. During this period, the management was focused on the company’s production
process and internal analysis and paid less attention to external business environment.
The third stage (1965 - 1985) is referred as reduction of waste of resource in business
operation.
Management accounting focussed on reduction of waste of resources in production processes
by eliminating ‘no-value activities’. During this period, Japan’s economic progress and rapid
technological developments contributed to the growth of global competition. The priority
for the companies was to adapt to the new business environment. Companies began to
seek both cost reduction and quality improvement at the same time. The use of robotics and
computer-controlled processes enabled companies to improve their quality and in many cases
impact on cost reduction.
The Fourth Stage (1985-2000) is refereed as Creation of value through effective resource:
During this period, technological innovations were at the forefront, competition was intensi-
fied, companies, as they were faced with major business uncertainties, and thus made them
focus on value creation through effective use of resources, which could be achieved ‘with the
use of technology that drives companies to create costumer value, shareholder value, and
organizational innovations’. The managerial accounting techniques that dominated this period
are: Activity-based Cost (ABC); Production just in time (JIT); Target cost; balanced scorecard;
Value chain analysis and strategic management accounting.
The various tools and techniques that developed during each particular phase /stage are given
below:
Reduction
Creation of
of waste of
Cost determination Information for Value through
Focus resource in
and financial control planning and control effective
Business
resource use
operation
Stages → 1760 -1950 1950 -1965 1965 -1985 1985 - till date
Methods ↓
Cost determi- Cost determination Standard cost
nation and accounting
accounting - developments
Standard costing Marginal costing
Direct Costing Target costing
Records of cost Activity based
accounting costing

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 Introduction to Management Accounting
Conceptual Understanding

allocation of Activity based

indirectcost management
Uniform costing
Absorption costing
Planning Budgeting Application of
discounted cash flow
Transfer costing
Controlling Return on Responsibility Application of
investments (ROI) accounting Kaizen
ton -mile ratio Gentani system Just in time
system
Kaizen costing
Strategic Life Cycle Value chain
analysis costing analysis
Five Forces
Model
PEST, SWOT
analysis
Customer
profitability
analysis
Competitor
analysis
Balanced
scorecard

2 Dec’23
Briefly discuss the scope of Management Accounting. [7]

Scope of Management Accounting

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 Introduction to Management Accounting
Conceptual Understanding

Answer
Some of the broad areas considered to be part of ‘management accounting’ is summarized in
the following lines:
• Budgeting, planning and forecasting
• Measuring organisational, divisional and departmental performance
• Comparing results and performance within and between organisations
• Assisting in the process of increasing effectiveness and efficiency
• Assessing the performance of past and future capital investments
• Advising on decisions about product mix, markets to be served and selling prices
• Advising on decisions on whether to outsource products, components, activities and
services
• Advising on decisions involving the investment of scarce funds between a range of possible
alternatives
• Assisting in the making of a wide range of strategic decisions
The above mentioned are some of the relatively precarious activities of the higher-level
management.
The fundamental activities of management accounting would include:
• calculating the profitability of products, services and operations,
• allocating costs to products,
• setting inter-divisional transfer prices.
There are also some functions of the management accountant which are focused on deliver-
ing critical information to the top-level management for initiating the process of increasing
effectiveness and efficiency.
Techniques such as activity-based cost management and theory of constraints are examples of
such specialized activities.
Some authors also prefer to include capital budgeting decision within the scope of management
accounting especially when there is a strategic aspect to it.

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 Introduction to Management Accounting
Relationship between Management Accounting and Cost Accounting

1.2
Relationship between Management
Accounting and Cost Accounting

1 Jun'23
Distinguish between cost accounting and management accounting. [6]

Cost Accounting Vs Management

Accounting

Answer
Cost Accounting Management Accounting
Cost accounting revolves around cost Management accounting helps management
computation, cost control, and cost make effective decisions about operations of
reduction. the business.
Cost accounting prevents a business from Management accounting offers a big picture
incurring costs beyond budget. of how management should strategize.
The scope is much narrower. The scope is much broader.
Quantitative. Quantitative and qualitative.
Cost accounting is one of the many subsets Management accounting is the universal set.
of management accounting.
The task of decision making very less. Historic and predictive information is the
Even if there is some, it is based on historic basis of decision-making.
information
Statutory audit of cost accounting is a The audit of management accounting has no
requirement in some specified industries. statutory requirement
Cost accounting isn't dependent on Management accounting is dependent on
management accounting to be successfully both cost & financial accounting for success-
implemented. ful implementation.
Management, shareholders, and vendors. Only for management.

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 Introduction to Management Accounting
Relationship between Management Accounting and Cost Accounting

2 MTP Dec'23 Set 1

Describe the differences between Management Accounting and Financial Accounting. [7]

Management Accounting Vs Financial

Accounting

Answer
Differences between Management Accounting and Financial Accounting:
Basis for Comparison Financial Accounting Management Accounting
Purpose Financial Accounting classifies, Management accounting helps
analyses, records, and Financial management make effective
transactions of a perticular period decisions about the business.
of the company
Application Financial accounting is prepared Management accounting helps
to reflect true and fair picture of managementto take meaningful
financial affairs. steps and strategize.
Scope The scope is pervasive, but not The scope is much broader.
as much as the management
accounting.
Information type Quantitative Quantitative and qualitative.
Inter dependence It is not dependent on Management accounting is
management accounting. basically decisionmaking account-
ing and depends on information
created by Financial Accounting
as well as Cost Accounting.
Statutory It is legally mandatory to prepare Management accounting has no
Requirement financial accounts of all companies. statutoryrequirement.
(for example in the Indian Context
Companies Act 2013, relevant rules
of Accounting standards furnishes
the statutory requirements)
Format Financial accounting has specific There’s no set format for present-
formats for presenting and ing information in management
recording information. accounting.
Users Mainly for potential investors as Only for management.
well as all stakeholders.

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 Introduction to Management Accounting
Relationship between Management Accounting and Cost Accounting

Verifiable The information presented is The information presented is

verifiable. predictive and not immediately
verifiable.

3 Jun’24
Distinguish between Financial Accounting and Management Accounting. [7]

Financial & Management Accounting

Answer
Basis for
Financial Accounting Management Accounting
Comparison
Purpose Financial Accounting classifies, Management accounting helps
analyses, records, and summariz- management make effective
es the financial transactions of a decisions about the business.
particular period of the company.
Application Financial accounting is to reflect true Management accounting helps
and fair picture of financial affairs. management to take meaningful
steps and Strategies.
Scope The Scope is pervasive, but not The Scope is much broader.
as much as the management
accounting.
Information Quantitative Quantitative and qualitative.
Type
Inter It is not dependent on management Management accounting is basically
Dependence accounting decision-making accounting and
depends on information created
by Financial Accounting as well as
Cost Accounting.
Statutory It is legally mandatory to prepare Management accounting has no
Requirement financial accounts of all companies. statutory requirement.
(For example, in the Indian Context
Companies Act 2013, relevant rules.
of accounting standards furnishes
the statutory requirements)

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 Introduction to Management Accounting
Relationship between Management Accounting and Cost Accounting

Format Financial accounting has specific There’s no set format for present-
formats for presenting and ing information in management
recording information. accounting.
Users Mainly for potential investors as well Only for Management.
as all stakeholders.
Verifiable The information presented is The information presented is
verifiable. predictive and not immediately
verifiable.

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 Introduction to Management Accounting
Role of a Management Accountant in Modern Business World

1.3
Role of a Management Accountant
in Modern Business World

1 MTP Jun'23 Set 1

Discuss the role of a management accountant in contemporary business eco system. [7]

Role of Management Accounting

Answer
There has been a paradigm shift in the role of the management accountant in the era of globali-
sation. The focus shifted to strategic analysis. This ushered in the fourth stage of the evolution
of management accounting. Authors have opined that most of the management account-
ing practices used, were actually developed by 1925, and for the next 60 years there was a
slowdown, or even a halt, in management accounting innovation.
Globalisation brought about significant changes in the business environment. Along with the
changes the roles of the management accountant had to be redefined. In the following lines
some of the impacts of the new business environment on management accounting is discussed.
• Global competition - Prior to the era of globalisation, many organizations operated in a
protected competitive environment. Globalisation ushered in changes where there have
been reductions in tariffs and duties on imports and exports as well as dramatic improve-
ments in transportation and communication systems. By this firms operate globally
and results in stiff competition from the very best organisations with changed business
operation worldwide. The new competitive environment has increased the demand
relating to quality and customer satisfaction. Customer profitability analysis and value
analysis are important issues in the arena of management accounting.
• Changing product life cycles – Changing profile of the customer along with behaviour-
al issues have contributed to drastically reduce the product life cycle, the management
accountant plays a crucial role as in order to compete successfully. Companies must be
able to manage their costs effectively at the design stage, have the capability to adapt to

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 Introduction to Management Accounting
Role of a Management Accountant in Modern Business World

new environment, different and changing customer requirements and reduce the time to
market of new and modified products.
• Advances in manufacturing technology - In order to compete effectively, companies
must be able to manufacture high quality innovative products at a low cost, and also
provide a first-class customer service. Flexibility to cope with short product life cycles,
demands for greater variety of product, more discriminating customers and increasing
international competition has created enormous pressure on the operational activities of
the business.
• The impact of information technology - The use of information technology (IT) to support
business activities has increased dramatically. Along with electronic business communi-
cation technologies known as e-business, e-commerce or internet commerce have also
developed significantly. Consumers have become more discerning in their purchases as
in online transactions it is relatively easy to compare the merits of different products and
services. This have a significant impact on the work of management accountants. The
role of the management accountant as a gatherer and processor of information is lost as
the managers can directly access the management accounting system on their personal
computers to derive the information they require for decision making.
• Environmental and sustainability issues – In recent times, ESG4 has become the focal
point in the operations of the company. Along with this, ethical issues have also come to
the forefront as the business has to deal with customers who are more aware of this issues
then they were a decade back.
• Deregulation and privatization – Prior to the era of globalization, companies in many
industrial sectors were government – owned monopolies and operated in a highly
regulated, protected and non-competitive environment. Thus the organizations, especial-
ly those incurring losses, were not under any pressure to improve the quality and efficiency
of their operations and to improve profitability by adding or dropping particular products
or services from their array of product or service. Globalization ushered in the privatization
and deregulation which resulted in the elimination of pricing and competitive restrictions
and made Companies to realize their cost base and determine the source of profitability
for their products, customers and markets.
• Focus on value creation – The scope of management accounting is enormous. Managers
who are in charge of the operations of the organisations depends on the management
accountants in realisation of the strategic goal of the organisations. With the advent of time,
the role of the management accountant has changed from merely interpreting, managing
and recording costs to creating value. Though cost reduction still remains as the basic
function of the management accountant as it has specific impact on selling price fixation
which impacts customer value. The new business environment resulted in management
accounting distinguishing between value-added and non-value-added activities.

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 Introduction to Management Accounting
Role of a Management Accountant in Modern Business World

2 MTP Dec'23 Set 2

Management Accounting serves as a tool to management – Discuss. [7]

Management Accountant and Strategic

Decisions

Answer
Strategies are long term plans which help organisations to realise its goal. Strategy is defined as
a general direction set for the company and its various components to achieve a desired state
in the future. A company’s strategy specifies how the organisation matches its own capabili-
ties with the opportunities in the marketplace. Basically businesses follow one of two broad
strategies. Some companies follow a cost leadership strategy. These companies, for long term
sustenance, choose to provide quality products or services at low prices and by cautious-
ly managing their costs. Other companies follow a product differentiation strategy. These
companies offer differentiated or unique products or services that appeal to their customers.
The products are often priced higher than the products or services of their competitors.
Mangers are faced with various challenges. One such is to decide between the two strategies
discussed above. The crucial issue is that this have long term impact on profitability and growth
of the company. Management accountants work closely with managers in various departments
to formulate strategies by providing information about the sources of competitive advantage,
such as:
• the company’s cost, productivity, or efficiency advantage relative to competitors or
• the superior prices the company can charge relative to the costs of adding features that
make its products or services distinctive.
Strategic cost management describes cost management that specifically focuses on strategic
issues. Management accounting information helps managers formulate strategy by answering
the following questions:
(a) Who are the most important customers, and how can the company deliver value to the
customers?
(b) What substitute products exist in the marketplace, and how do they differ from products
of the company in terms of features, price, cost, and quality?
(c) What is most critical capability of the company which may be technology, production, or
marketing?
(d) How can we leverage it for new strategic initiatives?
(e) Will adequate cash be available to fund the strategy, or will additional funds need to be
raised?

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 Introduction to Management Accounting
Role of a Management Accountant in Modern Business World

The best-designed strategies and the best-developed capabilities are useless unless they are
effectively executed which depends primarily on the information generated and provided by
the management accountant. This linkage between successful implementation of strategy and
the accounting information generated by management accounting is the subject matter of
strategic cost management.

3 MTP Jun’24 Set 1

Describe the functions of a Management Accountant in Modern Business World. [7]

Functions of Management Accountant

Answer
The functions of a management accountant can be categorized as below:
1. Planning and Accounting - Management accountants prepare an accounting system
covering costs, sales forecasts, profit planning, production planning, and allocation of
resources. It should also include capital budgeting, short-term and long-term financial
planning. They also prepare the procedures necessary to implement the plan effectively.
2. Controlling - Management accountants assist in the control of an organisation’s
performance through the use of standard costing, budget control, accounting ratios, funds
flow statements, cost-cutting initiatives, and assessing capital expenditure proposals and
returns on investment.
3. Reporting - Management accountants assist the top management in finding out the root
cause of an unfavourable operation or event by identifying the real reasons for the adverse
events as well as the responsible parties and comprehensively reporting them.
4. Coordinating - Management accountants improve an organisation’s efficiency and profits
by providing various coordination tools such as budgeting, financial reporting, financial
analysis and interpretation, and so on. These tools aid management by comparing cost
and financial records, preparing financial budgets and establishing standard costs, and
analyzing cost deviations to enable management by exception.
5. Communication - Management accountants create a wide range of reports to communi-
cate results to the superiors. Through published financial statements and returns, they also
inform the outside world about their company’s success.
6. Financial evaluation and Interpretation - Management accountants analyze the data and
present it to the management in a non-technical approach, together with their comments
and ideas, so that the shareholders and senior management can understand it and make
informed decisions.

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Role of a Management Accountant in Modern Business World

7. Tax Administration - Management accountants are in charge of tax policies and processes.
They make the reports that are required by various authorities. Further, they ensure that
quarterly tax payments are made in advance, as required by the relevant Act, to prevent
the payment of penal interest on late tax payments.
8. Evaluation of external effects - There may be changes in government policy and existing
laws. These amendments and policy changes can affect business goals. Management
accountants assess the extent of any impact of these external factors on the business and
report it to the stakeholder to take necessary precautionary measures.
9. Economic appraisal - When the government makes regular announcements about the
country’s economic situation, management accountants is entrusted with making the
economic study and determine the influence of current economic conditions on the
company’s operations. They compile a report containing their observations and present it
to high management.
10. Asset Protection - Management accountants separate fixed asset registers for each type
and provide internal checks and controls to protect the company’s assets. They also create
the rules and regulations for each type of fixed asset and get insurance coverage for all
types of fixed assets.

4 MTP Dec’24 Set 1

Globalisation brought about significant changes in the business environment. Along with the
changes the roles of the management accountant had to be redefined. In the following lines,
discuss some of the impacts of the new business environment on management accounting.
[7]

Impact of new business environment on

management accounting

Answer
The impacts of the new business environment on management accounting are: -
• Global competition - Prior to the era of globalisation, many organizations operated in a
protected competitive environment. Globalisation ushered in changes where there have
been reductions in tariffs and duties on imports and exports as well as dramatic improve-
ments in transportation and communication systems. This has facilitated firms to operate
globally and resulted in stiff competition from the very best organisations worldwide.
Business operations also changed significantly. The new competitive environment has
increased the demand for information relating to quality and customer satisfaction.

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 Introduction to Management Accounting
Role of a Management Accountant in Modern Business World

Customer profitability analysis and value analysis are important issues being incorporated
in the arena of management accounting.
• Changing product life cycles – Changing profile of the customer along with behavioural
issues have contributed to drastically reduce the product life cycle. First mover advantage
is critical and every organisation is desperately seeking the advantage by increasing their
investment in research and development. In this respect, the management accountant
plays a crucial role as in order to compete successfully, companies must be able to manage
their costs effectively at the design stage, have the capability to adapt to new environ-
ment, different and changing customer requirements and reduce the time to market of
new and modified products.
• Advances in manufacturing technology - In order to compete effectively, companies
must be able to manufacture high quality innovative products at a low cost, and also
provide a first-class customer service. Flexibility to cope with short product life cycles,
demands for greater variety of product, more discriminating customers and increasing
international competition has created enormous pressure on the operational activities of
the business. Some internationally reputed manufacturing companies have responded to
these by replacing traditional production systems with lean manufacturing systems that
seek to reduce waste by implementing just-in-time (JIT) production systems, focusing
on quality, simplifying processes and focusing on advanced manufacturing technologies
(AMTs).
• The impact of information technology - The use of information technology (IT) to support
business activities has increased dramatically. Along with electronic business communi-
cation technologies known as e-business, e-commerce or internet commerce have also
developed significantly. Consumers have become more discerning in their purchases as
in online transactions it is relatively easy to compare the merits of different products and
services. This have a significant impact on the work of management accountants. The
role of the management accountant as a gatherer and processor of information is lost as
the managers can directly access the management accounting system on their personal
computers to derive the information they require for decision making. Management
accountants have now become more involved in interpreting the information generated
from the accounting system and providing business support for managers
• Environmental and sustainability issues – In recent times, ESG has become the focal
point in the operations of the company. Along with this, ethical issues have also come to
the forefront as the business has to deal with customers who are more aware of this issues
then they were a decade back. Thus, there is desperate need for organisations to be run
in a suitable way. Sustainable development, where it is acknowledged that environmental
resources are limited and should be preserved for future generations, is the order of the
day. Management accounting with specific focus on environmental issues is becoming
increasingly important in organizations as environmental costs are large in many organisa-
tions. There are three specific reasons for this:
 Environmental costs are often high in the many manufacturing organisations.
 Regulatory requirements often impose huge fines for non-compliance.

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 Introduction to Management Accounting
Role of a Management Accountant in Modern Business World

 Companies are increasingly realizing that being socially and environmentally responsi-
ble improves their image and this has positive impact on their bottom line.
The above mentioned changes impacted the management of the companies and the managers
have realized that they need to develop system for measuring and reporting environmental
costs along with preparation of detailed report on the consumption of scarce environmental
resources, hazardous materials used and pollutants emitted to the environment.
• Deregulation and privatization – Prior to the era of globalization, companies in
many industrial sectors were government owned monopolies and operated in a highly
regulated, protected and non-competitive environment. Thus the organisations, especially
those incurring losses, were not under any pressure to improve the quality and efficien-
cy of their operations and to improve profitability by adding or dropping particular
products or services from their array of product or service. Thus trivial attention was given
to developing management accounting systems that accurately measured the costs and
profitability of individual products or services. Globalization ushered in the privatization
and deregulation which resulted in the elimination of pricing and competitive restrictions.
Thus, companies were compelled to design an elaborate management accounting system
that made them to realize their cost base and determine the source of profitability for their
products, customers and markets.
• Focus on value creation – The scope of management accounting is enormous. Managers
who are in charge of the operations of the organisations depends on the management
accountants in realisation of the strategic goal of the organisations. With the advent of time,
the role of the management accountant has changed from merely interpreting, managing
and recording costs to creating value. Though cost reduction still remains as the basic
function of the management accountant as it has specific impact on selling price fixation
which impacts customer value. The new business environment resulted in management
accounting distinguishing between value-added and non-value-added activities.
• There is another aspect of new business paradigm which the management accountant has
to consider as they develop the company’s management accounting system. Intangibles
have increased manifold. This presents a challenge to management accountants as to
how to identify, measure and report on the value of intangibles.
• Customer orientation – In the new business environment, gaining competitive advantage
has become the singular goal of every business organisation. Companies have realized
that in order to sustain in today’s competitive environment they need to become more
customer driven and recognize that customers are crucial to their future success. This
has made the companies realize that customer satisfaction is one of the most important
critical success factor (CSF) which helps companies realize their strategic goal. Customer
satisfaction is relational to cost, quality, reliability, delivery and the choice of innovative
new products.

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 Activity Based Costing


Chapter 2
Activity Based Costing

2.1 Traditional Cost System

Definition and Meaning of Activity Based Costing

2.2 (ABC)

2.3 Steps in ABC System

2.4 Cost Pools and Cost Drivers

2.5 Merits and Demerits of ABC System

2.6 Activity Based Information and Decision Making

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 Activity Based Costing
Traditional Cost System

2.1
Traditional Cost System

1 Postal Test Paper

You are the Cost Controller of ABC Company Limited. You are vouching for the introduction
of Activity Based Costing in the Company and in the meeting with other executives of the
Company, you said ‘Why is using a single plant wide allocation rate not always accurate?’
You are required to give your view, in support of the above statement. [8]

Applicability - ABC vs Single OH rate

Answer
As a Cost Controller of ABC Company Limited, the following points are to be noted, in favour of
implementation of Activity Based Costing, in the Company:
1. Using a single plant wide allocation rate is not always accurate because it is based on
only one allocation base and uses that same allocation base to allocate overhead to all
products.
2. The allocation base selected might not accurately reflect the way products actually use
a company’s resources (there might not be a direct cause-and-effect relationship with
overhead costs).
3. In contrast, activity-based costing (ABC) identifies multiple activities, each with its own
allocation base, to more accurately reflect the way products actually use a company’s
resources (activities).
4. Thus ABC costs are closer to the true cost of making products. One should feel more
comfortable making decisions using ABC cost data.

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 Activity Based Costing
Definition and Meaning of Activity Based Costing (ABC

2.2
Definition and Meaning of Activity
Based Costing (ABC)

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 Activity Based Costing
Steps in ABC System

2.3
Steps in ABC System

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 Activity Based Costing
Cost Pools and Cost Drivers

2.4
Cost Pools and Cost Drivers

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 Activity Based Costing
Merits and Demerits of ABC System

2.5
Merits and Demerits of ABC System

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 Activity Based Costing
Activity Based Information and Decision Making

2.6
Activity Based Information and Decision Making

1 MTP Jun'23 Set 1

ABC Company manufactures three products: A, B, and C. Data for the period just ended is as
follows:
A B C
Production (units) 20000 25000 2000
Sales price (per unit) ₹ 20 ₹ 20 ₹ 20
Material cost (per unit) ₹5 ₹ 10 ₹ 10
Labour hours (per unit) 2 hours 1 hour 1 hour
Overheads for the period were as follows:
₹
Set-up costs 90,000
Receiving 30,000
Despatch 15,000
Machining 55,000
1,90,000

Cost driver data A B C

Machine hours per unit 2 2 2
Number of set-up 10 13 2
Number of deliveries received 10 10 2
Number of orders dispatched 20 20 20
As a cost accountant you are required to
(i) Calculate the cost and profit per unit, absorbing all the overheads on the basis of labour
hours.
(ii) Calculate the cost and profit per unit absorbing the overheads using an Activity Based
Costing approach. [4 + 4 = 8]

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 Activity Based Costing
Activity Based Information and Decision Making

Traditional Vs ABC

Answer
(i) Total overheads ₹1,90,000
Total labour hours:
A = (20,000 × 2) = 40,000
B = (25,000 × 1) = 25,000
C = (2,000 × 1) = 2,000
67,000

Overhead Absorption Rate = ₹1,90,000 ÷ 67,000 hours = ₹2.836 per hour = ₹2.84 per hour
(ii) Statement of Cost and Profit (Amount in ₹)
Particulars A B C
Materials 5 10 10
Labour 10 5 5
Overheads (at ₹2.84 per hr) 5.68 2.84 2.84
20.68 17.84 17.84
Selling price 20 20 20
Profit / Loss (0.68) 2.16 2.16

Overheads per units Total A B C

Set-up costs ₹ 90,000 36,000 46,800 7,200
(Cost per set up = ₹ 90,000÷25)
Receiving ₹ 30,000 13,636 13,636 2,728
(Cost per delivery = ₹ 30,000÷22)
Dispatch
(Cost per order = ₹ 15,000÷60) ₹ 15,000 5,000 5,000 5,000
Machining ₹ 55,000 ₹ 23,404 ₹ 29,256 ₹ 2,340
(Cost per machine hour = ₹ 55,000 ÷
94,000)
Total ₹ 1,90,000 78,040 94,692 17,268
Number of units 20,000 25,000 2,000
Overheads p.u. ₹ 3.90 ₹ 3.79 ₹ 8.63

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 Activity Based Costing
Activity Based Information and Decision Making

Statement of Cost and Profit (Amount in ₹)

Particulars A B C
Materials 5 10 10
Labour 10 5 5
Overheads 3.90 3.79 8.63
18.90 18.79 23.63
Selling price 20.00 20.00 20.00
Profit /(Loss) ₹ 1.10 ₹ 1.21 (₹ 3.63)

2 MTP Jun'23 Set 2

Kalyani Manufacturing Company has three salaried accounts payable clerks responsible for
processing purchase invoices. Each clerk is paid a salary of ₹30,000 and is capable of processing
5,000 invoices per year (working efficiently). In addition to the salaries, Kalyani spends ₹9,000
per year for forms, postage, checks, and so on (assuming 15,000 invoices are processed). During
the year, 12,500 invoices were processed.
Required:
• Calculate the activity rate for the purchase order activity. Break the activity into fixed and
variable components.
• Compute the total activity availability, and break this into activity usage and unused
activity.
• Calculate the total cost of resources supplied, and break this into activity usage and
unused activity [4]

Activity Rate, Availability, Unused Activity

Answer
1. Activity rate = [(3 x ₹ 30,000) +₹ 9,000] ÷15,000
= ₹ 6.60 per invoice
2. Fixed activity rate = ₹ 90,000÷15,000
= ₹ 6.00 per invoice
3. Variable activity rate = ₹ 9,000÷15,000
= ₹ 0.60 per invoice

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Activity Based Information and Decision Making

• Activity availability = Activity usage + Unused activity

15,000 invoices = 12,500 invoices + 2,500 invoices
• Cost of resources supplied = Cost of activity used + Cost of unused activity
= ₹90,000 + (₹0.60 x 12,500)
= (₹6.60 x 12,500) + (₹6.00 x 2,500)
= ₹82,500 + ₹15,000
= ₹97,500

3 MTP Jun'23 Set 2

“The basic idea justifying the use of Activity-Based Costing (ABC) and Activity-Based Budgeting
(ABB) are well publicized, and the number of applications has increased. However, there are
apparently still significant problems in changing from existing systems” – in reference to the
context, provide explanation as to -
(i) Which characteristics of an organization, such as its structure, product range, or environ-
ment, may make the use of activity based techniques particularly useful.
(ii) The problems that may cause an organization to decide not to use, or to abandon the use
of, activity based techniques. [4]

Characteristics, Problems of ABC

Answer
(1) Activity-based costing (ABC) is a costing method that identifies activities in an organiza-
tion and assigns the cost of each activity to all products and services according to the
actual consumption by each. Therefore, this model assigns more indirect costs (overhead)
into direct costs compared to conventional costing.
ABC system is a very valuable tool of control. It offers a number of advantages to the
management and the following are the main advantages:
(i) It brings accuracy and reliability of the costing data in determination of the cost of the
products.
(ii) It facilitates cause and effect relationship to exercise effective cost control.
(iii) It provides necessary cost information to the management to take decisions on any
matter, relating to the business.
(iv) It is much helpful in fixing the cost and selling price of a product.
(v) It facilitates overhead costs allocate directly to the specific product.

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 Activity Based Costing
Activity Based Information and Decision Making

(vi) It enables to manage the activities rather than costs.

(vii) It helps to remove all types of wastages and inefficiencies.
(viii) It provides valuable information to evaluate on the relative efficiencies of various
plants and machinery.
(ix) Cost Driver Rates will help in significant impact on the development of new products
or modification of existing products.
(2) This will arise when the products manufactured by the manufacturing companies are not
standardized and labour hours are predominating. Further a clear distinction between
value added and non-value added activities are difficult to make

4 Jun'23
A Drug Store of MONSL Ltd. is presently selling three types of drugs namely ‘Drug S’, ‘ Drug T’
and “Drug Z’. It has provided the following data for year 2022-23 for each product line:
Drugs Type
S T Z
Revenues (in ₹) 74,50,000 1,11,75,000 1,86,25,000
Cost of goods sold (in ₹) 41,44,500 68,16,750 1,20,63,750
Number of purchase orders placed (in Nos.) 560 810 630
Number of deliveries received (in Nos.) 950 1000 850
Hours of shelf—stocking time (in hours) 900 1250 2350
Units sold (in Nos.) 1,75,200 1,50,300 1,44,500
Following Additional information is also provided:
Total Cost
Activity Description of Activity Cost Allocation base
(₹)
Drug License Fee Drug License Fee 5,00,000 To be distributed in ratio 2:
3:5 between S, T and Z
Ordering Placing orders for purchases 8,30,000 2,000 purchase orders
Delivery Physical delivery and receipt 18,20,000 2,800 deliveries
of goods
Shelf Stocking Stocking of goods 32,40,000 4,500 hours of shelf-stocking
time
Customer Support Assistance provided to 28,20,000 4,70,000 units sold
customers
You are required to calculate the operating income and operating income as a percentage (%)
of revenue for each product line if:
(i) All the support costs (other than cost of goods sold) are allocated in the ratio of cost of
goods sold.

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 Activity Based Costing
Activity Based Information and Decision Making

(ii) All the support costs (other than cost of goods sold) are allocated using Activity Based
Costing System. [9]

Operating Income

Answer
(a) Operating Income and Operating Income as a percentage of revenues for each
product line.
(When support costs are allocated to product lines based on costs of goods sold of each
product)
Drug S (₹) Drug T (₹) Drug Z (₹) Total (₹)
Operating income: 16,47,700 16,31,550 17,35,750 50,15,000
Operating income as a % of revenues: 22.12% 14.60% 9.32% 13.46%
(b) Operating Income and Operating Income as a percentage of revenues for each
product line.
(When support costs are allocated to product lines using an activity-based costing system)
Drug S (₹) Drug T (₹) Drug Z (₹) Total (₹)
Operating income: 6,56,400 14,20,300 29,38,300 50,15,000
Operating income as a % of revenues: 8.81% 12.71% 15.78% 13.46%

5 Postal Test Paper

ABC Ltd. uses activity based costing and accumulates overhead costs in the following cost
pools:
i. Human Resources
ii. Parts management
iii. Purchasing
iv. Quality Control
v. Equipment set-up
vi. Training employees
vii. Assembly department
viii. Receiving department

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 Activity Based Costing
Activity Based Information and Decision Making

You are to find out for each cost pool whether the cost pool would be unit-level, batch-level,
product-level or facility level. [8 × 1 = 8]

Classification of Activities

Answer
Activity Cost Pool Level
Human Resources Facility-level
Parts management Product-level
Purchasing Batch-level
Quality Control Unit-level
Equipment set-up Unit-level
Training employees Facility-level
Assembly department Unit-level
Receiving department Batch-level

6 MTP Dec'23 Set 1

Your Cost Controller is not happy about the existing system of charging overheads to its Products,
A and B. You have been newly appointed as a Management Accountant of the company and
you are asked to implement the ABC Costing for allocation of overheads to the Products. You
have identified the following activities, budgeted costs, and activity consumption cost drivers
as follows:
Activity Budgeted Cost Activity Consumption Cost Driver
Engineering ₹ 1,25,000 Engineering hours
Setups 3,00,000 Number of setups
Machine operation 15,00,000 Machine-hours
Packing 75,000 Number of packing orders
Total ₹ 20,00,000
You have also gathered the following operating data pertaining to each of its products:
Particulars Product A Product B Total
Engineering hour 5,000 7,500 12,500
Number of setups 200 100 300

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Activity Based Information and Decision Making

Machine hours 50,000 1,00,000 1,50,000

Number of packing orders 5,000 10,000 15,000
You are now required to provide with necessary calculations and relevant information, in the
form of a report to the Cost Controller about the allocation of overheads costs to the products.
[7]

Allocation using ABC

Answer
Basic Calculations and Workings:
Activity Consumption Cost Budgeted Activity Activity Consumption
Budgeted Cost
Driver Consumption Rate
Engineering hours ₹ 1,25,000 12,500 ₹ 10 per hour
Number of setups 3,00,000 300 1,000 per setup
Machine hours 15,00,000 1,50,000 10 per hour
Number of packing Orders 75,000 15,000 5 per order
Factory overhead costs are assigned to both products by these calculations:
Product A (5,000 units)
Rate Activity
Activity Overheads
Activity Consumption Consumption Total Cost Driver
Consumption per unit
Overheads
Engineering hours ₹ 10 5,000 ₹ 50,000 ₹ 10
Number of Setups 1,000 200 2,00,000 40
Machine hours 10 50,000 5,00,000 100
Number of packing orders 5 5,000 25,000 5
Overhead cost per unit 155
Product B (20,000 units)
Activity
Activity Consumption Cost Activity Total Overheads
Consumption
Driver Consumption Overheads per unit
Rate
Engineering hours ₹ 10 7,500 ₹ 75,000 ₹ 3.75
Number of setups 1,000 100 1,00,000 5.00

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 Activity Based Costing
Activity Based Information and Decision Making

Machine hours 10 1,00,000 10,00,000 50.00

Number of packing orders 5 10,000 50,000 2.50
Overhead cost per unit 61.25
The report should cover the above calculations and necessary explanations, about the selection
of Cost Drivers and calculation of Cost Driver rates, for the allocations of overheads to the
Products A and B.

7 MTP Dec'23 Set 2

M Ltd. was absorbing overheads on the basis of direct labour hours. A newly appointed CMA
has suggested that the company should introduce ABC system and has identified cost drivers
and cost pools as follows:
Activity Cost Pool Cost Driver Associated Cost (₹)
Stores Receiving Purchase Requisitions 2,96,000
Inspection Number of Production Runs 8,94,000
Dispatch Orders Executed 2,10,000
Machine Set-up Number of Set-up 12,00,000
The following information is also supplied:
Particulars Product A Product B Product C
No. of Set-up 360 390 450
No. of Orders Executed 180 270 300
No. of Production Runs 50 1,050 1,200
No. of Purchase Requisitions 300 450 500
Calculate activity based production cost of all the three products. [7]

Production cost using ABC

Answer
Selection and computation of Cost Driver Rates:
1. Stores Receiving – No. of Purchase Requisitions = 2,96,000 ÷1250 = 236.8
2. Inspection Cost - No. of Production runs = 8,94,000 ÷2300 = 388.6956
3. Dispatch Cost – No. of orders executed = 2,10,000 ÷750 = 280

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Activity Based Information and Decision Making

12, 00 , 000
4. Machine Setup Costs - No. of setups = = 1,000
1, 200

Computation of Production Cost of Three products

A B C Total
Stores Receiving 71,040 1,06,560 1,18,400 2,96,000
Inspection 19,435 4,08,130 4,66,435 8,94,000
Dispatch 50,400 75,600 84,000 2,10,000
Machine Setup 3,60,000 3,90,000 4,50,000 12,00,000
5,00,875 9,80,290 11,18,835 26,00,000

8 Dec'23
Following are the data of three product lines of a departmental store for the year 2022-23:
Cake Pizza Soft Drinks
Revenues ₹30,24,750 ₹52,51,500 ₹19,83,750
Cost of goods sold ₹22,50,000 ₹37,50,000 ₹15,00,000
Cost of bottles returned ₹30,000
Number of purchase orders placed 360 840 360
Number of deliveries received 660 2,190 300
Hours of shelf-stocking time 2,700 5,400 540
Ttems sold 3,06,000 11,04,000 1,26,000
Additional information related to the store are as follows:
Activity Description of activity Total Cost Cost-allocation base
Bottles Returns Returning of empty bottles ₹ 30,000 Direct tracing to soft
drink line
Ordering Placing of orders for purchases ₹ 3,90,000 1,560 purchase
orders
Delivery Physical delivery and receipt of goods ₹ 6,30,000 3,150 deliveries
Shelf stocking Stocking of goods on store shelves and ₹ 4,32,000 8,640 hours of shelf
on-going restocking stocking time
Customer Assistance provided to customers ₹ 7,68,000 15,36,000 items sold
Support including check-out
Calculate the total cost and operating income using Activity Based Costing system. [7]

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 Activity Based Costing
Activity Based Information and Decision Making

Total cost and Operating income

Answer
Total cost and Operating Income using ABC
Soft Drinks
Cake (₹) Pizza (₹) Total (₹)
(₹)
Total cost: 27,60,000 52,20,000 17,70,000 97,50,000
Operating income 2,64,750 31,500 2,13,750 5,10,000

9 MTP Jun’24 Set 1

A manufacturing company has three accounts clerks responsible for processing purchase
invoices of suppliers. Each clerk is paid a salary of ₹1,50,000 per annum and is capable of
processing 5,000 purchase invoices per year. In addition to the salary, the company spends
₹45,000 per year for printing of forms, postage etc. (assuming that 15,000 purchase invoices
are processed).
During the year, 12,500 purchase invoices were processed.
You are required to:
1. Calculate the activity rate for the purchase order activity. Break the activity rate into fixed
and variable components.
2. Calculate the total activity availability and break this into activity usage and unused
activity.
3. Calculate the total cost of resources supplied and break this into activity usage and unused
activity. [7]

Activity Rate, Used and Unused Activity

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 Activity Based Costing
Activity Based Information and Decision Making

Answer
1. Activity Rate = [(3 × ₹1,50,000) + ₹45,000] ÷ 15,000 = ₹33 per invoice
Fixed Activity Rate = ₹4,50,000 ÷ 15,000 = ₹30 per invoice
Variable Activity Rate = ₹45,000 ÷ 15,000 = ₹3 per invoice.
2. Activity availability = Activity usage + Unused Activity
15,000 invoices = 12,500 invoices + 2,500 invoices
3. Cost of resources supplied = Cost of activity used + Cost of unused activity
or, ₹4,50,000 + (₹3 × 12,500) = (₹33 × 12,500) + (₹30 × 2,500)
or, ₹4,87,500 = ₹4,12,500 + ₹75,000.

10 Jun’24
BONT Ltd., is following Activity Based Costing. The budgeted overheads and cost driver volumes
of the company are as follows:
Budgeted Overheads Budgeted
Cost Pool Cost Driver
(₹) Volume
Material Procurement 11.60 Lakhs No. of Orders 2,200
Material Handling 5.00 Lakhs No. of Movements 1,360
Maintenance 19.40 Lakhs Maintenance hours 16,800
Set-up 8.30 Lakhs No. of Set-ups 1,040
Quality Control 3.52 Lakhs No. of Inspections 1,800
Machinery 14.40 Lakhs No. of Machine hours 48,000
The company has produced a batch of 5200 components AXL 6. Its material cost was ₹ 2.60
Lakhs and labour cost was ₹ 4-90 Lakhs.
The usage of activities for the said batch are as follows:

Material Orders 52 Maintenance hours 1380

Material Movements 36 Quality Control inspections 56
Set-ups 50 Machine hours 3600
Required:
(i) Calculate the cost driver rates that are used for tracing the appropriate amount of
overheads to the said batch (approximate rates to whole number).
(ii) Ascertain the cost of batch of components AXL 6 using Activity Based Costing (ABC).

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 Activity Based Costing
Activity Based Information and Decision Making

Cost Driver Rate and Cost of Batch

Answer
(i) Cost Driver Rates :
(₹)
Material procurement 527
Material Handling 368
Maintenance 115
Set up 798
Quality Control 196
Machinery 30
(ii) Cost of batch of Components AXL 6 using ABC = ₹ 11,08,228

11 MTP Dec’24 Set 1

ABC & Associates provides consulting and tax preparation services to its clients. It charges a
₹100 fee per hour for each service. The firm’s revenues and costs for the month March 2022 are
shown in the following income statement:
Particulars Tax Preparation Tax Consulting Total
Revenue - Amount (₹) 1,30,000 2,70,000 4,00,000
Expenses:
Secretarial support 80,000
Supplies 72,000
Computer costs, etc 40,000
Profit 1,92,000
The firm uses ABC and the following are the cost drives:
Overhead Cost Cost Driver Tax Preparation Tax Consulting
Secretarial support Number of clients 72 48
Supplies Transactions with clients 200 300
Computer costs Computer hours 1,000 600

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Activity Based Information and Decision Making

Required:
(i) Prepare the income statement using activity-based costing and the firm’s three cost
drivers.
(ii) Calculate the income statement using direct-labour hours as the only allocation base:
1,300 hours for tax preparation; 2,700 hours for tax consulting.
(iii) How might the firm’s decisions be altered if it were to allocate all overhead costs using
direct labour hours?
(iv) Under what circumstances would the labour-based allocation and activity-based costing
(using the three cost drivers) result in similar profit results? [7]

Traditional Cost vs Activity Based Cost

Answer
Activity-based versus Traditional Costing
(i)
Tax Preparation Consulting Total
Particulars Amount Amount Amount
₹ ₹ ₹
Revenue 1,30,000 2,70,000 4,00,000
Less: Expenses Secretarial support 48,000 32,000 80,000
Supplies 28,800 43,200 72,000
Computer Depreciation 25,000 15,000 40,000
Profit 28,200 1,79,800 2,08,000
Working Notes:
• ₹80,000 ÷ 120 clients = ₹666.67 per client
• ₹ 72,000 ÷ 500 transactions = ₹144 per transaction
• ₹40,000 ÷ 1,600 hours = ₹25 per computer hour
• ₹666.67 per client × 72 clients = ₹48,000
• ₹144 per hour × 200 transactions = ₹28,800
• ₹25 per computer hour × 1,000 hours = ₹ 25,000

2.20|CMA Inter Management Accounting

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 Activity Based Costing
Activity Based Information and Decision Making

(ii)
Particulars Tax Preparation (₹) Tax Consulting (₹) Total (₹)
Revenue 1,30,000 2,70,000 4,00,000
Expenses 62,400 1,29,600 1,92,000
Profit 67,600 1,40,400 2,08,000
Working Notes:
• ₹48 per labour hour (₹1,92,000 total expenses ÷ 4,000 labour hours )
• ₹62,400 = ₹48 per labour hour × 1,300 hours of labour
• 2,700 labour hours × ₹48 per labour hour = ₹1,29,600
(iii) Under the labour-based overhead allocation, tax preparation appears to be more profita-
ble than it does under ABC, and might lead the firm to concentrate more heavily on tax
preparation.
(iv) ABC and traditional costing systems generally yield comparable product-line profits
when overhead is a small portion of costs, or when cost drivers are highly correlated with
direct-labour hours.
In this case, labour hours were distributed 32.5% to Preparation and 67.5% to Consulting.
If firm’s three cost drivers were each also distributed 32.5% to preparation and 67.5% to
Consulting, the labour-hour and ABC allocation would be identical.

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 Activity Based Costing
Activity Based Information and Decision Making

NOTES

2.22|CMA Inter Management Accounting

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 Marginal Costing


Chapter 3
Marginal Costing

3.1 Concept

3.2 Cost-Volume-Profit Analysis

3.3 Break-Even Charts and Profit Charts

3.4 Multiple Product Break Even Analysis

3.5 Differential Cost Analysis

Marginal Costing Vs. Absorption Costing (advanced

3.6 applications)

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 Marginal Costing
Concept

3.1
Concept

No questions have been asked yet from this chapter !

3.2 |CMA Inter Management Accounting

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 Marginal Costing
Cost-Volume-Profit Analysi

3.2
Cost-Volume-Profit Analysis

No questions have been asked yet from this chapter !

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 Marginal Costing
Break-Even Charts and Profit Chart

3.3
Break-Even Charts and Profit Charts

1 MTP Jun'23 Set 2

(i) Z plc currently sells products Aye, Bee and Cee in equal quantities and at the same selling
price per unit. The contribution to sales ratio for product Aye is 40 per cent; for product
Bee it is 50 per cent and the total is 48 per cent. If fixed costs are unaffected by mix and are
currently 20 per cent of sales. If the product mix is changed to: Aye 40% Bee 25% Cee 35%
Calculate the new total contribution/total sales ratio.
(ii) RT plc sells three products.
Product R has a contribution to sales ratio of 30%.
Product S has a contribution to sales ratio of 20%.
Product T has a contribution to sales ratio of 25%.
Monthly fixed costs are ₹100 000.
If the products are sold in the ratio: R: 2 S: 5 T: 3
Calculate the monthly breakeven point (to nearest ₹) [4 + 4 = 8]

Total Contribution/Total Sales Ratio,

Monthly Breakeven Point

Answer
(i) Let contribution to sales ratio of product Cee is C
Contribution/sales (%) = (0.33 × 40%) + (0.33 × 50%) + (0.33 × C) = 48%
0.33C = 0.48 – 0.132 – 0.65
0.183
C = = 54 %
0.33
Cee = 54% (Balancing figure)
The total contribution/sales ratio for the revised sales mix is:
= (0.40 × 40% ) + (0.25 × 50% ) + (0.35 × 54% )
= 47.4%

3.4 |CMA Inter Management Accounting

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 Marginal Costing
Break-Even Charts and Profit Chart

(ii) Weighted average contribution to Sales ratio

 30%  2    20%  5   25%  3
= = 23.5%
10
Fixed Cost (₹ 1,00,000)
Break even sales = = ₹ 4,25,532
Contribution to sales ratio (23.5%)

2 Jun'23
RONBANI Ltd., a manufacturing company, has prepared its budget to produce 2,00,000 units.
The variable cost per unit is ₹ 16 and fixed cost is ₹ 4 per unit. The company fixes its selling price
to fetch a profit of 20% on total cost.
You are required to calculate:
(i) Present break-even sales (in quantity).
(ii) Revised break-even sales (in quantity), if it reduces its selling price by 10%. [4]

Break-even Sales

Answer
(i) Present Break-even Sales (quantity) = 1,00,000 units
(ii) Revised Break-even Sales (quantity) = 1,42,858 units

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 Marginal Costing
Multiple Product Break Even Analysis

3.4
Multiple Product Break Even Analysis

1 MTP Dec'23 Set 1

S Ltd. furnishes you the following information relating to the half year ended 30th June, 2022.

Fixed expenses ₹ 45,000

Sales value ₹ 1,50,000
Profit ₹ 30,000
During the second half the year the company has projected a loss of 710,000.
Calculate:
(i) The B.E.P and M/S for six months ending 30th June, 2022.
(li) Expected sales volume for the second half of the year assuming that the P/V Ratio and
Fixed expenses remain constant in the second half year also.
The B.E.P and M/S for the whole year for 2022. [7]

B.E.P and M/S Half year and Whole year

Answer
Fixed Cost  Profit
(i) P/V Ration = 100
Sales
₹ 45,000 + ₹ 30,000
= × 100 = 50%
1,50,000
₹ 45,000
B.E Sales for half year = = ₹ 90,000
0.5
MIS for half year = ₹ 1,50,000 – ₹ 90,0000 = ₹ 60,000

3.6 |CMA Inter Management Accounting

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 Marginal Costing
Multiple Product Break Even Analysis

` 45, 000    ` 10 , 000 

(ii) Expected Sales = = 50%
S
0.5S = ₹ 35,000
35, 000
S= = ₹ 70,000
0.5
90 , 000
B.E Sales for Whole year = = ₹ 1,80,000
0.5
Margin of safety for whole year = (₹ 1,50,000 + ₹ 70,000) – ₹ 1,80,000 = ₹ 40,000

2 MTP Dec'23 Set 2

Y Company has just been incorporated and plan to produce a product that will sell for ₹10 per
unit. Preliminary market surveys show that demand will be around 10,000 units per year. The
company has the choice of buying one of the two machines ‘A’ would have fixed costs of ₹30,000
per year and would yield a profit of ₹30,000 per year on the sale of 10,000 units. Machine ₹B’
would have fixed costs ₹18,000 per year and would yield a profit of ₹22,000 per year on the sale
of 10,000 units. Variable costs behave linearly for both machines.
Required to calculate:
(i) Break-even sales for each machine
(ii) Sales level where both machines are equally profitable
(iii) Range of sales where one machine is more profitable than the other. [7]

Break-even, Indifference Point & Range of

sales

Answer
(i) Computation of Break Even of each machine and other required information:
A (₹) B (₹)
Selling price 10 10
Units 10,000 10,000
Sales 1,00,000 1,00,000
Fixed Cost 30,000 18,000
Contribution (F+P) 60,000 40,000

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 Marginal Costing
Multiple Product Break Even Analysis

Contribution/Unit 6 4
Variable Cost per unit 4 6
(i) Break Even Units 30 , 000 18 , 000
= 5,000 units (or) = 4,500 units (or)
6 4
= ₹ 50,000 = ₹ 45,000
(ii) Sales level where both machine are equally profitable
Differences in Fixed Cost 30 , 000  18 , 000
=  = 6000 Units
Differences in V.C per Unit 64

(iii) For sales level of 6,000 and above units, machine A would be more profitable because
variable cost/unit is less and on the other hand, if sales level below 6,000 units Machine B
would be more profitable.

3.8 |CMA Inter Management Accounting

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 Marginal Costing
Differential Cost Analysi

3.5
Differential Cost Analysis

1 Postal Test Paper

A company is at present working at 90 per cent of its capacity and producing 13,500 units per
annum. It operates a flexible budgetary control system. The following figures are obtained from
its budget.
Particulars 90% 100%
Sales (₹) 15,00,000 16,00,000
Fixed expenses (₹) 3,00,500 3,00,600
Semi-fixed expenses (₹) 97,500 1,00,500
Variable expenses (₹) 1,45,000 1,49,500
Units made 13,500 15,000
Labour and material costs per unit are constant under present conditions. Profit margin is 10
per cent.
(a) You are required to determine the differential cost of producing 1,500 units by increasing
capacity to 100%
(b) What would you recommend for an export price for these 1,500 units taking into account
that overseas prices are much lower than indigenous prices? [7]

Export Offer

Answer
Computation of material and labour cost
Particulars ₹ ₹
Sales at present 15,00,000
(-) Profit @ 10% 1,50,000
Total cost 13,50,000

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 Marginal Costing
Differential Cost Analysi

(-) All costs other than material & labour

Fixed expenses 3,00,500
Semi fixed expenses 97,500
Variable expenses 1,45,000 5,43,000
Material & Labour cost 8,07,000
(a) Statement showing differential cost of 1500 units:
Particulars ₹
Material & Labour (₹ 8,07,600 × 1500 ÷ 13,500) 89,667
Fixed expenses ( ₹ 3,00,600 – ₹ 3,00,500) 100
Semi fixed expenses (₹ 1,00,500 – ₹ 97,500) 3,000
Variable expenses (₹ 1,49,500 – ₹ 1,45,000) 4,500
Differential cost 97,267
(b) Differential cost per unit = ₹ 97,267 ÷1,500 = ₹ 64.84
The minimum price for these 1,500 units should not be less than ₹ 64.84.

3.10 |CMA Inter Management Accounting

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 Marginal Costing
Marginal Costing Vs. Absorption Costing (advanced applications)

3.6
Marginal Costing Vs. Absorption
Costing (advanced applications)

1 MTP Jun'23 Set 1

I. The following data has been extracted from the cost records of CYTOGEN Inc.For a particu-
lar period, the Sales revenue is ₹ 2,00,000 and the profit is ₹ 20,000. If it is known that the
variable Cost ratio is 60% you are required to calculate:
(i) the Contribution to Sales Ratio
(ii) the Fixed Cost and
(iii) the Sales volume to earn a profit of ₹ 50,000
II. What do you mean by Angle of Incidence in a Break-Even Chart? Can it be used in manageri-
al decision making? [4 + 4 = 8]

PV Ratio, Fixed Cost, Sales, AOI

Answer
I. Sales = ₹ 2,00,000
Variable Cost = 60% = ₹ 1,20,000
(1) P/V Ratio = 40%
(2) Contribution = ₹ 80,000
Contribution = Fixed Cost + Profit
Or, fixed Cost = ₹ 62,000
(3) Sales volume to earn a profit of ₹ 50,000 = Fixed Cost + Desired Profit ÷ P/V Ratio
= ₹ 2,75,000

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 Marginal Costing
Marginal Costing Vs. Absorption Costing (advanced applications)

II. The formal break even chart is as follows:

y Total Sales

Cost & Revenue

b Total Cost

Angle of Incidence

a FC

o Unit x
Area represented by a = Loss Area Area represented by b = Profit Area

At the intersection point of the total cost line and total sales line, an angle is formed called
Angle of Incidence.
Yes, it can be used in managerial decision making. The break even analysis is used to answer
many questions of the management in day to day business.

2 MTP Jun'23 Set 1 & Set 2

An exporter of auto machine parts is earning a profit of ₹ 1,00,000 on a sale of ₹ 12,00,000.
Selling price is ₹ 40 per part and variable cost is ₹ 30 per part. The exporter incurs an additional
fixed cost of ₹ 3,00,000 on product improvement which also enables him to economise ₹ 5 in
per part variable cost. As per trade agreements, the sale of his parts is restricted to the old value
of ₹ 12,00,000.
Determine the selling price per part so that the exporter earns the same profit at the same
sales value? [7]

Sales to Earn the Required Profit

Answer
Units sold = Sales ÷ Selling Price per unit = ₹ 12,00,000 ÷ ₹ 40 = 30,000 units

Sales 40 12,00,000
Less: Variable Cost 30 9,00,000
Contribution 10 3,00,000

3.12 |CMA Inter Management Accounting

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 Marginal Costing
Marginal Costing Vs. Absorption Costing (advanced applications)

Less: Profits 1,00,000

Fixed cost 2,00,000
Hence, total fixed cost in the new case = ₹ 2,00,000 + ₹ 3,00,000 = ₹ 5,00,000
Contribution in the New Case = New Fixed Cost + Profits = 5,00,000 + 1,00,000 = ₹6,00,000
Since as per agreement the sale value is restricted to the old value that is ₹12,00,000.
Hence P/V Ratio will be:
₹ 6,00,000 ÷ ₹12,00,000 × 100 = 50%
The variable cost in the new case = ₹ 30 - ₹ 5 = ₹ 25
Variable Cost Ratio = 100 - P/V Ratio = 100 - 50 = 50%
Computation of New Selling Price:
If VC is 50, then SP = ₹ 100
If VC is 1, then SP = 100 ÷ 50
If VC is 25, then SP = 100 ÷ 50 × 25 = ₹ 50 per unit

3 Jun'23
Write down the differences between Absorption Costing & Marginal Costing. [4]

Absorption Costing Vs Marginal Costing

Answer
The differences between Absorption Costing & Marginal Costing are:
Absorption Costing Marginal Costing
Both fixed and variable costs are considered Only variable costs are considered for
for product costing and inventory valuation. product costing and inventory valuation.
Fixed costs are charged to the cost of Fixed costs are regarded as period costs. The
production. Each product bears a reasonable profitability of different products is judged
share of fixed cost and thus the profitability by their P/V ratio.
of a product is influenced by the apportion-
ment of fixed costs.

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 Marginal Costing
Marginal Costing Vs. Absorption Costing (advanced applications)

Cost data are presented in convention- Cost data are presented to highlight the total
al pattern. Net profit of each product is contribution of each product.
determined after subtracting fixed cost along
with their variable cost.
The difference in the magnitude of opening The difference in the magnitude of opening
stock and closing stock affects the unit cost stock and closing stock does not affect the
of production due to the impact of related unit cost of production.
fixed cost.
In case of absorption costing the cost per In case of marginal costing the cost per
unit reduces, as the production increases as unit remains the same, irrespective of the
it is fixed cost which reduces, whereas, the production as it is valued at variable cost.
variable cost remains the same per unit.

4 Jun'23
M/s Ankita Plastics Limited provides you the data of the following products for the year 2022-23.
Particulars 1" PVC Pipe 1/2" PVC Pipe
Profit (₹) 3,00,000 60,000
Unit Selling price (₹) 200 150
P/V Ratio 40% 50%
Sales Mix = 2:1
Joint Fixed Cost = ₹ 8,15,000
M/s Ankita Plastics Limited expects that number of units to be sold in 2023-24 would be same as
in 2022-23. However, due to upgradation in manufacturing process, the joint fixed cost would
be reduced by 10% and the variable cost would increase by 8%.
You are required to calculate the following:
A. Number of units of product 1” PVC Pipe and 1/2” PVC Pipe sold in 2022-23.
B. Total expected profit of the company from the two products in 2023-24. [ 4 + 3 = 7]

Units Sold, Expected Profit Weighted Average Basis

3.14 |CMA Inter Management Accounting

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 Marginal Costing
Marginal Costing Vs. Absorption Costing (advanced applications)

Answer
A. Number of units of products- sold in 2022-23
1’’ PVC Pipe 10,000 units
1/2’’ PVC Pipe 5,000 units
B. Total expected profit of the company from the two products in 2023-24 = ₹ 3,15,500

5 Postal Test Paper

ABC Limited has production capacity of 5,00,000 units per annum at its full capacity.
Company’s Cost structure is as under:

Variable production cost per unit ₹ 32.00

Variable selling expenses per unit ₹ 9.60
Fixed production cost per annum ₹ 30,00,000
Fixed selling expenses per annum ₹ 20,00,000
During the year ended 31st March, 2023, the company worked at 80 percent of its capacity. The
operating data for the year are as follows:
Production 4,00,000 Units
Sales ₹ 64 per Unit; 3,87,500 Units
Opening stock of finished goods 50,000 Units
Fixed production expenses are absorbed on the basis of capacity and fixed selling expenses are
recovered on the basis of period.
You are required to prepare statements of Cost and Profit for the year ending 31st March, 2023:
(a) On the basis of marginal costing
(b) On the basis of absorption costing [3 + 4 = 7]

Marginal vs Absorption - with opening

stock

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 Marginal Costing
Marginal Costing Vs. Absorption Costing (advanced applications)

Answer
(a) Statement of Cost and Profit under Marginal Costing for the year ending 31st March,
2022 Output = 4,00,000 units
Particulars Amount (₹) Amount (₹)
Sales: (3,87,500 units @ ₹ 64 per unit) 2,48,00,000
Less: Marginal costs:
Variable cost of production (400000 × ₹ 32) 1,28,00,000
Add: Opening stock (50000 units @ ₹ 32) 16,00,000
Less: Closing Stock [(4,00,000 + 50,000 – 3,87,500) = 62,500 (20,00,000)
units @ ₹ 32]
Variable cost of production of 3,87,500 units 1,24,00,000
Add: Variable selling expenses @ ₹ 9.60 per unit 37,20,000 1,61,20,000
Contribution (sales – variable cost) 86,80,000
Less: Fixed Cost of Production 30,00,000
Fixed selling expenses 20,00,000 50,00,000
Profit under marginal costing 3,68,0000
(b) Statement of Cost and Profit under Absorption Costing for the year ending 31st
March, 2022 Output = 4,00,000 units
Particulars Amount (₹) Amount (₹)
Sales: 3,87,500 units @ ₹ 64 2,48,00,000
Less : Cost of sales:
Variable cost of production (4,00,000 @ ₹ 32) 1,28,00,000
Add: Fixed cost of production absorbed 4,00,000 units @ ₹ 24,00,000
6 (As per W.N. 1)
Add: Opening Stock 19,00,000
Less : Closing Stock 23,75,000
Production cost of 3,87,500 units 14,72,5000
Selling expenses: Variable: ₹ 9.60 × 3,87,500 units 37,20,000
Fixed 20,00,000 2,04,45,000
Profit 43,55,000
Less : Overheads under absorbed: (As per W.N. 2) 6,00,000
Profit under absorption costing 37,55,000
Working Notes:
(a) Absorption rate for fixed cost of production = ₹ 30,00,000÷5,00,000 units = ₹ 6 per unit
(b) Fixed production overhead under absorbed = ₹ (30,00,000–24,00,000) = ₹ 6,00,000

3.16 |CMA Inter Management Accounting

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 Marginal Costing
Marginal Costing Vs. Absorption Costing (advanced applications)

6 Postal Test Paper

From the cost records of a company for a specific period, for product X, the information given
in the first column can be ignored since it is only one of the several projections of an assistant
accountant, but it may be useful to you.
Particular This Period Actual (₹) One of The Future Projections (₹)
Sales (Units) 10,000 20,000
Profit (Loss) (10,000) 10,000
Fixed Costs 30,000 30,000
Variable Cost Per Unit 8 8
On the basis of the first column, determine
1. What increased sales volume is required to cover an additional attractive packaging cost
of ₹ 0.50 per unit, to increase the sales, at the existing sales price, to yield zero profit?
2. What increased sales volume is in required at the present sale price, to cover an additional
publicity expense of ₹ 5,000 for that period, while yielding a profit of ₹ 5,000.
3. What increased sales volume is required to reach a profit of ₹ 4,000 while reducing the
selling price by 3 per cent per unit? [7]

Increase in SP and Volume

Answer
(1) Sales volume required to yield zero profit: = Fixed costs/ CM per unit = ₹ 30,000/₹ 1.50 =
20,000 units. Sales volume required = 20,000 units (₹ 2,00,000). Existing sales volume =
10,000 units (₹ 1,00,000). Difference represents increase in sales volume required to make
zero profit = 10,000 units (₹ 1,00,000).
(2) Assuming situation (2) independent of (1): Sales volume required to earn a profit of ₹ 5,000
= [₹ 30,000 + ₹ 5,000 (publicity expenses) + ₹ 5,000 (profit)]/₹ 2 = 20,000 units (₹ 2,00,000);
10,000 units (₹ 1,00,000) is the increased sales volume required.
(3) Assuming (3) to be independent of situations (1) and (2): Desired sales volume to earn a
profit of ₹ 4,000= (₹ 30,000 + ₹ 4,000)/(₹ 9.70 – 8) = 20,000 units (or ₹ 1,94,000). Increased
sales volume required is 10,000 units.
Working Note:
Determination of total sales revenue and selling price per unit:
Total sales revenue = Total costs – Loss

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 Marginal Costing
Marginal Costing Vs. Absorption Costing (advanced applications)

Total costs = FC + (VC per unit × Sales in units)

₹ 80,000 = ₹ 30,000 + (₹ 8 × 10,000)
Total sales revenue = ₹ 1,10,000 – ₹ 10,000 = ₹ 1,00,000
SP per unit = ₹ 1,00,000/10,000 = ₹ 10.

7 Postal Test Paper

A Co. currently operating at 80% capacity has the following; profitability particulars:
Amount Amount
Particulars
(₹) (₹)
Sales 12,80,000
Costs:
Direct Materials 4,00,000
Direct labour 1,60,000
Variable Overheads 80,000
Fixed Overheads 5,20,000 11,60,000
Profit 1,20,00
An export order has been received that would utilise half the capacity of the factory. The order
has either to be taken in full and executed at 10% below the normal domestic prices, or rejected
totally.
The alternatives available to the management are given below:
(i) Reject order and Continue with the domestic sales only, as at present;
(ii) Accept; order, split capacity equally between overseas and domestic sales and turn away
excess domestic demand;
(iii) Increase capacity so as to accept the export order and maintain the present domestic sales
by:
(a) buying an equipment that will increase capacity by 10% and fixed cost by ₹40,000 and
(b) Work overtime at one and a half the normal rate to meet balance of required capacity.
Prepare comparative statements of profitability and suggest the best. [12]

Export Offer

3.18 |CMA Inter Management Accounting

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 Marginal Costing
Marginal Costing Vs. Absorption Costing (advanced applications)

Answer
Statement showing computation of comparative profit of different alternatives:
Amount (₹)
Particulars 80% capacity 100% capacity 130% capacity
Sales 12,80,000 *8,00,000 + 7,20,000 **12,80,000 + 7,20,000
Variable cost:
Material 4,00,000 5,00,000 6,50,000
Direct labour 1,60,000 2,00,000 2,60,000
Variable Overheads 80,000 1,00,000 1,30,000
Overtime premium 20,000
6,40,000 8,00,000 10,60,000
Contribution 6,40,000 7,20,000 9,40,000
Fixed cost (5,20,000) (5,20,000) (5,60,000)
Profit 1,20,000 2,00,000 3,80,000
From the above computations we find that the profit is more at alternative III i.e., accepting the
foreign order fully & maintaining the present domestic sales.
12, 80 , 000 1 12, 80 , 000 1
*     90%
80% 2 80% 2

12, 80 , 000 12, 80 , 000 1

**    90%
80% 80% 2

8 MTP Dec'23 Set 2

From the following information calculate:
(1) P/V Ratio
(2) Break-Even Point
(3) If the selling price is reduced to ₹ 80, calculate New Break-Even Point:
₹
Total sales 5,00,000
Selling price per unit 100
Variable cost per unit 60
Fixed cost 1,20,000
[7]

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 Marginal Costing
Marginal Costing Vs. Absorption Costing (advanced applications)

PVR, BEP

Answer
(1) P/V Ratio = Contribution ÷ Sales × 100
Contribution = Sales - Variable Cost
Total Sales = ₹ 5,00,000
Selling price per unit = ₹ 100
Sales in units = 5,000 units
Contribution = ₹ 2,00,000
P/V Ratio = 40%
(2) Break-Even Point in sales = Fixed Cost ÷ P/V Ratio = ₹ 3,00,000
(3) If the Selling price is reduced to ₹ 80 : Sales = ₹ 4,00,000
P/V Ratio = (80 - 60) ÷ 80 = 25% ,
Contribution per unit = 80 - 60 = ₹ 20
Break-Even Point (in units) = 1,20,000 ÷ 20 = 6,000 units
Break-Even Point in Sales = 1,20,000 ÷ 25% = ₹ 4,80,000

9 Dec'23
M/s BLB Industries provided you the following information for the year ended 31-03-2023:
Amount
Particulars
(In ₹)
Sales 40,000
Raw Material Cost 20,000
Direct Wages 6,000
Fixed & Variable Overhead 10,000
Profit 4,000
Units Sold 200 units
In the next financial year M/s BLB Industries expects the following:
(i) Wage rate will increase by 50%.
(i) Fixed Cost will decrease by ₹ 1,000.

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 Marginal Costing
Marginal Costing Vs. Absorption Costing (advanced applications)

(iii) No. of units to be sold in the next year is 300 units.

(iv) Total Fixed & Variable overhead in the next financial year will be ₹ 12,000.
How many units are required to be sold in the next year so that same amount of profit per unit
as in 2023 can be achieved? [7]

Number of units to be sold

Answer
600 Units to be sold in 2023-24 to earn same amount of profit per unit of the last year (2022-23).

10  MTP Jun’24 Set 1

Reaxon Ltd. a manufacturing company provides you the following details for the year 2023:

Sales (16,000 units) ₹16,00,000

Less : Expenses (including ₹ 8,00,000 Fixed Expenses) ₹17,60,000
Net loss ₹ 1,60,000
The manager believes that an increase of ₹4,00,000 in advertising outlays will increase sales
substantially. His plan was approved by the chairman of the board.
Required:
(i) Calculate P/V Ratio and Break Even Sales.
(ii) Calculate what additional sales will be required to offset that increase in advertisement
outlays.
(iii) Determine what should be selling price per unit if the breakeven point is brought down to
20,000 units? [7]

P/V Ratio, BES, Additional Sales to offset,

SP for BE

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Marginal Costing Vs. Absorption Costing (advanced applications)

Answer
(i) Calculation of P/V Ratio and Break Even Sales (BES):
P/V Ratio = (Sales -Variable Cost)/ Sales × 100
P/V Ratio = (16,00,000 - 9,60,000)/ 16,00,000 × 100
P/V Ratio = 40%
BEP (Sales) = (Fixed Cost)/ (P/ V Ratio)
= (₹ 8,00,000 + ₹ 4,00,000)/40%
= ₹ 30,00,000
Or,
BEP (Sales) Unit = (₹8,00,000+₹4,00,000)/ (₹100-₹60)
= ₹12,00,000/₹40
= 30,000 units.
(ii) Additional Sales Volume = (Proposed Expenditure)/ (P/V Ratio)
= ₹4,00,000/40%
= ₹10,00,000
(iii) Selling price if BEP is 20000 units:
BEP = Fixed cost / contribution
20,000 = 12,00,000/C,
or C = ₹12,00,000/20,000
= ₹60
S-V=C
Sales – ₹60 = ₹60
Sales = ₹60 + ₹60 = ₹120 Or,
SP per unit = VC Per unit + (Contribution/BEP)
= ₹60 + (₹12,00,000/20,000)
= ₹120

11 Jun’24
RNS Ltd., a manufacturing company has introduced a new product and marketed 20000 units.
The variable cost and profit of the product are ₹ 20 per unit and ₹ 4 per unit respectively.
The Fixed overheads are ₹ 3,20,000.

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 Marginal Costing
Marginal Costing Vs. Absorption Costing (advanced applications)

Required:
(i) Analyse the BEP (in quantity) and Margin of Safety (in amount).
(ii) Calculate the Margin of Safety if profit is ₹ 64,000.
(iii) If the selling price is reduced by the company by 10%, demand is expected to increase
by 5000 units. Analyse its impact on Profit, BEP (in quantity) and Margin of Safety (in
amount). [7]

BES, MOS, SP

Answer
(i) BEP = 16,000 units
Margin Of Safety (MOS) = ₹ 1,60,000
(ii) MOS = ₹ 1,28,000 or 3,200 units
(iii) Profit = ₹ 80,000
BEP = 20,000 units MOS = ₹ 1,80,000
Thus, MOS is also increased by ₹ 20,000 in case of reduction in selling price.

12 MTP Dec’24 Set 1

Company XYZ manufactures and sells a single product. Here are the details for the current
period:
Selling Price per Unit: ₹50
Variable Cost per Unit: ₹30
Profit: ₹20,000
Current Sales Volume: 5,000 units
Calculate the following:
(i) Fixed cost
(ii) P/v ratio
(iii) Break-Even Point in Units
(iv) Margin of safety
(v) Number of Units Needed to Achieve a Desired Profit of ₹40,000 [7]

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 Marginal Costing
Marginal Costing Vs. Absorption Costing (advanced applications)

Fixed Cost, PVR, BEP, MOS, Units to be sold

Answer
(i) Calculation of Fixed cost:
Sales = current sales volume × selling price per unit
= 5,000 units×₹50
= ₹2,50,000
Variable cost = variable cost per unit × current sales volume
= ₹30 × 5,000 units
= ₹1,50,000
Contribution = sales – variable cost
= ₹2,50,000-1,50,000
=1,00,000
Profit =₹20,000
Fixed cost = contribution – profit
= 1,00,000-20,000
= 80,000
(ii) Calculation of P/V ratio:
P/V ratio = contribution/ sales
= 1,00,000/2,50,000
= 40%
(iii) Calculation of Break-even point in units
Break - even sales = fixed cost ÷ p/v ratio
= 80,000/40%
= ₹200,000
Break-even point in units = break-even sales/ selling price per unit
= ₹2,00,000/₹50
= 4,000units.

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 Marginal Costing
Marginal Costing Vs. Absorption Costing (advanced applications)

(iv) Calculation of margin of safety

MOS = sales – break-even sales
= ₹2,50,000-₹2,00,000
= ₹50,000
(v) Number of units needed to achieve a desired profit of ₹40,000
Desired Profit = ₹40,000 Fixed cost = ₹80,000
Desired Contribution = fixed cost + profit
= ₹80,000 + ₹40,000
= ₹1,20,000
Desired sales = desired contribution/ p/v ratio
= ₹1,20,000/40%
= ₹3,00,000
Therefore, no. of units needed to achieve a desired profit of ₹40,000 = ₹3,00,000/₹50
= 6,000 units.

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 Marginal Costing
Marginal Costing Vs. Absorption Costing (advanced applications)

NOTES

3.26 |CMA Inter Management Accounting

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 Applications of Marginal Costing in Short Term Decision Making


Chapter 4
Applications of Marginal Costing in
Short Term Decision Making

4.1 Pricing Decision

4.2 Make or Buy decisions

4.3 Accept an Order or Reject

Optimum Utilization of Factors of Production

4.4 [Limiting Factor Analysis]

4.5 Replacement Decision

4.6 Evaluation of Alternative Choices

4.7 Subcontracting and Ancillarisation

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 Applications of Marginal Costing in Short Term Decision Making


4.8 Expansion of Business

4.9 Shutdown or Continue

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 Applications of Marginal Costing in Short Term Decision Making
Pricing Decision

4.1
Pricing Decision

1 Postal Test Paper

A Company is manufacturing a product marks an average net profit of ₹ 2.50 per piece on a
selling price of ₹ 14.30 by producing and selling 6,000 pieces or 60% of the capacity. His cost of
sales is as under:
Particulars ₹
Direct material 3.50
Direct wages 1.25
Works overheads (50% fixed) 6.25
Sales overheads (25% variable) 0.80
During the current year, he intends to produce the same number but anticipates that fixed
charges will go up by 10%, with direct labour rate and material will increase by 8% and 6%
respectively but he has no option of increasing the selling price. Under this situation, he obtains
an offer for further 20% of the capacity.
What minimum price you will recommend for acceptance to ensure the manufacturer an
overall profit of ₹ 16,730. [2 + 6 = 8]

Minimum Price

Answer
Computation of profit at present after increase in cost
Particulars ₹
Selling price 14.30
Variable costs:
Material (₹ 3.5 × 106÷100) 3.710
Labour (₹ 1.25 × 108÷100) 1.350

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 Applications of Marginal Costing in Short Term Decision Making
Pricing Decision

Works overhead 3.1250

Sales overhead 0.200
Total 8.385
Contribution per unit 5.915
Total contribution (6,000 × ₹ 5.915) 35,490
Fixed costs
Works OH ₹ 3.125
Sales OH ₹ 0.600 3.725 (₹ 3.725 × 6,000 = ₹ 22,350 × 110/100) 24,585
Profit 10,905

Computation of selling price of the order (₹ )

Variable cost of order (2,000 × 8.385) 16,770
(+) required profit (16,730 – 10,905) 5,825
Sales required 22,595
Selling price of order = ₹ 22,595÷2,000 = 11.2975 (or) 11.30

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 Applications of Marginal Costing in Short Term Decision Making
Make or Buy decisions

4.2
Make or Buy decisions

1 MTP Jun'23 Set 1

As a Management Accountant of Bush Radio Company you find that while it costs ₹ 12.50
to make a component X, the same is available in the market at ₹ 11.50 with an assurance of
continued supply. The break-down of the cost is:
Elements of cost ₹
Materials ₹ 5.50
Labour ₹ 3.50
Other variable overheads ₹ 1.00
Depreciation & other fixed cost ₹ 2.50
Total Cost ₹ 12.50
a. Analyse the above situation and submit the needful cost related information to enable the
management to take a make or buy decision?
b. Examine the possibility of accepting an offer of ₹ 9.70 each per unit received from the
supplier. [8]

Make or Buy

Answer
Marginal Cost Statement
Particulars Per Unit ₹
Materials 5.50
Labour 3.50
Variable Overheads 1.00
Marginal Cost 10.00

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Make or Buy decisions

1. The marginal cost of producing the component is ₹ 10 per unit and fixed cost per unit is ₹
2.50, thereby making a total cost of ₹ 12.50 per unit. But this component is available in the
market at ₹ 11.50. As the market price per unit is less than the total cost, apparently it looks
better to buy the component instead of making it. But a close observation reveals that the
component will actually cost ₹ 14 (i.e. 11.50+2.50) if it is purchased, as the fixed cost of ₹
2.50 is required to be incurred even if the component is purchased. Therefore, it may not
be wise to buy a component which will actually cost ₹ 14, which is being manufactured at
₹ 12.50.
2. If the price offered by the supplier is ₹ 9.70 per unit, then it is advisable to purchase the
component from the outside market as the outside market price of ₹ 9.70 is less than
marginal cost of ₹ 10. There will be saving of ₹0.30 per unit if the component is purchased
from outside market
One of the best ways for sales promotion is to offer quotations at low rates. A company is
producing 80,000 units (80% of capacity) and making a profit of ₹ 2,40,000. Suppose the Central
Government has given a tender notice for 20,000 units. It is expected that the units taken by the
Government will not affect the sale of 80,000 units which the company is already selling and
the company also wishes to submit the lowest possible quotation. The company may quote
any amount above marginal cost, because it will give an additional marginal contribution and
hence profit.

2 Dec’23
M/s Bishalgarh Tiles Limited is manufacturing and selling 4 types of PVC Pavers Block which are
used for laying in public parks. The Board of Dircctors of M/s Bishalgarh Tiles Limited is consider-
ing a proposal for product promotion campaign which would cost the company ₹2,50,000. The
Business development department of M/s Bishalgarh Tiles Limited provides you the following
two alternative Sales Budgets for the next financial year.
Alternative-1 Produets (Units in Nos.)
Without Product AON NEON ZEON PP
Promotion Campaign 2,00,000 3,50,000 3,20,000 1,90,000

Alternative-2 Produets (Units in Nos.)

Without Product AON NEON ZEON PP
Promotion Campaign 2,40,000 3,80,000 3,50,000 2,00,000
Selling price and Variable Production Cost are budgeted as follows:
Products (₹ Per Unit)
Particulars
AON NEON ZEON PP
Selling Price 12.00 14.00 16.00 22.00
Variable Production Cost:

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 Applications of Marginal Costing in Short Term Decision Making
Make or Buy decisions

Direct Material 5.00 6.50 8.00 10.00

Direct Labour 2.00 2.50 3.50 4.50
Tlmiablc Production Overhead 0.84 0.72 1.20 1.20
M/s Bishalgarh Tiles Limited provides you the following additional details:
(i) The Variable production overhead is absorbed on a Machine Hour basis at a rate of ₹ 1.20
per Machine hour.
(ii) Fixed overhead to be ₹ 35,000 p.a.
(iii) Production capacity during the budgeted period is 8,90,000 Machine hours.
(iv) Product AON & ZEON could be bought from market at ₹ 10.50 per unit & ₹ 15.50 per unit
respectively. ’
(v) The machine capacity will not increase after product promotion campaign.
Determine whether M/s Bishalgarh Tiles Limited should invest in product promotion campaign
and advise how the production facilities would be best utilized. [14]

Investment in Product Promotion

Campaign

Answer
Incremental Gain ₹ 50000
Decision: M/s Bishalgarh Limited should invest in Product Promotion Campaign as the same
will increase overall profit of the Company by ₹ 50000.

3 Dec’23
Company XYZ produces two components (M and N) and is planning the allocation of its
available resources for the next period. 750 units of component M and 600 units of component
N are required to be produced but machine hour capacity is restricted to a total of 3,000 hours.
Any deficit of components produced in-house can be made up by the purchase of any quantity
of either component from an outside supplier. The objective of the company is to satisfy the
requirement for components at minimum total cost.

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 Applications of Marginal Costing in Short Term Decision Making
Make or Buy decisions

The following information is available concerning cach component.

Particulars M N
Cost (% per unit): 62.00 87.00
Direct Materials
Direct Labour 51.00 75.00
Variable production overheads 12.00 13.00
Fixed production overheads 48.00 64.00
Total 173.00 239.00
Machine hours (per unit) 2.00 3.00
Price from outside supplier (% per unit) 185.00 259.00
Calculate the variable costs of producing each component in - house, extra costs of buying-in
each component and determine which component should have production priority. [7]

Variable costs and Production Priority

Answer
Products M(₹) N(₹)
Total Variable Cost of producing in-house 125 175
Extra cost of buying in each component 60 84
Extra cost of buying per machine hour 30 28
Priority should be given to the In-house production of component M in order to minimize the
extra cost of buying-in.

4 MTP Jun’24 Set 1

Susma Products Co. Ltd. manufactured and sold in a year 15,000 units of a particular product
fetching a sales value of ₹15 lakhs. After charging direct material @ 30% on sales value, direct
labour 20% on sales value, variable overheads ₹10 per unit, the company earned profit of ₹ 162/3
per unit during the year. The existing equipment can produce a maximum of 20,000 units per
annum. In case, the demand exceeds the maximum output, new equipment will be required
which will cost ₹10 lakhs and it will have a life span of 10 years, with no residual value.
A prospective customer is willing to place an order on the company for 10,000 units per year
regularly at 90% of the present selling price, which will be, if accepted, over and above the
existing market for 15,000 units.

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 Applications of Marginal Costing in Short Term Decision Making
Make or Buy decisions

Irrespective of the fact whether or not the new order materializes, the cost increases with
immediate effect are:
1. 10% in the Direct Materials.
2. 25% in the Direct Labour.
3. ₹50,000 in Fixed Overheads per year.
If the order of additional 10,000 units is accepted, the fixed overhead will increase by another
₹50,000 by way of increased administration expenses.
You are required to determine whether the company should accept the new business at the
stipulated price or decline the new offer and make a concerted sales drive to sell the present
unused capacity at the present selling price. The sales drive will cost ₹ 60,000 per year.
Ignore the financial charges on the cost of the equipment and assume there is no opening and
closing inventories. Variable costs will increase in direct proportion to the output. [14]

Evaluation of new offer

Answer
Present Selling price = ₹ 15,00,000/15,000 units = ₹ 100 per unit

Present Cost Structure: ₹

Direct materials (30% of sales value) 4,50,000
Direct labour (20% of sales value) 3,00,000
Variable overheads (₹10 per unit) 1,50,000
9,00,000
Contribution (₹ 15,00,000 – ₹9,00,000) 6,00,000
Profit (₹ 16 2/3 per unit ) 2,50,000
Fixed Overheads 3,50,000
Comparative statement of the proposals (Revised cost basis)
Present Maximum Present plus
Particulars
capacity Capacity 10,000 units
Units 15,000 20,000 25,000
Sales value (₹) 15,00,000 20,00,000 15,00,00
(+) 9,00,000
= 24,00,000
Direct materials (33% on sales value)(₹) 4,95,000 6,60,000 4,95,000

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 Applications of Marginal Costing in Short Term Decision Making
Make or Buy decisions

(10/15 × ₹4,95,000) (+) 3,30,000

Direct labour (25% on sales value) (₹) 3,75,000 5,00,000 3,75,000
(10/15 × 3,75,000) (+) 2,50,000
Variable overhead (₹10 per unit) 1,50,000 2,00,000 2,50,000
Fixed overhead 3,50,000 3,50,000 3,50,000
(+) 50,000 (+)50,000 (+)50,000
Sales drive Costs - 60,000 -
Depreciation on new Equipment - - 1,00,000
Total costs 14,20,000 18,20,000 22,00,000
Profit 80,000 1,80,000 2,00,000
It will be advisable for the company not to accept the offer. The Company should instead to sell
20,000 units @₹100 per unit, since the acceptance of the offer will reduce the amount of profit.

5 MTP Jun’24 Set 1

XYZ Co. purchases 40,000 glass cases per annum from an outside supplier at ₹ 5 each. The
production manager feels that these should be manufactured and not purchased. A machine
costing ₹ 1,00,000 (no salvage value) will be required to manufacture the item within the factory.
The machine has an annual capacity of 60,000 units and life of 5 years. The costs required for
manufacture of each glass case is as follows:

Direct Materials ₹ 2.00

Direct Labour ₹ 1.00
Variable overheads 100% of Labour Cost
You are required to solve and decide:
(i) should the company continue to purchase the glass cases from outside supplier or should
it make them in the factory?
(ii) should the company accept an order to supply 10000 glass cases to the market at a selling
price of ₹ 4.50 per unit? [7]

Make / Buy Decision

4.10 |CMA Inter Management Accounting

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 Applications of Marginal Costing in Short Term Decision Making
Make or Buy decisions

Answer
(i) Total variable cost of manufacturing one glass case = ₹ 4.00 Additional Fixed cost of
manufacture p.a.
Depreciation (1,00,000 x 1/5) = ₹ 20,000
Since the marginal cost of manufacturing the case is less than the supplier’s price of ₹ 5,
there shall be a saving of ₹ (₹ 5 - 4) or ₹ 1 per case if the Case is manufactured within the
factory. Manufacturing will however result in an additional fixed cost of ₹ 20,000 p.a.
Total saving = 40,000 cases @ ₹ 1 = ₹ 40,000
Less additional fixed cost (depreciation) = ₹ 20,000
Net Savings = ₹ 20,000
Therefore, it is advisable to manufacture the cases in the factory.
(ii) If the company accepts to sell additional 10,000 units at 4.50, then additional contribution
is 10,000 × 0.50 = ₹ 5,000. This will add to total profit.

6 Jun’24
KAUTILYA LTD, currently working at 80% capacity, has the following particulars:
Particulars ₹
Sales 48,00,000
Direct Materials 15,00,000
Direct Labour 6,00,000
Variable Overheads 3,00,000
Fixed Overheads 19,00,000
An export order has been received that would utilize half (50%) the capacity of the factory.
The order cannot be split i.e. either it is to be taken in full and executed at 10% below the
normal domestic price or be rejected totally. The alternatives available to the management of
the company are:
(i) Reject the order and continue with domestic sales only (as at present level of sales). Or,
(ii) Accept the order, split the capacity (100%) between overseas and domestic sales and turn
away excess domestic demand. Or,
(iii) Increase capacity so as to accept the export order and maintain the present domestic sales
by -
A. Buying an equipment that will increase capacity by 10%. This will result in an increase
of ₹1,50,000 in fixed costs; and
B. Work overtime to meet balance of required capacity. In that case, labour will be paid
at one and a half (11/2) times the normal wage rate.

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 Applications of Marginal Costing in Short Term Decision Making
Make or Buy decisions

Required:
Prepare a comparative statement of profitability and suggest the best alternative. [7]

Export Offer

Answer
KAUTILYA LTD
Statement of comparative profitability
Alternatives: Alternatives - I Alternatives - II Alternatives - III
Sales domestic 48,00,000 30,00,000 48,00,000
Sales Export – 27,00,000 27,00,000
Total Sales 48,00,000 57,00,000 75,00,000
Direct Materials 15,00,000 18,75,000 24,37,500
Direct Labour 6,00,000 7,50,000 10,50,000
Variable overhead 3,00,000 3,75,000 4,87,500
Total variable cost 24,00,000 27,00,000 35,25,000
Contribution 24,00,000 27,00,000 35,25,000
Fixed overheads 19,00,000 19,00,000 20,50,000
Profit 5,00,000 8,00,000 14,75,000
Suggestion:
It reveals from the comparative analysis that Altemative-III i.e. 80% capacity for domestic sales
& 50% capacity for Export Sales is the best as it would give highest profits (₹ 14.75 lakhs)

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 Applications of Marginal Costing in Short Term Decision Making
Accept an Order or Reject

4.3
Accept an Order or Reject

1 MTP Dec’24 Set 1

A Co. currently operating at 80% capacity has the following profitability particulars:
Particulars Amount ₹
Sales 16,00,000
Costs:
Direct Materials 5,80,000
Direct labour 2,40,000
Variable Overheads 60,000
Fixed Overheads 5,20,000
Profit 2,00,000
An export order has been received that would utilise 40% of the capacity of the factory. The
order has either to be taken in full and executed at 10% below the normal domestic prices, or
rejected totally. The alternatives available to the management are given below:
A. Reject order and Continue with the domestic sales only, as at present;
B. Accept the order, and turn away excess domestic demand;
C. Increase capacity so as to accept the export order and maintain the present domestic sales
by:
(i) buying an equipment that will increase capacity by 10% and fixed cost by ₹65,000and
(ii) Work overtime at one and a half the normal rate to meet balance of required capacity.
Prepare comparative statements of profitability and suggest the best.
Prepare a statement showing profits from different alternatives and suggest the best. [7]

Export Offer

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 Applications of Marginal Costing in Short Term Decision Making
Accept an Order or Reject

Answer
Alternative (A): Continue with domestic sales and reject the export order
Serial Description Workings ₹ Lakhs
1 Capacity Given – 80%
2 Sales Given 16.00
3 Variable Costs
a. Direct Material Given 5.80
b. Direct Labour 2.40
c. Variable Overheads 0.60
d. Sub Total 8.80
4 Contribution (2-3) 7.20
5 Fixed Costs Given 5.20
6 Profit (4-5) 2.00
Alternative (B): Accept the export order and allow the domestic market to starve to the extent
of excess of demand
This alternative envisages utilization of 40% of the capacity for the export order and 60% of
the capacity for domestic market. Further, the export order is to be executed at 10% below the
current domestic prices i.e.., (100- 10) % = 90% of the price. Accordingly:
Sales at 100% Capacity = (16 ÷ 80%) = ₹20 Lakhs
Value of the export order = (40% of Capacity × 90% of the Price) = (20 × 40% × 90%) = ₹7.20
lakhs.
Value of the domestic sales = (20 × 60%) = ₹ 12.00 lakhs.
Serial Description Workings ₹ Lakhs
1 Capacity Export 40% + Domestic 60%
2 Sales 7.20 + 12.00 19.20
3 Variable Costs
a. Direct Material (5.80 / 80%) × 100% 7.25
b. Direct Labour (2.40 / 80%) × 100% 3.00
c. Variable Overheads (0.60 / 80%) × 100% 0.75
d. Sub Total 11.00
4 Contribution (2-3) 8.20
5 Fixed Costs Given 5.20
6 Profit (4-5) 3.00
Alternative (C): Increase capacity so as to accept the export order and maintain the domestic
demand by:

4.14 |CMA Inter Management Accounting

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 Applications of Marginal Costing in Short Term Decision Making
Accept an Order or Reject

(i) Purchasing additional plant and increasing 10% capacity and thereby increasing fixed
overheads by ₹ 65,000, and
(ii) Working overtime at one and half time the normal rate to meet balance of the required
capacity
Serial Description Workings ₹Lakhs
1 Capacity Export 40% + Domestic 80%
2 Sales 7.20+16.00 23.20
3 Variable Costs
a. Direct Material (5.80 / 80%) × 120% 8.70
b. Direct Labour (2.40 / 80%) × 120% 3.60
c. Variable Overheads (0.60 / 80%) × 120% 0.90
d.Overtime Premium [Balance (2.40 / 80%) × 10% × 50% 0.15
capacity of 10%]
e. Sub Total 13.35
4 Contribution (2-3) 9.85
5 Fixed Costs (5.20 + 0.65) 5.85
6 Profit (4-5) 4.00
From the above computation, it was found that the profit is more at the III alternative i.e.
accepting the foreign order fully and maintaining the present domestic sales, it is the best
alternative to be suggested.

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 Applications of Marginal Costing in Short Term Decision Making
Optimum Utilization of Factors of Production [Limiting Factor Analysis]

4.4
Optimum Utilization of Factors of
Production [Limiting Factor Analysis]

1 Jun’24
M/s Posco Limited is manufacturing 4000 units of product Zimzam utilising 100% of its machine
capacity. The selling price per unit and cost per unit of product Zimzam are as under:
Amount Amount
Particulars
(₹) (₹)
Selling Price per unit 700
Cost per unit:
Direct Material Cost 100
Variable Machine Operating Cost (₹ 100 per Machine Hour) 150
Other Factory Overhead Cost 180
Selling & distribution Overhead Cost 200 630
Profit per unit 70
Posco Limited can sell maximum 8000 units of product Zimzam in market. However, due to
limited machine hour capacity, it can produce maximum 4000 units of product Zimzam
in-house. M/s SB Limited, a quality supplier of products, can supply up to 3000 units of product
Zimzam at a price of ₹620 per unit up to Posco’s place.
Posco Limited can use its facility to manufacture an alternative product called Bonbon. It can
sell up to 10,000 units of Bonbon annually. The selling price per unit and cost per unit of product
Bonbon are as under:
Amount Amount
Particulars
(₹) (₹)
Selling Price per unit 700
Cost per unit:
Direct Material Cost 300
Variable Machine Operating Cost (₹ 100 per Machine Hour) 50
Other Factory Overhead Cost 50
Selling & distribution Overhead Cost 100 500
Profit per unit 200

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 Applications of Marginal Costing in Short Term Decision Making
Optimum Utilization of Factors of Production [Limiting Factor Analysis]

Posco Limited provides you the following additional information:

(i) Variable Selling & distribution Overhead cost per unit are as under:
Amount
Particulars
(₹)
Manufacturing product Zimzam In-house 80
Purchasing product Zimzam from M/s SB Limited 60
Manufacturing product Bonbon In-house 70
(ii) Posco Limited uses machine hour as the basis for assigning fixed factory overhead cost.
The fixed factory overhead cost for the year is ₹ 2,40,000. These costs will not be affected
by the product mix decision.
Required:
(i) Suggest the quantity of each product that M/s Posco Limited should manufacture/
purchase to maximise its profit.
(ii) Calculate total profit of M/s Posco Limited under (i) above. [14]

Application of Marginal Costing

Answer
(i) Quantity of each product to be manufactures / purchased
Particulars Machine Hours Qty.
Manufacturing Bonbon 5000 10000
Manufacturing Zimzam 1000 666/667
Purchase of Zimzam from M/s SB Ltd. - 3000
(ii) Total Profit of M/s Posco Ltd.under (i) above = ₹ 25,26,500

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 Applications of Marginal Costing in Short Term Decision Making
Replacement Decision

4.5
Replacement Decision

1 Jun'23
M/s Visual Infotech Pvt. Limited is a multiple product manufacturer. One product line consists
of CCT V Camera and the company manufactures three different models. M/s Visual Infotech
Pvt. Limited is currently considering a proposal from a supplier who want to supply lenses of
the CCTV Camera to M/s Visual Infotech Pvt. Limited.
M/s Visual Infotech Pvt. Limited currently produces all the lenses it requires. In order to meet
customers’ needs, M/s Visual Infotech Pvt. Limited produces three different types of lenses for
each CCTV Camera model (i.e. nine different lenses).
The supplier would charge ¥ 2,500 per lens, regardless of type of lens. For the next year, M/s
Visual Infotech Pvt. Limited has projected the cost of its own production of lenses as follows
(based on projected volume of 10,000 units):
Particulars Amount (₹)
Direct Material 75,00,000
Direct Labour 65,00,000
Variable Overhead 55,00,000
Fixed Overhead:
Factory Supervisors’ Cost 35,00,000
Other Fixed Cost 65,00,000
Total Production Cost 2,95,00,000
Additional information:
1. The equipment utilized to produce the lenses has no alternative use and no market value.
2. The space occupied by the lens production unit will remain idle if the company purchases
the lenses from outside market rather than produce in-house.
3. Factory supervision cost is for salary of a Quality Manager & Production Supervisor who
would be dismissed from the company if the company closes its lens production unit.
Required:
(i) Determine the net profit or loss of purchasing (rather than manufacturing) the lenses
required for CCTV Camera.

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 Applications of Marginal Costing in Short Term Decision Making
Replacement Decision

(ii) Determine the level of production where the company would be indifferent between
buying and producing the lenses. If the future volume level is predicted to decrease, would
that influence your decision?
(iii) What would be your decision if the space presently occupied by lens production unit could
be leased to another company at a lease rent of % 25,00,000 per annum? [7]

Net Profit Or Loss Of Purchasing, Indiffer-

ence Level Of Production, Decision Making

Answer
(i) Net profit or loss of purchasing (rather than manufacturing) the lenses required for CCTV
Camera = ₹ - 20,00,000
(ii) Indifference point = 6363.64 Units
If the future volume level is predicted to decrease, the option where Fixed cost is lower is
preferable, i.e., Purchase from outside market.
(iii) Net Profit if the lenses are purchased rather than manufacturing in-house = ₹ 5,00,000
Therefore, the company should buy the lenses from outside market rather than making
them in-house.

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 Applications of Marginal Costing in Short Term Decision Making
Evaluation of Alternative Choices

4.6
Evaluation of Alternative Choices

1 MTP Dec'23 Set 1

A review, made by the top management of Sweet and Struggle Ltd. which makes only one
product, of the result of two first quarters of the year revealed the following:

Sales in units 10,000

Loss ₹ 10,000
Fixed Cost (for the year ₹1,20,000) ₹ 30,000 / Quarter
Variable cost per unit ₹8
The finance Manager who feels perturbed suggests that the company should at least breakeven
in the second quarter with a drive for increased sales. Towards this the company should
introduce a better packing which will increase the cost by ₹ 0.50 per unit.
The Sales Manager has an alternate proposal. For the second quarter additional sales promotion
expenses can be increased to the extent of ₹ 5,000 and a profit; of ₹ 5,000 can be aimed at for
the period with increased sales.
The production manager feels otherwise. To improve the demand the selling price per unit has
to be reduced by 3%. As a result the sales volume can be increased to attain a profit level of ₹
4,000 for the quarter.
The Managing Director asks for as a cost Accountant to evaluate these three proposals and
calculate the additional units required to reach their respective targets help him to make a
decision. [14]

Evaluation Of Three Proposals, Additional

Units

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 Applications of Marginal Costing in Short Term Decision Making
Evaluation of Alternative Choices

Answer
Results of the first quarter: Sales 10,000 units
Particulars (₹)
Total Variable Cost (10,000 × ₹ 8) 80,000
(+) Fixed Cost 30,000
Total Cost 1,10,000
(+) Loss (10,000)
Sales 1,00,000
Comparative Statement of 3 proposals
Computation of total no. of units and additional units required to retain the target of respective
Managers
Finance Manager Sales Manager Production Manager
Selling Price ₹ 10 ₹ 10 ₹ 10
Variable Cost ₹ 8.50 ₹8 ₹8
Contribution ₹ 1.50 ₹2 ₹ 1.70
Fixed Cost ₹ 30,000 ₹ 35,000 ₹ 30,000
Target Break Even Profit of 5000 Profit of 4000
30 , 000 35, 000 + 5, 000 30 , 000 + 4 , 000
No. of Units required
1.50 2 1.70
Sales (Units) in First Quarter 20,000 20,000 20,000
Additional Sales volume 10,000 10,000 10,000
required in Second Quarter
as Compared to first Quarter

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 Applications of Marginal Costing in Short Term Decision Making
Subcontracting and Ancillarisation

4.7
Subcontracting and Ancillarisation

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 Applications of Marginal Costing in Short Term Decision Making
Expansion of Business

4.8
Expansion of Business

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 Applications of Marginal Costing in Short Term Decision Making
Shutdown or Continue

4.9
Shutdown or Continue

1 Postal Test Paper

A company is engaged in three distinct lines of production. Their production cost per unit and
selling prices are as under:
X Y Z
Production (Units) 3,000 2,000 5,000
₹ ₹ ₹
Material Cost 18 26 30
Wages 7 9 10
Variable overheads 2 3 3
Fixed Overheads 5 8 9
32 46 52
Selling price 40 60 61
Profit 8 14 9
The management wants to discontinue one line and gives you the assurance that production
in two other lines shall be raised by 50%.
They intend to discontinue the line which produces Article X as it is less profitable.
(a) Do you agree to the scheme in principle?
(b) Offer your comments and show the necessary statements to support your decision.
[4 + 4 = 8]

Discontinue Decision

Answer
The decision should be taken on the relative profitability of various alternatives as ascertained
below:

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 Applications of Marginal Costing in Short Term Decision Making
Shutdown or Continue

Total fixed Expenses ₹

X (3,000 × ₹ 5) 15,000
Y (2,000 × ₹ 8) 16,000
Z (5,000 × ₹ 9) 45,000
Total Fixed Expenses 76,000
Contribution per unit of different products: (S – V)

X ₹ (40 – 27) = ₹ 13 per unit

Y ₹ (60 – 38) = ₹ 22 per unit
Z ₹ (61 – 43) = ₹ 18 per unit
Profit from different production arrangements may be found as under:
(a) If ‘X’ is given up , sale of ‘Y’ and ‘Z’ will increase by 50%.
The sales of Y would be i.e., Y – 3,000 units, Z – 7,500 units.
Contribution Y = 3,000 × ₹ 22 = ₹ 66,000
Contribution Z = 7,500 × ₹ 18 = ₹ 1,35,000
Total = ₹ 2,01,000
Less: Fixed Cost = ₹ 76,000
Profit = ₹ 1,25,000
(b) If Y is discontinued, production of X and Z will be more by 50% i.e., X-4,500 units, Z- 7,500
units. Contribution X = 4500 × ₹ 13 = ₹ 58,500
Contribution Z = 7500 × ₹ 18 = ₹ 1,35,000
= ₹ 1,93,000
Less: Fixed Cost = ₹ 76,000
Profit = ₹ 1,17,500
(c) If Z is given up, production of ‘X’ and ‘Y’ will be is X – 4500 units, Y – 3000 units.
Contribution X = 4500 × ₹ 13 = ₹ 58,500
Contribution Y = 3000 × ₹ 22 = ₹ 66,000
₹ 1,24,500
Less: Fixed Cost = ₹ 76,000
Profit = ₹ 48,500
Under these three alternatives the profit is maximum (₹ 1,25,000) when ‘X’ is discontinued.
Therefore, we may agree with the management’s decision to discontinue product ‘X’.

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 Applications of Marginal Costing in Short Term Decision Making
Shutdown or Continue

NOTES

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 Transfer Pricing


Chapter 5
Transfer Pricing

5.1 Concept

5.2 Methods and Techniques

Divisional Performance and Problem of Goal

5.3 Congruence

Determination of Inter-departmental or
5.4 Inter-company Transfer Price

5.5 International Transfer Pricing

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 Transfer Pricing
Concept

5.1
Concept

1 Postal Test Paper

In a meeting with the Director Finance of your company, he had pointed out that there might
be some disadvantages in taking divisions as a profit centres. As a Management Accountant of
the company.
You are required to state the various disadvantages in taking divisions as a profit centres. [5]

Disadvantages in Taking Divisions as a

Profit Centres

Answer
As a Management Accountant, the following points are considered to be of importance:
(i) Divisions may compete with each other and may take decisions to increase profits at the
expense of other divisions thereby overemphasizing short term results.
(ii) It may adversely affect co-operation between the divisions and lead to lack of harmony in
achieving organizational goals of the company. Thus, it is hard to achieve the objective of
goal congruence.
(iii) It may adversely affect co-operation between the divisions and lead to lack of harmony in
achieving organizational goals of the company. Thus, it is hard to achieve the objective of
goal congruence.
(iv) The cost of activities, which are common to all divisions, may be greater for decentralized
structure than centralized structure. It may thus result in duplication of staff activities.
(v) Top management loses control by delegating decision making to divisional managers. There
are risks of mistakes committed by the divisional managers, which the top management,
may avoid.
(vi) Series of control reports prepared for several departments may not be effective from the
point of view of top management.
(viii) It may underutilize corporate competence.

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 Transfer Pricing
Concept

(ix) It leads to complications associated with transfer pricing problems.

(x) It becomes difficult to identity and defines precisely suitable profit centres.
(xi) It confuses division’s results with manager’s performance.

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 Transfer Pricing
Methods and Techniques

5.2
Methods and Techniques

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 Transfer Pricing
Divisional Performance and Problem of Goal Congruence

5.3
Divisional Performance and
Problem of Goal Congruence

1 MTP Jun'23 Set 1

A company has two divisions, X and Y. Division X manufactures a component which is used
by Division Y to produce a finished product. For the next period, output and costs have been
budgeted as follows.
Particulars Division X Division Y
Component units 50,000
Finished units 50,000
Total variable costs ₹ 2,50,000 ₹ 6,00,000
Fixed Costs ₹ 1,50,000 ₹ 2,00,000
You, as a cost accountant, are required to advise on the transfer price to be fixed for Division
X’s component under the following circumstances:
(i) Division X can sell the component in a competitive market for₹10 per unit. Division Y can
also purchase the component from the open market at that price.
(ii) Further to the situation mentioned in (i) above, assume that Division Y currently buys the
component from an external supplier at the market price of ₹10 and there is reciprocal
agreement between the external supplier and another Division Z, within the same group.
Under this agreement, the external supplier agrees to buy one product unit from Division
Z at a profit of ₹4 per unit to that division, for every component which Division Y buys from
the supplier. [3 + 4 = 7]

TP - Goal Congruency Effect of Div Z's Loss

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 Transfer Pricing
Divisional Performance and Problem of Goal Congruence

Answer
(i) In this case the transfer price is to be fixed up as follows
Transfer Price = Marginal Cost + Opportunity Cost i.e. ₹ (5 + 5) = ₹10
Note: Marginal Cost = ₹2,50,000 / 50,000 units = ₹5
Opportunity cost ₹5 is computed on the basis that the Division A will sacrifice ₹ 5 if they
sell the product to Division Y.
(ii) In this situation, the transfer price will be worked out as under:
Transfer price = Marginal Cost + Contribution + Profit foregone by Division Z
= ₹(5 + 5 + 4) = ₹14
In situation (ii), if Division Y purchases from Division X, it will not purchase from external
supplier.
Hence, the supplier will stop purchasing from Division Z, which will result in a loss of profit
to Division Z @ ₹4 per unit, and therefore this amount will be recovered from the transfer
price.

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 Transfer Pricing
Determination of Inter-departmental or Inter-company Transfer Price

5.4
Determination of Inter-departmental
or Inter-company Transfer Price

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 Transfer Pricing
International Transfer Pricing

5.5
International Transfer Pricing

1 MTP Jun'23 Set 2; PTP

Division A is a profit centre, which produces four products P, Q, R and S. Each product is sold in
the external market also. Data for the period is as follows:
P Q R S
Market Price per unit (₹) 350 345 280 230
Variable Cost of production per unit (₹) 330 310 180 185
Labour hours required per unit 3 4 2 3
Product S can be transferred to Division B but the maximum quantity that might be required
for transfer is 2,000 units of S.
The maximum sales in the external market are:

P 3,000 units
Q 3,500 units
R 2,800 units
S 1,800 units
Division B can purchase the same product at a slightly cheaper price of ₹ 225 per unit instead
of receiving transfers of products S from Division A.
Suggest the transfer price for each unit for 2,000 units of S, if the total labour hours available
in Division A are?
(i) 24,000 hours?
(ii) 32,000 hours? [8]

TP-Goal Congruency Key Factor

5.8 |CMA Inter Management Accounting

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 Transfer Pricing
International Transfer Pricing

Answer
Statement showing contribution per unit and per labour hour
Particulars P Q R S
Selling Price per unit (₹) 350 345 280 230
Variable Cost per unit (₹) 330 310 180 185
Contribution per unit (₹) 20 35 100 45
Labour Hours per unit 3 4 2 3
Contribution per labour hour (₹) 6.67 8.75 50 15
Ranking IV III I II
(i) Statement Showing Production Plan
Total Hours Products Hours/unit Allocation of Hours
24,000 P 3 -
Q 4 13,000*
R 2 5,600*
S 3 5,400*
24,000
* R = (2800 × 2) =5600, S = (1800 × 3) = 5400,
Therefore, [24000 hours – (5600 + 5400)] = 13000 hours is allocated to product Q.
As maximum allocation is (3500 units × 4) = 14000 hours.
Statement showing Transfer Price per unit of Product S
Total Labour Hours require for S (2,000 units × 3 hours per unit) 6,000
Hours derived from Product Q (1,500 units × 4 hours per unit) 6,000
Variable manufacturing cost for Product ‘S’ (2,000 × ₹185) = ₹ 3,70,000
Contribution foregone/Opportunity Cost of Product Q (1,500 × ₹35) ₹ 52,500
₹ 4,22,500
Hence Transfer Price per unit (₹ 4,22,500 ÷ 2,000 units) = ₹ 211.25
(ii) Statement Showing Production Plan
Total Hours Products Hours/unit Allocation of Hours
32,000 P 3 7,000
Q 4 14,000
R 2 5,600
S 3 5,400
32,000

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 Transfer Pricing
International Transfer Pricing

Statement Showing Transfer Price per unit of Product S

Total Labour Hours require for S (2,000 units × 3 hours per unit) 6,000
Hours derived from Product P (2,000 units × 3 hours per unit) 6,000
Variable manufacturing cost for Product ‘S’ (2,000 × ₹185) = ₹ 3,70,000
Contribution foregone/Opportunity Cost of Product PQ (2,000 × ₹20) ₹ 40,000
₹ 4,10,000
Hence, Transfer Price per unit ( ₹ 4,10,000 ÷ 2,000 units) = ₹ 205.00

2 MTP Jun'23 Set 2; MTP Dec'23 Set 1

XYZ Ltd which has a system of assessment of Divisional Performance on the basis of residual
income has two Divisions, X and Y. X has annual capacity to manufacture 15,00,000 numbers
of a special component that it sells to outside customers, but has idle capacity. The budgeted
residual income of Y is ₹ 1,20,00,000 while that of X is ₹ 1,00,00,000. Other relevant details
extracted from the budget of X for the current year were as follows:

Sale (outside customers) 12,00,000 units @ ₹ 180 per unit

Variable cost per unit ₹ 160
Divisional fixed cost ₹ 80,00,000
Capital employed ₹ 7,50,00,000
Cost of Capital 12%
Y has just received a special order for which it requires components similar to the ones made
by X. Fully aware of the idle capacity of X, Y has asked X to quote for manufacture and supply of
3,00,000 numbers of the components with a slight modification during final processing. X and
Y agree that this will involve an extra variable cost of ₹ 5 per unit.
Suggest the transfer price which X should quote to Y to achieve its budgeted residual income.
[7]

TP using Residual Income

Answer
Contribution required at Budgeted Residual Income
Fixed cost ₹ 80,00,000
Profit on ₹ 7,50,00,000 × 12% = ₹ 90,00,000

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 Transfer Pricing
International Transfer Pricing

Residual Income = ₹ 1,00,00,000

Total Contribution required = ₹ (80,00,000 + 90,00,000 + 1,00,00,000)
= ₹ 2,70,00,000
Contribution derived from existing units = 12,00,000 × ₹ 20 = ₹ 2,40,00,000
Contribution required on 3,00,000 units = ₹ 2,70,00,000 – ₹ 2,40,00,000 = ₹ 30,00,000
Contribution per unit = ₹ 30,00,000 / 3,00,000 units = ₹ 10
Increase in Variable Cost = ₹ 5
Transfer price = Variable Cost + Desired Residual Income + Increase in Variable Cost
= ₹ 160 + ₹ 10 + ₹ 5
= ₹ 175

3 Postal Test Paper

Explain the opportunity cost approach to transfer pricing [3]

Opportunity Cost Approach

Answer
It represents the opportunity which has been foregone by following one course of action rather
than another. Thus, if goods are transferred internally the organisation could lose a contribu-
tion to profit which could have been obtained from an external sale. Generally, an opportunity
cost approach will be used to establish a range of transfer prices in situations where the market
is imperfect.

4 Jun'23
Zen Limited produces four products— A, B, C & D in Division-X. Products are sold in the external
market and the cost data for the month of July, 2022 is as under:
Particulars Product-A Product-B Product-C Product-D
Selling price per unit in external market (₹) 250 450 300 350
Hours required to produce one unit 5 10 10 8
P/V Ratio 30% 40% 45% 50%

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 Transfer Pricing
International Transfer Pricing

Product-D can be transferred to Division-Y. However, maximum quantity that might be required
by Division-Y is 1500 units of Product-D. The maximum sales of the products in the external
market are:
Product-A - 3,000 Units
Product-B - 4,000 Units
Product-C - 3,500 Units
Product-D - 2,000 Units
What should be the transfer price for each unit of Product-D if the total labour hours available
in Division-X are:
(i) 70,000 Hours
(ii) 80,000 Hours [8]

Transfer Price - Goal Congruency Key Factor

Answer
(i) Transfer price where total labour hours available is 70000 hours = ₹ 295
(ii) Transfer price where total labour hours available is 80000 hours = ₹ 286

5 MTP Dec'23 Set 2

Division A is a profit centre that produces three products X, Y and Z and each product has an
external market.
The relevant data is as:
X Y Z
External market price per unit (₹) 48 46 40
Variable cost of production (division A) (₹) 33 24 28
Labour hours per unit (division A) 3 4 2
Maximum external sales units 800 500 300
Up to 300 units of Y can be transferred to an internal division B.
Division B has also the option of purchasing externally at a price of ₹45 per unit.

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 Transfer Pricing
International Transfer Pricing

Calculate the transfer price for Y the total labour hours available in division A is:
(a) 3800 hours
(b) 5600 hours [14]

TP-Goal Congruency Key Factor

Answer
X (₹) Y (₹) Z (₹)
Selling Price 48 46 40
Variable Cost 33 24 28
Contribution 15 22 12
Contribution per Hr 5 (15/3) 5.5 (22/4) 6 (12/2)
III II I

Computation of Transfer Price at 3800 hrs. (₹)

Variable cost per unit of Y 24
Add: Opportunity Cost
As there is no idle capacity for division A. It has to sacrifice 1200 hrs production
of any product i.e. production X because contribution per hr is less
Total contribution = 1200 X 5 = 6000
Contribution/Unit = 6000/300 = 20 20
44

Computation of Transfer Price at 5600 hrs available (₹)

Variable cost per unit 24
Add: Opportunity cost
Out of the 1200 hrs required to transfer product Y, 600 Hrs are available and
another 600 hrs they have to give up the production of X.
Total Contribution = 600 X 5 = 3000
Contribution/Unit = 3000 / 300 = 10 10
Transfer Price 34

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 Transfer Pricing
International Transfer Pricing

6 MTP Dec’24 Set 1

Aurthor company is a multidivisional company and its managers have been delegated full
profit responsibility and autonomy to accept or reject transfers from other divisions.
Division X produces a sub-assembly with a ready competitive market. This sub-assembly is
currently used by Division Y for a final product that is sold outside at ₹1,200. Division X Charges
Division Y market price for the sub-assembly which is ₹700 per unit. Variable costs are ₹520 and
₹600 for Divisions X and Y respectively.
The manager of Division Y feels that Division X should transfer the subassembly, at a lower price
than market because at this price, Division Y is unable to make a profit.
Required:
(i) Calculate Division Y’s profit contribution if transfers are made at the market price and also
the total contribution to profit for the company.
(ii) Assume that Division A can sell all its production in the open market. Should Division X
transfer goods to Division Y? If so, at what price.
(iii) Assume that Division can sell in the open market only 500 units at ₹700 per unit out of
1,000 units that it can produce every month and that a 20 per cent reduction in price is
necessary to sell at full capacity. Should transfers be made? If so, how many units should
it transfer and at what price? prepare a schedule showing comparisons of contribution
margins under three different alternatives to support your decision. [14]

Divisional Profit and Units to be

transferred

Answer
Particulars ₹ ₹
Calculation for Division Y’s contribution Margin
1. Selling Price of Final Product 1,200
Less: Division Y’s variable cost 600
Division Y’s purchase cost 700 1,300
Division Y’s loss (100)
Calculation for Company’s contribution Margin
Selling price of final product 1,200
Less: Division Y’s variable cost 600
Division X’s variable cost 520 1,120

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 Transfer Pricing
International Transfer Pricing

Company’s Contribution margin 80

2. Selling price of sub-assembly 700
Less: Division X’s variable cost 520
Company’s contribution margin 180
The company contribution is ₹100 greater if the sub-assembly is sold on the intermediate
market rather than to Division B. Thus, it should be sold in the intermediate market. The market
price would be the appropriate transfer price if transfers were made:
Alternative 1: Transfer 1,000 units to Division Y.
Alternative 2: Sell 500 units in the intermediate market at ₹700 and transfer 500 units to Division
Y.
Alternative 3: Sell 1,000 units on the intermediate market at 20% reduced price.
Alternative 1: ₹
Company sales: (1000 units × ₹1200) 12,00,000
Less: Variable costs (1000 units @ ₹520 + 1,000 units @ ₹600) 11,20,000
Contribution margin 80,000

Alternative 2: ₹
Company sales: 9,50,000
(500 units @ ₹700 + 500 units @ ₹1,200)
Variable costs: (1000 units @ ₹520 + 500 units @ ₹600) 8,20,000
Contribution margin 1,30,000

Alternative 3: ₹
Company sales:
1000 units @ ₹560 (700 – 140) 5,60,000
Variable costs: (1000 units @ ₹520 ) 5,20,000
Contribution Margin 40,000
Conclusion:
Transfers should be made, 500 units should be transferred to Division Y. The transfer price should
be set at a price greater than the variable cost of Division X (₹520) and less than the marginal
revenue to Division Y (₹600). Division Y’s marginal revenue will be ₹600 (₹1,200 market price -
division Y’s own variable cost ₹600).

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 Transfer Pricing
International Transfer Pricing

NOTES

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 Standard Costing and Variance Analysis


Chapter 6
Standard Costing and Variance
Analysis

6.1 Material and Labour Variances

6.2 Variable Overhead Variance

6.3 Fixed Overhead Variance

6.4 Sales Variance

6.5 Interpretation of Variances and Inferences Drawn

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 Standard Costing and Variance Analysis
Material and Labour Variances

6.1
Material and Labour Variances

1 MTP Jun'23 Set 1

SK Limited makes and sells a single product ‘Jay’ for which the standard cost per unit is as follows;
₹ per unit
Direct Material 4 kg @ ₹ 12.00 per kg 48.00
Direct Labour 5 hours @ ₹ 7.00 per hour 35.00
Variable production overhead 5 hours @ ₹ 2.00 per hour 10.00
Fixed production overhead 5 hours @ ₹ 10.00 per hour 50.00
143.00
The variable production overhead varies with the hours worked. Overhead is absorbed into
production on the basis of standard hours of production and the normal volume of production
for the period just ended was 20 000 units (100 000 standard hours of production).
For the period under consideration, the actual results were;
Production of ‘Jay’ 18000 units (₹)
Direct material used – 76000 kg at a cost of 8,36,000
Direct labour cost incurred – for 84000 hours worked 6,04,800
Variable production overhead incurred 1,72,000
Fixed production overhead incurred 10,30,000
You are required
(i) to analyse and show, by element of cost, standard cost for the output for the period;
(ii) to scrutinize and list relevant variances in a way which reconciles standard cost with actual
cost;
Note: Fixed production overhead sub-variances of capacity and volume efficiency (productivi-
ty) are not required [2 + 6 = 8]

Cost Variances

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 Standard Costing and Variance Analysis
Material and Labour Variances

Answer
Standard cost of output produced (18000 units) (₹)
Direct Material 8,64,000
Direct Labour 6,30,000
Variable production overhead 1,80,000
Fixed production overhead 9,00,000
25,74,000

Standard cost of output Variances Actual cost

(₹) (₹) (₹)
Direct materials 8,64,000
Price variance 76,000 (F)
Usage variance 48,000 (A)
Actual cost 8,36,000
Direct labour 6,30,000
Rate variance 16,800 (A)
Efficiency variance 42,000 (F)
Actual cost 6,04,800
Variable production overhead 1,80,000
Expenditure variance 4,000 (A)
Efficiency variance 12,000 (F)
Actual cost 1,72,000
Fixed production overhead 9,00,000
Expenditure variance 30,000 (A)
Volume variance 1,00,000 (A)
Actual cost 10,30,000
25,74,000 68,800 (A) 26,42,800
Notes
(a) (Standard price – Actual price) × Actual quantity
(₹ 12 – ₹ 8,36,000/76,000) × 76,000
∴ (₹ 12 – ₹ 11) × 76,000 = ₹ 76,000 (F)
(b) (Standard quantity - Actual quantity) x Standard price
(18,000 × 4 kg – 76,000) × ₹ 12
∴ (72000 kg – 76,000 kg) × 12 = ₹ 48,000 (A)
(c) (Standard rate – Actual rate) × Actual hours
( ₹7 – ₹ 6,04,800/84,000) × 84,000
∴ (₹ 7 - ₹ 7.2) × 84,000 hours = ₹ 16,800 (A)

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 Standard Costing and Variance Analysis
Material and Labour Variances

(d) (Standard hours – Actual hours) × Standard rate

(18,000 × 5 hrs – 84,000) × ₹ 7 = ₹ 42,000 (F)
(e) (Actual hours × Standard rate) – Actual cost
(84,000 × ₹ 2 – ₹ 1,72,000) = ₹ 4,000 (A)
(f ) (Standard hours – Actual hours) × Standard rate
(18,000 × 5 hrs – 84,000 hours) × ₹ 2 = ₹ 12,000 (F)
(g) Budgeted fixed overheads - Actual fixed overheads
(20,000 × ₹ 50 – ₹ 10,30,000) = ₹ 30,000 (A)
(h) (Actual output – Budgeted output) × Standard rate
(18,000 – 20,000) × ₹ 50 = ₹ 1,00,000 (A)

2 MTP Jun'23 Set 2

ACE LLP follows a standard costing system and produces a product called the ‘PRO GEAR’. You
are recently appointed as the cost accountant of the Company. The established standards for
materials and labour follow:
Material A: 3 Kg @ ₹ 6 ₹ 18
Labour: 4 hr @ ₹ 7.50 per hr ₹ 30
The operating data for the month of January 2023 are as under:
Work in process, January 1: 200 units, all materials, and 20% complete as to labour.
Work in process, January 31: 600 units, all materials, and 80% complete as to labour.
During the month of January 2023, 6400 units of the product was completed. All materials are
added at the beginning of processing in the department.
20,900 Kgs of materials were used in production during the month, at a total cost of ₹ 1, 23,310.
Direct labour amounted to ₹ 2, 08,670, which was at a rate of ₹ 7.70 per hour.
You are required to critically analyse the necessary variances and comment. [7]

Material & Labour Variances WIP based

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 Standard Costing and Variance Analysis
Material and Labour Variances

Answer
It is important to note that in addition to the usual procedures used to solve standard cost
problems, equivalent production (FIFO) must be calculated. The equivalent production
determined by the FIFO method will be used to calculate the standard materials and standard
labour allowed. Two variances (price and quantity) must be determined for materials, and two
variances (rate and efficiency) must be determined for labour.
With the results of equivalent production as calculated above the variances are to be calculated
as follows:
Calculation of Equivalent Production for Materials and Labour by the FIFO Method:
Materials:

Work in process, May 1: 200 units (all materials added last period) 0
Units started and finished during May (6,400 – 200) 6,200
Work in process, May 31: 600 units (all materials added) 600
Total equivalent production - materials 6,800
Labour:

Work in process, May 1: 200 units (80% of labour required) 160

Units started and finished during May 6,200
Work in process, May 31: 600 units (80% labour added) 480
Total equivalent production - labour 6,840
Determining the Materials and Labour Variances:
Materials Variances
Materials price variance = (Actual Price – Standard Price) × Actual quantity
= (₹ 5.90 - ₹ 6.00)
= ( ₹ 5.90 - ₹ 6.00) × 20,900
= ₹ 2,090 (F)
Materials Quantity variance = (Actual Quantity –Standard Quantity)×Standard Price
= [20,900 – (6,800 × 3)] × ₹ 6.00
= [20,900 – 20,400] x ₹ 6.00
= ₹ 3,000 (A)
Note: ₹ 1,23,310 ÷ 20,900 = ₹5.90 per kg.

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 Standard Costing and Variance Analysis
Material and Labour Variances

Labour Variances
Labour Rate Variance = (Actual Rate - Standard Rate) × Actual hours
= (₹ 7.70 – ₹ 7.50) × 27,100
= ₹ 5,420 (A)
Labour Efficiency Variance = (Actual Hours – Standard Hours) × Standard Rate
= [27,100 – (6,840 × 4)] × ₹7.50
= ₹ 1,950 (F)
Note: ₹ 2,08,670 ÷ ₹ 7.70 = 27,100 hours
The Manager (Cost) should write a ‘Report’ to the MD showing the above variance calculations.

3 Postal Test Paper

The following data is obtained from the cost record of ABC Limited:

Standard Mix Actual Mix

Material X 120 kg. @ ₹25 Materials X 110 kg. @ ₹ 30
Material Y 80 kg. @ ₹50 Material Y 90 kg. @ ₹ 45
200 kg. 200 kg.
Less: Loss 30% 60 kg. Less: Loss 25% 50 kg.
Output 140 kg. Output 150 kg.
You are required to find out the following material variances:
(i) Cost Variance;
(ii) Price Variance;
(iii) Usage Variance;
(iv) Mix Variance;
(v) Yield Variance. [7]

Material Variances

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 Standard Costing and Variance Analysis
Material and Labour Variances

Answer
Working Notes:
1. Calculation of Total Standard Material Cost or (SQ × SP):
Material X: 120 × ₹ 25 = 3,000
Material Y: 80 × ₹ 50 = 4,000
Total Standard cost of output of 140 kgs 7,000
Hence, Total Standard Cost for Actual Output 150 kg = ₹ 7000 ÷ 140 × 150 = ₹ 7500
Hence, per unit standard cost of output = ₹ 7,500/150 = ₹ 50
2. Total Actual Cost or (AQ x AP):
Material X 110 × ₹ 30 = ₹ 3,300
Material Y 90 × ₹ 45 = ₹ 4,050
Total Actual Cost ₹ 7,350
3. (AQ x SP) =
Material X 110 × ₹ 25 = ₹ 2,750
Material Y 90 × ₹ 50 = ₹ 4,500
₹ 7,250
4. Revised Standard Quantity (RSQ) For Material X :
(Total AQ 200 ÷ Total Standard Quantity 200) × Standard Quantity for Mateial X
i.e., 120 = 120 kg.
Similarly, RSQ for Material Y = 80 kg.
5. (RSQ × SP) =
Material X 120 × ₹ 25 = ₹ 3,000
Material Y 80 × ₹ 50 = ₹ 4,000
₹ 7,000
Computation of Variances:
(i) Material Cost Variance = Total Standard Cost – Total Actual Cost = ₹ 7,500 – ₹ 7,350
= ₹ 150 (F)
(ii) Material Price Variance= AQ (SP-AP) or (AQ × SP) - (AQ × AP) = ₹ 7,250 – ₹ 7,350 = ₹ 100 (A)
(iii) Material Usage Variance = SP (SQ-AQ) or (SP × SQ) - (SP × AQ) = ₹ 7,500 – ₹ 7,250 = ₹ 250 (F)
(iv) Material Mix Variance = SP (RSQ-AQ) or (SP × RSQ) - (SP × AQ) = ₹ 7,000 – ₹ 7,250 = ₹ 250(A)
(v) Material Yield Variance = Standard Cost per unit (AY – SY) = ₹ 50 (150-140) = ₹ 500 (F)

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Material and Labour Variances

4 MTP Dec'23 Set 2

The standard mix of product M5 is as follows:
LBs Material Price Per LB
50 A 5.00
20 B 4.00
30 C 10.00
Standard loss is 10% of input. There is no scrap value. Actual production for month was LB.7240
of M5 from 80 mixes. Purchases and consumption is as follows:
LBs Material Price
4160 A 5.5
1680 B 3.75
2560 C 9.5
Calculate variances. [7]

Material Variances

Answer
Standard Data Actual Data
Quantity Price Value Quantity Price Value
A 4200 5 21000 4160 5.50 22880
B 1680 4 6720 1680 3.75 6300
C 2520 10 25200 2560 9.50 24320
8400 52920 8400 53500
- Loss@ 10% 840 - 1160 -
7560 52920 7240 53500

SQSP (1) RSQSP (2) AQSP (3) AQAP (4)

A 4,022.22 × 5 = 20,111 4,160 × 5 = 20,800
B 1,608.89 × 4 = 6,436 1,680 × 4 = 6,720
C 2,413.33 × 10 = 24,133 2,560 × 10 = 25,600
50,680 52,920 53,120 53,500

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 Standard Costing and Variance Analysis
Material and Labour Variances

4 , 200
SQ for A = × 7,240
7, 500

1, 680
SQ for B = × 7,240
7, 560

2, 520
SQ for C = × 7,240
7, 560
(A) Material yield Variance (1 – 2) = 2240 (A)
(B) Material Mix Variance (2 – 3) = 200 (A)
(C) Material usage Variance (1 – 3) = 2440 (A)
(D) Material Price Variance (3 – 4) = 380 (A)
(E) Material Cost Variance (1 – 4) = 2820 (A)

5 MTP Jun’24 Set 1

Z Limited manufactures a standard product. The standard mix of it is:
Material X: 60% at ₹15 per kg.
Material Y: 40% at ₹10 per kg.
Normal loss in output is 20 percent of input due to shortage of material Y. The actual results for
May, 2023 were:
Material X: 210 kg at ₹16 per kg.
Material Y: 190 kg at ₹10.50 per kg.
Actual output : 330 kg.
You are required to calculate:
(i) Material Cost Variance
(ii) Material Price Variance
(iii) Material Usage Variance
(iv) Material Mix Variance
(v) Material Yield Variance. [14]

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 Standard Costing and Variance Analysis
Material and Labour Variances

Material Variances

Answer
Working notes:
1. Total SQ for Actual output= 330 × 100 ÷ 80 = 412.50 kg.
Standard Quantity for X = 412.50 × 60% = 247.50 kg.
Standard Quantity for Y = 412.50 × 40 % = 165.00 kg.
2. RSQ = Total Actual quantity × Standard proportion
Revised Standard Quantity for X = (210 + 190) = 400 × 60% = 240 kg.
Revised Standard Quantity for Y = = (210 + 190) = 400 × 40% = 160 kg.
3. Standard Yield (SY) by using actual quantity: 400kg × 80% = 320 kg.
Computation of Material Variances:
(i) Material Cost Variance = (SQ × SP) – (AQ × AP)
For material X: (247.5 × ₹15) – (210 × ₹16) = ₹3,712.50 – ₹ 3,360 = ₹352.50 (F)
For material Y: (165 × ₹ 10) – (190 × ₹ 10.50) = ₹ 1,650 – ₹ 1,995 = ₹ 345 (A)
Total Material Cost Variance = ₹ 7.50 (F)
(ii) Material Price Variance = AQ (SP – AP)
For X: 210 (₹ 15 – ₹ 16) = ₹ 210 (A)
For Y: 190 (₹ 10 – ₹ 10.50) = ₹ 95 (A)
Total Material Price Variance = ₹ 305 (A)
(iii) Material Usage Variance = SP (SQ – AQ)
For X: ₹15 (247.50 – 210) = ₹562.50 (F)
For Y: 10 (165 – 190) = ₹ 250.00 (A)
Total Material Usage Variance = ₹ 312.50 (F)
(iv) Material Mix Variance = SP (RSQ – AQ)
For X: ₹ 15 (240 – 210) = ₹ 450 (F)
For Y: ₹ 10 (160 – 190) = ₹ 300 (A)
Total Material Mix Variance = ₹ 150 (F)

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 Standard Costing and Variance Analysis
Material and Labour Variances

(v) Material Yield Variance = Standard Cost per unit (SC) (AY – SY)
= ₹ 16.25 (330 – 320)
= ₹ 162.50(F)
Standard Cost (SC) per unit = ₹ 16.25, calculated as under:
X: 247.50 × ₹15 = ₹3,712.50
Y: 165 × ₹ 10 = ₹1,650.00
₹5,362.50
Total Standard Cost for 330 units of output = ₹ 5362.50
Hence, SC per unit = ₹ 5362.50 ÷ 330= ₹ 16.25

6 MTP Dec’24 Set 1

Following information is given regarding standard composition and standard rates of a gang
workers:
Standard composition Standard hourly rate
100 Men ₹0.625
50 Women ₹0.400
50 Boys ₹0.350
According to given specifications, a week consists of 40 hours and standard output for a week
is 1,000 units.
In a particular week, gang consisted of 130 men, 40 women and 30 boys and actual wages were
paid as follows:
Men @ ₹0.6 per hour
Women @ ₹0.425
Boys @ ₹0.325 per hour
Two hours were lost in the week due to abnormal sale time. Actual production was 960 units in
the week.
Calculate the following-
(i) Labour rate variance,
(ii) Labour mix variance,
(iii) Labour idle time variance,
(iv) Labour yield variance,
(v) Labour efficiency variance,
(vi) Labour cost variance [7]

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 Standard Costing and Variance Analysis
Material and Labour Variances

Labour Variances

Answer
L1 - Actual payment to workers for actual hours worked
Actual composition of gang Hrs. worked Actual Rate (₹) Amount (₹)
130 Men × 40 × 0.600 3,120
40 Women × 40 × 0.425 680
30 Boys × 40 × 0.325 390
4,190
L2 - Payment involved, if workers had been paid at standard rate
Actual composition of gang Hrs. worked Standard Rate (₹) Amount (₹)

130 Men × 40 × 0.625 3,250

40 Women × 40 × 0.400 640
30 Boys × 40 × 0.350 420
4,310
L3 - Payment involved, if workers had been used according to proportion of standard gang and
payment had been made at standard rate
Standard composition of gang Hrs. worked Standard Rate (₹) Amount (₹)
100 Men × 40 × 0.625 2,500
50 Women × 40 × 0.400 800
50 Boys × 40 × 0.350 700
4,000
L4 - Standard labour cost of labour hours utilized
Standard composition of gang Hrs. utilized Standard Rate (₹) Amount (₹)
100 Men × 38 × 0.625 2,375
50 Women × 38 × 0.400 760
50 Boys × 38 × 0.350 665
3,800

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 Standard Costing and Variance Analysis
Material and Labour Variances

L5 - Standard labour cost of output achieved

Standard labour cost for Standard output
× Actual output
Standard output

4,000
× 960 units
10,000 units

= ₹3840
Variances:
(i) Labour Rate Variance = L1 – L2 = ₹4190 – ₹4310 or ₹120 (F)
(ii) Labour Mix Variance = L2 – L3 = ₹4310 – ₹4000 or ₹310 (A)
(iii) Labour Idle Time Variance = L3 – L4 = ₹4000 – ₹3800 or ₹200 (A)
(iv) Labour Yield Variance = L4 – L5 = ₹3800 – ₹3840 or ₹40 (F)
(v) Labour Efficiency Variance = L2 – L5 = ₹4310 – ₹3840 or ₹470 (A)
Alternatively,
Labour Efficiency Variance = Labour Mix Variance + Labour Idle Time Variance + Labour
Yield Variance
= 310 (A) + 200 (A) + 40 (F) or ₹470 (A)
(vi) Labour Cost Variance = L1 – L5 = ₹4190 – ₹3840 or ₹350 (A)
Alternatively, Labour Cost Variance = Labour Rate Variance + Labour Mix Variance + Labour
Idle Time Variance + Labour Yield Variance
= 120 (F) + 310 (A) + 200 (A) + 40 (F) or ₹350 (A)

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 Standard Costing and Variance Analysis
Variable Overhead Variance

6.2
Variable Overhead Variance

No questions have been asked yet from this chapter !

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 Standard Costing and Variance Analysis
Fixed Overhead Variance

6.3
Fixed Overhead Variance

1 MTP Jun'23 Set 1

AB Ltd. has furnished the following information:
Budgeted Actual (for March 2023)
Number of working days 25 27
Production (in Units) 20000 22000
Fixed Overheads ₹ 30000 ₹ 31000
Budgeted fixed overhead rate is ₹ 1.00 per hour. In March 2023, the actual hours worked were
31500.
Calculate:
(i) Fixed overhead Efficiency Variance
(ii) Fixed overhead Capacity Variance
(iii) Fixed overhead Calendar Variance
(iv) Fixed overhead Volume Variance
(v) Fixed overhead Expenditure Variance [7]

FOH Variances

Answer
Standard rate per unit (Budgeted overheads/Budgeted output) i.e.,
= (₹30‚000/20‚000 units) = ₹ 1.50
Standard time per unit (30‚000/20‚000) = 1.50 hours
(i) Efficiency Variance = Standard overhead rate (Standard hours for actual output – Actual
hours worked)
₹1.00 (33,000 – 31,500) = ₹ 1,500 (F)

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Fixed Overhead Variance

Standard hour for actual output = 22,000 units @ 1.5 hours = 33,000 hours.
(ii) Capacity Variance = Standard rate per hour (Actual hours worked – Budgeted hours for 27
days)
₹1 (31,500 – 32,400) = ₹ 900 (A)
Budgeted hrs for 25 days = 30,000 therefore, budgeted hours for 27 days
= 32,400 i.e., (30‚000÷25 ×27)
(iii) Calendar Variance
Standard Overheads rate per day (Actual working days – Budgeted working days)
₹1,200× (27 – 25) = ₹ 2,400 (F), where, Standard Overheads rate per day
= ₹30,000÷25 days = ₹1,200
(iv) Volume Variance
Standard rate per unit (Actual Output – Budgeted output)
₹ 1.50 × (22,000 – 20,000) = ₹ 3,000 (Favourable).
(v) Expenditure Variance
Budgeted overheads – Actual overheads
₹ 30,000 – ₹ 31,000 = ₹1,000 (Adverse).

2 Jun'23
DASON Ltd., using standard costing system has the following information for the month of
September 2022.
Budgeted Fixed overheads for the month: ₹ 5,00,000. Overheads are recovered on the basis
of standard machine hours. The company had budgeted for 1,00,000 machine hours for the
month. During the month, the company used 1,10,000 machine hours while it should have
used 95,000 machine hours for actual output. Actual Fixed Overheads for the month: ₹4,70,000.
Required:
Analyse the following Fixed Overhead Variances:
(i) Fixed Overhead Volume Variance
(ii) Fixed Overhead Efficiency Variance
(iii) Fixed Overhead Cost Variance. [5]

Fixed Overhead Volume Variance

Fixed Overhead Efficiency Variance
Fixed Overhead Cost Variance

6.16 |CMA Inter Management Accounting

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 Standard Costing and Variance Analysis
Fixed Overhead Variance

Answer
(i) Fixed Overheads Volume Variance = ₹ 25,000 (Adv.)
(ii) Fixed Overheads Efficiency Variance = ₹ 75,000 (Adv.)
(iii) Fixed Overheads Cost Variance = ₹ 5,000 (Fav.)

3 MTP Dec'23 Set 1

The cost accountant of a Co. was given the following information regarding the OHs for Feb,
2022:
a. Overhead cost variance ₹ 1,400 (A)
b. Overheads volume variance ₹ 1,000 (A)
c. Budgeted hours for Feb, 2022: 1,200 Hours
d. Budgeted OH for Feb, 2022: ₹ 6,000
e. Actual rate of recovery of OH ₹ 8 per hour
You are required to assist him in computing the following for Feb, 2022
i. OH expenditure variance
ii. Actual OH incurred
iii. Actual hours for actual production
iv. OH capacity variance
v. OH efficiency variance
vi. Standard hours for actual production [7]

Fixed Overhead Variances Missing Figures

Answer
1 2 3 4
SRSH SRAH SRBH ARAH
5 × 1000 5 × 800 5 × 1200 8 × 800
5000 4000 6000 6400
SRSH – SRBH = Volume Variance
SRSH – 6000 = – 1000 (A)

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Fixed Overhead Variance

SRSH = 5000
SRSH – ARAH = Cost Variance
5000 – ARAH = – 1400(A)
ARAH = 6400
Flexible budget showing OH rate par labour hour
(1) OH Expenditure Variance = 6000 – 6400 = 400(A)
(2) Actual Over Incurred ARAH = 6400
(3) Actual Hrs for Actual production = AH = 800
(4) OH Capacity Variance = 4000 – 6000 = 2000(A)
(5) OH Efficiency Variance = 5000 – 4000 = 1000(F)
(6) Std. Hrs for Actual Production = SH = 1000
Budgeted Fixed OH 6 , 000
SR = = =5
Budgeted Hours 1, 200

4 MTP Jun’24 Set 1

The following information is extracted from the records of Aljhon Ltd. a manufacturing company
using standard costing system for the month ending October, 2023:
Budget Actual
Fixed Overhead 10,000 12,000
Production(units) 2,000 2,100
Standard Time per Unit (hours) 10 —
Actual Hours Worked — 21,000
Required to calculate the following Fixed Overhead Variances:
(i) Fixed Overhead Cost Variance
(ii) Fixed Overhead Expenditure Variance
(iii) Fixed Overhead Volume Variance. [7]

Fixed Overhead Variances

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 Standard Costing and Variance Analysis
Fixed Overhead Variance

Answer
For Fixed Overhead Variance:
Actual Fixed Overhead incurred (Given) ₹12,000
Budgeted Fixed Overhead for the period ₹10,000
Standard Fixed overhead for production
= (Standard output for actual time X Standard Fixed Overhead per unit)
= 2,100 unit X (₹ 10,000 ÷ 2,000 unit) ₹10,500
(i) Fixed Overhead Variance = Standard F.O. – Actual F.O.
= ₹10,500 – ₹12,000
= ₹1,500 (A)
(ii) F.O. Expenditure Variance = Budgeted F.O. – Actual F.O.
= ₹10,000 – ₹12,000
= ₹2,000 (A)
(iii) F.O. Volume Variance = Standard F.O. – Budgeted F.O.
= ₹10,500 – ₹10,000
= ₹500 (F)

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 Standard Costing and Variance Analysis
Sales Variance

6.4
Sales Variance

1 MTP Jun'23 Set 2

Pradeep LLP of Delhi follows a standard cost system. For a particular month the following is
extracted from their cost records.
Budgeted Actual
Product Quantity Quantity
Price (₹) Value (₹) Price (₹) Value (₹)
(Units) (Units)
X 600 3 1800 800 4 3200
Y 800 4 3200 600 3 1800
Analyse Sales Variances. [8]

Sales Variances

Answer
(i) Sales Value Variance = Actual Value of Sales – Standard Value of Sales
Total Actual Value of Sales = ₹ 3,200 + ₹ 1,800
= ₹ 5,000
Total Standard Value of Sales = ₹ 1,800 + ₹ 3,200 = ₹ 5,000
Sales Value Variance = (₹5,000 – ₹ 5,000) = Nil
(ii) Sales Price Variance = Actual Quantity Sold × (Actual Price – Standard Price)
Product A → 800 × (₹4 – ₹ 3) = ₹ 800 Favourable
Product B → 600 × (₹3 – ₹4) = ₹ 600 Unfavourable
Total Sales Price Variance = ₹(800 – 600) = ₹ 200 Favourable
(iii) Sales Volume Variance = Standard Price× (Actual Units – Standard Units)
Product A → ₹ 3× (800 – 600) = ₹ 600 Favourable

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Sales Variance

Product B → ₹4 × (600–800) = ₹ 800 Unfavourable

Total Sales Volume Variance = ₹(600 – 800) = ₹ 200 Unfavourable.

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Interpretation of Variances and Inferences Drawn

6.5
Interpretation of Variances
and Inferences Drawn

1 Jun'23
DOXTIN Ltd. is using a system of Standard Costing and has a manufacturing division which
makes a product to which the following details relate:
Per unit (₹)
Direct Material: 5 kg. at ₹ 20 100
Direct labour: 12 hours at ₹ 20 240
Variable overheads: 12 hours at ₹ 10 120
Relevant fixed overheads are based at ₹ 1,00,000 per month and planned output is 2,000 units
per month. The selling price is ₹ 550 per unit. During a recent month when output was 1,800
units, the following actual costs were incurred:
(₹)
Direct Materials (8,500 kg) 1,72,000
Direct labour (20,000 hours) 4,20,000
Variable overhead : 2,20,000
Fixed overhead 98,000
9,10,000
Profit 40,000
Sales value 9,50,000
Required:
(i) Analyse and calculate the variances which occurred during the month.
(ii) Reconcile the actual profit with budgeted profit. [7 + 3 = 10]

Variances and Reconciliation

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 Standard Costing and Variance Analysis
Interpretation of Variances and Inferences Drawn

Answer
(i) Material Price variance = ₹2,000 (Adv)
Material Usage variance = ₹10,000 (Fav)
Direct wage rate variance = ₹20,000 (Adv)
Wage Efficiency variance = ₹32,000 (Fav)
Variable Overhead expenditure variance = ₹ 20,000 (Adv)
Variable overhead efficiency variance = ₹16,000 (Fav)
Fixed overhead expenditure variance = ₹2,000 (Fav)
Fixed overhead capacity variance = ₹16,667(Adv)
Fixed overhead efficiency variance = ₹6,667 (Fav)
Sales margin price variance = ₹40,000 (Adv)
Sales margin volume variance = ₹8,000 (Adv)
(ii) Reconciliation of Profit
₹
Budgeted Profit 80,000
Favorable Variances: 1,46,667
Adverse variances: (1,06,667)
Actual Profit (for the period): 40,000

2 Postal Test Paper

In a Cost Conference, the speaker discussing budgets and standard costs made the following
statement:
“Budgets and standards are not the same thing. They have different purposes and are set up
and used in different ways; yet a specific relationship exists between them.”
(A) Identify distinctions or differences between budgets and standards.
(B) Identify similarities between budgets and standards. [8]

Similarities, Differences Between Budgets

And Standards

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Interpretation of Variances and Inferences Drawn

Answer
(a) (i) In budgetary control, budgets are used as a means of planning and control. The
targets of various segments are set in advance and actual performance is compared
with predetermined objects. In this way management can assess the performance of
different departments. On the other hand, standard costing also set standards and
enables to determine efficiency on the basis of standards and actual performance.
Budgetary control is essential to determine standard costs, whereas, the standard
costing system is necessary for planning budgets.
(ii) In budgetary control the budgets are prepared for the concern as a whole whereas
in standard costing the standards are set for producing a product or for providing a
service.
(iii) In standard costing, unit concept is used while in budgetary control total concept is
used.
(iv) The budgets are fixed on the basis of past records and future expectations. Standard
costs are fixed on the basis of technical information. Standard costs are planned costs
and these are expected in future.
(v) As far as scope is concerned, in case of budgetary control it is much wider than standard
costing. Budgets are prepared for incomes, expenditures and other functions of the
departments such as purchase, sale, production, finance and personnel department.
In contrary, standards are set up for expenditures only and, therefore, for manufactur-
ing departments standards are set for different elements of cost i.e., material, labour
and overheads.
(vi) Further, in budgetary control, the targets of expenditure are set and these targets
cannot be exceeded. In this system the emphasis is on keeping the expenditures
within the budgeted figures. In standard costing the standards are set and an attempt
is made to achieve these standards. The emphasis is on achieving the standards.
Actual costs may be more than the standard costs and there can be no such thing in
budgetary control.
(vii) The budgetary control system can be applied partly or wholly. Budgets may be
prepared for some departments and may not be prepared for all the departments. If a
concern is interested in preparing production budget only, it is free to do so.
Standard costing cannot be used partially; it will have to be used wholly. The
standards will have to be set for all elements of cost. In fact, the systems operate in
two different fields and both are complimentary in nature.
(b) Although standards and budgets have certain differences, they possess similarities
which are of such a nature that the existence of standard costs greatly facilitates budget
preparation.
(i) The first similarity is that both budgets and standards attempt to predetermine
expenses. The budget and the standards have been set by records of current
operational methods or procedures and have not just been set by hopes for so-called
“good production.”

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Interpretation of Variances and Inferences Drawn

(ii) Second, both consider departmental expenses according to accounts, generally

speaking, all departments have their sub-accounts. They have been budgeted for a
certain amount to be spent for specific uses. If there are cost differences, they should
be investigated at the time they are happening.
(iii) Third similarity is that both assume costs are controllable along direct lines of
supervision and responsibility. Supervisors are responsible to manage not only for
production but also for cost of production. Supervisors should be aware of the budget
as well as the standards for their departments.
(iv) Finally, both require the issuance of periodic comparative cost reports. When the
costs are much higher or lower than the budgeted amount and are controlled by
standards, these differences should be broken down to show management specific
reasons for these differences at each interim reporting period.
Budgets are similar to standard costs in their methods of approach and measurement.
If standard costs are known, budgeted costs can be derived from them by the applica-
tion of ratios.

3 MTP Dec'23 Set 1

ABC Ltd. adopts a Standard Costing System. The standard output for a period is 20,000 units
and the standard cost and profit per unit is as under:

Particulars (₹ )
Direct Material (3 units @ ₹ 1.50) 4.50
Direct Labour (3 hrs. @ ₹ 1.00) 3.00
Direct expenses 0.50
Factory overheads : Variable 0.25
Fixed 0.30
Administration overheads 0.30
Total Cost 8.85
Profit 1.15
Selling Price (Fixed by government) 10.00

The actual production and sales for a period was 14,400 units. There has been no price revision
by the government during the period.
The following are the variances worked out at the end of the period:
Particulars Favourable (₹) Adverse (₹)
Direct Material
Price 4,250
Usage 1,050

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Interpretation of Variances and Inferences Drawn

Direct labour
Rate 4,000
Efficiency 3,200
Factory overheads
Variable – expenditure 400
Fixed – expenditure 400
Fixed – Volume 1,680
Administration overheads
Expenditure 400
Volume 1,680
You are required to:
Ascertain the details of actual costs and prepare a Profit and Loss Statement for the period
showing the actual Profit/Loss. Show working clearly.
Reconcile the Actual Profit with Standard Profit. [14]

Profit Reconciliation Statement

Answer
Statement showing the Actual Profit and Loss Statement
Particulars Amount (₹) Amount (₹)
Standard Material Cost (14,400 × 4.50) 64,800
Add: Price Variance 4,250
Less: Usage Variance (1,050) 68,000
Standard Labour Cost (14,400 × 3) 43,200
Add: Rate Variance 4,000
Less: efficiency Variance (3,200) 44,000
Direct expenses (14,400 × 0.50) 7,200
Prime Cost 1,19,200
Factory overhead:
Variable (14,400 × 0.25) 3,600
Less: expenditure Variance (400) 3,200
Fixed (14,400 × 0.30) 4,320
Add: Volume Variance 1,680

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Interpretation of Variances and Inferences Drawn

Less: expenditure Variance (400) 5,600

Administration overhead (14,400 × 0.3) 4,320
Add: Volume Variance 1,680
Add: exp. Variance 400 6,400
Total Cost 1,34,400
Profit (B/F) 9,600
Sales 1,44,000
Statement showing Reconciliation of Standard Profit with Actual Profit
Particulars ₹ ₹
Standard Profit for AO (14,400 × 1.15) 16,560
Add: Material usage Variance 1,050
Labour efficiency Variance 3,200
Variable overhead expenditure Variance 400
Fixed overhead expenditure Variance 400 5,050
21,610
Less: Material Price Variance 4,250
Labour Rate Variance 4,000
Fixed overhead Volume Variance 1,680
Administration expenditure Variance 400
Administration Volume Variance 1,680 12,010
Actual Profit 9,600

4 Dec'23
M/S Gems Limited provided you the following data for the month of March, 2023.
Particulars Standard Actual
Fixed Overhead ₹30,000 ₹35,000
Units Produced 1,000 1,200
Hours per unit 1 1.1
No. of days 20 23
You are required to calculate the following Fixed Overhead Variances:
(i) Efficiency Variance
(ii) Capacity Variance
(iii) Idle Time Variance
(iv) Volume Variance

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Interpretation of Variances and Inferences Drawn

(v) Budget/Expenditure Variance

(vi) Fixed Overhead Cost Variance [7]

Fixed Overhead Variances

Answer
(i) Efficiency Variance = ₹ 3600 (A)
(ii) Capacity Variance = ₹ 5100 (F)
(iii) Idle Time variance = ₹ 4500 (F)
(iv) Volume Variance = ₹ 6000 (F)
(v) Budget / Expenditure Variance = ₹ 5000 (A)
(vi) Fixed Overhead Cost Variance = ₹ 1000 (F)

5 Jun’24
JK Ltd. has furnished the following information:
Standard overhead absorption rate per unit ₹ 20 Standard rate per hour ₹ 4 Budgeted production
12000 units Actual production 15560 units
Actual overheads were ₹ 2,95,000 out of which X 62,500 is fixed.
Actual hours 74000
Overheads are based on the following flexible budget:

Production (units) 8000 10000 14000

Total Overheads (₹) 1,80,000 2,10,000 2,70,000
Required (with detailed working note and on hourly basis):
(i) Calculate Standard Variable O/H and Fixed O/H rates per hour.
(ii) Calculate Variable Overhead Efficiency and Expenditure Variance.
(iii) Calculate Fixed Overhead Efficiency and Capacity Variance. [7]

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 Standard Costing and Variance Analysis
Interpretation of Variances and Inferences Drawn

VOH and FOH Variances

Answer
(i) Standard Variable Overhead Rate per hour = ₹ 3
Standard Fixed Overhead Rate per hour = ₹ 1
(ii) Variable Overhead Efficiency Variance = ₹ 11,400 (F)
Variable Overhead Expenditure Variance = ₹ 10,500 (A)
(iii) Fixed Overhead Efficiency Variance = ₹ 3,800 (F)
Fixed Overheads Capacity Variance = ₹ 14,000 (F)

6 MTP Dec’24 Set 1

The budgeted output of a manufacturing company for 2023-24 was 5,000 units. The financial
results in respect of actual output of 4,800 units achieved during the year were as under:
₹ ₹
Direct Material 29,700 Fixed Overheads 39,000
Direct Wages 44,700 Profit 36,600
Variable Overheads 72,750 Sales 2,22,750
The standard direct wages rate is ₹4.50 per hour and the standard variable overhead rate is
₹7.50 per hour.
The cost accounts recorded the following variances for the year:
Variances Favourable (₹) Adverse (₹)
Material Price - 300
Material Usage - 600
Wage rate 750 -
Labour efficiency - 2,250
Variable overhead expense 3,000 -
Variable overhead efficiency - 3,750
Fixed overhead expense - 1,500
Selling price 6,750 -

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Interpretation of Variances and Inferences Drawn

(i) Prepare a statement showing the original budget and the standard product cost sheet per
unit.
(ii) Prepare a statement showing the reconciliation of originally budgeted profit and actual
profit. [14]

Profit Reconciliation Statement

Answer
(i) Statement showing the original budget and standard cost sheet per unit
Actual cost, Standard cost,
Adjustment of Standard cost,
profit & sales of profit & sales profit & sales of
Particulars variances (₹)
4,800 units of 4,800 units 5,000 units
(₹) (F) (A) (₹) Total (₹) p.u.
Sales 2,22,750
Sales price variance 6,750 - 2,16,000 2,25,000 45.00
Direct Material 29,700
Material price - 300
variance
Material usage - 600
variance
Standard material 28,800 30,000 6.00
cost
Direct wages 44,700
Wages rate variance 750 -
Labour efficiency - 2,250
variance
Standard Labour 43,200 45,000 9.00
cost
Variable overheads 72,750
V.O. expenditure 3,000 -
variance
V.O. efficiency - 3,750
variance
Standard variable 72,000 75,000 15.00
overhead
Fixed overheads 39,000

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Interpretation of Variances and Inferences Drawn

Fixed overhead - 1,500

exp. variance
Budgeted F.O. 37,500 37,500 7.50
Cost of sales 1,86,150 1,81,500 1,87,500 37.50
Profit 36,600 34,500 37,500 7.50
(ii) Statement showing the reconciliation of original budgeted profit and actual profit
Details Amount
Particulars
(₹) (₹)
Budgeted Profit 37,500
Add: Favourable cost variances
Wage Rate 750
Variable overhead expense 3,000 3,750
41,250
Add: Sales price variance 6,750
48,000
Less: Adverse cost variances
Material Price 300
Material usage 600
Labour efficiency 2,250
Variable overhead efficiency 3,750
Fixed overhead expense 1,500 8,400
39,600
Less: Sales margin volume variance 1,500
[5,000 – 4,800 = 200 units × ₹7.50 profit per unit]
38,100
Less: Fixed overhead volume variance 1,500
[200 units × ₹7.50 budgeted fixed overhead per unit]
Actual Profit 36,600

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Interpretation of Variances and Inferences Drawn

NOTES

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 Forecasting, Budgeting and Budgetary Control


Chapter 7
Forecasting, Budgeting and Budgetary
Control

7.1 Introduction

7.2 Rationale for Budgets

7.3 General principles in the Budgetary process

7.4 Formulation of various types of Budgets

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 Forecasting, Budgeting and Budgetary Control
Introduction

7.1
Introduction

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 Forecasting, Budgeting and Budgetary Control
Rationale for Budgets

7.2
Rationale for Budgets

No questions have been asked yet from this chapter !

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 Forecasting, Budgeting and Budgetary Control
General principles in the Budgetary process

7.3
General principles in the Budgetary process

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 Forecasting, Budgeting and Budgetary Control
Formulation of various types of Budgets

7.4
Formulation of various types of Budgets

1 MTP Jun'23 Set 1

Zee Co. Ltd. wishes to arrange overdraft facilities with its bankers from the period August to
October 2022 when it will be manufacturing mostly for stock. Prepare a cash budget for the
above period from the following data given below:
Month Sales Purchases Wages Manufacturing Exp. Office Exp. Selling Exp.
June 1,80,000 1,24,800 12,000 3,000 2,000 2,000
July 1,92,000 1,44,000 14,000 4,000 1,000 4,000
August 1,08,000 2,43,000 11,000 3,000 1,500 2,000
September 1,74,000 2,46,000 12,000 4,500 2,000 5,000
October 1,26,000 2,68,000 15,000 5,000 2,500 4,000
November 1,40,000 2,80,000 17,000 5,500 3,000 4,500
December 1,60,000 3,00,000 18,000 6,000 3,000 5,000
Additional Information:
a. Cash on hand 1-08-2022 ₹ 25,000.
b. 50% of credit sales are realized in the month following the sale and the remaining 50%
in the second month following. Creditors are paid in the month following the month of
purchase.
c. Lag in payment of manufacturing expenses half month.
d. Lag in payment of other expenses one month [8]

Cash Budget

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 Forecasting, Budgeting and Budgetary Control
Formulation of various types of Budgets

Answer
Cash Budget for 3 months from August to October 2022
August September October
Particulars
(₹) (₹) (₹)
Receipts:
Opening balance 25,000 44,500 (66,750)
Sales 1,86,000 1,50,000 1,41,000
Total Receipts (A) 2,11,000 1,94,500 74,250
Payments:
Purchases 1,44,000 2,43,000 2,46,000
Wages 14,000 11,000 12,000
Mfg. Exp. 3,500 3,750 4,750
Office Exp. 1,000 1,500 2,000
Selling Exp. 4,000 2,000 5,000
Total payments (B) 1,66,500 2,61,250 2,69,750
Closing Balance (A-B) 44,500 (66,750) (1,95,500)
Notes to Solution:
1. Manufacturing Expense:
August September October
Particulars
(₹) (₹) (₹)
July (₹4,000/2) 2,000 -- --
August (₹3,000/2) 1,500 1,500 --
September (₹4,500/2) -- 2,250 2,250
October (₹5,000/2) -- -- 2,500
Total 3,500 3,750 4,750

2. Sales
August September October
Particulars
(₹) (₹) (₹)
June (₹1,80,000/2) 90,000 -- --
July (₹1,92,000/2) 96,000 96,000 --
August (₹1,08,000/2) -- 54,000 54,000
September (₹1,74,000/2) -- -- 87,000
Total 1,86,000 1,50,000 1,41,000

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 Forecasting, Budgeting and Budgetary Control
Formulation of various types of Budgets

2 MTP Jun'23 Set 1

When the financial controller of Better Company set the budget for the year ahead, it was
expected that monthly output of cake packages would be 12,000 units. In March the output
was increased to 14,000 per month following negotiation with a chain of corner shops. The
following table contains the original budget and the actual outcome for the month of March.
Particulars Original Budget Actual for March
Cake packages output 12,000 14,000
Direct materials 48,000 53,000
Direct labour 24,000 29,000
Variable overhead 6,000 7,200
Fixed overhead 4,000 4,500
Total production costs 82,000 93,700
The Financial Controller wants you to analyse the variances in order to prepare a report. [7]

Flexible Budget Analysis

Answer
The report should contain the following:
Original Flexible Actual for
Variance
Particulars budget budget March
(1) (2) (3) (2) – (3)
Units manufactured 12,000 14,000 14,000
₹ ₹ ₹ ₹
Direct materials 48,000 56,000 53,000 3,000 (F)
Direct labour 24,000 28,000 29,000 1,000 (A)
Variable overhead 6,000 7,000 7,200 200 (A)
Fixed overhead 4,000 4,000 4,500 500 (A)
Total costs 82,000 95,000 93,700 1,300 (F)
The direct materials variance is 5.4% of the flexible budget amount and needs investigating
even although it is favourable.
Two possible questions to investigate are:
(1) Did the budget estimates use outdated prices?

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Formulation of various types of Budgets

(2) Has the buying department chosen low price materials without perhaps considering the
quality?
The labour variance is 3.6% of the flexible budget amount. Questions that could be asked here
are:
(1) Has there been a rise in pay rates since the budget was set?

3 MTP Dec'23 Set 1

At 80% capacity
Plant Capacity
(₹)
Variable Overheads:
Indirect labour 12,000
Stores including spares 4,000
Semi Variable:
Power (30% - Fixed; 70% -Variable) 20,000
Repairs (60%- Fixed; 40% -Variable) 2,000
Fixed Overheads:
Depreciation 11,000
Insurance 3,000
Salaries 10,000
Total overheads 62,000
Estimated Direct Labour Hours 1,24,000

Draw up a flexible budget For overhead expenses on the basis of the above data and determine
the overhead rates at 70%, 80% and 90%. [7]

Flexible Budget

Answer
Flexible Budget at Different Capacities and Determination of Overhead Rates
Particulars 70% (₹) 80% (₹) 90% (₹)
(A) Variable overheads:
Indirect labour 10,500 12,000 13,500
Stores including spares 3,500 4,000 4,500

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 Forecasting, Budgeting and Budgetary Control
Formulation of various types of Budgets

Total (A) 14,000 16,000 18,000

(B) Semi Variable overheads:
Power (Working Note) 18,250 20,000 21,750
Repairs (Working Note) 1,900 2,000 2,100
Total (B) 20,150 22,000 23,850
(C) Fixed overheads:
Depreciation 11,000 11,000 11,000
Insurance 3,000 3,000 3,000
Salaries 10,000 10,000 10,000
Total (C) 24,000 24,000 24,000
Grand Total (A + B + C) 58,150 62,000 65,850
Labour Hours 70% 1,24,000 90%
1,24,000 × 1,24,000 ×
80% 80%
= 1,08,500 = 1,39,500
58 , 150 62, 000 65, 850
Overhead rate per hour (₹) = 0.536 = 0.50 = 0.472
1, 08 , 500 1, 24 , 000 1, 39 , 500

Working notes: Semi Variable overheads

70% 90%
Power:
70% 90%
Variable (70%) 14,000 × = 12,250 14,000 × = 15,750
80% 80%
Fixed (30%) 6,000 6,000
Total 18,250 21,750
Repairs:
70% 90%
Variable (40%) 800 × = 700 800 × = 900
80% 80%
Fixed (60%) 1,200 1,200
Total 1,900 2,100

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Formulation of various types of Budgets

4 MTP Jun'23 Set 2

Prepare a Cash Budget for the three months ending 30th June, 2023 from the information
given below:
Sales Materials Wages Overhead
Month
(₹) (₹) (₹) (₹)
February 14,000 9,600 3,000 1,700
March 15,000 9,000 3,000 1,900
April 16,000 9,200 3,200 2,000
May 17,000 10,000 3,600 2,200
June 18,000 10,400 4,000 2,300
Credit terms are:
• Sales / Debtors: 10% sales are on cash, 50% of the credit sales are collected next month and
the balance in the following month.
• Creditors: Materials 2 months
Wages 1/4 month
Overheads 1⁄2 month
• Cash and bank balance on 1st April, 2023 is expected to be ₹ 6,000.
Other relevant information are:
• Plant and machinery will be installed in February 2017 at a cost of ₹ 96,000. The monthly
instalment of ₹ 2,000 is payable from April onwards.
• Dividend @ 5% on preference share capital of ₹ 2, 00,000 will be paid on 1st June.
• Advance to be received for sale of vehicles ₹ 9,000 in June.
• Dividends from investments amounting to ₹1,000 are expected to be received in June. [8]

Cash Budget

Answer
Cash Budget for the 3 Months Ending 30th June 2023 (Amount in ₹)
Particulars April May June
Opening Balance (A) 6,000 3,950 3,000
Add: Receipts : (B)

7.10 |CMA Inter Management Accounting

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 Forecasting, Budgeting and Budgetary Control
Formulation of various types of Budgets

Cash Sales 1,600 1,700 1,800

Collection from debtors [see note(i)] 13,050 13,950 14,850
Advance for sale of vehicles - - 9,000
Dividends from Investments - - 1,000
Total (A+B) 20,650 19,600 29,650
Less: Payments :
Materials 9,600 9,000 9,200
Wages [see note (ii)] 3,150 3,500 3,900
Overheads 1,950 2,100 2,250
Instalment of Plant & Machinery 2,000 2,000 2,000
Preference dividend - - 10,000
Total (C) 16,700 16,600 27,350
Closing Balance (A+B-C) 3,950 3,000 2,300
Working Notes:
(i) Computation of Collection from Debtors (Amount in ₹)
Month Total Sales Credit Sales Feb Mar Apr May June
Feb 14,000 12,600 --- 6,300 6,300 --- ---
Mar 15,000 13,500 --- --- 6,750 6,750 ---
Apr 16,000 14,400 --- --- --- 7,200 7,200
May 17,000 15,300 --- --- --- --- 7,650
13,050 13,950 14,850
(ii) Wages payment in each month is to be taken as three-fourths of the current month plus
one-fourth of the pre-vious month

5 MTP Jun'23 Set 2

What is budgetary control? What are the objectives of budgetary control? [4]

Budgetary Control, Objectives

Answer
Budgetary Control is defined as “the establishment of budgets, relating the responsibilities
of executives to the requirement of a policy, and the continuous comparison of actual with
budgeted results either to secure by individual action the objective of that policy or to provide

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 Forecasting, Budgeting and Budgetary Control
Formulation of various types of Budgets

a base for its revision.” Budgetary control is intimately connected with budgets. The Chartered
Institute of Management Accountants, London defines ‘Budgetary control; as “the establish-
ment of budgets, relating the responsibilities of executive to the requirements of a policy and
the continuous comparison of actual with budgeted results either to secure by individual
action the objectives of that policy or to provide a firm basis for its revision”. The process of
budgetary control is set up with the objective to closely monitor whether or not the actual sales
and expenses are in line with the financial plan.
Objectives of Budgetary Control:
Budgeting is a forward planning. It serves basically as a tool for management control; it is rather
a pivot of any effective scheme of control. The objectives of budgeting may be summarized as
follows:
• Planning: Planning has been defined as the design of a desired future position for an
entity and it rests on the belief that the future position can be attained by uninterrupted
management action.
• Co-ordination: Budgeting plays a significant role in establishing and maintaining
coordination
• Measurement of Success: Budgets present a useful means of informing manager how
well they are performing in meeting targets they have previously helped to set.
• Motivation: Budget is always considered a useful tool for encouraging manager to
complete things in line with the business objectives.
• Communication: A budget serves as a means of communicating information within a firm.
• Control: Control is essential to make sure that plans and objectives laid down in the budget
are being achieved.

6 Jun’23
ASHUB (P) Company manufactures two products — X and Y. A forecast of units to be sold in the
first five month of the year is given below:
Months Product X Product Y
April 1,000 2,800
May 1,200 2,800
June 1,600 2,400
July 2,000 2,000
August 2,400 1,600

7.12 |CMA Inter Management Accounting

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 Forecasting, Budgeting and Budgetary Control
Formulation of various types of Budgets

Other information is as follows:

Cost per unit (₹) Product X Product Y
Direct Materials 12.50 19.00
Direct Labour 4.50 7.00
Factory Overhead 3.00 4.00
There will be no opening and closing work-in-progress at the end of any month. Finished
product (in units), equal to half of the budgeted sales of the next month, should be in stock at
the end of each month (including previous year ended March).
You are required to prepare:
(i) Production (in quantity) Budget for April to July; and
(ii) Summarized Production Cost Budget for the period. [4 + 3 = 7]

Production Budget, Summarized

Production Cost Budget

Answer
(i) Production Budget for the period of April to July
Budgeted Production (units)
Month
X Y
April 1,100 2,800
May 1,400 2,600
June 1,800 2,200
July 2,200 1,800
Total 6,500 9,400
(ii) Production cost budget for the period April to July:
Details Total Cost for X & Y (Rs)
Direct Material 2,59,850
Direct Labour 95,050
Factory Overhead 57,100
Total 4,12,000

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Formulation of various types of Budgets

7 Jun’23; MTP Dec’23 Set 2

ANTU GLASS Company provides the following details relating to Master Budget for the year
ended March 31, 2024,

Sales:
Toughened Glass ₹ 60,00,000
Bent Glass ₹ 20,00,000
Direct material cost 60% of sales
Diner wages 20 workers @ ₹ 1,500 per month
Factory overheads:
Indirect labour-
Works manager ₹ 5,000 per month
Foreman ₹ 4,000 per month
Stores and spares 2.5% on sales
Depreciation on machinery ₹ 1,26,000
Light and power ₹ 30,000
Repairs and maintenance ₹ 80,000
Others sundries 10% on direct wages
Administration, selling and distribution expenses ₹ 3,60,000 per year
Required:
Prepare the Master Budget for the year ended March 31, 2024. [8]

Master Budget

Answer
Master Budget for the year ended March 31, 2024
(₹) (₹)
Total Sales 80,00,000
Less: Works Cost
Prime Cost 51,60,000
Fixed Factory Overhead 2,64,000
Variable Factory Overhead 3,16,000
57,40,000

7.14 |CMA Inter Management Accounting

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 Forecasting, Budgeting and Budgetary Control
Formulation of various types of Budgets

Gross Profit 22,60,000

Less: Adm., Selling and distribution expenses 3,60,000
Net Profit 19,00,000

8 MTP Dec'23 Set 2

Prepare Cash Budget for M/s Alpha Manufacturing Co. on the basis of the following informa-
tion for the first six months of 2022.
(i) Costs and prices remain unchanged.
(ii) Cash Sales are 25% of the total sales and 75% credit sales.
(iii) 60% of credit sales are collected in the month after sales, 30% in the second month and
10% in the third, no bad debts are anticipated.
(iv) Sales forecasts are as follows:
October 2021 ₹ 12,00,000 November 2021 ₹ 14,00,000
December 2021 ₹ 16,00,000 January 2022 ₹ 6,00,000
February 2022 ₹ 8,00,000 March 2022 ₹ 8,00,000
April 2022 ₹ 12,00,000 May 2022 ₹ 10,00,000
June 2022 ₹ 8,00,000 July 2022 ₹ 12,00,000
(v) Gross profit margin 20%
(vi) Anticipated Purchases:
January 2022 ₹ 6,40,000 February 2022 ₹ 6,40,000
March 2022 ₹ 9,60,000 April 2022 ₹ 8,00,000
May 2022 ₹ 6,40,000 June 2022 ₹ 9,60,000
(vii) Wages and Salaries to be paid:
January 2022 ₹ 1,20,000 February 2022 ₹ 1,60,000
March 2022 ₹ 2,00,000 April 2022 ₹ 2,00,000
May 2022 ₹ 1,60,000 June 2022 ₹ 1,40,000
(viii) Interest on ₹ 20,00,000 @ 6% on debentures is due by end of March and June.
(ix) Excise deposit due in April ₹2,00,000
(x) Capital expenditure on Plant and Machinery planned for June ₹ 1,20,000
(xi) Company has a cash balance of ₹ 4,00,000 at 31.12.2021
(xii) Company can borrow on monthly basis.
(xiii) Rent is ₹ 8,000 per month. [14]

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Formulation of various types of Budgets

Cash Budget

Answer
Cash Credit Oct Nov Dec Jan Feb Mar Apr May June July Aug
Oct 3,00,000 9,00,000 - 5,40,000 2,70,000 90,000 - - - - - - -
Nov 3,50,000 10,50,000 - - 6,30,000 3,15,000 1,05,000 - - - - - -
Dec 4,00,000 12,00,000 - - - 7,20,000 3,60,000 1,20,000 - - - - -
Jan 1,50,000 4,50,000 - - - - 2,70,000 1,35,000 4,50,000 - - - -
Feb 2,00,000 6,00,000 - - - - - 3,60,000 1,80,000 60,000 - - -
Mar 2,00,000 6,00,000 - - - - - 3,60,000 1,80,000 60,000 - -
Apr 3,00,000 9,00,000 - - - - - - 5,40,000 2,70,000 90,000 -
May 2,50,000 7,50,000 - - - - - - - 4,50,000 2,25,000 -
Jun 2,00,000 7,50,000 - - - - - - - - 3,60,000 -

Jan Feb Mar April May June

Opening Balance 4,00,000 9,07,000 10,34,000 6,51,000 3,28,000 5,50,000
Receipts
Cash sales 1,50,000 2,00,000 2,00,000 3,00,000 2,50,000 2,00,000
Collection from Dr’s 11,25,000 7,35,000 6,15,000 5,85,000 7,80,000 7,80,000
Total 16,75,000 18,42,000 18,49,000 15,36,000 13,58,000 15,30,000
Payments
Purchases 6,40,000 6,40,000 9,60,000 8,00,000 6,40,000 9,60,000
Wages & salaries 1,20,000 1,60,000 2,00,000 2,00,000 1,60,000 1,40,000
Int. on debentures - - 1,30,000
(20,00,000*6%*1/4)
(20,00,000*6%*1/4) - - 1,30,000
(20,00,000*6%*1/4)
Payment of Exice - - - 2,00,000 - -
duty
Expn on Plant & - - - - - 1,20,000
Mach
Rent Exp 8,000 8,000 8,000 8,000 8,000 8,000
Total 7,68,000 8,08,000 11,98,000 12,08,000 8,08,000 12,58,000
Closing Bal 9,07,000 10,34,000 6,51,000 3,28,000 5,50,000 2,72,000

7.16 |CMA Inter Management Accounting

Divya Jadi Booti
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 Forecasting, Budgeting and Budgetary Control
Formulation of various types of Budgets

9 Dec'23
From the following data obtained from the Cost Records of M/s Palapalli Oil Limited, prepare a
Cash Budget for the period of 3 months ending 31-03-2024.
Direct Direct Direct Factory Admin
Month
Material (₹) Labour (₹) Expenses (₹) Overhead (₹) Overhead (₹)
Oct 70,000 25,000 13,000 30,000 48,000
Nov 80,000 30,000 16,000 35,000 56,000
Dec 75,000 35,000 17,000 42,500 68,000
Jan 65,000 30,000 14,000 37,500 53,000
Feb 90,000 45,000 25,000 50,000 72,000
March 1,10,000 50,000 28,000 55,000 75,000
Total 4,90,000 2,15,000 1,13,000 2,50,000 3,72,000
Additional Information:
(i) Cash in hand on 01-01-2024 is ₹ 1,35,000.
(ii) The Company produces two products - Lubricating Oil & Grease Oil and operates three
sales offices at Kolkata, Delhi & Chennai for sale of their products. Actual and budgeted
sales units from October, 2023 to March, 2024 are as under:
Lubricating Oil Grease Oil
Month
Kolkata Delhi Chennai Kolkata Delhi Chennai
Qty Qty Qty Qty Qty Qty
(Units) (Units) (Units) (Units) (Units) (Units)
Oct 1,000 1,200 900 750 900 1,000
Nov 1,200 1,440 1,080 900 1,080 1200
Dec 1,100 1,320 990 825 990 1,100
Jan 1,000 1,200 900 750 900 1,000
Feb 1,400 1,300 1,300 900 1,200 1,300
Mar 1,600 1,500 1,400 1,200 800 1,700
The sales price per unit of product Lubricating Oil is ₹ 90 and that of product Grease Oil is
₹ 75.There is an increcasc in sales price per unit by ₹ 3 & ₹ 2 for Lubricating Oil & Grease Oil
respectively from Jan, 2024,
(iii) 20% of sales arc on cash basis. Remaining 80% salcs are on credit basis. 50% of credit sales
are collected in the next month and remaining 50% are collected in the second month
following.
(iv) Lagin payment to creditors for material — 1 Month
(v) Wages to the labours are paid between 1st to Sth of the month duc.
(vi) Direct expenses are paid 1 month in lag.

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(vii) Factory overheads and Admin overheads are paid 11/2 months in lag.
(viii) Mr. R. Rajendran, Principal Director of the company will get superannuation from the
company on 31-03-2024 after serving the company for 24 years. His superannuation
benefits comprise of Gratuity of ₹ 7,00,000 and Benevolent fund of ₹ 1,00,000. It is the
general practice of the Company to release the gratuity amount and Benevolent fund on
the last day of service.
(ix) On1st April, 2023, the company purchased a vehicle for its directors at a cost of ₹ 14,00,000
by taking 2 years’ loan from Bank. EMI for the bank loan is auto debited by bank @ ₹75,000
per month. [14]

Cash Budget

Answer
Cash Budget for the three months period January 2024 to March 2024 (₹)
Particulars Jan, 24 Feb,24 Mar,24
Receipts:
Opening balance 1,35,000 3,80,000 6,19,410
Sales 5,38,000 5,33,910 5,91,140
Total Receipts (A) 6,73,000 9,13,910 12,10,550
Payments:
Creditors for direct material
Lag in payment - 1 month 75,000 65,000 90,000
Direct Labour 35,000 30,000 45,000
Direct Expenses 17,000 14,000 25,000
Factory Overhead 35,000 42,500 37,500
Admin Overhead 56,000 68,000 53,000
Gratuity & Benevolent fund payment of Mr. R. Rajendran - - 8,00,000
EMI for Vehicle loan 75,000 75,000 75,000
Total Payments (B) 2,93,000 2,94,500 11,25,500
Closing balance of Cash (A-B) 3,80,000 6,19,410 85,050

7.18 |CMA Inter Management Accounting

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 Forecasting, Budgeting and Budgetary Control
Formulation of various types of Budgets

10 Dec'23
X Cell Chemical Ltd. manufactures two products AB+ and CD+ by mixing the raw materials in
the proportion shown: [7]
Raw Materials Product AB+ Product CD+
A 80%
B 20%
C 50%
D 50%
The finished of products AB+ and CD+ are equal to the weight of ingredients. During the month
of June, it is expected that 60 tons of AB+ and 200 tons of CD+ will be sold.
Actual and budgeted inventories for the month of June are as follows:
Actual Inventory (1st June) Quantity Budgeted Inventory (30th June)
(Tons) Quantity (Tons)
A 15 20
B 10 40
C 200 300
D 250 200
Product AB+ 10 5
Product CD+ 50 60
The purchase prices of materials for June are expected to be as follows:
Material Cost per ton (₹)
A 500
B 400
C 100
D 200
Al materials will be purchased on 3rd of June.
Prepare Production Budget and Material Requirement Budget for the month of June and the
Material Purchase Budget indicating the total expenditure for material for the month of June.

Production and Material requirement

Budget

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Formulation of various types of Budgets

Answer
(a) Production Budget
Particulars AB+ CD+
Production 55 210
(b) Material Requirement Budget
Particulars A B C D
Product AB+ 44 11 -- --
Product CD+ -- -- 105 105
(c) Purchase Budget
Particulars A B C D
Particulars A B C D
Purchases (By weight in Tons) 49 41 205 55
Cost per ton 500 400 100 200
Purchases (₹) 24,500 16,400 20,500 11,000

11  MTP Jun’24 Set 1

With the following data for a 60% activity, prepare a budget for production at 80% and 100 %
capacity Production at 60% capacity 300 units.
Materials: ₹ 100 per unit
Labour: ₹ 40 per unit
Expenses: ₹ 10 per unit
Factory expenses: ₹ 40,000 (40% fixed)
Administrative expenses: ₹ 30,000 (60% fixed). [7]

Flexible Budget

7.20 |CMA Inter Management Accounting

Divya Jadi Booti
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 Forecasting, Budgeting and Budgetary Control
Formulation of various types of Budgets

Answer
Flexible Budget (₹)
60% 80% 100%
Particulars
Capacity Capacity Capacity
300 units 400 units 500 units
Material (₹ 100 per unit) 30,000 40,000 50,000
Labour (₹ 40 per unit) 12,000 16,000 20,000
Expenses (₹10 per unit) 3,000 4,000 5,000
Variable Factory Expenses (₹80 per unit) 24,000 32,000 40,000
Variable Administrative Expenses (₹40 per unit) 12,000 16,000 20,000
Fixed Factory Expenses (40 % of ₹40,000) 16,000 16,000 16,000
Fixed Administrative Expenses (60% of ₹ 30,000) 18,000 18,000 18,000
Total 1,15,000 1,42,000 1,69,000

12 Jun’24
M/s Lalkamal Limited manufactures two products X and Y and sells their products through its
East and North-East division. Budgeted sales units from January to June, 2024 are as under:
Product - X Product - Y
North-East North-East
Month East Division East Division
Division Division
Qty (Units) Qty (Units) Qty (Units) Qty (Units)
Jan, 24 2000 2500 2000 1500
Feb, 24 2200 2700 3000 2500
Mar, 24 3000 3500 4000 3500
Apr, 24 2500 2400 2000 1700
May, 24 2400 2000 1800 1500
June, 24 3000 3400 3200 2800
Total 15100 16500 16000 13500
Additional information:
(i) The sale price per unit of Product X is ₹ 100 and that of Product Y is ₹ 75. The Company
has conducted a market survey and from the market study, it reveals that Product X is
overpriced by ₹ 5 per unit and Product Y is underpriced by ₹ 10 per unit. Considering the
market study, the marketing division of the company has proposed for price change and
the Management of the company has approved the same. As a result, expected percent-
age increase in sales units are as under:

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Product East Division North-East Division

X + 5% + 10%
Y + 10% + 6%
(ii) The Company sells 20% of its products in cash. Remaining 80% of sales are on credit basis.
30% of credit sales are collected in the same month and balance 65% are realized in the
next month. On an average 5% of credit sales becomes bad debts.
(iii) Considering the risk of bad debts, the company is planning to enter into a factoring
agreement with M/s PVK Limited for the sales made on credit w.e.f. June, 2024. As a result,
entire credit sale proceeds are realized in the same month. M/s PVK Limited charges 2% as
factoring commission.
(iv) P/V ratio of the company is 40%.
(v) 60% of the Variable Cost are Direct Material Cost which are paid 1 month in lag.
(vi) 30% of the Variable Cost are Direct Labour Cost which are paid within 7th of the subsequent
month.
(vii) Remaining Variable Cost are Variable Overheads. 50% of Variable Overheads are paid in the
same month and balance in the next month.
(viii) Fixed Cost of the company for the whole year is budgeted to be ₹ 50 lakhs including
depreciation of ₹ 2 lakhs. Fixed Costs are expected to be evenly distributed over all months
and costs incurred are paid in the same month.
(ix) Cash in hand as on 01-04-2024 is ₹ 2,70,000.
Required:
Prepare a Cash Budget for the three months ending 30th June, 2024. [14]

Cash Budget

Answer
Cash Budget for the three months period - April to June, 2024 (₹)
Particulars April, 24 May, 24 June, 24
Receipts:
Opening balance 2,70,000 1,46,823 13,063
Sales 10,74,014 7,67,793 15,96,992
Total Receipts 13,44,014 9,14,616 16,10,055
Payments:

7.22 |CMA Inter Management Accounting

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 Forecasting, Budgeting and Budgetary Control
Formulation of various types of Budgets

Direct Material 4,87,566 3,02,524 2,70,666

Direct Labour 2,43,783 1,51,262 1,35,333
Factory Overhead 65,842 47,767 58,737
Fixed Cost 4,00,000 4,00,000 4,00,000
Factoring Commission - - 19,296
Total Payments 11,97,191 9,01,553 8,84,032
Closing balance of Cash 1,46,823 13,063 7,26,023

13 Jun’24
ENTEC Ltd., an electronic gadget manufacturer has prepared sales budget for the next few
months. In this respect, following figures are available:
Months Electronic gadgets’ sales
January 5000 units
February 6000 units
March 7000 units
April 7500 units
May 8000 units
Apart from other materials, two units of batteries are required to manufacture a gadget. The
company wants to hold stock of batteries at the end of each month to cover 30% of next month’s
production and to hold stock of manufactured gadgets to cover 25% of the next month’s sale.
3250 units of batteries and 1200 units of manufactured gadgets were in stock on 1st January.
Required:
(i) Prepare the production budget (in units) for the month of January, February, March and
April.
(ii) Prepare the purchase budget for batteries (in units) for the month of January, February
and March. [7]

Production and Purchase Budget

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Formulation of various types of Budgets

Answer
(i) Production Budget (in units)
Particulars January February Mach April
Gadgets to be produced 5,300 6,250 7,125 7,625
(ii) Purchase budget for batteries
Particulars January February March
No. of units required for Production 14,350 16,775 18,825
No. of units to be purchased 11,100 13,025 14,550

14 MTP Dec’24 Set 1

Prepare a Cash Budget for the three months ending 30th June, 2024 from the information
given below:
(i)
Month Sales (₹) Materials (₹) Wages (₹) Overheads (₹)
February 14,000 9,600 3,000 1,700
March 15,000 9,000 3,000 1,900
April 16,000 9,200 3,200 2,000
May 17,000 10,000 3,600 2,200
June 18,000 10,400 4,000 2,300
(ii) Credit terms are:
Sales/debtors: 10% sales are on cash, 50% of the credit sales are collected next month and
the balance in the following month.
Creditors: Materials 2 months Wages 1/4 in the following month
Overheads 1/2 in the following month
(iii) Cash and bank balance on 1st April, 2022 is expected to be ₹ 6,000.
(iv) Other relevant information are:
• Plant and machinery will be installed in February 2022 at a cost of ₹96,000. The
monthly instalment of
• ₹2,000 is payable from April onwards.
• Dividend @ 5% on preference share capital of ₹2,00,000 will be paid on 1st June.
• Advance to be received for sale of vehicles ₹9,000 in June.
• Dividends from investments amounting to ₹1,000 are expected to be received in June.
[7]

7.24 |CMA Inter Management Accounting

Divya Jadi Booti
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 Forecasting, Budgeting and Budgetary Control
Formulation of various types of Budgets

Cash Budget

Answer
Cash Budget for the 3 Months Ending 30th June 2024
Particulars April (₹) May (₹) June (₹)
Opening Balance (A) 6,000 3,950 3,000
Add: Receipts : (B)
Cash Sales 1,600 1,700 1,800
Collection from debtors [see note(i)] 13,050 13,950 14,850
Advance for sale of vehicles - - 9,000
Dividends from Investments - - 1,000
Total (A+B) 20,650 19,600 29,650
Less: Payments :
Materials 9,600 9,000 9,200
Wages [see note (ii)] 3,150 3,500 3,900
Overheads 1,950 2,100 2,250
Instalment of Plant & Machinery 2,000 2,000 2,000
Preference dividend - - 10,000
Total (C) 16,700 16,600 27,350
Closing Balance (A+B-C) 3,950 3,000 2,300
Working Notes:
(i) Computation of Collection from Debtors
(Amount in ₹)
Month Total Sales Credit Sales Feb Mar Apr May June
Feb 14,000 12,600 --- 6,300 6,300 --- ---
Mar 15,000 13,500 --- --- 6,750 6,750 ---
Apr 16,000 14,400 --- --- --- 7,200 7,200
May 17,000 15,300 --- --- --- --- 7,650
13,050 13,950 14,850
(ii) Wages payment in each month is to be taken as three-fourths of the current month plus
one- fourth of the previous month.

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 Forecasting, Budgeting and Budgetary Control
Formulation of various types of Budgets

NOTES

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 Divisional Performance Measurement

Chapter 8
Divisional Performance Measurement

Organisations with Multiple divisions, Benefits of

8.1 Decentralization

8.2 Du Pont Analysis

Divisional Performance Measurement tools – ROI,

8.3 Residual Income

Economic Value Added – Definition, EVA Centre, EVA

8.4 Driver

8.5 Introduction to Learning Curve

8.6 Balanced Score Card for Variable Pay Management

CMA Inter Management Accounting

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 Divisional Performance Measurement
Organisations with Multiple divisions, Benefits of Decentralizatio

8.1
Organisations with Multiple divisions,
Benefits of Decentralization

No questions have been asked yet from this chapter !

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 Divisional Performance Measurement
Du Pont Analysis

8.2
Du Pont Analysis

1 MTP Jun'23 Set 2

The following data are given for the Rajasthan division for 2022:

Return on investment (ROI) 25%

Sales ₹ 12,00,000
Margin 10%
Minimum required rate of return 18%
Compute the division’s operating assets. (use the DuPont analysis of ROI)
Compute the division’s residual income (RI). [4]

Division’s Operating Assets. & Residual Du Pont

Income

Answer
Profit Sales
By definition (DuPont), ROI = ×
Sales Operating Assets

= Margin × Asset Turnover

⇒ 25% = 10% × Asset Turnover
Therefore, the turnover must be 2.5 times.
Sales
Since, the Asset turnover =
Operating Assets

` 12,00,000
2.5 times =
Operating Assets

Therefore, Operating Assets = ₹ 4,80,000

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 Divisional Performance Measurement
Du Pont Analysis

Residual Income (RI) = Operating income - Minimum required operating income

Given, Margin = 10%
Operating Income
We know Margin (10%) =
Sales

Operating Income
=
` 12,00,000

= ₹ 12,00,000 × 10%
Therefore, the Operating Income = ₹ 1,20,000
Residual Income (RI) = ₹ 1,20,000 − (18% × ₹ 4,80,000)
= ₹ 1,20,000 − ₹ 86,400
= ₹ 33,600

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 Divisional Performance Measurement
Divisional Performance Measurement Tools - ROI, Residual Income

8.3
Divisional Performance Measurement
Tools - ROI, Residual Income

1 Jun'23
The following information relates to the operating performance of two divisions of SINTRA Ltd.
for last year.

Particulars Division M Division N

Operating Income ₹ 15,00,000 ₹ 25,00,000
Operating Assets ₹ 60,00,000 ₹ 1,25,00,000
ROI 25% 20%
Required:
(i) Analyse which division is more successful in terms of ROI.
(ii) Using 15 percent as the minimum required rate of return, calculate the Residual Income
for each division.
(iil) Identify the division which is more successful under the measure in (ii). [5]

ROI and RI

Answer
(i) Here, Division M is more successful since its return (ROI) is Rs. 0.25 for each rupee invested
in operating assets which is more than that of Division N i.e. 20%.
(ii) The residual income (RI) at 15% for each division is
Division M (₹) Division N (₹)
Residual Income 6,00,000 6,25,000
(iii) Division N is more successful since its RI is greater than Division N.

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 Divisional Performance Measurement
Divisional Performance Measurement Tools - ROI, Residual Income

2 MTP Dec'23 Set 1

Consider the following:
Division A Division B
Operating assets ₹ 50,00,000 ₹ 1,25,00,000
Operating income ₹ 10,00,000 ₹ 22,50,000
ROI 20% 18%
(i) Which is the more successful division in terms of ROI?
(ii) Using 16 percent as the minimum required rate of return compute the residual income for
each division. Which division is more successful under this rate? [7]

ROI & Residual income

Answer
(i) Division A is more successful as since it returns ₹ 0.20 for each rupee invested (as compare
to ₹ 0.18 for Division B).
(ii) The residual income at 16 percent for each division is computed as follows:
Division A Division B
Operating income ₹ 10,00,000 ₹ 22,50,000
Minimum required income ₹ 8,00,000 ₹ 20,00,000
(16% × 50,00,000) (16% × ₹ 1,25,00,000)
RI ₹ 2,00,000 ₹ 2,50,000
Division B is more successful.

3 MTP Jun’24 Set 1

An investment centre has net assets of ₹8,00,000, and made profits before interest of ₹1,60,000.
The notional cost of capital is 12%. This is the company’s target return.
An opportunity has arisen to invest in a new project costing ₹1,00,000.
The project would have a four-year life, and would make profits of ₹15,000 each year.
Required to compute:
(A) What would be the ROI with and without the investment? (Base your calculations on

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 Divisional Performance Measurement
Divisional Performance Measurement Tools - ROI, Residual Income

opening book values). Determine would the investment centre manager wish to undertake
the investment if performance is judged on ROI.
(B) What would be the average annual RI with and without the investment? (Base your calcula-
tions on opening book values). Determine would the investment centre manager wish to
undertake the investment if performance is judged on RI? [7]

ROI & RI

Answer
(A) ROI
Without the investment With the investment
Profit ₹ 1,60,000 ₹ 1,75,000
Capital employed ₹ 8,00,000 ₹ 9,00,000
ROI = (Profit/ Capital Employed × 100) 20.0% 19.4%
ROI would be lower; therefore, the centre manager will not want to make the investment.
Since his performance will be judged as having deteriorated. However, this result in
dysfunctional behaviour since the company’s target is only 12%.
(B) RI
Without the Investment with the investment
Profit 1,60,000 1,75,000
Less: Notional Interest 96,000 1,08,000
RI (₹ 8,00,000 × 12%) 64,000 (₹ 9,00,000 ×12%) 67,000
The investment centre manager will want to undertake the investment because it will
increase RI. This is the correct decision for the company since RI increases by ₹3,000 as a
result of the investment.

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 Divisional Performance Measurement
Economic Value Added Definition, EVA Centre, EVA Driver

8.4
Economic Value Added Definition,
EVA Centre, EVA Drivers

1 MTP Jun'23 Set 1

LOTUS Inc has reported annual operating profits for the year of ₹ 89.2 million after charging
₹ 9.6 million for the full development costs of a new product that is expected to last for the
current year and two further years. The cost of capital is 13 per cent per annum. The balance
sheet for the company shows fixed assets with a historical cost of ₹ 120 million. A note to the
balance sheet estimates that the replacement cost of these fixed assets at the beginning of the
year is ₹ 168 million. The assets have been depreciated at 20 per cent per year. The company has
a working capital of ₹ 27.2 million. Ignore the effects of taxation.
You as a cost accountant is asked to calculate the economic valued added (EVA) of the
company. [7]

Economic Value Added Dividend

Answer
Profit ₹ 89.20
Add back:
Current depreciation (₹120 × 20%) ₹ 24.00
Development Costs (₹9.60 × 2/3) ₹ 6.40
Less: Replacement depreciation (₹168 × 20%) ₹ 33.60
Adjusted profit 86.00
Less: Cost of capital charge (13% × ₹168) 21.84
EVA 64.16
Note: 13% × [Fixed assets (₹168 – (₹33.6) + working capital (₹27.2) + development costs (₹ 6.4)]

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 Divisional Performance Measurement
Economic Value Added Definition, EVA Centre, EVA Driver

2 MTP Jun'23 Set 2

MI Ltd. has earned a net profit of ₹ 15 lakhs after Tax at 30%. Interest cost charged by the
financial institutions was ₹ 10 lakhs. The Invested capital is ₹ 95 Lakhs of which 55% is debt. The
company maintains a weighted average cost of capital of 13%.
• Compute the operating Income.
• Compute the Economic Value Added.
• The company has 6 lakhs equity shares outstanding. How much dividend can the company
pay before the value of the entity starts declining? [5]

Economic Value Added Dividend

Answer
Taxable Income = ₹15 lac ÷ (1 – 0.30)
= ₹ 21,42,857 or ₹ 21.43 lacs
• Operating Income = Taxable Income + Interest
= ₹ 21,42,857 + ₹ 10,00,000
= ₹ 31,42,857 or ₹ 31.43 lacs
• EVA = EBIT (1 – Tax Rate) – WACC × Invested Capital
= ₹ 31,42,857 (1 – 0.30) – 13% × ₹ 95,00,000
= ₹ 22,00,000 – ₹12,35,000
= ₹ 9,65,000
• EVA Dividend = ₹ 95,00,000 ÷ 6,00,000 = ₹ 1.6083

3 Jun'23
From the following information obtained from the books of M/s AYC Limited, calculate
Economic Value Added (EVA).

Equity Share of ₹ 100 each Nos. 1,50,000

10% Debenture of ₹ 10 each Nos. 20,00,000
Tax rate 30%
Degree of Financial Leverage (DFL) 1.1 times

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 Divisional Performance Measurement
Economic Value Added Definition, EVA Centre, EVA Driver

Securities Premium (₹) ₹ 1,50,00,000

Reserve & Surplus (₹) (including Capital Reserve of € 90 lacs) ₹ 2,00,00,000
It is the prevailing practice for the companies in the industry to which AYC Limited belongs to
pay at least a dividend of 14% p.a. to its Equity Shareholders. [6]

Economic Value Added

Answer
Economic Value Added (EVA) = ₹ 70,00,000

4 Dec'23
M/s Srilok Polymer has provided you the following data for the year ended 31-03-2023.
Particulars Value
Total Capital Employed (₹) 45,00,000
Debt Equity Ratio 1:4
Interest rate of debt 12%
Effective Income Tax Rate 31.2%
Risk free rate of return 10%
Long term market rate of return (based on BSE Sensex) 15%
Degree of Financial Leverage 1.1 times
The beta (b) factor 1.40
Calculate the Economic Value Added (EVA) and commenton your answer. Approximate up to 2
decimal places. [7]

Economic Value Added

Answer
Economic Value Added (EVA) = ₹ 131094

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 Divisional Performance Measurement
Economic Value Added Definition, EVA Centre, EVA Driver

Comment:
The Positive EVA of ₹131094 indicates that M/s Srilok Polymer Limited has surpassed the
expectation of its Shareholders.

5 MTP Dec'23 Set 2

H Ltd.’s current financial year’s income statement reports its net income as ₹ 15,00,000. H’s
marginal tax rate is 40% and its interest expense for the year was ₹ 15,00,000. The company has
₹ 1,00,00,000 of invested capital, of which 60% is debt.
In addition, H Ltd. tries to maintain a Weighted Average Cost of Capital (WACC) of 12.6%.
(i) Compute the operating income or EBIT earned by H Ltd. in the current year.
(ii) What is H Ltd.’s Economic Value Added (EVA) for the current year? [7]

Economic Value Added PBT + Interest

Answer
(i) Taxable income = Net Income ÷ (1 – Tax Rate)
or, Taxable income = ₹ 15,00,000 ÷ (1 – 0.40) = ₹ 25,00,000
Again, taxable income = EBIT – Interest
or, EBIT = Taxable Income + Interest
= ₹ 25,00,000 + ₹ 15,00,000
= ₹ 40,00,000
(ii) EVA = EBIT (1 – T) – (WACC × Invested capital)
= ₹ 40,00,000 (1 – 0.40) – (0.126 × ₹ 1,00,00,000)
= ₹ 24,00,000 – ₹ 12,60,000 = ₹ 11,40,000.

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 Divisional Performance Measurement
Economic Value Added Definition, EVA Centre, EVA Driver

6 Jun’24
The Summarized Balance Sheet of M/s Sova Limited as on 31-03-2024 is as under:
Amount (₹ Amount (₹
Liabilities Asset
in Lakhs) in Lakhs)
Equity Share Capital 25 Fixed Assets 80
Reserve & Surplus 15 Other Assets 20
12% Bond 10
Accumulated Depreciation 5
Other Liabilities 45
100 100
M/s Sova Limited is engaged in manufacturing Electrical Transformers. The Sales & Cost details
for the year ended 31-03-2024 is as under:
Particulars Value
Selling Price per unit ₹ 5,000
P/V Ratio 20%
Margin of Safety (MOS) Ratio 60%
Fixed Cost per annum ₹ 25
Lakhs
Tax rate 30%
Risk free rate of return 8%
Market rate of return 17%
P factor 11
Debt-Equity Ratio 1 :4
Required:
Calculate the Economic Value Added (EVA). [7]

EVA

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 Divisional Performance Measurement
Economic Value Added Definition, EVA Centre, EVA Driver

Answer
Computation of Economic Value Added (EVA)
Particulars Amount (₹)
Profit after tax (PAT) 25,41,000
Add: Interest on 12% debt net of taxes 84,000
Total Return to providers of fund 26,25,000
Less: Cost of Capital Employed 8,00,000
Economic Value Added (EVA) 18,25,000

7 MTP Dec’24 Set 1

The following information is supplied by ABC Ltd. for the year 31-03-2024:
Sl.
Particulars (₹ In Crores) (₹ In Crores)
No.
(i) Profit after tax (PAT) 275.90
(ii) Interest 4.95
(iii)Equity Share Capital 40.00
Accumulated Surplus 750.00
Shareholders fund 790.00
Loans (Long term) 40.00
Total long term funds 830.00
(iv) Market Capitalization 2900.00
Additional information
(a) Risk free rate 12.00
(b) Long Term Market Rate (Based on BSE Sensex) 15.50 %
(c) Effective tax rate for the company 30 %
(d) Beta (β) for last few years
Year
1 0.48
2 0.52
3 0.60
4 1.10
5 0.99
You are required to calculate the Economic Value Added of ABC Ltd. as on 31st March, 2024
[7]

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 Divisional Performance Measurement
Economic Value Added Definition, EVA Centre, EVA Driver

EVA

Answer
Net Operating Profit after Tax (NOPAT) = Profit After Tax (PAT) + Interest (net of tax)
= 275.90 + 4.95 × (1-0.30)
= 279.365 crores

Debit Capital ₹40 crores

Equity capital = ₹790 crores
Capital employed = ₹830 crores
Debt to capital employed = ₹40 crores / ₹830 crores = 0.04819
Equity to capital employed = ₹790 crores / ₹830 crores = 0.9518
Interest cost before tax ₹4.95 crores
Less: Tax (30% of ₹4.85 crores) (₹1.485 crores)
Interest cost after tax ₹3.465 crores
Cost of debt = (₹3.465 crores / ₹40 crores) × 100
= 8.66%
According to Capital Asset Pricing Model (CAPM)
Beta for calculation of EVA should be the highest of the given beta for the last few years.
Accordingly,
Cost of equity capital = risk free rate + beta (market rate - risk free rate)
= 12% + 1.10 × (15.50% - 12%)
= 12% + 1.10 × 3.5%
= 15.85%
Weighted Average Cost of Capital (WACC) = Equity to Capital Employed (CE) x Cost of Equity
capital + Debt to CE × Cost of Debt
= 0.09518 × 15.85% + 0.04819× 8.66%
= 15.08% + 0.41%
= 15.49%

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 Divisional Performance Measurement
Economic Value Added Definition, EVA Centre, EVA Driver

Cost of Capital Employed (COCE) = WACC × Capital Employed

= 15.49% × ₹830 crores
= ₹128.567 crores
Economic Value Added (E.V.A.) = NOPAT – COCE
= ₹279.365 crores – ₹128.567 crores
= ₹150.798 crores

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 Divisional Performance Measurement
Introduction to Learning Curve

8.5
Introduction to Learning Curve

1 MTP Jun'23 Set 1

(i) Carson, Inc., uses a learning curve of 80 percent for all new products it develops. A trial
run of 500 units of a new product shows total labour-related costs (direct, indirect labour,
and fringe benefits) of ₹ 1,20,000. Management plans to produce 1,500 units of the new
product during the next year.
Compute the expected labour-related costs for the year to produce the 1,500 units.
Find the unit cost of production for next year.
(ii) State the limitations and the problems associated with learning curve analysis. [5 + 3 = 8]

Expected Labour Related Costs,

Limitations

Answer
(i) 1st Batch = 500 units
Quantity Cumulative Average Cost Cumulative Total Cost
500 units 240 (120000 ÷ 500) 1200000 (given)
1000 units 192 (80% of 240) 192000
2000 units 153.6 (80% of 192) 307200

Cost of producing 2000 units ₹ 3,07,200

Less Initial Cost of producing 500 units ₹ 1,20,000
Cost of production of 1500 units (in ₹ 1,87,200
next year)
Per Unit Cost ₹ 1,87,200 ÷ 1500 Units 1,24,800
(ii) Limitations and problems associated with learning curve analysis include:
a. Learning curve analysis is appropriate only for labour-intensive operations involving
repetitive tasks where repeated trials improve performance. If the production process

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Introduction to Learning Curve

primarily relies on robotics and computer controls, little repetitive labour is involved
and thus little opportunity exists for learning to take place.
b. The learning rate is assumed to be constant. In real life, the decline in labour time
might not be constant.
c. The reliability of a learning curve calculation can be jeopardized because an observed
change in productivity might actually be associated with factors other than learning,
such as a change in the labour mix, the product mix, or other factors. If some factor
or factors other than learning are affecting productivity, a learning model developed
using the affected historical data will produce in-accurate estimates of labour time
and cost.

2 MTP Jun'23 Set 2

MAGNA CARTA LTD a manufacturers of fountain pens received an order for 16 units of a new
fountain pen called the DENIMA. The first unit required 40 direct labour hours. So far, 4 units
have been completed and a total of 102.40 direct labour hours has been recorded for the 4
units. The Production Manager expects on 80% learning effect for this type of work.
The direct cost attributed to the centre in which the unit is manufactured and its costs are as
follows:
₹
Direct Material 30.00 per unit
Direct Labour 6.00 per hour
Variable overhead 0.50 per direct labour hour
Fixed overheads apportioned 5.00 per direct labour hour
You are required to calculate the estimated product cost for the initial order based on the cost
data given. [6]

Estimated Product Cost for the Initial

Order

Answer
MAGNA CARTA LTD received an order for 16 units of a new fountain pen called the DENIMA. The
first unit required 40 direct labour hours. The production schedule is subject to 80% learning
effect which implies that for every doubling of production the cumulative average labour hour
would be 80% of the previous and the total would be the multiplied effect of the number of
units produced and the cumulative average labour hour. The table shown below shows the
effect of 80% learning effect.

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 Divisional Performance Measurement
Introduction to Learning Curve

Production (units) Cumulative Average labour hour Total labour hour

1 40 40
2 32 (0.80×40) 64
4 25.6 (0.80×32) 102.40
8 20.48 (0.80×25.6) 163.843
16 16.384 (0.80×20.48) 262.144
Computation of total cost for the initial order of 16 units:
₹
Material (30 ×16) 480.00
Direct labour (262.144 [as calculated in above table] × 6) 1572.86
Variable overheads (0.5 × 262.144) 131.07
Fixed overhead apportioned (5 × 262.144) 1310.72
Total cost 3494.65

3 Jun'23
What do you mean by Learning Curve? State the applications of Learning Curve. [4]

Learning Curve and Application

Answer
Learning Curve:
A learning curve is a function that measures how labour hours per unit reduces as units of
production increases, because workers are learning and becoming expert at their jobs. The
management uses this technique to predict how labour hours and labour cost will decreases as
more units are produced.
Application of Learning Curve:
The areas in which the application of learning curve can help an organization are as follows:
1. Improvement of productivity: As the experience is gained, the performance of workers
improves, time taken per unit of production is reduces and thus productivity increases.
2. Cost Prediction: Learning Curve provides better cost predictions to enable organization
to quote competitive price for potential orders.

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 Divisional Performance Measurement
Introduction to Learning Curve

3. Work scheduling: Learning curve enables organizations to predict the inputs required
more effectively and helps in the preparation of accurate delivery schedule.
4. Standards setting: Organizations prepare budgets & standards considering learning
curve to avoid significance variances.

4 MTP Dec'23 Set 1

A firm received an order to make and supply eight units of standard product which involves
intricate labour operations. The first unit was made in 10 hours. It is understood that this type of
operations is subject to 80% learning rate. The workers are getting a wage rate of ₹ 12 per hour.
(i) What is the total time and labour cost required to execute the above order?
(ii) If a repeat order of 24 units is also received from the same customer, what is the labour
cost necessary for the second order? [7]

Total Time and Labour Cost for First Order

and Repeat Order

Answer
(i) 80% Learning Curve results are given below:
Production (Units) Cumulative Average Time (hours) Total Time (hours)
1 10 10
2 8 16
4 6.4 25.6
8 5.12 40.96
16 4.096 65.54
32 3.2768 104.86
Labour time required for first eight units = 40.96 hours
Labour cost required for 8 units = 40.96 hours × ₹ 12/hr = ₹ 491.52
(ii) Labour time for 32 units = 104.86 hours
Labour time for first eight units = 40.96 hours
Labour time required for 2nd order for 24 units = 63.90 hours (104.86 – 40.96)
Labour cost for 24 units = 63.90 hours × ₹ 12/hr = ₹ 766.80

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 Divisional Performance Measurement
Introduction to Learning Curve

5 Dec'23
M/s Keshav Industries reccived a Work Order to make 64 pieces of logo engraving work on MS
End fittings which involves intricate labour operations. The logo engraving is done in a special-
ized machine which processes two logo engraving work were completed in 10 minutes’ time.
The operation is subject to 80% learning rate. The direct labour rate per hour is ₹100.
Determine total time and labour cost required to execute the work order. If a repeat work order
of 100% of original quantity is also received from the same customer, what will be the total time
& labour cost necessary for the repeat Work Order? [7]

Total time and Labour related cost for first

order and repeat order

Answer
(i) Labour time to do logo engraving in the 64 pcs of MS End Fittings is 104.64 minutes.
Labour cost for 64 units = ₹ 174.40
(ii) labour time required to execute repeat order is 63.04 Minutes
Labour cost for repeat order of 64 units = ₹ 105.07

6 MTP Dec'23 Set 2

The learning curve as a management accounting has now become or going to become an
accepted tool in industry, for its applications are almost unlimited.
When it is used correctly, it can lead to increase business and higher profits; when used without
proper knowledge, it can lead to lost business and bankruptcy.
Illustrate the use of learning curves for calculating the expected average units cost of making.
(a) 4 machines
(b) 8 machines
Using the data below:
Data:
Direct Labour needed to make first machine = 1000 hrs.
Learning curve = 90%
Direct Labour cost = ₹ 15 per hour.

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 Divisional Performance Measurement
Introduction to Learning Curve

Direct materials cost = ₹ 1,50,000

Fixed cost for either size orders = ₹ 60,000. [7]

Use of learning curves for Calculating the

Expected Average units cost

Answer
The term “learning curve” refers to the idea that efficiency increases the more experience a
person has with a given task. As a result, the time required for performing the task decreases as
increases occur in the number of times the task has been performed.
Higher costs per unit early in production are part of the start-up costs when a new activity is
begun. It is commonly accepted that new products and production processes experience a
period of low productivity followed by increasing productivity. However, the rate of productivi-
ty improvement declines over time until the improvement stops. The required production time
reaches a level where it remains until another change in production occurs.
Learning curve analysis is used in planning, budgeting, and forecasting and also to determine
estimated labour costs when bidding on a contract. A company needs to be able to estimate
what the long-term costs of production will be.
Statement showing computation of cost of making 4 machines & 8 machines:
Average time Labour cost Material Fixed cost Total
No of machines
Hours (₹) (₹) (₹) (₹)
1 1,000 15,000 1,50,000 60,000 2,25,000
2 900 13,500 1,50,000 30,000 1,93,500
4 810 12,150 1,50,000 15,000 1,77,150
8 729 10,935 1,50,000 7,500 1,68,435
Average cost of making 4 machines = ₹ 1,77,150
Average cost of making 8 machines = ₹ 1,68,435

7 Jun’24
ZEMAN Ltd., a manufacturing company has 10 direct workers, who work for 25 days a month
of 8 hour per day. The estimated down time is 25% of total available time. The company makes
gift items. The company has received an order of 30 units from a customer. The first unit of gift
item required 40 direct labour hours to manufacture.

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 Divisional Performance Measurement
Introduction to Learning Curve

The company expects 90% (Index is = - 0.152) learning curve for this type of work. The company
uses standard absorption costing and cost data is as under:

Direct Material ₹ 60 per unit

Direct Labour ₹ 6 per direct labour hour
Variable Overheads ₹ 2 per direct labour hour
Fixed Overheads ₹ 7,500 per month
Required:
(i) Calculate the total cost per unit of gift item for the first order of 30 units.
(ii) If the company receives a repeat order from the said customer for 40 units of gift items,
ascertain the price per unit to be quoted to yield a profit of 20% on selling price. (All
figures to be rounded off to whole number).
[Given: (30)– 0.152 = 0-596; (50)– 0.152 = 0– 552; (60)– 0.152 = 0– 537 and (70)– 0.152 = 0.524] [7]

TC of First order and repeat order

Answer
(i) Total Cost per unit of the first order of 30 units = ₹ 369.83 i.e. ₹ 370
(ii) Price to be quoted to yield 20% on Selling Price= ₹ 380

8 MTP Dec’24 Set 1

C has designed a new type of sailing boat, for which the cost and sales price of the first boat to
be produced has been estimated as follows:
Particulars ₹
Materials 5,000
Labour (800 hrs @ ₹5 per hr) 4,000
Overhead (150% of labour cost) 6,000
15,000
Profit mark-up (20%) 3,000
Sales price 18,000
It is planned to sell all the yachts at full cost plus 20%. An 80% learning curve is expected to
apply to the production work. Only one customer has expressed interest in buying the yacht so

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 Divisional Performance Measurement
Introduction to Learning Curve

far, but he thinks ₹18,000 is too high a price to pay. He might want to buy two or even four of
the yachts over the next six months.
He has asked the following questions:
(i) If he paid ₹18,000 for the first yacht, what price would he have to pay later for a second
yacht?
(ii) Could C quote the same unit price for two yachts, if the customer ordered two at the same
time?
(iii) If the customer bought two yachts now at one price, what would be the price per unit for
a third and fourth yacht, if he ordered them both together later on?
(iv) Could C quote a single unit price for the following numbers of yachts if they were all
ordered now?
Four yachts
Eight yachts
Assuming there are no other prospective customers for the yacht, calculate the price for
different yachts and how would the questions be answered? [7]

Price for different volumes

Answer
Incremental
Cumulative
Total time for time for
Number average time
all yachts to additional
of yachts per yacht
date (Hours) yachts
(Hours)
(Hours)
1 800.00 800.00
2 (×80%) 640.00 (×2) 1,280.00 (1,280.00 - 800.00) 480.00
4 (×80%) 512.00 (×4) 2,048.00 (2,048.00 - 1,280.00) 768.00
8 (×80%) 409.60 (×8) 3,276.80 (3,276.80 - 2,048.00) 1,228.80

(a) Separate price for a second yacht: ₹

Materials 5,000
Labour (480 hrs @ ₹5) 2,400
Overhead (150% of labour cost) 3,600
Total cost 11,000
Profit (20%) 2,200

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Introduction to Learning Curve

Sales price 13,200

(b) A single price for the first two yachts:
Materials cost for two yachts 10,000
Labour (1,280 hrs @ ₹5) 6,400
Overhead (150% of labour cost) 9,600
Total cost for two yachts 26,000
Profit (20%) 5,200
Total sales price for two yachts 31,200
Price per yacht (÷ 2) 15,600
(c) A price for the third and fourth yachts:
Materials cost for two yachts 10,000
Labour (768 hours @ ₹5) 3,840
Overhead (150% of labour cost) 5,760
Total cost 19,600
Profit (20%) 3,920
Total sales price for two yachts 23,520
Price per yacht (÷ 2) 11,760
(d) A price for the first four yachts together and for the first eight yachts together
First four First eight
Particulars
yachts ₹ yachts ₹
Materials 20,000 40,000
Labour (2,048 hrs × ₹5) 10,240 (3,276.80 hours × ₹5) 16,384
Overhead (150% of labour cost) 15,360 (150% of labour cost) 24,576
Total cost 45,600 80,960
Profit (20%) 9,120 16,192
Total sales price 54,720 97,152
Price per yacht (÷ 4) 13,680 (÷ 8) 12,144

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 Divisional Performance Measurement
Balanced Score Card for Variable Pay Management

8.6
Balanced Score Card for
Variable Pay Management

1 MTP Jun’24 Set 1

Describe the four perspectives of the Balanced Scorecard. [7]

Four Perspectives

Answer
The four Perspectives of the Balanced Scorecard:
1. Financial Perspective:
This perspective evaluates the Profitability of the strategy. Because cost reduction relative
to competitors, costs and sales growth are key strategic initiatives, the financial perspec-
tives focuses on how much of operating income and return on capital results from reducing
costs and selling more units.
2. Customers Perspective:
This perspective identifies the targeted market segments and measures the company’s
success in these segments. To monitor its growth objectives, number of new customers
and customer’s satisfaction.
3. Internal business process Perspective:
This perspective focuses on internal operations that further the customers’ perspec-
tive by creating value for customers and further the financial perspective by increasing
shareholder value. Chipset determines internal business process improvement targets
after benchmarking against its main competitors. The internal business process perspec-
tive comprises three sub processes:
• The innovation process:
Creating products, services and processes that will meet the needs of customers,
aiming at lowering costs and promote growth by improving the technology of its
manufacturing.

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Balanced Score Card for Variable Pay Management

• The operations process:

Producing and delivering existing products and services that will meet the needs of
customers. The strategic initiatives are (A) improving manufacturing quality reducing
delivery time to customers and (B) Meeting specified delivery dates.
• Post sales service providing service and support to the customer after the sale of a
product of service. Although customers do not require much post sales service.
4. Learning & Growth Perspectives:
This perspective identifies the capabilities of the organization must excel at to achieve
superior internal processes that create value for customers and shareholders.
A Company’s learning and growth perspectives emphasize three capabilities:
• Employee Capabilities measured using employee education and skill levels.
• Information system capabilities, measured by percentage of manufacturing processes
with real-time feedback and
• Motivation measured by employee satisfaction and percentage of manufacturing and
sales employees (line employees) empowered to manage processes.

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 Responsibility Accounting


Chapter 9
Responsibility Accounting

Concept of Cost, Revenue, Profit and Responsibility

9.1 Centres

9.2 Preparation of Responsibility Report

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 Responsibility Accounting
Concept of Cost, Revenue, Profit and Responsibility Centre

9.1
Concept of Cost, Revenue, Profit
and Responsibility Centres

1 MTP Jun'23 Set 2

Analyse the importance of revenue centre and investment centre from the view point of
operations management. [3]

Importance Of Revenue Centre And

Investment Centre

Answer
1. Revenue Centre
A revenue center is strictly defined as an organizational unit that is responsible for the
generation of revenues and has no control over setting selling prices or budgeting costs.
In a revenue center, performance evaluations are limited because the manager has control
over only one item: revenues.
The importance of revenue centre is to analyse the comparison between actual performance
(as well as in any other area that has revenue control) with budgeted performance to
determine variances from expectations. Budgeted and actual revenues may differ because
of either volume of units sold or price of units sold. To compare budgeted and actual
revenues, the price and volume components of revenue must be distinguished from one
another.
2. Investment Centre
An investment center is an organizational unit whose manager is responsible for managing
revenues and current expenses.
The investment center is particularly appropriate for those cases where investment
decisions must be made very rapidly in order to take advantage of changes in local business
conditions. This is a particularly important issue for those companies in rapidly expanding
markets, or where consumer needs change rapidly, where waiting for investment approval
from a central authority may result in lost sales.

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Concept of Cost, Revenue, Profit and Responsibility Centre

In addition, the center’s manager has the authority to acquire, use, and dispose of plant
assets to earn the highest feasible rate of return on the center’s asset base. Many investment
centers are independent, free standing divisions or corporate subsidiaries.

2 MTP Dec'23 Set 1

Explain the relation between decentralization and responsibility accounting. [7]

Decentralization And Responsibility

Accounting

Answer
A responsibility accounting system facilitates decentralization by providing information about
the performance, efficiency, and effectiveness of organizational subunits and their managers.
Responsibilityaccounting is the key management control tool in a decentralized organization.
The term ‘responsibility accounting’ refers to the accounting process that reports how well
managers (of responsibility centres) have fulfilled their responsibility. It is a system that measures
the plans (by budgets)and actions (by actual results) of each responsibility centre. Also known
as activity or profitability accounting, it is an information system that personalizes control
reports by accumulating and reporting cost and revenue information according to defined
responsibility centres within a company. Responsibility accounting systems are tailored to the
organizational structure so that revenue and costs are accumulated and reported by centres of
responsibility within the organization.
Responsibility accounting is the system for collecting and reporting revenue and cost informa-
tion by areas of responsibility. It operates on the premise that managers should be held responsi-
ble for their performance, the performance of their subordinates, and all activities within their
responsibility center. Responsibility accounting,also called profitability accounting and activity
accounting.
A responsibility accounting system produces responsibility reports that assist each successively
higher levelof management in evaluating the performances of subordinate managers and their
respective organizational units. The reports should be tailored to fit the planning, controlling,
and decision-making needs of subordinate managers and should include both monetary and
nonmonetary information.
In the past, the major emphasis in organizational planning was on optimizing economic
resources to achieve company objectives. However, in recent years the value of human
resources has been recognized and become an important consideration in planning. In general,
a company is organized along lines of responsibility. The traditional organizational chart, with
its pyramid shape, illustrates the lines of responsibility flowing from the CEO down through the

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Concept of Cost, Revenue, Profit and Responsibility Centre

vice presidents to middle- and lower-level managers. It indicates, as organizations growlarg-

er, these lines of responsibility become longer and more numerous. The structure becomes
cumbersome. Contemporary practice is moving toward a flattened hierarchy. This structure
emphasizing teams is consistent with decentralization. Organizing divisions as responsibili-
ty centers creates the opportunity to control the divisions through the use of responsibility
accounting. Revenue center control is achieved by evaluating theefficiency and the effective-
ness of divisional managers on the basis of sales revenue.

3 Dec'23
What do you mean by Cost Centre? How is it different from Profit Centre? [7]

Cost and Profit Centre

Answer
Meaning of Cost Centre
A Cost Centre is defined as a function or department within an Organization which is not directly
generating revenues and profits to the company but is still incurring expenses to the company
for its operations. The contributions made by the cost centres in terms of profits is indirect.
For example, a Company’s human resource and Accounts departments could be considered as
Cost Centres because these units do not generate revenues or charge for services, but they do
incur cost.
Cost Centre vs. Profit Centre
A Cost Centre is different from Profit Centre in the following way
Cost Centre Profit Centre
A Cost Centre is an organizational unit whose A Profit Centre is an organizational unit
manager has the authority only to incur costs whose manager is responsible for generat-
and is specifically evaluated on the basis of ing revenues and managing expenses
how cost are controlled. related to current activity. Thus, Profit Centre
should be independent organizational unit
whose managers have the ability to obtain
resources at the most economical prices.
The objective of Cost Centre is the control The objective of Profit Centre is to maximise
over the incurrence of expenses. the Centre's profit.
The Area of Operation of Cost Centre is The Area of Operation of Profit Centre is
comparatively narrow. comparatively wide.

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Concept of Cost, Revenue, Profit and Responsibility Centre

Cost Centres managers are responsible for Profit Centres managers are responsible for
cost only, both costs and revenues.

4 MTP Jun’24 Set 1

Explain briefly the concept of Revenue Center. [7]

Revenue Centre

Answer
A revenue center is strictly defined as an organizational unit that is responsible for the generation
of revenues and has no control over setting selling prices or budgeting costs. For instance, in
many retail stores, each sales department is considered an independent unit and managers are
evaluated based on their departments’ total revenues.
A revenue center is one where the employees located in a specific functional area are solely
responsible for attaining preset revenue levels. The sales department is sometimes considered
to be a revenue center. In this capacity, employees are essentially encouraged to obtain new
sales without regard to the cost of obtaining them. This can be a dangerous way to run a
function, unless strict guidelines are set up that control the overall spending limits allowed,
the size and type of customer solicited, and the size and type of orders obtained. Otherwise,
the sales staff will obtain orders from all kinds of customers, including those with poor credit
records or histories of returning goods, not to mention orders that are so small that the cost of
processing the order exceeds the profit gained from the sale.
Other counterproductive activities associated with revenue centers are the inordinate use of
travel funds to meet with customers, selling products at large discounts from the standard
price, offering special promotional guarantees to customers, allowing credits on previously
purchased products if the price subsequently declines, and offering to extend payment terms.
For all of these reasons, revenue centers are not recommended without the addition of stringent
controls to ensure that the sales staff obtains only revenues that will result in adequate levels
of profitability.
In a revenue center, performance evaluations are limited because the manager has control over
only one item: revenues. Actual performance in revenue centers (as well as in any other area
that has revenue control) should be compared against budgeted performance to determine
variances from expectations. Budgeted and actual revenues may differ because of either
volume of units sold or price of units sold. To compare budgeted and actual revenues, the price
and volume components of revenue must be distinguished from one another. The sales price
variance is calculated by multiplying the actual number of units sold by the difference between

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Concept of Cost, Revenue, Profit and Responsibility Centre

actual and budgeted sales prices. This variance indicates the portion of the total revenue
variance that is related to a change in selling price. The sales volume variance is calculated by
multiplying the budgeted sales price by the difference between the actual and budgeted sales
volumes.

5 Jun’24; MTP Dec’24 Set 1

What do you mean by Responsibility Centre? Explain in brief the various types of Responsibil-
ity Centers. [7]

Meaning and Types of Responsibility

Centres

Answer
Responsibility Centre:
A Responsibility Centre may be defined as an area of responsibility which is controlled by an
individual. A responsibility centre is an activity such as department over which a manager
exercises responsibility. Responsibility Centre may be departments, product lines, territories or
any other type of identifiable unit or combination of units. All costs relating to the centre are
collected and the manager responsible for such a cost centre judged by reference to the activity
levels achieved in relation to costs. Even an individual machine may be treated as responsibility
centre for cost control and cost reduction.
There are four types of Responsibility Centre are commonly identified. These are:
1. Cost or Expense Centre: The most elementary form of Responsibility Centre is the cost
Centre, which itemizes all of the expenses incurred to run a specified function, but ignores
the cost of capital involved in it, as well as any associated returns. A Cost Centre is an
organizational unit whose manager has the authority only to incur costs and is specifi-
cally evaluated on the basis of how cost are controlled. The objective of Cost Centre is the
control over the incurrence of expenses. Cost Centres managers are responsible for cost
only.
2. Profit Centre: A Profit Centre is an organizational unit whose manager is responsible for
generating revenues and managing expenses related to current activity. Thus, Profit Centre
should be independent organizational unit whose managers have the ability to obtain
resources at the most economical prices. The objective of Profit Centre is to maximise the
Centre’s profit. Profit Centres managers are responsible for both costs and revenues.
3. Revenue Centre: A Revenue Centre is strictly defined as an organizational unit that is
responsible for generation of revenues and has no control over selling price or budgeting
cost. It is a distinct operating unit of a business that is responsible for generating sales

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Concept of Cost, Revenue, Profit and Responsibility Centre

and is judged solely on its ability to generate sales; it is not judged on the amount of costs
incurred. Revenue centers are employed in heavily sales- focused organizations.
4. Investment Centre: An investment Centre is an organizational unit whose manager is
responsible for managing revenues and current expenses. An investment center is a center
that is responsible for its own revenues, expenses, and assets and manages its own financial
statements which are typically a balance sheet and an income statement.

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Preparation of Responsibility Report

9.2
Preparation of Responsibility Report

1 MTP Dec'23 Set 2

List the characteristics of responsibility reporting. [7]

Characteristics

Answer
The characteristics of responsibility reporting:
1. Reports should fit the organization chart, that is, the report should be addressed to the
individual responsible for the items covered by it, who, in turn, will be able to control those
costs under his jurisdiction. Managers must be educated to use the results of the reporting
system.
2. Report should be prompt and timely. Prompt issuance of a report requires that cost
records be organized so that information is available when it is needed.
3. Reports should be issued with regularity. Promptness and regularity are closely tied up
with the mechanical aids used to assemble and issue reports.
4. Reports should be easy to understand. Often they contain accounting terminology
that managers with little or no accounting training find difficult to understand, and vital
information may be incorrectly communicated. Therefore, accounting terms should be
explained or modified to fit the user. Top management should have some knowledge
of the kind of items chargeable to an account as well as the methods used to compute
overhead rates, make cost allocations and analyze variances.
5. Reports should convey sufficient but not excessive details. The amount and nature
of the details depend largely on the management level receiving the report. Reports to
management should neither be flooded with immaterial facts nor so condensed that
management lacks vital information essential to carrying out its responsibilities.
6. Reports should give comparative figures, i.e., a comparison of actual with budgeted
figures or of predetermined standards with actual results and the isolation of variances.

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Preparation of Responsibility Report

7. Reports should be analytical. Analysis of underlying papers, such as time tickets, scraps
tickets, work orders, and materials requisitions, provide reasons for poor performance
which might have

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NOTES

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 Decision Theory

Chapter 10
Decision Theory

10.1 Decision Making under Certainty

10.2 Decisions Making under Risk

10.3 Decision Making under Uncertainty

10.4 Decision Tree

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1 Postal Test Paper

What is Decision Theory and how is it related to other theories? [7]

Decision Theory and its Relation

Answer
Decision making is the most significant aspect of the management process. Efficacy of every
aspect of management (planning, organizing, control, etc.) is pivoted on the effectivity of the
decision making process. Effective decision making is linked to fulfilment of the objectives
of the organization. An elaborately designed decision making process helps to make a more
deliberate and effective decision.
The steps of the process are discussed below:
Step 1: Identify the decision – it is important to identify the nature of decision that the decision
maker is faced with. This paves way for making effective decisions.
Step 2 : Gather relevant information - Before decision making, it is important to gather all
relevant information.
The source of information can be two types,
• Internal source- information available within the organisation.
• External source – information that are available beyond the scope of the organisation.
Step 3: Identify the alternatives – on the basis of the information collected the alternatives
are zeroed upon. At this juncture it is important to make a list of all possible alternatives in order
to make a correct and effective decision.
Step 4: Consider the evidence - In this step, the decision maker uses his knowledge and
emotion to imagine what it would be like if one particular alternative is chosen and carried out.
This would have to be thought about for all the possible alternatives. As the decision maker
goes through this process (often with subtlety), he starts developing a notion as to which
alternative results in the achievement of the organisational goal.
Step 5: Take action - In this step the decision maker is ready to make his call which is decided
upon in the previous step.
Step 6: Review of the decision - After the above steps are undertaken and a decision is arrived
at, the process of evaluation has to begin where the impact of the decision is considered. If the
desired result is not achieved, the whole process has to be revisited.
The theoretical underpinnings of the decision making process is the subject matter of Decision

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 Decision Theory

Theory. The following aspects are noteworthy:

• Decision theory involves economic and statistical approaches for studying an individual’s
choices. Because it is based on ideas, attitudes, and wishes, analysts refer to it as a theory
of choice.
• Decision theory enables the entity to make the most rational decision feasible in unknown
and uncertain conditions, repercussions, and behaviours.
• In order to make better business decisions, companies worldwide use this theory to
understand how customers and markets operate.
• Mathematicians, economists, marketers, data and social scientists, biologists, psycholo-
gists, philosophers, and politicians use two theory forms: normative and descriptive.
Though decision theory deals with the methods for determining the optimal course of action
when a number of alternatives are available, given that the consequences cannot be forecast
with certainty, for the purpose of this section of the study note, discussion is restricted to
problems occurring in business, with consequences that can be described in Rupees of profit
or revenue, cost or loss. For these problems, it is reasonable to consider that the best alternative
is the one which results in the highest profit or revenue, or lowest cost or loss, on the average,
in the long run.

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10.1
Decision Making under Certainty

No questions have been asked yet from this chapter !

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 Decision Theory

10.2
Decisions Making under Risk

1 MTP Jun'23 Set 2

How will you use the concept of Expected Value of Perfect Information (EVPI) in managerial
decision making? [2]

Expected Value of Perfect Information

Answer
Expected Value of Perfect Information (EVPI) is the maximum amount that is worth paying for
additional information in an uncertain situation, calculated by comparing the expected value
of a decision if the information is acquired against the expected value in the absence of the
information. It is calculated by comparing the expected value of a decision if the information is
acquired against the expected value in the absence of the information.

2 MTP Jun'23 Set 2

A company wishes to go ahead with one of two mutually exclusive projects, but the profit
outcome from each project will depend on the strength of sales demand, as follows.
Strong Demand Profit Moderate Demand Profit Weak Demand Profit/(Loss)
(₹) (₹) (₹)
Project 1 80,000 50,000 (5,000)
Project 2 60,000 25,000 10,000
Probability of 0.2 0.4 0.4
demand
The company could purchase market research information at a cost of ₹ 4,500. This would
predict demand conditions with perfect accuracy.
What value the company obtain from this perfect market research information? [6]

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Value of Perfect Information

Answer
Expected value in the absence of the information = ₹ 1,500
EV of Project 1 = (0.2 × ₹ 80,000) + (0.4 × ₹ 50,000) – (0.4 × ₹ 5,000) = ₹ 34,000
EV of Project 2 = (0.2 × ₹ 60,000) + (0.4 × ₹ 25,000) + (0.4 × ₹ 10,000) = ₹ 26,000
Project 1 would be chosen on the basis if EV without perfect information. With perfect informa-
tion, this decision would be changed to Project 2 if market research indicates weak demand.
EV with perfect information : (0.2 × ₹ 80,000) + (0.4 × ₹ 50,000) + (0.4 × ₹ 10,000)
= ₹ 40,000
Value of perfect information = ₹ (40,000 - ₹ 34,000) – ₹ 4,500 cost = ₹ 1,500

3 MTP Dec'23 Set 2

The following information is available for a Company:
Sales Volume (units) Probability (%)
10,000 10
12,000 15
14,000 25
16,000 30
18,000 20
Projected sales and costs are as under:

Sales Price per unit: ₹6

Variable Cost per unit: ₹ 3.50
Fixed Costs: ₹ 34,000
Required:
(i) Probability that the Company will at least Break-even
(ii) Probability that the Profit will be at least ₹ 10,000. [7]

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 Decision Theory

Probability of break even/profit

Answer
(i) Contribution per unit = ₹ 2.50 (₹ 6 – ₹ 3.50)
BEP (units) = Total Fixed Costs ÷ Contribution per unit = ₹ 34,000 ÷ ₹ 2.50 = 13,600 units.
The probability that at least Break-even = 0.25 + 0.30 + 0.20 = 0.75 = 75%.
(ii) The Profit will be at least ₹ 10,000:
Then, BEP (units) = ₹ 34,000 + ₹ 10,000 ÷ ₹ 2.50 = 17,600 units.
The required Probability = 20%

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10.3
Decision Making under Uncertainty

1 MTP Jun'23 Set 1

For the upcoming planting season, farmer Visal can plant corn (A1), wheat (A2), or soybeans (A3)
or use the land for grazing (A4). The payoffs associated with the different actions are influenced
by the amount of rain: heavy rainfall (S1), moderate rainfall (S2), light rainfall (S3), or drought
(S4). The payoff matrix (in thousands of rupees) is estimated as;

S1 S2 S3 S4
A1 -20 60 30 -5
A2 40 50 35 0
A3 -50 100 45 -10
A4 12 15 15 10
Develop a course of action for farmer Visal based on each of the four decision criterion under
uncertainty. [8]

Course of Action - Maximum, Laplace, Payoff Maximisation

Savage, Hurwicz

Answer
The four criterions under uncertainty are
1. The maximin or Minimax Criterion
2. The Laplace Criterion
3. The Savage Criterion
4. The Hurwicz Criterion
These are given below
(i) The Maximin (since it is a payoff maximisation)
S1 S2 S3 S4 Row min
A1 -20 60 30 -5 -20

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 Decision Theory

A2 40 50 35 0 0
A3 -50 100 45 -10 -50
A4 12 15 15 10 10 ← maximin
(ii) The Laplace Criterion - Assume equal probabilities (1/4) as there are four states of finance
S1 S2 S3 S4 EV= ∑ P(Xi) × Xi Figures in ₹
thousand
A1 -20 60 30 -5 ¼(-20+60+30-5) = 16.25 ₹16,250
A2 40 50 35 0 ¼(40+50+35+0) = 31.75 ₹ 31,250
A3 -50 100 45 -10 ¼(-50+100+45-10) = 21.25 ₹ 21,250
A4 12 15 15 10 ¼(12+15+15+10) = 13 ₹ 13,000
Since it is a payoff maximization problem, decision A2 would be selected which implicates
highest payoff of ₹31,250
(iii) Savage Criterion
This criterion posits the formulation of a regret matrix. The original matrix
S1 S2 S3 S4
A1 -20 60 30 -5
A2 40 50 35 0
A3 -50 100 45 -10
A4 12 15 15 10
The regret matrix is determined by subtracting the given values from 40, 100, 45, and 10
from columns 1 to 4, respectively, and so the following regret matrix is obtained. Now we
can calculate minimize (since it is a payoff maximization problem)
S1 S2 S3 S4
A1 60 40 15 15 60
A2 0 50 10 10 50 ← Minimax
A3 90 0 0 20 90
A4 38 85 30 0 85
(iv) The Hurwicz Criterion
The following table summarizes the computation
Alternative Rowmin Row Max [α(Rowmax)+(1-α)(Rowmin)]
A1 -20 60 [α(60) + (-20)(1- α)] = 60α - 20+20α = 80α - 20
A2 0 50 [α(50) + (0)(1-α)] = 50α
A3 -50 100 [α(100) + (-50)(1-α)] = 150α - 50
A4 10 15 [α(15) + (10)(1-α)] = 5α +10
The decision maker will have to decide upon the appropriate α. And thus he can decide
upon the optimum alternative.

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 Decision Theory

2 MTP Jun'23 Set 2

TIKLIBUKLI School is situated in the outskirts of a town and the school is preparing a summer
camp in the jungles of Sonargaon, to train the students in wilderness survival. The school
estimates that attendance can fall into one of four categories: 200, 250, 300, and 350 persons.
The cost of the camp will be the smallest when its size meets the demand exactly. Deviations
above or below the ideal demand levels incur additional costs resulting from constructing more
capacity than needed or losing income opportunities when the demand is not met. Letting a1
to a4 represent the sizes of the camp (200, 250, 300, and 350 persons) and s1 to s4 the level of
attendance, the following table summarizes the cost matrix (in thousands of Rupees) for the
situation:

S1 S2 S3 S4
A1 5 10 18 25
A2 8 7 12 23
A3 21 18 12 21
A4 30 22 19 15
The authorities request your consultancy to apply the following decision criterion and
determine the appropriate course of action;
(i) The Minimax Criterion
(ii) The Laplace Criterion
(iii) The Savage Criterion
(iv) The Hurwicz Criterion [1 + 2 + 2 + 2 = 7]

Minimax, Laplace, Savage and Hurwicz Cost Maximisation

Criterion

Answer
(i) The Minimax Criterion
S1 S2 S3 S4 Row Max
A1 5 10 18 25 25
A2 8 7 12 23 23
A3 21 18 12 21 21 ← Minimax
A4 30 22 19 15 30

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 Decision Theory

(ii) The Laplace Criterion

Assume equal probabilities (1/4) as there are four states of nature.
Figures in
s1 s2 s3 s4 EV= ∑ P(Xi) × Xi
₹ thousand
1
a1 5 10 18 25 (5 + 10 + 18 + 25) = 14.5 ₹ 14,500
4
1
a2 8 7 12 23 (8 + 7 + 12 + 23) = 12.5 ₹ 12,500
4
1
a3 21 18 12 21 (21 + 18 + 12 + 21) = 18.0 ₹ 18,000
4
1
a4 30 22 19 15 (30 + 22 + 19 + 15) = 21.5 ₹ 21,500
4
Since it is a cost minimisation problem, decision a2 would be selected which implicates the
lowest cost of ₹ 12500.
(iii) The Savage Criterion
This criterion posits the formulation of a regret matrix. The regret matrix is determined by
subtracting 5, 7, 12, and 15 from columns 1 to 4, respectively. And so the following regret
matrix is got.
s1 s2 s3 s4 Row Max
a1 0 3 6 10 10
a2 3 0 0 8 8 ← Minimax
a3 16 11 0 6 16
a4 25 15 7 0 25
(iv) The Hurwicz Criterion
The following table summarizes the computation
Alternative Row Min Row Max α (Row Min) + (1-α) (Row Max)
a1 5 25 25 - 20α
a2 7 23 23 - 16α
a3 12 21 21 - 9α
a4 15 30 30 - 15α
The decision maker will have to decide upon the appropriate α. And thus he can decide
upon the optimum alternative.

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 Decision Theory

3 Jun'23
SIDSORY Ltd., a food products company, is contemplating the introduction of a revolutionary
new product with new packaging to replace the existing product at a much higher price (S,),
or, a moderate change in the composition of the existing product with a new packaging at a
small increase in price (S1), or, a small change in the price (S2). The possible states of nature or
events are (i) high increase in the sales (N1), (ii) no change in the sales (N2) and (iii) decrease in
the sales (N3). The marketing department of the company worked out the pay-offs in terms of
yearly net profits for each of the strategies for these events (expected sales). This is represented
in the following table.
Pay-offs (in ₹)
State of Nature
Strategies
N1 N2 N3
S1 7,00,000 3,00,000 1,50,000
S2 5,00,000 4,50,000 0
S3 3,00,000 3,00,000 2,00,000
Required:
Develop a course of action for SIDSORY Ltd., based on -
(i) Maximin Criterion
(ii) Maximax Criterion
(iii) Laplace Criterion
(iv) Hurwicz Criterion [Alpha (a) = 0.4] [8]

Maximin, Maximax, Laplace and Hurwicz

Criterion

Answer
(i) Maximin Criterion: S3 Strategy is to be selected.
(ii) Maximax Criterion: S1 Strategy is to be selected.
(iii) Laplace Criterion: S1 Strategy is Selected.
(iv) Hurwicz Criterion (a = 0.4): S1 Strategy is Selected.

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 Decision Theory

4 MTP Dec'23 Set 1

Describe the meaning of uncertainty in decision making. [7]

Uncertainty In Decision Making

Answer
In case of certainty, the future is known and the decision maker, thus, need not worry about the
happening /not happening of a particularstate of nature as the future is cent percent assured.
Whereas under condition of uncertainty, the future statesof nature are unknown. There is
no information available on the happening /not happening of the future stateof nature. In
decision making under uncertainty, the probability distribution associated with the states is
either unknown or cannot be determined. This lack of information has led to the development
of special decision criteria.
In simple terms, situations where objectives probabilities cannot be assigned to the states of
the nature as no prior information is available gives rise to the condition of decision making
under uncertainty.
Uncertainty, in common parlance, is a state of not knowing whether a proposition is true or
false. Suppose Mr A went to a casino. There the dealer is about to roll a dice. If the result is a six,
Mr A is going to lose ₹100.
What is Mr A’s risk? What, is the subjective opinion (subjective probability) that Mr A will lose
₹100?
It may seem to be one chance in six (which is a general answer). But it is not known from previous
how may sidesthe dice have. The information that the die is 10 sided one changes the perspec-
tive about probability of throwinga six. This example illustrates how one can be uncertain but
not realize it. To clarify, an individual is uncertain of a proposition if she
• does not know it to be true or false or
• is oblivious to the proposition.
Probability is often used as a metric of uncertainty, but its usefulness is limited. At best, probabil-
ity quantifies perceived uncertainty.
A decision problem, where a decision-maker is aware of various possible states of nature
but has insufficient information to assign any probabilities of occurrence to them, is termed
as decision-making under uncertainty. Adecision under uncertainty is when there are many
unknowns and no possibility of knowing what could occur inthe future to alter the outcome of
a decision.

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 Decision Theory

The decision maker feels the uncertainty about a situation when he can’t predict with complete
confidence what the outcomes of the actions will be. The decision maker experiences uncertain-
ty about a specific question whenhe can’t give a single answer with complete confidence.

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 Decision Theory

10.4
Decision Tree

1 MTP Jun'23 Set 1

Farmer Visal can plant either corn or soybeans. The probabilities that the next harvest prices will
go up, stay the same, or go down are 0.25, 0.30, and 0.45, respectively. If the prices go up, the
corn crop will net ₹ 30,000 and the soybeans will net ₹ 10,000. If the prices remain unchanged,
McCoy will (barely) break even.
But if the prices go down, the corn and soybeans crops will sustain losses of ₹ 35,000 and ₹
5000, respectively.
(i) Represent McCoy’s problem as a decision tree.
(ii) Suggest Visal on the crop that he should plant. [7]

Decision Tree

Answer
(a)
Price will go up
(0.25)
₹ 30,000

Price will go stay

Corn the same (0.45)
₹0

Price will go
down (0.45)
₹ –35,000
Decision
Point Price will go up
(0.25)
₹ 10,000

Price will go stay

Soyabeens the same
₹0

Price will go
down (0.45)
₹ –5,000

(ii) EV(corn) = - ₹ 8,250, [(30,000 × 0.25) + (– 35,000 × 0.45)]

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 Decision Theory

EV(soybeans) = ₹ 250, [(10,000 × 0.25) + (– 5,000 × 0.45)]

Therefore, select soybeans.

2 Jun'23
Mr. Kunch, a business man has two independent investments A and B available to him but he
lacks the capital to undertake both of them simultaneously.
He can choose to take A first and then stop, or, if A is successful then take B, or, vice versa. The
probability of success on A is 0.7 while for B it is 0.4. Both investments require an initial capital
outlay of ₹ 2000; and both return nothing if the venture is unsuccessful. Successful completion
of A will return ₹ 3,000 (over cost), and successful completion of B will return ₹ 5,000 (over cost).
Required:
(i) Represent Mr. Kunch’s problem as decision tree.
(ii) Suggest Mr. Kunch as to which investment he should chose. [7]

Decision Tree and Suggestion

Answer
(i)
0
op
St
Successful
0.4
D2 Acc
ept –600
A Fall
0.3
tB

Succe
p

ssful 2,100
ce
Ac

Fall
-1,200
0.6
Do not accept
D1 A&B
0

–600
Ac

tB Successful
ce

0.3 l
al

p 2,000
pt

ce 0.4
F

Ac
A

0
Successful Fall .6
D3 -1,200
Sto
0.7 p
0

Discussion Tree

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 Decision Theory

(ii) The best strategy is to accept A first, and then to accept B, if A is successful.

3 Dec'23
The following information has been obtained from the books of M/s Das & Kumars for the year
ended 31-03-2023,

Units sold 2,00,000 Fixed Cost (3)

Selling Price per unit (₹) 10
Particulars Variable Cost per unit: (₹)
Works overhead 4.00 2,00,000
Administrative overhead 1.00 50,000
Selling & distribution overhead 0.50 1,30,000
Income Tax rate (including education cess) is 31.20%.
The firm predicts variable works overhead at different sales level as under:
₹ 5.50 when sales are 1,80,000 units
₹ 4.00 when sales are 2,00,000 units
₹ 3.50 when sales are 2,40,000 units
The Sales team has forecasted the sales as follows:
Probability 0.3 - 1,80,000 units
Probability 0.5 - 2,00,000 units
Probability 0.2 - 2,40,000 units
The Works Manager has indicated the variable works overhead as follows:
Probability 0.2 — ₹ 5.50 per unit
Probability 0.6 — ₹ 4.00 per unit
Probability 0.2 - ₹ 3.50 per unit.
Prepare a Probabilistic Budget and calculate the Expected Value. Comment on your answer.
[7]

Probabilistic Budget

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 Decision Theory

Answer
Table showing Probabilistic Budget & Expected Value
Profit after tax Joint Probability Expected Profit
Sales Volume
(PAT) (₹) (JP) (₹) PAT x JP
180000 110080 0.06 6604.80
P = 0.3 295840 0.18 53251.20
357760 0.06 21465.60
200000 151360 0.10 15136.00
P = 0.5 357760 0.30 107328.00
426560 0.10 42656.00
240000 233920 0.04 9356.80
P = 0.2 481600 0.12 57792.00
564160 0.04 22566.40
Expected Value (EV) 336156.80
Comment: It can be observed that an expected profit estimate will be ₹ 336,156.80.

4 MTP Jun’24 Set 1

B Ltd. has a new wonder product, the V, of which it expects great things. At the moment the
company has two courses of action open to it, to test market the product or abandon it.
If the company test markets it, the cost will be ₹ 1,00,000 and the market response could be
positive or negative with probabilities of 0.60 and 0.40.
If the response is positive the company could either abandon the product or market it full scale.
If it markets the V in full scale, the outcome might be low, medium or high demand, and the
respective net gains/ (losses) would be (200), 200 or 1,000 in units of ₹1,000 (the result could
range from a net loss of ₹ 2,00,000 to a gain of ₹10,00,000). These outcomes have probabilities
of 0.20, 0.50 and 0.30 respectively.
If the result of the test marketing is negative and the company goes ahead and markets the
product, estimated losses would be ₹ 6,00,000.
If, at any point, the company abandons the product, there would be a net gain of ₹ 50,000 from
the sale of scrap. All the financial values have been discounted to the present.
Required:
Prepare and draw a decision tree and also include figures for cost, loss or profit on the appropri-
ate branches of the tree. [7]

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 Decision Theory

Decision Tree

Answer
The starting point for the tree is to establish what decision has to be made now. What are the
options?
(A) To test market
(B) To abandon
The outcome of the ‘abandon’ option is known with certainty. There are two possible outcomes
of the option to test market, positive response and negative response.
Depending on the outcome of the test marketing, another decision will then be made, to
abandon the product or to go ahead.
High 0.3
+ 1,000
Market Medium 0.5
E + 200
Positive Low 0.2
0.6
C – 200
Abandon
+ 50
B

Test Negative Market

D + 600
– 100 0.4 Abandon
– 50
A

Abandon
+ 50

5 Jun’24
TEXTON Ltd. (TL), a textile company, is considering whether to enter a new market. In case
the company decides to enter this market, it must increase its production. To achieve higher
production, it must either install a new plant with a cash outlay of ₹ 3,00,000 or pay overtime
wages to its workers, which are expected to amount to ₹ 1,00,000. If the company decides to
enter the market, there is a 60% chance of its shareholders approving the installation of the
new plant. A random sample of current market structure reveals that there are 40% chances for
achieving a high level of sales by the company, 30% chances of achieving a medium level of
sales, 20% chances of low sales and 10% chances of achieving no sales. Further, a high level of
sales will yield a profit of ₹ 10,00,000, a medium level of sales will yield a profit of ₹ 6,00,000 and

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 Decision Theory

a low level of sales will yield a profit of ₹ 2,00,000. If there are no sales, the company will lose ₹
5,00,000, apart from the cost of the equipment.
Required:
Represent the above problem in the form of a decision tree and suggest the option that should
be selected by the company. [7]

Decision Tree

Answer
High (0.4)
10,00,000
Medium (0.3)
(0.6
) 6,00,000
ro val C Low (0.2)
App 2,00,000
0
0,00 No. Sales (0.1)
Plan
t A – 3,0 – 5,00,000
New No
.A
pp
2 . (0
.4)
₹0
–1 High (0.4)
,00
Enter the market ,00
0
10,00,000
OT Medium (0.3)
6,00,000
1 B Low (0.2)
2,00,000
No. Sales (0.1)
Do not enter – 5,00,000
₹0

EMV of chance node C = ₹ 5,70,000

EMV of node B = ₹ 5,70,000
EMV of node A = ₹ 1,62,000
EMV of decision node 2 = New plant: ₹ 1,62,000
Overtime: = ₹ 4,70,000
EMV of decision node 1 = Enter Market = ₹ 4,70,000 (Max.) and pay overtime
Do not enter market = ₹ 00
Suggestion :
Since EMV of Decision Node – 1 (₹ 4,70,000) is maximum the company should enter the market
and pay overtime wage.

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 Decision Theory

6 MTP Dec’24 Set 1

LTB Ltd. has a new wonder product, the V, of which it expects great things. At the moment the
company has two courses of action open to it, to test market the product or abandon it. If the
company test markets it, the cost will be ₹1,00,000 and the market response could be positive
or negative with probabilities of 0.60 and 0.40.If the response is positive the company could
either abandon the product or market it full scale.
If it markets the V in full scale, the outcome might be low, medium or high demand, and the
respective net gains/ (losses) would be (200), 200 or 1,000 in units of ₹1,000 (the result could
range from a net loss of ₹2,00,000 to a gain of ₹10,00,000). These outcomes have probabilities
of 0.20, 0.50 and 0.30 respectively.
If the result of the test marketing is negative and the company goes ahead and markets the
product, estimated losses would be ₹6,00,000.
If, at any point, the company abandons the product, there would be a net gain of ₹50,000 from
the sale of scrap. All the financial values have been discounted to the present.
Required:
(i) Draw a decision tree.
(ii) Include figures for cost, loss or profit on the appropriate branches of the tree. [7]

Decision Tree

Answer
The starting point for the tree is to establish what decision has to be made now. What are the
options?
(a) To test market
(b) To abandon
The outcome of the ‘abandon’ option is known with certainty. There are two possible outcomes
of the option to test market, positive response and negative response.
Depending on the outcome of the test marketing, another decision will then be made, to
abandon the product or to go ahead.

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 Decision Theory

High 0.3
+ 1,000
Market Medium 0.5
E + 200
Positive Low 0.2
C – 200
0.6 Abandon
+ 50
B
Test Negative Market
– 100 D – 600
0.4 Abandon
+ 50
A

Abandon
+ 50

Evaluating decisions by using decision trees has a number of limitations as follows:

i. The time value of money may not be taken into account.
ii. Decision trees are not very suitable for use in complex situations.
iii. The outcome with the highest EV may have the greatest risks attached to it. Managers may
be reluctant to take risks which may lead to losses.
iv. The probabilities associated with different branches of the ‘tree’ are likely to be estimates,
and possibly unreliable or inaccurate.

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 Objectives

Chapter 11
Objectives

MTP Jun’23 Set 1

1. Multiple Choice Questions [1 × 12 = 12]

(i) _____ is the study of managerial aspects of financial accounting.

(a) Cost accounting
(b) Financial accounting
(c) Management accounting
(d) Business accounting
(ii) Just-in-time inventory management and Activity based costing were developed during
the _____.
(a) 1st stage
(b) 2nd stage
(c) 3rd stage
(d) 4th stage
(iii) In an ABC system, the allocation bases that are used for applying costs to services or
procedures are called:
(a) Cost Pool
(b) Cost Drivers
(c) Cost Absorption
(d) Cost Object
(iv) Which of the following would not be deducted from sales in a management report
prepared using ABC?
(a) Direct materials
(b) Direct labour
(c) Variable selling and administration costs
(d) Shipping costs
(v) _____ an item for which cost measurement is required e.g. product, job or a customer.
(a) Cost Pool

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 Objectives

(b) Cost Driver

(c) Cost Absorption
(d) Cost Object
(vi) Which of the following criterion is not used for decision-making under uncertainty?
(a) Maximin
(b) Maximax
(c) Minimax
(d) Maximise expected value
(vii) Circumstances that influence the profitability of a decision are referred to as _____.
(a) Strategies
(b) A payoff matrix
(c) States of nature
(d) the marginal utility of money
(viii) In a responsibility accounting system, managers are accountable for:
(a) Incremental costs.
(b) Product costs but not for period costs.
(c) Costs over which they have control.
(d) Variable costs but not for fixed costs.
(ix) A company has two divisions. The divisions are identical in terms of the number and type
of machines they have and the operations they carry out. However, one division was set
up four years ago and the other was set up one year ago. Head office appraises the division
using both return on the investment (ROI) and residual income (RI). Which of the following
statements is correct in relation to the outcome of the appraisal for each division?
(a) Both ROI and RI will favour the older division
(b) ROI will favour the older division, but RI will treat each fairly
(c) RI will favour the newer division and ROI will favour the older division
(d) Both RI and ROI will favour the newer division
(x) Which of the following would be an argument for the use of net book value in the computa-
tion of operating assets in return on investment calculations?
(a) It allows the manager to replace old, worn- out equipment with a minimum adverse
impact on ROI.
(b) It allows ROI to decrease over time as assets get older.
(c) It is consistent with how plant and equipment items are reported on the balance sheet.
(d) It eliminates both age of equipment and method of depreciation as factors in ROI
computations.

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 Objectives

(xi) Production at 60% activity is ₹ 600 units, if flexible budget needs to be calculated at 80%
activity what will be units produced?
(a) ₹ 800
(b) ₹ 600
(c) ₹ 1200
(d) ₹ 1000
(xii) In which of the following circumstances is there a strong argument that profit centre
accounting is a waste of time?
(a) When the transferred item is also sold on an external market.
(b) When the supplying division is based in a different country to head office.
(c) If the transferred item is a major product of the supplying division.
(d) If there is no similar product sold on an external market and the transferred item is a
major product of the supplying division.

2. State True or False: [1 × 7 = 7]

(i) Globalization and the rapid growth of international trade has made inter-company pricing
an everyday necessity for the vast majority of businesses.
(ii) Divisional Autonomy is the degree of freedom a division manager can exercise in decisions
making.
(iii) The Budget manual is a schedule, document or booklet, which shows in a written form, the
budgeting organization and procedure.
(iv) If the occurrence or non-occurrence of one event does not change the probability of the
occurrence of the other event, the two events are said to be independent.
(v) Benchmarking is a process of measuring the performance of a company’s products,
services, or processes against those of another business considered to be the best in the
industry.
(vi) ABC recognizes the increased complexity of modern businesses with its multiple cost
drivers, many of which are transaction based rather than volume based.
(vii) A revenue centre is strictly defined as an organizational unit that is responsible for the
generation of revenues and has full control over setting selling prices or budgeting costs.

3. Fill in the blanks: [1 × 6 = 6]

(i) Transfer prices based on full cost are appropriate if top management treats the divisions
like _____.
(ii) If the selling division has, _____ a transfer price based on _____ would be an appropriate
transfer price, although it would hurt the performance of the selling division.

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 Objectives

(iii) lean manufacturing systems that seek to reduce waste by implementing _____ production
systems and focussing on _____.
(iv) There has been a paradigm shift in the role of the management accountant in the era of
globalisation. The focus shifted to _____.
(v) If a decision maker can estimate the _____ of the future events, these should be incorpo-
rated into the decision model.
(vi) Under marginal costing, the stock is valued at _____ .
Answer:

(a) (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) (x) (xi) (xii)
c c b d d d c c a c a d

(b) (i) (ii) (iii) (iv) (v) (vi) (vii)

True True True True True True False

(c) (i) (ii) (iii) (iv) (v) (vi)

Cost Excess just-in-time (JIT) strategic probabilities Variable
centres capacity, production systems, analysis costz
variable advanced manufacturing
cost technologies (AMTs)

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 Objectives

MTP Jun’23 Set 2

1. Multiple Choice Questions [1 × 12 = 12]

(i) In a product mix decision, which is the most important factor to consider in order trying to
maximise profit?
(a) contribution per unit of a scarce resource used to make the product
(b) contribution per unit of the product
(c) variable cost per unit of the product
(d) product unit selling price
(ii) Which of the following costs incurred by a commercial airline can be classified as variable?
(a) Interest costs on leasing of aircraft
(b) Pilots’ salaries
(c) Depreciation of aircraft
(d) None of these three costs can be classified as variable
(iii) A large margin of safety indicates _____.
(a) Over capitalization
(b) The soundness of business
(c) Overproduction
(d) None of the above
(iv) Usually the production budget is stated in terms of _____.
(a) Money
(b) Quantity
(c) Both of the above
(d) None of the above
(v) Revision of budgets is necessary when original budget was prepared with _____.
(a) only management’s direction
(b) judgement of employees only
(c) Inappropriate data
(d) All of the above
(vi) Which of the following is NOT a method of transfer pricing?
(a) Cost plus transfer price
(b) Internal price plus transfer price
(c) Market-based transfer price

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(d) Two-part transfer price

(vii) What transfer pricing method is preferred by Cost Accountant?
(a) Cost Based
(b) Negotiated
(c) Market Based
(d) Dual Pricing
(viii) Management accounting deals with _____ data.
(a) qualitative
(b) quantitative
(c) both qualitative and quantitative
(d) only non-financial
(ix) The following is the limitation of management accounting –
(a) Costly Affair
(b) Evolutionary Stage
(c) Psychological Resistance
(d) All of the above
(x) Objectives of Management Accounting _____.
(a) Policy formulation
(b) Helpful in decision making
(c) Helpful in controlling
(d) All of the above
(xi) Which of the following costs is relevant in decision-making?
(a) committed costs
(b) accounting costs
(c) historical costs
(d) cash costs
(xii) The cost data provide invaluable information for taking the following managerial decision(s)
(a) To make or buy
(b) To own or hire fixed asset
(c) Determining the expansion or contraction policy
(d) All of the above

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 Objectives

2. State True or False [1 × 7 = 7]

(i) Management Accounting reports are public documents.

(ii) The budgetary control system is designed to fix responsibilities on executives through
preparation of budgets.
(iii) A cash budget is a summary of all functional budgets.
(iv) Experience curve effects are reinforced when two or more products do not share a common
activity or resource.
(v) Differential Cost is the change in the costs which results from the adoption of an alterna-
tive course of action.
(vi) While marginal costing excludes the entire fixed costs, some of the fixed costs may be
taken into account as being relevant for the purpose of differential cost analysis.
(vii) The early identification of principal budget factor is important in the budgetary planning
process because it indicates which budget should be prepared first.

3. Fill in the blanks [1 × 6 = 6]

(i) The preparation of Du Pont Control chart is related to analysis of _____.

(ii) _____ contains the picture of total plans during the budget period and it comprises
information relating to sales, profit, cost, production etc.
(iii) _____ is stated as a budget which is made to change as per the levels of activity attained.
(iv) _____ are often quoted in management literature as those areas in which an organization
needs to perform best if it is to achieve overall success.
(v) If a decision maker can estimate the _____ of future events, these should be incorporated
into the decision model.
(vi) Direct costing is also referred as _____.
Answers:

1. (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) (x) (xi) (xii)
a d b c c b b c d d a d

2. (i) (ii) (iii) (iv) (v) (vi) (vii)

False True False False True True True

3. (i) (ii) (iii) (iv) (v) (vi)

Return on Master Flexible Critical Probabilities Marginal
Equity Budget Budget success costing
factor(CSFs)

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Jun’23

1. Multiple Choice Questions [1 × 12 = 12]

(i) Profit Volume ratio is equal to:

(a) Variable cost as a percentage of sales
(b) Fixed cost as a percentage of sales
(c) Excess of sales over variable cost as a percentage of sales
(d) Total cost as a percentage of sales ;
(ii) A Limited produces 500 units of product in 7,500 hours against standard hours of 8,000. If
standard rate per hour is ¥ 75, then labour efficiency variance will be:
(a) ₹ 37,500 (F)
(b) ₹ 37,500 (A)
(c) ₹ 40,000 (F)
(d) ₹ 38,000 (F)
(iii) Divisional managers prepare _____ without reference to the past budget or achievements.
(a) Outcome Budgets
(b) Performance Budgets
(c) Programme Budgets
(d) Zero Base Budgets
(iv) According to Norton and Kaplan, the balanced scorecard shouldbeusedas .
(a) acontrol system
(b) a diagnostic system
(c) astrategic system
(d) All of the above
(v) A/An is an organizational unit whose manager is responsible for generating revenue and
managing expenses related to current activity.
(a) Expense Centre
(b) Revenue Centre
(c) Cost Centre
(d) Profit Centre
(vi) RTM Ltd., using Activity Based Costing (ABC), manufactures two types of products-P and
Q respectively. During a period, the company incurred ₹ 50,000 as inspection cost and it
worked for 10 and 15 production runs respectively for producing product P and Q. The
inspection cost for product P under ABC system was:

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(a) ₹ 20,000
(b) ₹ 30,000
(c) ₹ 40,000
(d) None of the above
(vii) The minimum expected opportunity loss (EOL) is
(a) equal to EVPI
(b) minimum Regret
(c) equal to EMV
(d) Both (A).and (B)
(viii) Responsibility Accounting is used for
(a) cost control
(b) planning
(c) decision making
(d) pricing
(ix) The term _____ is used to describe a location to which overhead costs are initially assigned.
(a) Cost driver
(b) Cost pool
(c) Activity
(d) Cost objects
(x) Units produced 50,000; Selling price per unit ₹ 15; Variable cost per unit ₹ 12; Fixed costs ₹
1,60,000. Calculate sales value when the profit to be earned is ₹ 80,000.
(a) ₹ 10,00,000
(b) ₹ 12,00,000
(c) ₹ 9,00,000
(d) ₹ 14,00,000
(xi) Economic Value Added (EVA) can be calculated as under:
(a) Return to Equity Shareholders fund — Cost of capital Employed.
(b) Return to providers of fund — Cost of capital Employed.
(c) Return to Long term loan fund — Cost of capital Employed.
(d) Return to Equity Shareholders fund — Cost of Equity.
(xii) According to DuPont methodology, the parameter(s) that drive Return on Equity (ROE) is
/ are:
(a) Operating performance

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(b) Asset usage performance

(c) Financial leverage
(d) All of the above

2. State whether the following statements are “True” or “False”: [1 × 7 = 7]

(i) Management accounting deals only with quantitative data.

(ii) In marginal coting both fixed and variable cost are considered for product costing and
inventory valuation.
(iii) Unavoidable fixed costs are considered as relevant cost.
(iv) Standards are arrived at on the basis of past performance.
(v) Division under transfer pricing system is treated as Cost Centre.
(vi) Production budget is also known as Subsidiary Budget.
(vii) Return on Investment (ROI) ignores the cost of equity capital.

3. Fill in the Blanks: 1x6=6

(i) A _____ is a norm against which the actual performance can be measured.
(ii) _____ analysis is the study of the interrelationship between cost, volume and profit at
various levels of activity.
(iii) _____ is an angle formed at the intersection point of total sales line and total cost line in a
formal break-even chart.
(iv) In Activity Based Costing, the allocation basis used for applying costs to services or products
is called _____
(v) _____ is the excess of total sales over BEP sales.
(vi) _____ theory proposes that a learner’s efficiency in a task improves over time, the more the
learner performs the task.
Answers :

1. (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) (x) (xi) (xii)
c a d c d a d a b b b d

2. (i) (ii) (iii) (iv) (v) (vi) (vii)

False False False False False True True

3. (i) Standard
(ii) Cost-volume-profit (CVP) / Break even
(iii) Angle of Incidence

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 Objectives

(iv) Cost driver

(v) Margin of safety
(vi) Learning curve

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 Objectives

MTP Dec’23 Set 1

1. Multiple Choice Questions [1 × 15 = 12]

(i) _____ is the study of managerial aspects of financial accounting

(a) Cost accounting
(b) Financial accounting
(c) Management accounting
(d) Business accounting
(ii) X Company uses activity-based costing for Product B and Product D. The total estimated
overhead cost for the parts administration activity pool was ₹5,50,000 and the expected
activity was 2000 part types. If Product D requires 1200 part types, the amount of overhead
allocated to product D for parts administration would be:
(a) ₹2,75,000
(b) ₹3,00,000
(c) ₹3,30,000
(d) ₹3,45,000
(iii) Cost attribution to cost units on the basis of benefit received from indirect activities, such
as ordering, setting-up, assuring quality is known as:
(a) Allocation
(b) Activity-based costing
(c) Always better control
(d) Absorption
(iv) What is Margin of Safety if Sales is 20,000 units and B.E.P is 15,000 units?
(a) 15000 units
(b) 5000 units
(c) 10000 units
(d) 20000 units
(v) Fixed cost per unit decrease when
(a) Production volume increases
(b) Production volume decreases
(c) Variable costs per unit decreases
(d) Prime costs per unit decreases
(vi) The break-even point of a manufacturing company is ₹1,60,000. Fixed cost is ₹48,000.
Variable cost is ₹12 per unit. The PV ratio will be:

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 Objectives

(a) 20%
(b) 40%
(c) 30%
(d) 25%
(vii) A radio manufacturer finds that it costs ₹6.25 per unit to make component M-140 and the
same is available in the market at ₹5.75 each. Continuous supply is also fully assured. The
break-down cost per unit as follows: Materials ₹2.75, Labour ₹1.75 other variable expenses
₹0.50, Depreciation and other fixed cost ₹1.25. What would be your decision, if the supplier
offered the component at ₹4.85 per unit?
(a) Make
(b) Buy
(c) Sell
(d) None of the above
(viii) Which one of the following is not considered as a method of Transfer Pricing?
(a) A Negotiated Transfer Pricing
(b) B Market Price Based Transfer Pricing
(c) C Fixed Cost Based Transfer Pricing
(d) D Opportunity Cost Based Transfer Pricing
(ix) Standard quantity of material for one unit of output is 10 kgs @ ₹8 per kg. Actual output
during a given period is 800 units. The standards quantity of raw material
(a) 8,000 kgs
(b) 6,400 Kgs
(c) 64,000 Kgs
(d) None of these
(x) Standard price of material per kg is ₹20, standard usage per unit of production is 5 kg.
Actual usage of production 100 units is 520 kgs, all of which was purchase at the rate of ₹
22 per kg.
Material cost variance is
(a) ₹ 2,440 (A)
(b) ₹ 1,440 (A)
(c) ₹ 1,440 (F)
(d) ₹ 2,300 (F)
(xi) Given Production at 60% activity, 600 units, Material ₹50 per unit, Labour ₹ 20 per unit,
Direct expenses ₹5 per unit, Factory overheads ₹20,000 (60% variable) and Administration

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expenses ₹15,000 (60% fixed). What will be the total cost per unit for production at 80%
capacity?
(a) ₹ 1,01,000
(b) ₹ 126.25
(c) ₹ 122
(d) ₹ 1,22,000
(xii) _____ is prepared for single level of activity and single set of business conditions.
(a) Fixed budget
(b) Flexible budget
(c) Both a and b
(d) None of the above
(xiii) If the time taken to produce the first unit of a product is 4000 hrs, what will be the total time
taken to produce the 5th to 8th unit of the product, when a 90% learning curve applies?
(a) 10,500 hours
(b) 12,968 hours
(c) 9,560 hours
(d) 10,368 hours
(xiv) In responsibility cost accounting the costs in focus are _____.
(a) Controllable costs
(b) Uncontrollable costs
(c) Both A and B
(d) None of the above
(xv) ABC stocks a weekly lifestyle magazine. The owner buys the magazines for ₹0.30 each and
sells them at the retail price of ₹0.50 each.
At the end of the week unsold magazines are obsolete and have no value. The estimated
probability distribution for weekly demand is shown below.
Weekly demand in units Probability
20 0.20
30 0.55
40 0.25
1.00
What is the expected value of demand?
(a) 30
(b) 20

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 Objectives

(c) 25
(d) None of the above
Answer:

(i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) (x) (xi) (xii) (xiii) (xix) (xv)
c c b b a c b c a b b a d a a

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 Objectives

MTP Dec’23 Set 2

1. Multiple Choice Questions [1 × 15 = 15]

(i) Management accounting deals with _____ data.

(a) Qualitative
(b) Quantitative
(c) Both qualitative and quantitative
(d) Non-financial
(ii) According to the Chartered Institute of Management Accountants (CIMA), cost attribution
to cost units on the basis of benefits received from indirect activities e.g. ordering, setting
up, and assuring quality is known as:
(a) Absorption costing
(b) Marginal costing
(c) Activity-based costing
(d) Job costing
(iii) The following information relate to ABC
Activity level 60% 80%
Variable costs (₹) 12,000 16,000
Fixed costs (₹) 20,000 22,000
The differential cost for 20% capacity is _____.
(a) ₹4,000
(b) ₹2,000
(c) ₹6,000
(d) ₹5,000
(iv) The break-even point is the point at which:
(a) There is no profit, no loss;
(b) Contribution margin is equal to total fixed cost;
(c) Total revenue is equal to total cost;
(d) All of the above.
(v) A decrease in sales price _____.
(a) does not affect the break-even point
(b) lowers the fixed cost
(c) Increases the break-even point

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 Objectives

(d) lowers the break-even point

(vi) What will be sales in rupees for desired profit if fixed cost is ₹30,000, desired profit is ₹15,000
and P/V ratio is 30%?
(a) ₹1,50,000
(b) ₹1,00,000
(c) ₹2,00,000
(d) None of the above
(vii) Variable cost is also referred to as in the marginal costing technique:
(a) Total cost
(b) Product cost
(c) Period cost
(d) None of the above
(viii) The sales and profit of a firm for the year 2021 are ₹1,50,000 and ₹20,000 and for the year
2022 are ₹1,70,000 and ₹ 25,000 respectively. The P/V Ratio of the firm is _____.
(a) 15%
(b) 20%
(c) 25%
(d) 30%
(ix) A company manufactures and sells three types of product namely A, B and C. Total sales
per month is ₹ 80,000 in which the share of these three products are 50%, 30% and 20%
respectively. The variable cost of these products is 60%, 50% and 40% respectively. The
combined P/V Ratio will be:
(a) 49%
(b) 48%
(c) 47%
(d) 50%
(x) M Group has two divisions, Division P and Division Q. Division P manufactures an item that
is transferred to Division Q. The item has no external market and 6,000 units produced are
transferred internally each year. The costs of each division are as follows?
Division P Division Q
Variable Cost ₹100 per unit 120 per unit
Fixed cost each year ₹1,20,000 90,000
Head Office management decided that a transfer price should be set that provides a profit
of ₹30,000 to Division P. What should be the transfer price per unit?
(a) ₹145

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(b) ₹125
(c) ₹120
(d) ₹135
(xi) Standard costing is a tool, which replaces the bottleneck of the _____ costing.
(a) Present
(b) Future
(c) Historical
(d) None of the above
(xii) During the month of December actual direct labour cost amounted to ₹39,550, the
standard direct labour rate was ₹10 per hour and the direct labour rate variance amounted
to ₹450 favourable. The actual direct labour hours worked was:
(a) 3,955 hours
(b) 4,000 hours
(c) 3,910 hours
(d) 4,500 hours
(xiii) A factory produces two types of articles Y and Z. Article Y takes 8 hours to make and Z takes
16 hours. In a month (25 days x 8 hours) 600 units of X and 400 units of Z are produced.
Given budgeted hours 8000 per month and men employed are 50. Determine Activity
ratio, Capacity ratio and efficiency ratio.
(a) 112%, 140%, 140%
(b) 140%, 112%, 140%
(c) 140%, 140%, 112%
(d) None of the above
(xiv) According to Kaplan & Norton, which of the balanced scorecard perspectives serves as the
focus of the other perspectives?
(a) Financial.
(b) Customer.
(c) Internal business processes.
(d) Learning & growth.
(xv) If a decision maker is risk averse, then the best strategy to select is the one that yields the
_____.
(a) Highest expected payoff.
(b) Lowest coefficient of variation.
(c) Highest expected utility.
(d) Lowest standard deviation

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 Objectives

Answers :

(i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) (x) (xi) (xii) (xiii) (xix) (xv)
c c c a c a b c c b c b c a c

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 Objectives

Dec’23

1. Multiple Choice Questions [1 × 12 = 12]

(i) Which of the following would decrease unit contribution margin the most?
(a) 10% decrease in selling price
(b) 10% increase in variable costs
(c) 10% decrease in variable costs
(d) 10% decrease in fixed costs
(ii) Which one of the following statements best demonstrates the concept of the learning
curve?
(a) Learning curve is a linear cost behavior influenced by learning.
(b) Learning curve is a judgmental method of estimating costs when learning is present.
(c) Alearning curve is a percentage by which average time per unit produced decreases
as output doubles,
(d) A learning curve is a percentage by which average time falls as output increases by
one unit.
(iii) AB Ltd. uses standard costing system. The following information pertains to direct labour
for Product X for the month of March, 2023:
Standard rate per hour ₹ 8; Actual rate per hour ₹ 8,40
Standard hours allowed for actual production is 2000 hours
Labour Efficiency variance = ₹ 1,600 (Adverse)
What were the actual hours worked?
(a) 1,800 Hours
(b) 1,810 Hours
(c) 2,200 Hours
(d) 2,190 Hours
(iv) Economic value added (EVA) is a concept that is closely related to residual income. EVA is
computed by
(a) subtracting the adjusted total cost of capital [rom the adjusted aller-tax income,
(b) subtracting adjusted after-tax income from total divisional investment.
(c) dividing adjusted after-tax income by adjusted divisional investment.
(d) dividing adjusted after-tax income by adjusted total cost of capital.
(v) Expected value in decision analysis is
(a) astandard deviation using the probabilitics as weights.

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 Objectives

(b) the square root of the squared deviations.

(c) ameasure of the difference between the best possible outcome and the outcome of
the original decision.
(d) an arithmetic mean using the probabilities as weights.
(vi) M/s SP Limited sells Glucon P at a selling price of ₹ 100 per unit. Variable cost per unit is ₹80
and Fixed cost for the year is ₹ 3,00,000. Actual quantity sold during the year is 1,00,000
boxes of Glucon P. The Break Even Point (Units) and Margin of Safety (Units) will be
(a) BEP (Units) will be 20,000 units and MOS (Units) will be 80,000 units.
(b) BEP (Units) will be 10,000 units and MOS (Units) will be 90,000 units.
(c) BEP (Units) will be 15,000 units and MOS (Units) will be 85,000 units.
(d) BEP (Units) will be 50,000 units and MOS (Units) will be 50,000 units.
(vii) Standard output is 1,000 units and actual output is 800 units. Standard price per Kg is ₹ 2
and Actual price per Kg is ₹ 3. Standard quantity per unit is 4 Kg. If actual quantity is 4,000
kgs, the Material Cost Variance will be
(a) ₹ 1,600 (F)
(b) ₹ 1,600 (A)
(c) ₹ 5,600 (A)
(d) ₹ 3,200 (A)
(viii) _____ is the budget which incorporates all functional budgets, which is finally approved,
adopted & employed.
(a) Zero Base Budget
(b) Rolling Budget
(c) Master Budget
(d) Performance Budge
(ix) M/s Shibaji Limited has Capital Employed of ₹ 4,50,000 and its Operating Income for the
year ended 31-03-2023 is ₹ 1,00,000. If the minimum expected rate of return is 14%, the
Residual Income (RI) of the Company is
(a) ₹ 35,000
(b) ₹ 43,000
(c) ₹ 40,000
(d) ₹ 37,000
(x) M/s Dutta Rubber manufactured 10,000 units of Biodegradable disposable containers at
the Material cost of ₹ 6 per unit. The Direct labour cost is ₹ 15 per unit out of which 2/3
is fixed. Factory overhead cost is ₹ 20 per unit of which 60% is fixed. The labour used for
manufacturing Biodegradable disposable containers can be used to manufacture another
product having selling price per unit of ₹ 40 and Material cost of ₹ 10 per unit, The Relevant

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 Objectives

Cost (RC) of manufacturing Biodegradable disposable containers is

(a) ₹ 66
(b) ₹ 44
(c) ₹ 36
(d) ₹ 32
(xi) Fixed cost is Relevant Cost if it is
(a) Discretionary
(b) Sunk
(c) Unavoidable
(d) Periodic
(xii) According to Norton and Kaplan, the balanced scorecard should be used as
(a) A Control system
(b) A Diagnostic system
(c) A Strategic system
(d) Both (A) & (C) above
(xiii) M/s NABARD Limited has provided you the following data for the financial year 2022-23.
Break Even Point (in ₹) = 2,66,666.67. Selling price per unit is ₹ 100 and Variable Cost per
unit is ₹ 70. Fixed Cost is ₹ 80,000. If the selling price per unit is reduced by 10% in the next
year, what will the new Break Even Point (in%)?
(a) ₹ 3,56,058
(b) ₹ 3,60,000
(c) ₹ 3,88,556
(d) ₹ 3,57,548
(xiv) M/s Agartala Plastics Private Limited has provided you the information of its pack aging
division. Fixed Assets = ₹ 10,00,000 & Current Assets = ₹ 10,00,000. Annual Fixed Cost of the
packaging division is ₹ 16,00,000, Variable Cost per unit is ₹ 10, If the budgeted volume per
year = 8,00,000 units and Return on Investment is 18%, the Transfer Price of the packaging
division will be
(a) ₹ 11.60
(b) ₹ 1245
(c) ₹ 13.40
(d) ₹ 10.90
(xv) Under Marginal Costing, the Opening & Closing stock is valued at which of the following
basis?
(a) Opening stock is valued at variable cost & closing stock is valued at total cost.

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 Objectives

(b) Opening stock is valued at total cost & closing stock is valued at variable cost.
(c) Both Opening & Closing stock is valued at variable cost.
(d) Both Opening & Closing stock is valued at total cost.
Answers :

(i) (a) (ii) (c) (iii) (c) (iv) (a) (v) (d)
(vi) (c) (vii) (c) (viii) (c) (ix) (d) (x) (b)
(xi) (a) (xii) (c) (xiii) (b) (xiv) (b) (xv) (c)

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MTP Jun’24 Set 1

1. Choose the correct option: [15 x 2 = 30]

(i) Is the study of managerial aspects of financial accounting.

(a) Cost accounting
(b) Financial accounting
(c) Management accounting
(d) Business accounting
(ii) Process of Cost allocation under Activity Based Costing is:
(a) Cost of Activities—Activities—Cost Driver – Cost allocated to cost objects
(b) Cost Driver — Cost of Activities— Cost allocated to cost objects – Activities
(c) Activities— Cost of Activities—Cost Driver – Cost allocated to cost objects
(d) Activities—Cost Driver – Cost allocated to cost objects — Cost of Activities
(iii) Plant depreciation is an example of which activity-level group?
(a) Unit-level activity
(b) Facility-level activity
(c) Batch-level activity
(d) Product-level activity
(iv) A decrease in sales price
(a) does not affect the break-even point
(b) lowers the fixed cost
(c) Increases the break-even point
(d) lowers the break-even point
(v) What will be the margin of safety if sales is ₹3,00,000 and B.E.P is ₹ 4,50,000?
(a) ₹1,00,000
(b) ₹1,50,000
(c) Amount of sales < B.E.P, therefore no margin of safety
(d) None of the above
(vi) The costing method where fixed factory overheads are added to inventory, is called:
(a) Activity-based costing
(b) Absorption costing
(c) Marginal costing
(d) All of the above

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 Objectives

(vii) Product A generates a contribution to sales ratio of 40%. Fixed cost directly attributable to
Product A amounted to ₹60,000. The sales revenue required to achieve a profit of ₹15,000
is:
(a) ₹ 2,00,000
(b) ₹ 1,85,000
(c) ₹1,87,500
(d) ₹ 2,10,000
(viii) M Group has two divisions, Division P and Division Q. Division P manufactures an item that
is transferred to Division Q. The item has no external market and 6,000 units produced are
transferred internally each year. The costs of each division are as follows:
Division P Division Q
Variable Cost ₹ 100 per unit ₹ 120 per unit
Fixed cost each year ₹ 1,20,000 ₹ 90,000
Head Office management decided that a transfer price should be set that provides a profit
of ₹ 30,000 to Division P. What should be the transfer price per unit?
(a) ₹ 145
(b) ₹ 125
(c) ₹ 120
(d) ₹ 135
(ix) Which one of the following is not considered as a method of Transfer Pricing?
(a) Negotiated Transfer Pricing
(b) Market Price Based Transfer Pricing
(c) Fixed Cost Based Transfer Pricing
(d) Opportunity Cost Based Transfer Pricing
(x) If standard cost ˃ actual, then it is:
(a) Not favourable
(b) Favourable
(c) Neither favourable nor not favourable
(d) None of the above.
(xi) What is the labour rate variance if standard hours for 100 units of output are 400 @ ₹ 2 per
hour and actual hours taken are 380 @ ₹ 2.25 per hour?
(a) ₹120 (A)
(b) ₹100 (A)
(c) ₹95 (A)

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(d) ₹ 25 (F)
(xii) A budgeting process which demands each manager to justify his entire budget in detail
from beginning is:
(a) Functional budget
(b) Master budget
(c) Zero base budgeting
(d) None of the above
(xiii) The following ratios have been calculated for a company:
Gross profit margin 42%
Operating profit margin 28%
Gearing (debt/equity) 40%
Asset turnover 65%
What is the return on capital employed for the company?
(a) 27·3%
(b) 18·2%
(c) 11·2%
(d) 16·8%
(xiv) Which of the following is responsibility center?
(a) Expense center
(b) Profit center
(c) Investment center
(d) All of the above.
(xv) The minimum expected opportunity loss (EOL) is
(a) Equal to EVPI
(b) Minimum regret
(c) Equal to EMV
(d) Both (A) and (B)
Answer:

(i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) (x)
(c) (c) (b) (c) (a) (b) (c) (b) (c) (b)
(xi) (xii) (xiii) (xiv) (xv)
(c) (c) (b) (d) (d)

11.26 |CMA Inter Management Accounting

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 Objectives

Jun’24

1. Multiple Choice Questions [2 × 15 = 30]

(i) Which one of the following statements is false?

(a) Management accountant uses cost accounting tools and techniques for planning and
decision making.
(b) Management accounting is mostly historical in its approach and it projects the past.
(c) Cost accounting system can be installed without management accounting.
(d) Management accounting focuses on wealth maximization.
(ii) According to DU-Pont Methodology, the parameter(s) that drive Return on Equity (ROE) is
/ are _____.
(a) Operating performance
(b) Asset usage performance
(c) Financial Leverage
(d) All of the above
(iii) Which one of the following Responsibility Centers, is an Organizational Unit whose
manager is responsible for managing revenues and current expenses?
(a) Investment Center
(b) Revenue Center
(c) Profit Center
(d) Cost of Expense Center
(iv) The Laplace Criterion is the feature of which of the following?
(a) Deterministic Model
(b) Decision making under certainty
(c) Decision making under uncertainty
(d) Optimization
(v) Bon, a division of BANT Ltd. a manufacturing company, has total assets of ₹ 12,00,000 and
an Operating Income of ₹ 3,00,000. What is the Division’s Residual Income (RI) if the cost of
capital is 15%?
(a) ₹ 1,80,000
(b) ₹ 1,50,000
(c) ₹ 1,20,000
(d) ₹ 60,000

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(vi) An employee of DOXIN Ltd. took 5 hours to complete the first unit job in the assembly line.
Using a 80% incremental unit time learning model, the time to be taken to complete the
second unit job will be _____.
(a) 4 hours
(b) 3 hours
(c) 2 hours
(d) 5 hours
(vii) In the factory of DOSN Ltd., using Standard Costing System, the details of overhead
expenditure for the month of May’24 are as under:
Standard (₹) Actual (₹)
Fixed Overheads 80,000 85,000
Variable Overheads 1,20,000 1,15,000
Output (units) 40,000 ?
If Fixed overhead volume variance is ₹ 4,000 (Adv.), identify the Actual Output (in units).
(a) 38000 units
(b) 41000 units
(c) 42000 units
(d) Insufficient information
(viii) FBT Ltd. is presently operating at 60% capacity and producing 600 units. The Cost structure
at 60% Level of Activity is: Material ₹ 50 per unit, Labour ₹ 25 per unit, Direct expenses ₹ 5
per unit, Factory overheads ₹ 20,000 (60% variable) and Administration expenses ₹ 15,000
(60% fixed). What will be the Total Cost per unit for production at 80% capacity?
(a) ₹ 1,05,000
(b) ₹ 131.25
(c) ₹ 126.25
(d) None of the above
(ix) SNG Ltd. is choosing which of three products P, Q and R to make and has calculated likely
payoffs under three possible scenarios (A1, A2 or A3), giving the following payoff table:
Profit/(Loss) Scenarios Product Chosen
P Q R
A1 40 80 20
A2 80 100 150
A3 100 (20) 70
Using maximax, identify the product which would be chosen by the company.
(a) Product P

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 Objectives

(b) Product Q
(c) Product R
(d) None of the above
(x) A _____ is defined as a budget continuously updated by adding a further accounting
period when the earlier accounting period has expired.
(a) Zero base budget
(b) Step-up budget
(c) Rolling budget
(d) Performance budget
(xi) In _____ both fixed and variable costs are considered for product costing and inventory
valuation.
(a) Marginal Costing
(b) Relevant Costing
(c) Absorption Costing
(d) Activity Based Costing
(xii) M/s Unicom Limited sold 200 units and 300 units of its product in 2023 and 2024 respective-
ly. If total overhead for 2023 and 2024 is ₹ 10,000 and ₹ 12,000 respectively, the fixed
overhead would be _____.
(a) ₹ 6,000
(b) ₹ 4,000
(c) ₹ 8,000
(d) ₹ 10,000
(xiii) If P/V Ratio is 20%, Selling price per unit is ₹ 50, Margin of safety is 2000 units and Fixed cost
is ₹ 30,000, the actual sales quantity is _____.
(a) 4000 units
(b) 6000 units
(c) 5000 units
(d) 7000 units
(xiv) A Limited produces 500 units of product in 7500 hours against standard hours of 8000. If
standard rate per hour is ₹ 50, then labour efficiency variance will be ₹ _____.
(a) 25,000 (F)
(b) 25,000 (A)
(c) 40,000 (F)
(d) 50,000 (F)

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 Objectives

(xv) Expected returns of two mutually exclusive project is 15%. The S.D. of return of Project-1
is 20% while S.D. of return of Project-2 is 10%. The Coefficient of variation of Project-1 and
Project-2 are _____.
(a) Project-1 = 0.75 and Project-2 = 0.90
(b) Project-1 = 1.33 and Project-2 = 0.66
(c) Project-1 = 1.43 and Project-2 = 0.86
(d) Project-1 = 1.39 and Project-2 = 0.56
Answer:

(i) (B)
(ii) (D)
(iii) (A)
(iv) (C)
(v) (C)
(vi) (B)
(vii) (A)
(viii) (B)
(ix) (C)
(x) (C)
(xi) (C)
(xii) (A)
(xiii) (C)
(xiv) (A)
(xv) (B)

11.30 |CMA Inter Management Accounting

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 Objectives

MTP Dec’24 Set 1

Choose the correct option: [15 x 2 = 30]
(xvi) Which of the following is not a characteristic of management accounting?
(a) Forward-looking
(b) Historical orientation
(c) Internal focus
(d) Decision - making
(xvii) The break-even point is where:
(a) Total costs equal total revenue
(b) Total revenue exceeds total costs
(c) Variable costs equal fixed costs
(d) Contribution margin is negative
(xviii) Variance analysis is used to:
(a) Identify the root causes of inefficiencies
(b) Calculate contribution margin
(c) Prepare financial statements
(d) Determine break-even point
(xix) Which of the following is not a relevant cost information in a make or buy decision in short
run (i.e., in marginal costing)?
(a) Burglary
(b) Fire
(c) Marine
(d) None of the above
(xx) If Sales - ₹ 9,00,000 ; Margin of safety = 40% ; P/V Ratio = 2/3, then what is the Break- even
Sales?
(a) ₹ 4,50,000
(b) ₹ 3,60,000
(c) ₹ 5,40,000
(d) ₹ 6,00,000
(xxi) Sale for two consecutive months, of a company are ₹3,80,000 and ₹ 4,20,000.The company‘s
net profits for these months amounted to ₹ 24,000 and ₹ 40,000 respectively. There is
no change in contribution/sales ratio or fixed costs. The contribution/sales ratio of the
company _____ is.
(a) 1/3

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 Objectives

(b) 2/5
(c) 1/4
(d) 3/8
(xxii) Standard Cost is _____ a cost.
(a) Pre-determined
(b) Actual
(c) Historical
(d) Short-term
(xxiii) Which of the following budgets should be prepared first?
(a) Production Budget
(b) Purchase Budget
(c) Master Budget
(d) Sales Budget
(xxiv) Labour Turnover _____
(a) The number of people working in the current period
(b) The number of people who left the organisation in the previous period
(c) Rate of change of labour force
(d) The rate of the change in the wages of the labour force
(xxv) The per unit expenses of the _____ portion varies with the volume of production while
portion remains the same with volume.
(a) Fixed; Variable
(b) Variable; Fixed
(c) Variable; Semi-Variable
(d) Fixed; Semi-Variable
(xxvi) Which method of costing is commonly used by companies that produce unique
products or services?
(a) Process costing
(b) Job costing
(c) Batch costing
(d) Both A and C
(xxvii) Material price variance is calculated by _____ .
(a) Standard Price × Actual Quantity - Actual Price × Actual Quantity
(b) Standard Price × Actual Quantity - Actual price × Standard Quantity

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 Objectives

(c) Actual Price × Actual Quantity - Standard price × Standard Quantity

(d) Actual price × Standard Quantity - Standard price × Standard Quantity
(xxviii) Calculate the material price variance from the following:
Actual Quantity - 2.5 kgs
Standard Price - ₹ 3 per kg
Actual Price - ₹ 5 per kg
Standard Quantity - 4.5 kgs
(a) ₹ 3(F)
(b) ₹ 5(A)
(c) ₹ 12(A)
(d) ₹ 6 (F)
(xxix) Which budgeting technique involves preparing budgets from the bottom of the
organization hierarchy to the top?
(a) Top-down budgeting
(b) Zero-based budgeting
(c) Incremental budgeting
(d) Bottom-up budgeting
(xxx) A manufacturing company budgets to produce 10,000 units during a period. It expects
to incur ₹50,000 in fixed overhead costs and ₹3 per unit in variable overhead costs. If
the actual production turns out to be 9,500 units, what is the company’s flexible budget
overhead cost?
(a) ₹74,500
(b) ₹77,000
(c) ₹79,500
(d) ₹78,500
Answer:

(i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) (x) (xi) (xii) (xiii) (xiv) (xv)
b a a b c b a d c a b a b d d

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 Objectives

Postal Test Paper

1. Multiple Choice Questions [1 × 12 = 12]

(i) Production at 60% activity is ₹ 600 units, if flexible budget needs to be calculated at 80%
activity what will be units produced?
(a) ₹ 800
(b) ₹ 600
(c) ₹1200
(d) ₹ 1000
(ii) In which of the following circumstances is there a strong argument that profit centre
accounting is a waste of time?
(a) When the transferred item is also sold on an external market.
(b) When the supplying division is based in a different country to head office.
(c) If the transferred item is a major product of the supplying division.
(d) If there is no similar product sold on an external market and the transferred item is a
major product of the supplying division.
(iii) Management accounting assists the management in _____.
(a) Planning
(b) Directing
(c) Controlling
(d) All of the above
(iv) Creation of value through effective use of resources is the focus area of the:
(a) 1st stage
(b) 2nd stage
(c) 3rd stage
(d) 4th stage
(v) In an ABC system, the allocation bases that are used for applying costs to services or
procedures are called:
(a) Cost Pool
(b) Cost Driver
(c) Cost Absorption
(d) Cost Object
(vi) Plant depreciation is an example of which activity-level group?
(a) Unit-level activity

11.34 |CMA Inter Management Accounting

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 Objectives

(b) Facility-level activity

(c) Batch-level activity
(d) Product-level activity
(vii) The main reason for the usage of Activity Based Costing, by replacing the traditional costing
system is that:
(a) The overhead recovery rates used in traditional costing systems are inappropriate for
decision-making.
(b) The companies deal with more number of products at present
(c) No scope for cause and effect relationship in traditional costing
(d) The new manufacturing technology needs information for feedback of performance
even the productis in progress.
(viii) Activity-based costing:
(a) Uses a plant-wide overhead rate to assign overhead
(b) Is not expensive to implement
(c) Typically applies overhead costs using direct labor-hours
(d) Uses multiple activity rates
(ix) Which of the following is least likely to be classified as a batch level activity in an activity
based costing system?
(a) Quality assurance
(b) Receiving and inspection
(c) Property taxes
(d) Production set-up
(x) Margin of safety is referred to as
(a) Excess of budgeted or actual sales over the variable expenses and fixed expense, at
break-even.
(b) Excess of budgeted or actual sales revenue over the fixed expenses.
(c) Excess of actual sales over budgeted sales.
(d) Excess of sales revenue over the variable expenses.
(xi) A decrease in sales price
(a) does not affect the break-even point
(b) lowers the fixed cost
(c) Increases the break-even point
(d) lowers the break-even point

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 Objectives

(xii) What will be sales in units if fixed cost is ₹50,000 Contribution per unit is ₹60 and desired
profit per unitis ₹10.
(a) ₹ 6,000
(b) ₹ 1,000
(c) ₹ 1,000
(d) ₹ 6,000

2. State True or False: [1 × 7 = 7]

(i) The purpose of moving from a traditional costing system to an ABC system must therefore
be based on the premise that the new information provided will lead to action that will
increase the overall profitability of the business.
(ii) Activity based costing is not expensive to implement.
(iii) The kind of cost which will not differ due to the volume of the production is called Fixed
cost.
(iv) Another term for marginal costing is variable costing.
(v) Fixation of selling price in the long run can be done without considering fixed costs.
(vi) Key factor is important in ascertaining the profitability.
(vii) Marginal-costing technique is also used in planning the profit level of the business.

3. Fill in the blanks: [1 × 6 = 6]

(i) A _____ is a norm against which the actual performance can be measured.
(ii) _____ allow for rest periods, machine breakdowns, and setup time.
(iii) Transfer prices based on full cost are appropriate if top management treats the divisions
like _____.
(iv) According to the principles that guide the preparation of the _____ a series of fixed budgets
are drawn for different levels of activity.
(v) _____ has been defined as a “budget based on functions, activities and projects.”
(vi) Return on investment encourages investment in projects that would otherwise be rejected
under _____.
Answers :

a) i ii iii iv v vi vii viii ix x xi xii

a d d d b b b d c c c c

b) i ii iii iv v vi vii
True False True True False True True

11.36 |CMA Inter Management Accounting

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 Objectives

c) i ii iii iv v vi
Standard Normal Cost Centers Flexible Performance Residual
Standards Budget Budget Income

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 Objectives

NOTES

11.38 |CMA Inter Management Accounting

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