MBPC1005

COST AND MANAGEMENT ACCOUNTING (3-0-0)

 SYLLABUS
Module-I.
Introduction to Cost Accounting and Management Accounting: Basic concepts: Scopes. Types of
Cost, Financial Accounting, Cost Accounting and Management Accounting., Methods of
Costing, Techniques of Costing, Classification of Costs, Cost Centre, Cost Unit, Profit Centre,
Investment Centre, Preparation of Cost Sheet, Total Costs and Unit Costs.

Module-II.
Cost Accounting System: Material Cost Management: Material Cost Valuing material issues
and stock,
Overheads: Meaning and Importance, production overhead, Primary distribution and Secondary
distribution, allocation and apportionment of cost. Absorption by production units, Methods,
over and under absorption of overhead.

Module-III.
Methods and Techniques: Job Costing, Contract costing and Process Costing, Joint Product and
By Products. Service Costing: Transport, Hospital, Canteen, Marginal Costing: Nature and
Scope, Marginal Cost Equation, Profit Volume Ratio, Break-even Chart, Application of
Marginal Costing Techniques for managerial decision making: Make or Buy decision,
selection of Suitable product Mix.

Management Tools: Budgetary Control: Functional budgets, Cost budget, Master Budget,
Cost Accounting
 Cost

Cost is the amount of resource given up in exchange for some goods or

services. The resources given up are money or money’s equivalent
expressed in monetary units.

The Chartered Institute of Management Accountants, London

defines cost as “the amount of expenditure (actual or notional)
incurred on, or attributable to a specified thing or activity”.

For a consumer cost means price. For management cost means

'expenditure incurred' for producing a particular product or rendering a
particular service. The process of ascertaining the cost is known as
costing. It consists of principles and rules governing the procedure of
finding out the costs of goods/ services. It aims at ascertaining the total
cost and also per unit cost.
 Costing

Costing is the techniques and processes of ascertaining costs. These

techniques consist of principles and rules which govern the procedure of
ascertaining cost of products or services. The techniques to be followed
for the analysis of expenses and the processes of different products or
services differ from industry to industry. The main object of costing is the
analysis of financial records, so as to subdivide expenditure and to
allocate it carefully to selected cost centers, and hence to build up a total
cost for the departments, processes or jobs or contracts of the
undertaking.
 Cost Accounting

Cost Accounting may be regarded as “a specialised branch of accounting

which involves classification, accumulation, assignment and control of
costs”.

The Costing terminology of C.I.M.A. London defines cost accounting as

“The establishment of budgets, standard costs and actual costs of
operations, processes, activities or products, and the analysis of variances,
profitability or the social use of funds”.
 Cost Accountancy

Cost Accountancy has been defined as “the application of costing and

cost accounting principles, methods and techniques to the science, art and
practice of cost control and the ascertainment of profitability. It includes
the presentation of information derived there from for the purpose of
managerial decision making”.
 Objective of Cost Accounting
(1) To analyse and classify all expenditures with reference to the cost of products
and operations.
(2) To arrive at the cost of production of every unit, job, operation, process,
department or service and to develop cost standard.
(3) To indicate to the management any inefficiencies and the extent of various
forms of waste, whether of materials, time, expenses or in the use of machinery,
equipment and tools. Analysis of the causes of unsatisfactory results may
indicate remedial measures.
(4) To provide data for periodical profit and loss accounts and balance sheets at
such intervals, e.g., weekly, monthly or quarterly, as may be desired by the
management during the financial year, not only for the whole business but also
by departments or individual products. Also, to explain in detail the exact
reasons for profit or loss revealed in total, in the profit and loss account.
(5) To reveal sources of economies in production having regard to methods,
types of equipment, design, output and layout. Daily, weekly, monthly or
quarterly information may be necessary to ensure prompt and constructive
action.
 Cont….

(6) To provide actual figures of cost for comparison with estimates and to
serve as a guide for future estimates or quotations and to assist the
management in their price-fixing policy.
(7) To show, where standard costs are prepared, what the cost of
production ought to be and with which the actual costs which are
eventually recorded may be compared.
(8) To present comparative cost data for different periods and various
volumes of output.
(9) To provide a perpetual inventory of stores and other materials so that
interim profit and loss account and balance sheet can be prepared
without stock taking and checks on stores and adjustments are made at
frequent intervals. Also to provide the basis for production planning and
for avoiding unnecessary wastages or losses of materials and stores.
(10) To provide information to enable management to make short-term
decisions of various types, such as quotation of price to special
customers or during a slump, make or buy decision, assigning priorities to
various products, etc.
 Scope of Cost Accounting
• Cost determination: It centers around gathering material, worker,
and overhead costs for calculating per unit and overall cost of the product. It
uses historical estimates or standard data for calculations. Various costing
methods like direct costing prove beneficial for its calculation.
• Cost audit: It conducts verification of cost sheets to ensure efficient
implementation of cost accounting principles in industries.
• Cost report: The data extracted from cost accounting helps prepare cost
reports. It aids strategic decision-making for the management.
• Cost control: It helps balance actual cost and the standard cost of a product.
• Cost system: It evaluates and monitors costs incurred in manufacturing goods
and services. Consequently, cost reports are prepared with its help.
• Cost computation: Cost accounting derives the actual per unit cost of a
commodity or product in bulk.
• Budgetary control: It helps in setting up budgetary control by management.
Management may forecast the expected expenses for different activities or
departments and then compare the actual spending. Hence, the budget helps
to identify sectors to control costs.
 Importance of Cost Accounting
Cost accounting is crucial for several reasons:
•Cost Control: It helps identify areas where costs can be reduced without
affecting the quality of the product or service
•Pricing Decisions: Understanding production costs allows businesses to
set competitive and profitable prices
•Profitability Analysis: It enables businesses to determine the
profitability of different products, services, or departments
•Budgeting: Cost accounting provides a basis for budgeting and financial
planning
•Performance Evaluation: It helps evaluate the efficiency and
effectiveness of operations and management
 Types of Cost Accounting
1. Standard Cost Accounting
Standard cost accounting involves comparing the actual costs incurred
during production to the standard costs predetermined by the company.
This method highlights discrepancies and allows for corrective actions to
improve cost efficiency.
2. Activity-Based Costing (ABC)
Activity-based costing assigns costs to products and services based on the
activities required for their production. This method provides a more
accurate representation of the actual costs by considering the various
activities involved in the production process.
3. Marginal Costing
Marginal costing, also known as variable costing, focuses on the costs that
vary with the level of production. It reveals the amount each unit
contributes towards covering fixed costs and generating profit. This
 Cont….

4. Absorption Costing
Absorption costing, or full costing, involves allocating all manufacturing costs to
the product, including fixed and variable costs. This method ensures that all
costs are accounted for in the product cost, providing a comprehensive view of
production expenses.
5. Job Costing
Job costing is a costing system that assigns costs to individual products or
batches. It is commonly used in industries where production is customized,
such as construction, printing, and specialized manufacturing.
6. Process Costing
Process costing is used in industries where production is continuous, and
products are indistinguishable from each other, such as in chemical, oil, and
food processing industries. It involves averaging costs over a large number of
identical units.
 Functions of Cost Accounting
1.Cost Allocation
One of the primary functions of cost accounting is to allocate costs to different
products, services, or departments. This allocation helps in understanding the cost
structure and identifying areas for cost control and reduction.
2.Cost Control
Cost accounting helps in controlling costs by monitoring expenses and comparing them
to standards or budgets. Variances are analyzed to identify areas of inefficiency and
take corrective actions.
3.Cost Reduction
Cost accounting seeks to minimize expenses while preserving or enhancing the quality
of products or services. It involves analyzing cost data to identify areas where expenses
can be minimized through improved processes, better resource utilization, and waste
reduction.
4.Budgeting and Forecasting
Cost accounting provides historical cost data and trends, which are essential for
budgeting and forecasting. This information helps in setting realistic budgets and
predicting future costs and revenues.
5.Pricing Decisions
To set prices that both attract customers and generate profits, accurate cost data is
 Cont….

6.Profitability Analysis
Understanding the cost structure allows businesses to analyze the profitability of
different products, services, or departments. This analysis helps in making informed
decisions about resource allocation and product mix.
7.Performance Evaluation
Cost accounting helps evaluate the performance of various departments, processes,
and personnel by comparing actual costs to standards and budgets. This evaluation
is crucial for identifying areas of improvement and rewarding efficient performance.
8.Inventory Valuation
Cost accounting provides an accurate valuation of inventory by determining the
cost of goods sold and the cost of goods remaining in stock. This data is important
for tax compliance.
9.Financial Reporting
Cost accounting provides detailed cost information that is essential for financial
reporting. This information helps in preparing financial statements and ensuring
compliance with accounting standards and regulations.
10.Decision-Making
Cost accounting provides valuable insights into the cost structure, helping
managers make informed decisions about pricing, production levels, product mix,
 Advantages of Cost Accounting

•Improved Decision Making: Provides detailed cost information to

support strategic decisions such as pricing, product mix, outsourcing, and
process improvement
•Enhanced Cost Control: Identifies cost overruns, inefficiencies, and
areas for cost reduction
•Accurate Product Costing: Determines the true cost of producing
goods or services, aiding in profit margin analysis and pricing strategies
•Performance Evaluation: Measures the efficiency of different
departments and processes
•Inventory Valuation: Helps in accurate valuation of inventory for
financial reporting
•Legal and Tax Compliance: Supports compliance with tax regulations
and financial reporting requirements
 Disdvantages of Cost Accounting

•Costly and Time-Consuming: Implementing and maintaining a cost

accounting system can be expensive and requires significant resources
•Subjectivity in Cost Allocation: Allocating overhead costs to products
or services can be subjective and involve estimates
•Focus on Historical Data: Cost accounting primarily relies on past
data, which may not accurately predict future costs
•Complexity: Understanding and using cost accounting information can
be complex, requiring specialized knowledge and skills
•Limited Scope: Cost accounting primarily focuses on production costs
and may not provide a comprehensive view of overall business
performance
 Classification Of Costs
The different bases of cost classification are:
(1) By time (Historical, Pre-determined).
(2) By nature or elements (Material, Labour and Overhead).
(3) By degree of traceability to the product (Direct, Indirect).
(4) Association with the product (Product, Period).
(5) By Changes in activity or volume (Fixed, Variable, Semi-variable).
(6) By function (Manufacturing, Administrative, Selling, Research and
development, Pre-production).
(7) Relationship with accounting period (Capital, Revenue).
(8) Controllability (Controllable, Non-controllable).
(9) Cost for analytical and decision-making purposes (Opportunity,
Sunk, Differential, Joint, Common, Imputed, Out-of-pocket, Marginal,
Uniform, Replacement).
(10) Others (Conversion, Traceable, Normal, Avoidable, Unavoidable,
Total).
 Cost Center
According to the Chartered Institute of Management Accountants, London, cost
centre means, “a production or service location, function, activity or item of
equipment whose costs may be attributed to cost units”. Cost centre is the
smallest organisational sub-unit for which separate cost collection is attempted.
Thus cost centre refers to one of the convenient unit into which the whole
factory organisation has been appropriately divided for costing purposes. Each
such unit consists of a department or a sub-department or item of equipment or,
machinery or a person or a group of persons. For example, although an assembly
department may be supervised by one foreman, it may contain several assembly
lines. Sometimes each assembly line is regarded as a separate cost centre with
its own assistant foreman. Take another example, in a laundry, activities such as
collecting, sorting, marketing and washing of clothes are performed. Each
activity may be considered as a separate cost centre and all costs relating to a
particular cost centre may be found out separately.
Types of Cost centres

Cost centres may be classified as follows :

(i) Productive, Unproductive and Mixed Cost Centres: Productive cost centres are
those which are actually engaged in making the products - the raw materials are handled
here and converted into saleable products. In such centres both direct and indirect costs
are incurred, machine shops, welding shops, and assembly shops are examples of
production cost centres in an engineering factory. Service or unproductive cost centres do
not make the products but are essential aids to the productive centres. Examples of such
service centres are those of administration, repairs and maintenance, stores and drawing
office departments. Mixed cost centres are those which are engaged some on productive
and other lines on service works. For instance, a tool shop serves as a productive cost
centre when it manufactures dies and jigs for specific order, but serves as servicing cost
centre when it does repairs for the factory.
(ii) Personal and Impersonal Cost Centre: A personal cost centre consists of a person
or a group of persons. An impersonal cost centre is one which consists of a department,
plant or item of equipment (or group of these).
(iii) Operation and Process Cost Centre: In case a cost centre consists of those
machines and/or persons which carry out the same operation is termed as operation cost
centre. If a cost centre consists of a continuous sequence of operations it is called process
cost centre. The determination of a suitable cost centre is very important for ascertainment
and control of cost. The manager in charge of a cost centre is held responsible for control of
 Cost Unit
The Chartered Institute of Management Accountants, London, defines a unit of cost as “a
unit of product or service in relation to which costs are ascertained”. A cost unit is a
devise for the purpose of breaking up or separating costs into smaller sub-divisions. These
smaller sub-divisions are attributed to products or services to determine product cost or
service cost or cost of time spent for a particular job etc. We may for instance determine
the cost per ton of steel, per tonne kilometre of a transport service or cost per machine
hour. The forms of measurement used as cost units are usually the units of physical
measurements like number, weight, area, length, value, time etc. Unit selected should be
unambiguous, simple and commonly used. Following are some examples of cost unit:
Industry/Product Cost unit
Automobile Number
Brick works 1000 bricks
Cement Tonne
Transport Tonne - Kilometre
Passenger - Kilometre
Chemicals Litre, gallon, kilogramme,
tonne
Steel Tonne
Sugar Tonne
 Cost Sheet
A cost sheet is a financial document that provides the details of costs that the business has
incurred in producing a particular product during a specific period. Cost Sheet is designed to
provide a detailed breakdown of the various costs incurred during the production process. It
shows various elements of cost, like prime cost, factory cost, cost of production, and total
cost. Cost Sheet is a periodic statement which is prepared at regular intervals, e.g., weekly,
monthly, yearly, etc. The preparation of a cost sheet at regular intervals helps the
management to track and manage all expenses related to the production of a particular
product effectively.
 Importance of Cost Sheet?
1. Reveals the Total Cost and Cost Per Unit: The cost Sheet provides data related to the cost incurred in the production of a
particular product. This cost data provides both the total cost and per unit cost of the product.
2. Provides Information: The cost Sheet shows the cost incurred in the production of a product at every production level.
This includes the cost of raw materials used, wages paid to laborers, cost incurred in administrative works, and cost of selling
and distribution.
3. Determination of Selling Price: The cost sheet helps in fixing the selling price of the product. With in-depth information on
the cost incurred on production, management can decide the selling price for its product through which it not only covers all
its expenses but also earns an optimum profit.
4. Decision Making: Cost Sheet helps the firm in decision-making. The cost data provided by the cost sheet helps in making a
wide range of decisions, such as decisions related to the purchase of raw materials and equipment, fixing of selling prices,
choosing the best inventory methods for cost-saving, etc.
5. Tracking of Expenses: The cost Sheet helps in tracking the expenses incurred in production. The cost Sheet provides in-
depth cost data from every production level, so management can easily keep tabs on all the expenses. This enables the
company to pinpoint the areas where corrective measures can be taken to improve efficiency.
6. Preparation of Tenders: The cost sheet helps in the preparation of tenders. An estimated cost sheet is used to quote prices
to the management. Cost data from previous cost sheets is used to prepare tenders and quotations and estimate price
changes.
 Types of Cost Sheet?

1. Historical Cost Sheet: The Historical Cost Sheet, which is prepared on a historical cost
basis, uses the actual cost incurred in production. The Historical Cost Sheet helps us obtain
an accurate picture of the actual cost incurred during the production of a product.
2. Estimated Cost Sheet: The Estimated Cost Sheet is based on the estimated cost and is
prepared just before production. The management uses an estimated cost sheet to quote
the prices of the products in advance or while submitting tenders for goods to be supplied.
The estimated cost sheet predetermines the cost of direct materials, direct labor, and other
overheads based on past costs, present market conditions, and anticipated changes in
future price levels.
 How to Prepare a Cost Sheet?
Following are the steps followed while preparing a cost sheet are:
Step 1: The first step is to find the prime cost. Calculation of prime cost includes adding all the
direct costs, like direct materials, direct labor, and direct materials.
Step 2: After finding the prime cost, the next step is to find the factory cost. Factory Cost is the
sum of prime cost and factory overheads. Additionally, we include the opening stock of work-
in-progress and subtract the closing stock of work-in-progress.
Step 3: The third step is to calculate the cost of goods sold. COGS is the sum of factory cost,
office and administrative overheads, and opening stock of finished goods and we deduct the
closing stock of finished goods.
Step 4: In this step, the total cost is calculated by adding selling and distribution overheads to
the cost of goods sold to find the total cost.
Step 5: The last step is to find Total Sales. Sales is the sum of total cost and profit. In case of
loss, the amount is subtracted from the total cost.
 Method of Preparation of Cost Sheet

Prime Cost = Direct Material Consumed + Direct Labour +

Direct Expenses
Step I
Direct Material= Material Purchased + Opening stock of raw
material-Closing stock of raw material.

Works Cost = Prime Cost + Factory Overheads (Indirect

Step II Material + Indirect Labour + Indirect Expenses)+opening
Work in progress-Closing Work in progress
Cost of Production = Works Cost + Office and
Step III Administration overheads + Opening finished goods-Closing
finished goods
Total Cost = Cost of Production + Selling and Distribution
Step IV
Overheads
Step V Profit =Sales – Total Cost
Proforma of A Cost Sheet
Cont….
PRACTICAL PROBLEMS
The following information is given to you from which you are required to prepare Cost Sheet for the
period ended on 31st march 2024:
 Module-II.
Cost Accounting System: Material Cost Management: Material Cost Valuing
material issues and stock,
Overheads: Meaning and Importance, production overhead, Primary distribution
and Secondary distribution,
allocation and apportionment of cost. Absorption by production units, Methods,
over and under absorption of
overhead
Meaning of the Word ‘Material’

Material refers to all commodities that are consumed in the process of

manufacture. Material can be defined “anything that can be stored,
stacked or stockpiled” It continues an important part of the cost of
production of commodity. They account for nearly 60% of the cost of
production of large number of organizations.
Types of Materials

1. Direct Materials:
Direct materials are raw materials that can be directly traced to the production of a specific
product. They are integral to the finished product and their costs are directly assigned to
that product. Examples include:
•Wood used in furniture manufacturing.
•Steel used in automobile production.
•Fabric used in clothing manufacturing.
The cost of direct materials is a significant component of the prime cost, which includes all
costs directly associated with the production of goods. accountingformanagement.org

Indirect materials are materials used in the production process that cannot be directly
traced to a specific product. They support the production process but do not become a part
of the finished product. Examples include:
•Lubricants for machinery.
•Cleaning supplies used in the factory.
•Glue used in small quantities during assembly.
Objectives of Material Control

(a) All types of raw materials should be available through out. This ensures uninterrupted
production schedule.
(b) There should be no under-stocking, which generally hampers the production process.
(c) There should be no over-stocking, which makes the capital dearer.
(d) The purchaser is able make a valuable contribution to reduction in cost by purchasing
raw materials at the most favourable prices.
(e) Purchase of material should be of the right quality consistent with the standards
prescribed in respect of the finished goods.
(f) Proper storage conditions should be provided to different types of raw material in order
to minimize the loss of material.
(g) There should be a system to give complete and up to date accounting information
about the availability of material.
MATERIALS COSTING METHODS

• First-In-First-Out (FIFO) Costing Methods

• Average Costing Methods
• Last-In-First-Out (LIFO) Costing Method
First-In-Out (FIFO)
This methods assumes that the goods purchased first or manufactured first
are issued/sold first. That is the goods issued or sold currently are those
which represent the earliest purchases amongst the goods held in inventory.
This would mean that the goods which remain in stock after the sales, are
those which represent the most recent purchases.

Last-In First-Out (LIFO)

This methods is just the opposite if FIFO methods. This method assumes
that the goods issued or sold out of the inventory are the ones most recently
purchased manufactured. Therefore the goods held in stock represent the
earlier purchases productions.

Weighted Average Method (WAM)

This method assumes that all inventory available are best represented by a
weighted average cost. The average cost of goods held in inventory is
recalculated every time a fresh purchase is made and goods issued or sold
out of inventory are priced at such average price till such time as the next
Format

Received Issue Balance

Doc.
Date Ref.
No
Qty Rate Amt Qty Rate Amt Qty Rate Amt
Q.1. XYZ Corporation sells a product, Widget A. During the month of March, the company made the following
purchases and sales:

Purchases:

Date Units Purchased Unit Cost

March 1 150 units $10
March 10 150 units $12
March 20 200 units $14

Sales:
Date Units Sold
March 5 120 units
March 15 180 units
March 25 150 units

Required:
1.FIFO Method:
2.LIFO Method:
Q2.
LMN Enterprises sells a product, Product B. During the month of April, the company made the
following purchases and sales:
Purchases: Date Units Purchased Unit Cost
April 1 200 units $15
April 2 200 unit $ 18
April 10 300 units $17
April 14 100 unit $ 19
April 20 400 units $20
Sales:
Date Units Sold
April 5 250 units
April 15 300 units
April 25 150 units
Required:
1.FIFO Method:
1. Calculate the Cost of Goods Sold (COGS)
for April.
2. Determine the Ending Inventory as of April
30.
2.LIFO Method:
Simple Average Method

Slove it on simple average Method

Weighted Average Method

Slove it on weighted average Method

 Stock Level

Maximum Level=
Re order Level + Reorder Quantity – (Minimum Consumption x Minimum
Reorder Period)

Minimum Level=
Re order Level - (Normal Consumption x Normal Reorder Period)

Re order Level = Maximum Consumption x Maximum Reorder Period or

Maximum lead time

Danger Level=
Normal Consumption OR Average consumption x Maximum Reorder Period
under emergency condition

Average stock Level = ½( Maximum Level + Minimum Level )

Or = Minimum Level+ ½( Reorder quantity )
 Reorder Quantity / Economic Order Quantity (EOQ)

Economic Order Quantity, also known as EOQ, is a widely used inventory management technique
that helps organizations determine the optimal level of order quantity for a particular item, which
minimizes the total inventory costs. The primary goal of EOQ is to provide a balance between the
costs associated with ordering and holding inventory efficiently. EOQ is useful for businesses in
order to reduce costs and keep adequate stock levels in order to meet customer demand while
minimizing all the related costs associated with holding excess inventory. EOQ is a valuable tool for
optimizing inventory management, but it is based on simplifying assumptions that may only hold
in some situations.
Q.1 In a manufacturing company, a material is used as follows:
- Maximum consumption: 12,000 units per week
- Minimum consumption: 4,000 units per week
- Normal consumption: 8,000 units per week
- Reorder quantity: 48,000 units

Time required for delivery—Minimum: 4 weeks; Maximum: 6 weeks.

Calculate:
(a) Reorder level
(b) Minimum level
(c) Maximum level
(d) Danger level
(e) Average stock level
Q2. In manufacturing its products, a company uses three raw materials A, B, and C, in
respect of which the following apply:

Usage
per unit Reorder Delivery
Raw Price per Order Minimum
of quantity period
materials kg (₹) level level
product (kg) (weeks)
(kg)
A 10 10,000 0.10 1 to 3 8,000 —
B 4 5,000 0.30 3 to 5 4,750 —
C 6 10,000 0.15 2 to 4 — 2,000
Weekly production varies from 175 to 225 units, averaging 200. What would you expect the
quantities of the following to be:
(a) Minimum stock of A
(b)Maximum stock level of B
(c) Reorder level of C
(d)Average stock level of A
Q3. About 50 items are required every day for a machine. A fixed cost of ₹50 per order is
incurred for placing an order. The inventory carrying cost per item amounts to ₹0.02 per day.
The lead period is 32 days.

Compute:
1. Economic Order Quantity
2. Reorder Level
Q4. Medical Aids Co. manufactures a special product A. The following particulars were collected for
the year 2010:
(a) Monthly demand of A: 1,000 units
(b) Cost of placing an order: ₹100
(c) Annual carrying cost per unit: ₹15
(d) Normal usage: 50 units per week
(e) Minimum usage: 25 units per week
(f) Maximum usage: 75 units per week
(g) Reorder period: 4 to 6 weeks

Compute from the above:

1. Reorder Quantity
2. Reorder Level
3. Minimum Level
4. Maximum Level
5. Average Stock Level
Overheads
Overheads: Meaning

Overhead cost refers to continuing company costs that are not directly
related to the creation of a product or service. It is vital not just for
budgeting but also for deciding how much a firm should charge for its
products or services in order to earn a profit. Overhead cost is any
expenditure required to sustain the business that is not directly tied to a
certain product or service. Overhead costs appear on a company's income
statement and have a direct impact on its overall profitability. To calculate
net income, the corporation must take into account overhead
expenditures.
Overheads
Overheads: Importance

1.Cost Control and Efficiency – Helps monitor and reduce unnecessary expenses.
2.Accurate Pricing Decisions – Ensures proper product pricing and profit margins.
3.Profitability Analysis – Helps in evaluating the actual profitability of the business.
4.Budgeting and Forecasting – Aids in financial planning and future cost estimation.
5.Financial Reporting and Decision Making – Ensures accurate financial statements and
better management decisions.
6.Resource Allocation – Helps in the optimal distribution of resources across departments.
7.Performance Evaluation – Assists in assessing departmental efficiency and identifying
cost-saving opportunities.
Overheads Distribution
 Steps in Overheads Distribution:

Unlike direct materials and direct wages, overheads cannot be charged to cost units
directly. The various steps taken for the distribution of overhead costs are as follows:
1.Classification and collection of overheads
2.Allocation and apportionment of overheads to production departments and service
departments
3.Re-apportionment of service department costs to production departments
4.Absorption of overheads of each production department in cost units
These steps are explained in detail in the following sections.
Collection of Overheads:

The procedure of classification of production overheads and of assigning standing order (code)
numbers has already been discussed. Such classification and codification is a prerequisite for the
collection of overheads.
Production overheads should be collected under standing order numbers. The main sources from
which overhead costs are collected are as follows:
(a) Invoice—for collection of indirect expenses, like rent, insurance, etc.
(b) Stores Requisitions—for collection of indirect materials.
(c) Wages Analysis Sheet—for collection of indirect wages.
(d) Journal entries—for collection of those overhead items which do not result in current cash
outlay and need some adjustment, e.g., depreciation, charge in lieu of rent, outstanding rent, etc
Allocation And Apportionment Of Overheads
Cost Allocation
Allocation is the process of identification of overheads with cost centers. An expense which
is directly identifiable with a specific cost centre is allocated to that centre. Thus it is
allotment of a whole item of cost to a cost centre or cost unit.
According To Chartered Institute Of Management Accountants, London: “Cost
Allocation is the charging of discrete, identifiable items of cost to cost centers or cost units”.
EXAMPLE: The total overtime wages of workers of a department should be charged to that
department. The electricity charges of a department if separate meters are there should be
charged to that particular department only.

Cost Apportionment
Cost apportionment is the allotment of proportions of cost to cost centers or cost units.
If a cost is incurred for two or more divisions or departments then it is to be
apportioned to the different departments on the basis of benefit received by them.
Apportionment is done in case of those overhead items which cannot be wholly
allocated to a particular department. Common items of overheads are rent and rates,
depreciation, repairs and maintenance, lighting, works manager’s salary etc.
 Difference between Allocation And Apportionment Of Overheads

BASIS OF
ALLOCATION OF OVERHEADS APPORTIONMENT OF OVERHEADS
DIFFERENCE
Allocation is the process of Apportionment is done in case of those
MEANING identification of overheads with cost overhead items which cannot be wholly
centers. allocated to a particular department.
Assignment of particular cost to a These costs are common to various
NATURE OF COSTS particular department or cost center departments and cannot be charged to
is called as allocation. a particular department or cost center.
PROPORTIONS OF Allocation deals with whole items of Apportionment deals with proportions
COSTS costs. of items of costs.
BASIS FOR No base is required for allocation of An equitable base is required for
APPORTIONMENT cost to a department, it is a direct Apportionment of cost to the
OR ALLOCATION process. production or services department.
When the overhead costs are related When the overhead costs are related to
APPLIES
to specific or single departments. different departments.
Wages paid to the head of the factory,
Salary paid to the employees of the rent of factory, electricity, etc. cannot
EXAMPLES maintenance department, can be be charged to a particular department,
allocated to that department. and then these can be apportioned
amongst various departments.
 Overhead Costing: Primary and Secondary

Primary Distribution

Primary distribution involves apportionment or allocation of overhead to all departments in a factory

on logical and rational basis. This process of apportionment is also known as departmentalization of
overhead. It is to be carefully noted that at the time of making primary distribution, the distinction
between production and service departments is ignored.

Following points should be considered for primary distribution of items of overheads:

(i) Basis for distribution should be equitable and practicable;
(ii) Method adopted for distribution should not be time-consuming;
(iii) Overhead expenses should be distributed among different departments on the basis of benefits
received by departments;
Secondary Distribution:
In a factory a product does not pass through Service department (S), but service department
renders service to production departments for carrying on production function. It is, therefore,
logical that the product cost should bear the equitable share of cost of service department. Under
this backdrop, the second step is to distribute the total cost of service departments among the
production departments.
The process of redistributing the cost of service departments among production departments is
known as secondary distribution. Here, the cost of service department means the apportioned
overheads plus direct materials plus direct labour and direct expenses of concerned service
department.
Allocation And Apportionment Of Overheads: cont..

Production Service Departments

Departments •Purchasing department
•Weaving department •Stores department
•Spinning department •Time-keeping department
•Crushing department •Personnel department
•Mixing department •Inspection department
•Grinding department •Canteen
•Annealing department •Labour welfare department
•Polishing department •Internal transport
•Finishing department department
•Melting shop •Accounting department
Apportionment Of Service Department Costs,

Service department Bases of apportionment

Store-keeping department Number of material requisitions, or value/quantity of materials
consumed in each department

Purchase department Value of materials purchased for each department, or number of

purchase orders placed

Time-keeping department and Number of employees, or total labour or machine hours

payroll department
Personnel department Rate of labour turnover, or number of employees in each
department
Canteen, welfare, and recreation Number of employees, or total wages
services
Maintenance department Number of hours worked in each department

Internal transport service Value or weight of goods transported, or distance covered

Inspection department Direct labour hours or machine operating hours

Drawing office Number of drawings made or man hours worked

COMMON BASES OF APPORTIONMENT OF OVERHEADS:
Overhead Cost Bases of Apportionment
1. (i) Rent and other building expenses Floor area, or volume of department
(ii) Lighting and heating
(iii) Fire precaution service
(iv) Air-conditioning
2. (i) Fringe benefits Number of workers
(ii) Labour welfare expenses
(iii) Time keeping
(iv) Personnel office
(v) Supervision
3. (i) Compensation to workers Direct wages
(ii) Holiday pay
(iii) ESI and PF contribution
(iv) Fringe benefits
Direct labour hours, or Direct wages, or
4. General overheads
Machine hours
5. (i) Depreciation of plant and machinery Capital values
(ii) Repairs and maintenance of plant and
machinery
(iii) Insurance of stock
6. (i) Power/steam consumption Technical estimates
(ii) Internal transport
(iii) Managerial salaries
Overhead Cost Bases of Apportionment

7. Lighting expenses No. of light points, or Area

Horse power of machines, or Number of
8. Electric power
machine hours, or Value of machines
Weight of materials, or Volume of materials,
9. (i) Material handling , (ii) Stores
overheads
or Value of materials | Quantity and value of
material received and issued
Q1. Mosich Co. Ltd, has three production departments A, B and C and two service departments D and E. The
following figures are extracted from the records of the company:

₹ ₹
Rent and rates 5,000 General lighting 600
Indirect wages 1,500 Power 1,500
Depreciation of machinery 10,000 Sundry expenses 10,000

The following further details are available:

Total A B C D E
Floor space (Sq. ft) 20,000 4,000 5,000 6,000 4,000 1,000
Light points 120 20 30 40 20 10
Direct wages (₹) 10,000 3,000 2,000 3,000 1,500 500

H.P. of machines 150 60 30 50 10 —

1,00,00
Value of machinery (₹) 2,50,000 60,000 80,000 5,000 5,000
0

Apportion the costs to various departments on the most equitable basis and prepare Overhead Distribution Summary.
Q2
The following data were obtained from the books of S N Engineering Company for the half-year ended 30 September
2024. Prepare a Departmental Distribution Summary.

Service
Production Departments
Departments
A B C X Y
Direct wages (RS) ₹ 7,000 ₹ 6,000 ₹ 5,000 ₹ 1,000 ₹ 1,000
Direct materials(RS) ₹ 3,000 ₹ 2,500 ₹ 2,000 ₹ 1,500 ₹ 1,000
Employees (NO) 400 300 300 100 100
Electricity(KWH) 8,000 kWh 6,000 kWh 6,000 kWh 2,000 kWh 3,000 kWh
Light points(NO) 10 15 15 5 5
Assets values (RS) ₹ 50,000 ₹ 30,000 ₹ 20,000 ₹ 10,000 ₹ 10,000
Area
800 sq. yds 600 sq. yds 600 sq. yds -200 sq. yds 200 sq. yds
occupied(Sq.Yard)
The overheads for 6 months were as under:
Stores overheads ₹400 , Motive power ₹1500, Electric lighting ₹200, Labour welfare ₹ 3000,
Depreciation ₹6000, Repairs and maintenance ₹1200, General overheads ₹10,000,
Rent and taxes ₹ 600
Apportion the expenses of Department X in the ratio of 4:3:3 and that of department Y in
proportion to direct wages, to departments A, B, and C, respectively.
Absorption of overhead
Absorption Of Overheads

Once departmentalization of overheads has been completed, the total cost of each
production department comprises the following:
(i) Costs allocated and apportioned to production departments
(ii) Costs of service departments re-apportioned to production departments.

The total overhead cost pertaining to a production department or cost centre is then
charged to or absorbed in the cost of the products or cost units passing through that
centre. This is known as absorption of overheads.

The absorption of overheads is the last step in the distribution plan of overheads. It is
defined as charging of overheads to cost units. In other words, overhead absorption is the
apportionment of overheads of cost centres over cost units. Absorption of overheads is
also known as levy, recovery, or application of overheads.

There are two steps in the absorption of overheads:

1.Computation of overheads absorption rate, and
2.Application of these rates to cost units.
Computation of overheads absorption rate,

Overhead Absorption Rate = Total Overhead Of Cost Center / Total

Unit In Base

Application of these rates to cost units.

Overhead Absorbed =No of Unit of Base in the Cost Unit X Overhead
Rate
Methods of Absorption Of Production Overheads

•Direct Materials Cost Percentage Rate

•Direct Labour Cost Percentage Rate
•Prime Cost Percentage Rate
•Direct Labour Hour Rate
•Machine Hour Rate
•Rate per Unit of Output
1.Direct Materials Cost Percentage Rate
Under this method, the amount of overheads to be absorbed by a cost unit
is determined by the cost of direct materials consumed in producing it.
This rate is computed by dividing the total overheads by the total cost of
direct materials consumed in the department.
Thus,
Overhead Rate = (Production overheads / Direct materials) x 100

Example: Production overheads = ₹40,000 Direct materials = ₹200,000

Overhead rate = (₹40,000 / ₹200,000) x 100 = 20%

Thus, if the direct material cost of a job or cost unit is ₹1,200, the overheads to be
absorbed by it will be ₹240 i.e., 20% of ₹1,200.
2. Direct Labour Cost Percentage Rate
method.
The overhead rate under this method computed by dividing
the production overhead by the direct labour cost

Overhead Rate = (production overhead /direct labour cost )

x 100
Example –
Production overheads: ₹40,000
- Direct labour cost: ₹1,00,000
- Overhead rate: (Production overheads / Direct labour cost) ×
100
- Overhead rate: (40,000 / 1,00,000) × 100 = 40%

-Thus a job for which direct wages of ₹200, the absorbed

3.Prime Cost Percentage Rate
Method
•This method is based on the premise that both materials and labor give rise to
factory overheads. Therefore, the total of the two, which is the prime cost, should be
taken as the base for absorption of factory overheads.
•It combines the material cost and labor cost methods.
•Direct Labour Hour Rate

This rate is calculated by dividing the total production overheads by the

total number of direct labour hours for the period.

Example:
•Production overheads: ₹40,000
•Direct labour hours: 50,000 hours
•Overhead rate: ₹40,000 / 50,000 hours = 80 paise per hour
Therefore, if a job takes 20 labour hours for production, ₹16 (i.e., 20
hours @ 80 paise) will be charged to that job for production overhead.
Machine Hour Rate:

•This rate is the overhead cost of running a machine for one hour.
•It is calculated by dividing the total factory overheads apportioned to a
machine by the number of machine hours for the period.

Machine hour rate = Production overheads / No. of machine

hours
Example:
•Production overheads of Machine I = ₹25,000
•No. of machine hours = 2,000

•Machine hour rate = Production overheads / No. of machine hours

•= 25,000 / 2,000 = ₹12.50
•If Machine I has been used for a job for 30 hours, overheads to be
absorbed by that job will amount to ₹375, i.e., 30 hrs × ₹12.50.
Rate per Unit of Output
Method
•This method is described as the simplest of all methods, where the
rate is determined by dividing the total overheads of a department by
the number of units produced.
Example Calculation:
•Production overheads: ₹22,000
•Number of units produced: 1,000

The text further explains that each unit produced will absorb ₹22 for
production overheads. It mentions that while this method is simple, it is
only advantageous when all cost units produced are identical. It cannot be
applied when products of different sizes, grades, qualities, etc., are
produced according to customer specifications and consume different
Standard Costing
Standard Costing: Standard cost and standard costing, standard costing and budgetary
control. Analysis of variances (Material, Labour and Sales),
Standard cost
Standard cost is the predetermined cost assigned to each unit of
production. It is based on cost elements—expected material, labour, and
overhead expenses. It serves as a benchmark for measuring actual
performance, enabling managers to identify variances, streamline
operations, and enhance cost efficiency in the production process.

Standard costing
Standard costing is a cost accounting method that assigns a
predetermined or “standard” cost to each production unit. This cost is
based on anticipated materials, labour, and overhead prices. Companies
use it as a control tool to help managers understand cost variances, which
are the differences between actual and standard costs.
Standard costing is an accounting method manufacturers use to estimate
the expected production process costs for the coming year. It helps
businesses set cost benchmarks, analyze variances, and improve cost
Variances in Standard Costing

Variances in standard costing refer to the differences between actual

costs and the predetermined or “standard” costs.

Material Variance measures the difference in cost due to changes in

material prices or usage. it is calculated by (Actual Price - Standard
Price) x Actual Quantity.

Labor Variance tracks wage rate or hour differences using the

formula (Actual Rate - Standard Rate) x Actual Hours.

Overhead Variance looks at the difference in fixed or variable overhead

costs, calculated as (Actual Overhead - Standard
Why is identifying variances
necessary?
•Track Progress Against Budgeted Costs: Variances help
organizations compare actual performance with budgeted costs, offering
insights into financial health.
•Identify Areas for Improvement: Analyzing variances highlights
inefficiencies or areas where processes can be optimized for better
performance.
•Informed Decision-Making: By understanding variances,
organizations can make decisions to optimize operations, reduce costs,
and improve efficiency.
•Regular Review of Standard Costs: Periodic review and updates of
standard costs ensure they remain aligned with market conditions and
changes in production processes.
•Corrective Action for Variance Management: Promptly addressing
variances helps maintain budget adherence and ensures the
organization remains on track to meet financial goals.
Advantages of Standard
Costing
The following are the important advantages of standard
costing :
(1) It guides the management to evaluate the production
performance.
(2) It helps the management in fixing standards.
(3) Standard costing is useful in formulating production planning
and price policies. (4) It guides as a measuring rod for
determination of variances.
(5) It facilitates eliminating inefficiencies by taking corrective
measures. .
Limitations of Standard Costing

Besides all the benefits derived from this system, it has a number of
limitations which are given below:
(1)Standard costing is expensive and a small concern may not meet the
cost.
(2)Due to lack of technical aspects, it is difficult to establish standards.
(3)Standard costing cannot be applied in the case of a- concern where
non-standardized products are produced.
(4)Fixing of responsibility is’ difficult. Responsibility cannot be fixed in the
case of uncontrollable variances.
(5)Frequent revision is required while insufficient staff is incapable of
 Key Points
 Standard Cost :It is a planned unit cost of the product, component or
service produced in a period.

 Standard Price :A predetermined price fixed on the basis of a

specification of a product or service and of all factors affecting that
price.

 Standard Time :The total time in which task should be completed at

standard performance.

 Variance : A divergence from the predetermined rates, expressed

ultimately in money value, generally used in standard costing and
budgetary control systems.

- Favourable Variance : Variances which are profitable for the

organisation are known as favourable variance.
- Adverse Variance : Variances which increase the cost for the
Material Cost Variance
•Definition: Material cost variance refers to the difference between the standard cost of
materials used and the actual cost of materials.
•Formula:
• Material Cost Variance = Standard Cost – Actual Cost
• Or: [(Standard Quantity × Standard Price) – (Actual Quantity × Actual Price)]
•Description: The variance reflects the difference between the standard material cost for
the actual production volume and the actual cost of material.
•Reasons for Variance:
• Difference in material price from the standard price.
• Difference in material consumption from standard consumption.
• Both price and usage differences.
The analysis of material cost variance is done by splitting it into two parts: Material
Price Variance and Material Usage Variance.
(A) Material Price Variance
It measures variance that arises in the material cost due to the difference in actual material purchase price from the
standard material price. Mathematically, it is written as:
Material Price Variance = [Standard Cost of Actual Quantity* - Actual Cost]
Or
Actual Quantity (AQ) × {Std. Price (SP) – Actual Price (AP)}
Or
[(SP × AQ) – (AP × AQ)]

(The difference between the Standard Price and Actual Price for the Actual Quantity Purchased)
*Here actual quantity means the actual quantity of material purchased. If in the question material purchase is not
given, it is taken as equal to material consumed.

Explanation: Material price variance can also be calculated by taking material used as actual quantity instead of
material purchased. This method is also correct but does not serve the purpose of variance computation. Material
price variance may arise from a variety of reasons, some of which may be controllable and some beyond the control
of the purchase department. If price variance arises due to inefficiency of the purchase department or any other
reason within its control, it is very important to report the variance as early as possible. This can be done by taking
the purchase quantity as the actual quantity for price variance computation.

Responsibility for Material Price Variance: Generally, the purchase department procures materials from the
market. The department is expected to perform its function prudently so that the company never suffers a loss due to
its inefficiency. The purchase department is held responsible for adverse price variance arising due to factors
controllable by the department.
(B) Material Usage Variance
•It measures variance in material cost due to the usage/consumption of materials. It is computed as follows:

Material Usage Variance = [Standard Cost of Standard Quantity for Actual Production - Standard Cost of Actual
Quantity*]
Or
Std. Price (SP) × { Std. Quantity (SQ) - Actual Quantity (AQ) }
Or
[(SQ × SP) - (AQ × SP)]

(The difference between the Standard Quantity specified for actual production and the Actual Quantity used, at
Standard Price)
*Here, actual quantity means the actual quantity of material used.

•Responsibility for Material Usage Variance: The production department is held responsible for adverse usage
variance.
•Reasons for Variance: Actual material consumption may differ from the standard quantity either due to:
1.Differences in proportion used from the standard proportion.
2.Differences in actual yield from the standard yield.

Material Usage Variance is divided into two parts:

(a) Material Usage Mix Variance.
(b) Material Yield Variance.
Material Mix Variance:
Variance in material consumption may arise due to difference in proportion actually used
from the standard mix/ proportion. It only arises when two or more inputs are used to
produce a product. Mathematically,

Material Mix Variance = [Standard Cost of Actual Quantity in Standard

Proportion – Standard Cost of Actual Quantity]
Or
Std. Price (SP) × {Revised Std. Quantity (RSQ) – Actual Quantity (AQ)}
Or
[(RSQ × SP) – (AQ × SP)]
(The difference between the Actual Quantity in standard proportion and Actual
Quantity in actual proportion, at Standard Price)
Material Yield Variance (Material Sub-usage Variance)
Variance in material consumption which arises due to yield or productivity of
the inputs. It may arise due to use of sub- standard quality of materials, inefficiency of
workers or due to wrong processing.

Material Yield Variance = [Standard Cost of Standard Quantity for Actual

Production – Standard Cost of Actual Quantity in standard proportion]
Or
Std. Price (SP) × {Std. Quantity (SQ) – Revised Standard Quantity (RSQ)}

Or
[(SQ × SP) – (RSQ × SP)]
(The difference between the Standard Quantity specified for actual production
and Actual Quantity in standard proportion, at Standard Purchase Price)
Verification of the formulae:

Material Cost Variance= Material Usage Variance + Material Price

Variance* Or,
Material Cost Variance= (Material Mix Variance + Material
Revised usage
Variance) + Material price variance
 Material
Variances
Material Cost Variance
[Standard Cost – Actual
Cost] [(SQ × SP) – (AQ ×
AP)]

Material Price Material Usage

Variance Variance
[(SP – AP) × AQ] [(SQ – AQ) × SP

Material Mix Material Yield

Variance Variance
[(SM – AQ) × SP] [(SQ – SM) × SP]

SQ- Standard Quantity , AQ– Actual Quantity , SM – Standard Mix ,

11 February SP – Standard Price , AP – Actual Price
2022
96
The standard and actual figures of product ‘Z’ are as under:
Standard Actual
Material quantity 50 units 45 units
Material price per unit ` 1.00 ` 0.80
CALCULATE material cost variances.

NXE Manufacturing Concern furnishes the following information:

Standard: Material for 70 kg

finished products 100 kg
Price of material ` 1 per kg

Actual: Output 2,10,000 kg

Material used 2,80,000 kg
Cost of Materials ` 2,52,000
CALCULATE: (a) Material usage variance, (b) Material price variance, (c) Material cost
variance.
ABC Ltd. produces an article by lending two basic raw materials. It operates a standard costing
system and the following standards have been set for raw materials:
The standard loss in processing is 15%. During April 2021, the company produced 1,700 kgs. of
finished output.
Material Standard mix Standard price (Rs per kg)
A 40% 4
B 60% 3

The position of stock and purchases for the month of April 2021 are as under:

Material Stock on Stock on Purchased during April 2021

01.04.2021 30.04.2021

(Kg.) (Kg.) (Kg.) (Rs)

A 35 5 800 3,400
B 40 50 1,200 3,000

Opening stock of material is valued at standard price. CALCULATE the following variances:
a) Material price variance
b) Material usage variance
c) Material yield variance
d) Material mix variance
e) Total Material cost variance
B. Labour Cost Variance
Amount paid to employees for their labour is generally known as employee or labour cost. In this
chapter labour cost is used to denote employees cost. Labour (employee) cost variance is the
difference between actual labour cost and standard cost. Mathematically it can be written as:

Labour Cost Variance = [Standard Cost – Actual Cost]

Or
[(SH × SR) – (AH* × AR)]
(The difference between the Standard Labour Cost and the Actual Labour Cost incurred
for the production achieved)

Reasons for variance: Difference in labour cost arises either due to difference in the actual
labour rate from the standard rate or difference in numbers of hours worked from standard
hours. Labour cost variance can be divided into three parts namely (i) Labour Rate Variance (ii)
Labour Efficiency Variance and (iii) Labour Idle time Variance.
Labour Rate Variance:
Labour rate variance arises due to difference in actual rate paid from standard rate. It is very
similar to material price variance. It is calculated as below:

Labour Rate Variance = [Standard Cost of Actual Time – Actual Cost]

Or
Actual Hours (AH*) × {Std. Rate (SR) – Actual Rate (AR)}
Or
[(SR×AH*) – (AR × AH*)]
(The difference between the Standard Rate per hour and Actual Rate per hour for the Actual Hours paid)

* Actual hours paid.

Responsibility for labour rate variance: Generally labour rates are influenced by the external
factors which are beyond the control of the organisation. However, personnel manager is
responsible for labour rate negotiation
Labour Efficiency Variance:
Labour efficiency variance arises due to deviation in the working hours from the standard working
hours.
Labour Efficiency Variance =
[Standard Cost of Standard Time for Actual Production – Standard Cost of Actual Time]
Or
Std. Rate (SR) × {Std. Hours (SH) – Actual Hours (AH*)}
Or
[(SH × SR) – (AH# × SR)]
(The difference between the Standard Hours specified for actual production and Actual Hours worked at
Standard Rate).

# Actual Hours worked

Responsibility for labour efficiency variance: Efficiency variance may arise due to ability of the workers, inappropriate
team of workers, inefficiency of production manager or foreman etc. However, production manager or foreman can be held
responsible for the adverse variance which otherwise can be controlled.
Labour efficiency variance is further divided into the following variances:
(A)Labour Mix Variance or Gang variance
(B)Labour Yield Variance (or Labour Revised-efficiency Variance)
Labour Mix Variance:
Labour efficiency variance which arises due to change in the mix or combination of different skill
set i.e. number of skilled workers, semi-skilled workers and un-skilled workers. Mathematically,

Labour Mix Variance Or Gang Variance =

[Standard Cost of Actual Time Worked in Standard Proportion – Standard Cost of Actual Time Worked]
Or
Std. Rate (SR) × {Revised Std. Hours (RSH) – Actual HoursWorked (AH)}
Or
[(RSH × SR) – (AH# × SR)]
(The difference between the Actual Hours worked in standard proportion and Actual Hours worked in actual
proportion, at Standard Rate).

# Actual Hours worked

Labour Yield Variance:
Labour efficiency variance which arises due to productivity of workers.

Labour Yield Variance Or Sub-Efficiency Variance =

[Standard Cost of Standard Time for Actual Production – Standard Cost of Actual Time Worked in
Standard Proportion]
Or
Std. Rate (SR) × {Std. Hours (SH) – Revised Std. Hours (RSH)}
Or
[(SH × SR) – (RSH × SR)]
(The difference between the Standard Hours specified for actual production and Actual Hours worked in
standard proportion, at Standard Rate).
Idle Time Variance:
It is calculated for the idle hours. It is difference between paid and worked hours. It is calculated as
below:

Labour Idle Time Variance = [Standard Rate per Hour × Actual Idle Hours]
Or
Std. Rate (SR) {Actual Hours Paid – Actual Hours Worked}
Or
[(AH*× SR) – (AH# ×SR)]
(The difference between the Actual Hours paid and Actual Hours worked at Standard Rate)

• Actual hours paid;

• # Actual Hours worked
 Verification of formulae:

Labour Cost Variance = Labour Rate Variance + Labour Efficiency

Variance (if hours paid and hours worked is same)
OR
Labour Cost Variance = Labour Rate Variance + Idle Time Variance +
Labour Efficiency Variance
OR
Labour Efficiency Variance = Labour Mix Variance + Labour Yield
Variance
 Labour
Variances
Labour Cost
Variance
[Standard Cost – Actual
Cost]
[(SH × SR) – (AH × AR)]
Labour Rate Labour Efficiency
Variance Variance
[(SR – AR) × [(SH – AH) × SR
AH]

Idle Time Labour Mix Labour Yield

Variance Variance Variance
Idle Hours x SR [(SM – AHW) × SR] [(SH – SM ) × SR]

SH - Standard Hours , AH – Actual Hours Paid , SM – Standard Mix ,

SR – Standard Rate , AR – Actual Rate , AHW – Actual Hours Worked
11 February © THE INSTITUTE OF CHARTERED ACCOUNTANTS OF
2022 INDIA 10
The standard and actual figures of a firm are as under

Standard time for the job 1,000 hours

Standard rate per hour Rs.50
Actual time taken 900 hours
Actual wages paid Rs. 36,000

Calculate the Variances.

NPX Ltd. uses standard costing system for manufacturing of its product X. Following is the budget
data given in relation to labour hours for manufacture of 1 unit of Product X :
Labour Hours Rate (Rs. )
Skilled 2 6
Semi-Skilled 3 4
Un- Skilled 5 3
Total 10
In the month of January, total 10,000 units were produced following are the details:
Labour Hours Rate (Rs. Amount (Rs. )
Skilled 18,000 7 1,26,000
Semi-Skilled 33,000 3.5 1,15,500
Un- Skilled 58,000 4 2,32,000
Total 1,09,000 4,73,500
Actual Idle hours (abnormal) during the month:
Skilled: 500
Semi- Skilled: 700
Unskilled: 800
Total 2,000
CALCULATE:
(a)Labour Variances.
(b)Also show the effect on Labour Rate Variance if 5,000 hours of Skilled Labour are paid @ Rs.
5.5 per hour and balance were paid @ Rs. 7 per hour.
Overheads Variance
Variable Overheads Cost
Variance
Variable overheads consist of expenses other than direct material and
direct labour which vary with the level of production. If variable overhead
consist of indirect materials, then in this case it varies with the direct
material used. On the other hand, if variable overhead is depending on
number of hours worked then in this case it will vary with labour hour or
machine hours. If nothing is mentioned specifically then we take labour
hour as basis. Variable overhead cost variance calculation is similar to
labour cost variance. Variable overhead cost variance is divided into two
parts.

(i) Variable Overhead Expenditure Variance

(ii) Variable OverheadVariable
Efficiency Variance
Overhead Cost Variance

Variable Overhead Expenditure Variable Overhead Efficiency

Variance Variance
 Variable Overhead Cost Variance
(Standard Variable Overheads for Actual Production – Actual Variable Overheads)

Variable Overhead Variable Overhead Efficiency

Expenditure (Spending) Variance Variance

(Standard Variable Overheads for Actual (Standard Variable Overheads for

Hours#) Production)
Less Less
(Actual Variable Overheads) (Standard Variable Overheads for Actual
Hours#)
[(SR – AR) × AH#] [(SH – AH#) × SR]
Or Or
[(SR × AH#) – (AR × AH#)] [(SH × SR) – (AH# × SR)]

# Actual Hours (Worked)

From the following information of G Ltd.,
CALCULATE (i) Variable Overhead Cost Variance; (ii) Variable Overhead
Expenditure Variance and (iii) Variable Overhead Efficiency Variance:

Budgeted production 6,000 units

Budgeted variable overhead Rs.1,20,000
Standard time for one unit of output 2 hours
Actual production 5,900 units
Actual overhead incurred Rs. 1,22,000
Actual hours worked 11,600 hours
Fixed overhead volume variance is further divided into the three variances:
(A)Efficiency Variance
(B)Capacity Variance and
(C)Calendar Variance

Fixed Overhead Cost

Variance

Fixed OH Expenditure Fixed OH Volume

Variance Variance

FOH FOH Capacity FOH

Efficiency Variance Calender
Variance Variance
 Fixed Overhead Cost Variance
(Absorbed Fixed Overheads) Less (Actual Fixed Overheads) (SH × SR) –(AH × AR)

Fixed Overhead Expenditure Variance Fixed Overhead Volume Variance

(Budgeted Fixed Overheads) Less (Actual Fixed (Absorbed Fixed Overheads) Less (Budgeted
Overheads) Fixed Overheads)
Or Or
(BH × SR) – (AH × AR) (SH × SR) – (BH × SR)

Fixed Overhead Capacity Fixed Overhead Calendar Fixed Overhead Efficiency

Variance Variance Variance

SR (AH – BH) Std. Fixed Overhead rate per SR(SH – AH)

day (Actual no. of Working days
Or – Budgeted Working days) Or
(AH × SR) – (BH × SR) (SH × SR) – (AH × SR)
 Note: When calendar variance is computed, there will be a modification in the capacity
variance. In that case revised capacity variance will be calculated and the formula is:
Revised Capacity Variance = (Actual hours – Revised budgeted hours) × Std. fixed
rate per hour

Verification of formulae:
F.O. Cost Variance = F.O. Expenditure Variance + F.O. Volume Variance
F.O. Volume Variance = Efficiency Variance + Capacity Variance + Calendar Variance

Basic terms used in the computation of overhead variance

Standard overhead rate (per hour) = Budgeted Overhead
Budgeted hours
Or
Standard overhead rate (per unit) = Budgeted Overhead
Budgeted output in units
Note: Separate overhead rates will be computed for fixed and variable overheads
Basic calculations before the computation of overhead
variances:
The following basic calculation should be made before computing
variances.
(i) When overhead rate per hour is used:
(a) Standard hours for actual output (SHAO)
SHAO = (Budgeted Hours / Budgeted Output) × Actual
Output
(b)Absorbed (or Recovered) overhead = Std. hours for actual output ×
Std. overhead rate per hour
(c)Standard overhead = Actual hours × Std. overhead rate per hour
(d)Budgeted overhead = Budgeted hours × Std. overhead rate per hour
(ii) When overhead rate per unit is used
(a) Standard output for actual hours (SOAH)
SOAH = (Budgeted Output / Budgeted Hours) ×Actual Hours
(b) Absorbed overhead = Actual output × Std. overhead rate per
unit
(c) Standard overhead = Std. output for actual time × Std.
overhead rate per unit
(d) Budgeted overhead = Budgeted output × Std. overhead rate per
unit
(e) Actual overhead = Actual output × Actual overhead rate per unit
(f) Overhead cost variance = Absorbed overhead – Actual overhead
The cost detail of J&G Ltd. for the month of September is as follows:

Budgeted Actual
Fixed overhead Rs. Rs.
15,00,000 15,60,000
Units of production 7,500 7,800
Standard time for one unit 2 hours -
Actual hours worked - 16,000
hours
Required:
CALCULATE (i) Fixed Overhead Cost Variance (ii) Fixed Overhead
Expenditure Variance (iii) Fixed Overhead Volume Variance (iv) Fixed
Overhead Efficiency Variance and (v) Fixed Overhead Capacity Variance.
A company has a normal capacity of 120 machines, working 8 hours per day of 25 days in a
month. The fixed overheads are budgeted at ` Rs. 1,44,000 per month. The standard time
required to manufacture one unit of product is 4 hours.
In April 2021, the company worked 24 days of 840 machine hours per day and produced 5,305
units of output. The actual fixed overheads were `Rs.1,42,000.

COMPUTE the following Fixed Overhead variance:

Efficiency variance
Capacity variance
Calendar variance
Expenditure variance
Volume variance
Total Fixed overhead variance
Job Costing
JOB COSTING

Job costing is a process of determining the cost associated with a job or

work, which helps analyze the applicable per unit cost of each job in the
entire production. The job costing sheet can be understood as a specific
work, contract, or batch done or completed to achieve any goal.
Job Costing, also known as project-based costing, is the method of tracking
costs related to a specific product, project, or job. It is used in construction
companies, ship-building, engineering concerns, furniture making, repair
shops, automobile garages, machine manufacturing industries, and
factories where jobs or orders can be kept separately.
Objectives of Job Costing
• Job costing aims to provide accurate and precise cost information
associated with specific projects or jobs within a company.
• It facilitates effective budgetary control by tracking and comparing
actual costs against budgeted costs for each job, ensuring financial
accountability.
• Enables a detailed analysis of the profitability of individual projects by
assessing revenue generated against the direct and indirect costs
incurred.
• Helps in allocating resources efficiently by identifying the labor,
materials, and overhead costs associated with each job.
• Job costing allows for the evaluation of the performance of different
departments or teams by analyzing their ability to manage costs within
the specified budget for a particular job.
• Assists in setting competitive and profitable pricing for future projects
based on historical cost data, ensuring accurate and competitive quotes.
• Provides valuable data for decision-making by offering insights into the
financial performance of individual projects, aiding in strategic business
Applications of Job Costing
Construction Industry: The construction industry extensively uses this
method. Each construction project is unique and is considered a separate
job. Job costing tracks the costs of materials, labour, and other expenses for
each project separately.
Manufacturing Industry: Job costing tracks the costs of producing
individual products or batches. For example, a furniture manufacturer may
use this method to track the costs of producing a specific type of chair or
table.
Printing Industry: This method tracks the costs of printing individual jobs
such as books, magazines, and brochures. Each job is considered a
separate project and is used to track the costs of materials, labor, and other
expenses incurred for each job.
Consulting Industry: The consulting industry tracks the costs of
consulting services to individual clients. Each consulting project is
considered a separate job. It tracks the labour, travel, and other expenses
incurred for each project.
Q 1: The estimated material cost of job D-2 is Rs. 5,000 and direct labour
cost is likely to be Rs. 1,000. In the machine shop it will require
machining by Machine No. 8 for 20 hours and by Machine No. 11 for 6
hours. Machine hour rates for Machine No. 8 and Machine No. 11 are Rs.
10 and Rs. 15 respectively. Last year, the direct wages amounted to Rs.
80,000 and factory overheads (excluding those related to Machine No. 8
and 11) amounted to Rs. 48,000. Similarly, the factory cost of all jobs
last year amounted to Rs. 2,50,000 and office expenses Rs. 37,500.
Prepare a statement of quotation which provides for 20% profit used on
selling price.
Q2. A shop floor supervisor of a small factory presented the following cost
for Job No. 303, to determine the selling price.

It is also noted that average

hourly rates for the three
Departments X, Y and Z are
similar.
You are required to:
(i) PREPARE a job cost sheet.
(ii) CALCULATE the entire revised cost using current financial year actual figures as
basis.
Contract costing
Contract costing

Contract costing is a method of cost accounting specifically tailored for

businesses involved in large-scale, long-term contracts. These contracts
are usually one-off projects undertaken by contractors and are executed
according to the client’s (or contractee’s) specifications. Contract costing
is often applied in industries where work is carried out off-site, such as
construction, engineering, shipbuilding, and infrastructure development.
This method enables companies to track costs and revenues for
individual contracts to determine profitability, manage resources
efficiently, and control expenses.
Objectives of Contract Costing

• Find a comparison between the actual cost with an estimated cost

• Analyse cost to provide a basis for cost-plus pricing
• Calculate profit over the long-term contract
• Guidance for managing resource utilisation
Features of Contract Costing
Cost Unit: Each contract is treated as a separate unit of cost. The costs related to
materials, labour, overheads, and subcontracting are all traced to the contract.
Long-Duration Projects: Contracts are typically long-term, spanning multiple accounting
periods, sometimes lasting several years.
Site-Specific Costs: Most contracts are performed on the contractee’s site, meaning
costs like transportation, site equipment, and labour are directly tied to that specific
location.
Direct and Indirect Costs: Contract costing includes direct costs such as materials and
labour and indirect costs like administrative overhead, which are allocated to contracts
based on predetermined criteria.
Payment in Installments: Contractors are usually paid in instalments as the work
progresses, with each payment corresponding to specific milestones.
Profit Calculation: Profits are calculated progressively, allowing the contractor to report
Application of Contract Costing

Construction: Building roads, bridges, dams, and buildings.

Shipbuilding: Constructing ships or vessels.
Engineering: Working on infrastructure or mechanical projects.
Public Works: Building infrastructure such as railways, drainage
systems, and canals.
Few important terms :
• Contractor : Person who undertakes the contracts .
• Contractee : Person for whom contract is undertaken .
• Contract Price : The price as agreed between the contractor and contractee for
the work to be done
• Work Certified : The part of work done for which contractee’s architect has
issued completion certificate . Generally payment is made to the contractor on
the basis of work certified .
• Work Uncertified : The part of work done by the contractor for which
contractee’s architect has not issued certificate .Work uncertified is always
valued at cost price .
• Progress Payment : Periodic payment made by the contractee to contractor
on the basis of work certified after deducting a certain amount known as
• Retention Money : Portion of value of work certified, which is kept by a contractee as security
money for any loss or damage caused by the contractor.
(Retention Money = Value of work certified – Payment actually made/ cash paid)

• Escalation Clause: A clause in a contract which empowers a contractor to revise the price of the
contract in case of increase in the prices of inputs due to some macro-economic or other agreed
reasons.

• Estimated Profit : ( Contract Price – Estimated total cost )

• Estimated Total Cost : (Cost incurred till date + Estimated cost )

• Value of Work Certified = Value of Contract × Work certified (%)

• Cost of Work Certified = Cost of work to date – (Cost of work uncertified + Material in hand +
Plant at site)
Cost of Work Uncertified: It represents the cost of the work which has been carried out by the
contractor but has not been certified by the expert. It is always shown at cost price. The cost of
uncertified work may be ascertained as follows:

(Amount) (Amoun
t)
Total cost to date xxx
Less: Cost of work certified xxx
Material in hand xxx
Plant at site xxx xxx
Cost of work uncertified xxx
•Cash Received: It is ascertained by deducting the retention money from the value of work
certified i.e.
Cash received = Value of work certified – Retention money

Cost Plus Contract: Cost- plus contract is a contract where the value of the
contract is determined by adding an agreed percentage of profit to the total
cost. These types of contracts are entered into when it is not possible to
estimate the contract cost with reasonable accuracy due to unstable condition
of factors that affect the cost of material, employees, etc.
•Notional Profit: It represents the difference between the value of work certified and cost
of work certified. It is determined
Notional profit = Value of work certified – (Cost of work to date – Cost of work not yet
certified)
Portion of notional profit or estimated profit to be transferred to profit and loss account

1- When work certified is less than 1/4 of the contract price, no profit is transferred to Profit and
Loss Account. This is based on the principle that no profit should be taken into account unless the
contract has advanced reasonably.

2- When work-in-progress certified is 1/4 or more but less than 1/2 of the contract price, then
generally 1/3 of the profit is transferred to Profit and Loss Account. The balance amount is treated as
reserve. Thus, profit to be transferred to Profit and Loss Account is computed by the following formula:
Transfer to P&L A/c = Notional Profit × 1/3
Alternatively, a more common practice is to further reduce this amount by the cash ratio:
Transfer to P&L A/c = Notional Profit × 1/3 × (Cash received / Work certified)

3-When work certified is 1/2 or more but less than 9/10 of the contract price (i.e.,
50% to 90%), then the profit transferred is:
Transfer to P&L A/c = Notional Profit × 2/3
Or commonly:
Transfer to P&L A/c = Notional Profit × 2/3 × (Cash received / Work certified)
4- When contract is near completion, the estimated profit should be calculated on the
whole contract. The proportion of estimated profit transferred is computed by one of the
following formulas:
a) Estimated Profit × (Work certified / Contract price)
b) Estimated Profit × (Work certified / Contract price) × (Cash received / Work certified)
c) Estimated Profit × (Cost of work to date / Estimated total cost of work)
d) Estimated Profit × (Cost of work to date / Estimated total cost of work) × (Cash
received / Work certified)
5-Loss on Uncompleted Contracts
In the event of a loss on uncompleted contracts, this should be transferred in full to the
Profit and Loss Account, whatever be the stage of completion.
Contract Account format,

Amount Amount
Particulars Particulars
(₹) (₹)
By Materials Returned to
To Materials Issued XXXX XXXX
Stores
To Materials Purchased (Direct) XXXX By Materials at Site (Closing) XXXX
To Wages XXXX By Work-in-Progress:
To Direct Expenses XXXX – Work Certified XXXX
To Plant & Machinery Installed XXXX – Work Uncertified XXXX

By Profit & Loss A/c

To Subcontract Costs XXXX XXXX
(Notional/Estimated)
To Overheads Allocated XXXX
To Notional/Estimated Profit c/d XXXX
Total XXXXX Total XXXXX
Q1.
The following was the expenditure on a contract for ₹12,00,000
commenced in January 2018:
•Materials – ₹2,40,000
•Wages – ₹3,28,000
•Plant – ₹40,000
•Overheads – ₹17,200
•Work uncertified – ₹8,000
Cash received on account of the contract on 31 December 2018 was
₹4,80,000 being 80% of the work certified. The value of materials in
hand was ₹12,000. The plant had undergone 20% depreciation.
Prepare Contract Account.
 Q2. The following are the particulars relating to a contract which has begun on 1 January 2018:

Particulars Amount in ₹
Contract price 5,00,000
Machinery 30,000
Materials 1,70,600
Wages 1,48,750
Direct expenses 6,330
Outstanding wages 8,240
Overheads 9,060
Uncertified work 5,380
Materials returned 3,700
Materials on hand 31 December 2018 1,600
Machinery on hand 31 December 2018 22,000
Value of work certified 3,92,000
Cash received 3,51,000

Prepare the Contract Account for the year 2018 showing the amount of profit that may be taken to the credit of
Profit and Loss A/c of the year. Also show the work-in-progress as it would appear in the balance sheet of the year.
Marginal Costing
Marginal costing

Marginal costing is a cost accounting technique focusing on the variable

costs of producing one additional unit of a product or service. It helps
determine the contribution margin and assists in making decisions related
to pricing, production, and profitability.
Marginal costing is a cost accounting technique that helps businesses
determine the cost of producing one additional unit of a product or
service. It is also known as “variable costing“ because it only
considers the variable costs associated with producing an additional unit
of a product or service, such as direct labour and materials.
Under marginal costing, fixed costs, such as rent and salaries, are
considered period costs that are not directly related to the production of
a specific unit. Instead, fixed costs are expensed in the period they are
incurred. This differs from absorption costing, another cost accounting
technique that allocates fixed costs to each unit produced.
Marginal Cost Calculation Method
Marginal cost is the expense incurred to produce one additional unit of a product or
service.
• Determine Total Variable Costs: Identify all variable costs involved in production, such
as materials and direct labor.
• Calculate the Cost of Additional Units: Add up the total variable costs associated with
producing one more unit.
• Find the Change in Total Cost: To determine the marginal cost, find the difference
between the total cost of producing 'n' units and the total cost of producing 'n+1'
units.
Applications of Marginal
Costing
Marginal costing is incredibly valuable for making crucial decisions by
providing clear insights into various alternatives. This technique helps in
choosing the best option by presenting all necessary facts.
• Evaluate different production techniques to find the most cost-effective
option.
• Determine if it's better to produce a product in-house or purchase it from
an external supplier.
• Plan and maximize potential profits by analyzing marginal costs.
• Adjust business activities to improve efficiency and reduce costs.
• Establish or modify prices based on marginal cost analysis to ensure
Advantages of Marginal
Costing
Limitations of Marginal
Costing
Doesn’t consider all costs: This approach only considers variable costs
and doesn’t consider fixed costs, such as rent and salaries. This can lead
to an incomplete picture of a business’s costs and profitability.
Can be misleading: It can be misleading in situations where fixed costs
are high and production levels are low. In such cases, the marginal cost
per unit may be high, leading to the incorrect conclusion that the product
could be more profitable.
Difficulty in allocating fixed costs: This costing method doesn’t
allocate fixed costs to each unit produced, making it difficult to determine
each unit’s cost accurately.
Not suitable for long-term planning: It is primarily a short-term
planning tool and may not be suitable for long-term planning. In the long
term, fixed costs may change and become variable, affecting product
profitability.
Doesn’t account for inventory valuation: This method needs to
Contribution and Marginal Cost Equation

• Contribution (C) = Sales (S) - Variable cost (V)

• Contribution ( C) = Fixed cost (F) + Profit (P)
• Contribution ( C) = Fixed cost (F) - Loss (L)

• Sales (S) - Variable cost (V) = Fixed cost (F) + Profit (P)

• Profit (P)= Sales (S) - Variable cost (V) - Fixed cost (F)
• Profit (P)= Contribution ( C) - Fixed cost (F)
• Fixed cost (F) = Contribution ( C) - Profit (P)
• Variable cost (V) = Sales (S) - Fixed cost (V) - Profit (P)
• Variable cost (V) = Sales (S) –Contribution (C)
Q-1
SALES = RS 12000
VARIABLE COST = RS 7000
FIXED COST = RS 4000
Calculate Contribution and Profit
The Profit Volume Ratio (PV
ratio)
The profit volume ratio (PV ratio) is a financial metric used to measure the
relationship between a company’s profit and its sales volume. It is calculated by
dividing the contribution margin by the sales revenue.

The formula for PV ratio is:

P/V ratio = (Contribution margin / Sales revenue) x 100

1.Contribution margin is the difference between the sales revenue and the variable
costs.
2.Sales revenue is the total amount of money earned from selling products or
services
Contribution = Sales x P/V ratio Sales =

= =
Q-2
SALES = RS 10000
VARIABLE COST = RS 8000
Calculate P/V Ratio
Break-even point (BEP)

The breakeven point is the point at which there is neither profit nor loss. At this point,
total cost is equal to total revenue and contribution is equal to fixed cost. The Break-even
point can be calculated in units or dollars

BEP (Units)

= Fixed cost ÷ Contribution per unit

= Fixed cost ÷ (Selling price- Total variable cost per unit)

BEP (Rs)

= Fixed cost ÷ CS Ratio

= Fixed cost ÷ Contribution per unit × Selling price

= Fixed cost ÷ (Selling price- Total variable cost per unit) × Selling price
Margin of Safety
Margin of safety refers to the difference between break even point and
expected profitability. It is the revenue earned by a company after it pays
fixed and variable costs incurred in the production of goods and services.
Margin of Safety = Expected or Actual Sales -
Break-even Sales
Margin of Safety at Break-Even Point
The margin of safety indicates the difference between anticipated profits and the break-
even point. It is determined by subtracting the break-even point from the current sales
level and then dividing the result by the current sales level.

The formula for calculating the margin of safety at the break-even point is:
Margin of Safety = [(Current Sales Level - Break-even Point) / Current Sales
Level] x 100
Alternatively, it can be calculated using:
Margin of Safety (MOS) = 1 - (Current Share Price / Intrinsic Value)
Calculation Method Formula
MOS% = [Current Sales – Break-Even Point /
Margin of Safety in Percentage
Current Sales] x 100
Safety Margin (units) = Current Sales –
Margin of Safety in Units
Break-Even Point / Sales Price per unit
MOS in (Rs) = Current (estimated) Sales –
Margin of Safety in (Rs)
Break-Even Point
Difference Between Marginal Costing and Break Even Analysis
Aspect Marginal Costing Break-Even Analysis
Definition A costing technique where only variable costs are A financial tool used to determine the sales
considered for decision-making and fixed costs are volume at which total revenues equal total
treated as period costs. costs, resulting in neither profit nor loss.
Purpose To assist in decision-making related to pricing, To identify the point at which a business
production levels, and product mix. covers all its costs and starts generating a
profit.
Cost Classification Focuses on separating costs into variable and fixed Uses the same classification but primarily for
categories. the purpose of understanding how sales
volume affects profitability.
Decision Focus Emphasizes on contributions, i.e., sales minus Emphasizes on finding the break-even point
variable costs, to cover fixed costs and generate to understand the minimum sales volume
profit. required to avoid losses.
Complexity in Multi- Involves analysis of contribution margins for each Generally simpler with single-product focus
product, making it complex for decision-making with but can be extended to multi-product
Product Scenarios multiple products. scenarios with weighted averages.
Time Horizon Typically used for short-term decision-making Can be used for both short-term and long-
considering variable and fixed costs in the short run. term planning, but mainly focuses on short-
term financial planning.
Profit Calculations Directly evaluates how changes in sales volume, Primarily calculates the sales volume needed
costs, and prices affect profitability through to cover all costs and achieve break-even,
contribution margin. sometimes extended to profit scenarios based
on sales volume.
Use of Fixed Costs Treated as period costs, not included in product Fixed costs are crucial for determining the
costing, and are charged against the profit of the break-even point, as they must be covered
period. along with variable costs to achieve break-
even.
Strategic Decisions Useful for decisions like whether to accept a special Often used to decide on the feasibility of a
order, discontinue a product, or choose between new product or project by understanding the
alternative products. sales volume needed for profitability.
SUMMERY OF ALL FORMULAS