Introduction to Cost and Management Accounting

Key Terms and Concepts

Cost

Definition: The amount of resources given up in exchange for goods or services. It can be
expressed both as a noun (amount of expenditure) and a verb (action to ascertain the cost of a
specified thing or activity).

• Example: The cost of producing a widget includes raw materials, labor, and overhead.

Costing

Definition: The technique and process of ascertaining costs.

• Example: Using a costing system to determine the cost of manufacturing a batch of

products.

Cost Accounting

Definition: The process of accounting for costs, which begins with recording income and
expenditure and ends with the preparation of periodical statements and reports for ascertaining
and controlling costs.

• Example: Preparing monthly cost reports for a manufacturing department.

Cost Accountancy

Definition: The application of costing and cost accounting principles, methods, and techniques
to cost control and profitability assessment.

• Example: Implementing cost control measures to reduce production costs without

compromising quality.

Management Accounting

Definition: The application of accounting and financial management principles to create,

protect, preserve, and increase value for stakeholders in for-profit and non-profit enterprises.

• Example: Using management accounting to make informed business decisions and

strategic planning.

Objectives of Cost Accounting

 1. Ascertainment of Cost:
o Accumulation and determination of costs for each cost object (unit, job, process,
department, or service).
o Example: Determining the cost of producing a single unit of product.
2. Determination of Selling Price and Profitability:
o Helps in setting selling prices and determining the profitability of cost objects.
o Example: Using cost data to negotiate prices with customers.
3. Cost Control:
o Maintaining discipline in expenditure by comparing actual costs with set
standards.
o Steps:
▪ Determination of pre-determined standards or targets.
▪ Measurement of actual performance.
▪ Comparison of actual performance with set standards.
▪ Analysis of variances and taking corrective actions.
4. Cost Reduction:
o Achieving real and permanent reductions in unit costs without impairing quality.
o Example: Streamlining production processes to reduce waste and lower costs.
5. Assisting Management in Decision Making:
o Providing relevant information for planning, organizing, controlling, and decision
making.
o Example: Using cost reports to decide whether to continue or discontinue a
product line.

Scope of Cost Accounting

1. Costing:
o Technique and process of ascertaining costs using historical, standard, process, or
operation cost methods.
2. Cost Accounting:
o Recording expenditure and preparing periodical statements for ascertaining and
controlling costs.
3. Cost Analysis:
o Identifying factors responsible for cost variances and fixing responsibility for cost
differences.
o Example: Analyzing why actual costs exceeded budgeted costs and taking steps
to prevent recurrence.
4. Cost Comparisons:
o Comparing costs involved in alternative actions, different products, and over time.
5. Cost Control:
o Examining costs in light of the advantages received from incurring them.
6. Cost Reports:
o Preparing reports to provide cost information to management.
7. Statutory Compliances:
o Ensuring adherence to legal and regulatory requirements related to cost
accounting.
Questions and Answers

Q1: What is the primary objective of cost accounting?

A1: The primary objective is the accumulation and ascertainment of costs for each cost object to
help in determining selling prices, controlling costs, and assisting in decision-making.

Q2: How does cost accounting help in cost control?

A2: Cost accounting helps in cost control by setting pre-determined standards, measuring actual
performance, comparing it with the standards, analyzing variances, and taking corrective actions.

Q3: What is the difference between cost control and cost reduction?

A3:

• Cost Control: Maintaining costs according to established standards, focusing on past and
present costs, and ending when targets are achieved.
• Cost Reduction: Continuously reducing costs by challenging all standards, focusing on
present and future costs, and having no visible end.

Q4: What is the role of management accounting in decision making?

A4: Management accounting provides relevant information for planning, organizing, controlling,
and making informed decisions that enhance the value for stakeholders.

Summary

• Cost and Management Accounting involves the application of various techniques to

ascertain, control, and reduce costs while aiding management in making informed
decisions.
• Objectives include cost ascertainment, determining selling prices, controlling costs, and
assisting in strategic decisions.
• Scope covers costing, cost accounting, cost analysis, comparisons, control, reporting, and
statutory compliance.
• Key Terms such as cost, costing, cost accounting, cost accountancy, and management
accounting are fundamental to understanding the field.
Chapter 2: Material Cost
Introduction

Material Cost refers to all commodities or physical objects used in the production of a
final product. These materials can be categorized as:

• Direct Materials: Costs directly attributable to the end product.

• Indirect Materials: Costs not directly attributable to a particular product.

Importance of Material Cost

Proper recording and control of material costs are crucial for:

1. Quality of Final Product: Quality of output depends on the quality of inputs.

2. Price of Final Product: Material costs significantly influence the product's final
price.
3. Production Continuity: Ensures smooth production processes without
interruptions due to material shortages.
4. Cost of Stock Holding and Stock-Out: Balancing stock holding costs and
avoiding revenue loss due to stock-outs.
5. Wastage and Other Losses: Efficient handling and processing to minimize
wastage and losses.
6. Regular Information About Resources: Updated information on material
availability and utilization for informed decision-making.

Material Control

Material Control involves activities and control mechanisms to keep material costs
within set standards. The objectives include:

1. Minimizing Interruption in Production: Ensures constant availability of

materials.
2. Optimizing Material Cost: Balancing price, ordering, and holding costs.
3. Reducing Wastages: Avoiding losses and wastages from long storage or
obsolescence.
4. Providing Adequate Information: Maintaining records for reliable information
on materials.
5. Timely Order Completion: Ensuring materials management supports timely
order fulfillment.

Material Procurement Procedure

The material procurement process involves several steps and documents, which can be
outlined as follows:

1. Bill of Materials (BOM): A detailed list specifying quantities and qualities of

materials needed for production.
2. Material Requisition Note: A voucher authorizing the issue of materials from
the store.
3. Purchase Requisition: Authorizes the purchase department to order specified
materials.
4. Inviting Quotation/Request for Proposal (RFP)/Notification Inviting Tender
(NIT): Steps to determine what, when, how much, where, and at what price to
purchase materials.
5. Selection of Quotation/Proposal: Evaluating factors like price, quality, and
delivery terms to select a supplier.
6. Preparation and Execution of Purchase Orders: Issuing formal purchase orders
to suppliers.
7. Receipt and Inspection of Materials: Ensuring received materials meet
specifications and are in good condition.
8. Goods Received Note: Documenting the receipt of materials.
9. Material Returned Note: Documenting materials returned to the supplier.

Key Terms and Concepts

• Economic Order Quantity (EOQ): The optimal order quantity that minimizes the
total cost of inventory, including holding and ordering costs.
• Inventory Control Techniques: Methods like Just-in-Time (JIT) to manage
inventory levels efficiently.
• Normal and Abnormal Losses: Differentiating between expected wastage and
unusual losses, and their accounting treatments.

Questions and Answers

Q1: What is the difference between direct and indirect materials?

• A1: Direct materials are directly attributable to the end product, while indirect
materials are not directly linked to a specific product.

Q2: Why is material control important in production?

• A2: Material control ensures uninterrupted production, optimizes material costs,

reduces wastages, provides necessary information, and supports timely order
completion.
Q3: What is a Bill of Materials (BOM)?

• A3: A BOM is a detailed list specifying the standard quantities and qualities of
materials required for producing a product.

Q4: What is EOQ and why is it important?

• A4: EOQ is the optimal order quantity that minimizes total inventory costs. It's
important for efficient inventory management and cost control.

Q5: How does the material procurement process ensure quality and efficiency?

• A5: Through steps like preparing BOM, issuing requisitions, selecting suppliers
based on multiple criteria, and inspecting received materials to meet specified
standards.
Employee Cost and Direct Expenses
Key Terms and Concepts
Employee (Labour) Cost 🧑

• Definition: Benefits paid or payable to employees for services rendered. This

includes wages, salaries, bonuses, and other incentives.
• Classification:
o Direct Employee Cost: Can be directly attributed to a cost object.
o Indirect Employee Cost: Cannot be directly attributed to a specific cost
object.

Importance of Employee Cost

• Vital for manufacturing products or providing services.

• Affects overall cost, efficiency, and output effectiveness.
• Includes both monetary and non-monetary compensation.

Attendance and Payroll Procedures

• Time-Keeping: Recording total attendance time of employees.

o Manual Methods: Attendance registers, metal disc/token methods.
o Mechanical Methods: Punch card systems, biometric attendance systems.
• Time-Booking: Recording the time spent on specific jobs.
• Payroll Procedures: Calculating and disbursing wages, including statutory
deductions like Provident Fund and ESI.

Idle Time and Overtime Cost

• Idle Time: Time during which employees are paid but not working due to
uncontrollable reasons.
• Overtime: Time worked beyond regular working hours, usually paid at a
premium rate.

Employee (Labour) Turnover

• Definition: The rate at which employees leave an organization and are replaced.
• Measurement: Calculated using different methods to analyze reasons and cost
impacts.
Methods of Remuneration and Incentive Systems

• Time Rate System: Payment based on the time worked.

• Piece Rate System: Payment based on the number of units produced.
• Incentive Systems: Additional payments to encourage higher performance.

Efficiency Rating Procedures

• Methods to measure and rate the efficiency of employees.

Direct Expenses

• Definition: Costs that can be directly attributed to a specific cost object.

• Examples: Direct materials, direct labor.

Questions and Answers

Key Questions

1. What is employee (labour) cost and why is it important?

o Answer: Employee cost refers to the total benefits paid to employees for
their services. It is important because it directly impacts the cost of
production and service delivery, influencing the overall efficiency and
effectiveness of the organization.
2. How are direct and indirect employee costs different?
o Answer: Direct employee costs can be directly attributed to a cost object
and vary with production volume. Indirect employee costs cannot be
directly attributed to a specific cost object and do not necessarily vary with
production volume.
3. What methods are used for time-keeping and why are they important?
o Answer: Methods include manual systems like attendance registers and
mechanical systems like punch cards and biometric systems. Accurate
time-keeping is essential for preparing payrolls, calculating overtime, and
maintaining discipline.
4. How is employee turnover measured and what are its impacts?
o Answer: Employee turnover is measured using different methods, such as
calculating the number of employees leaving and being replaced within a
period. High turnover can increase costs and disrupt productivity.
5. What are the different methods of remuneration and how do they work?
 o Answer: Remuneration methods include the time rate system (payment
based on hours worked), piece rate system (payment based on units
produced), and various incentive systems to boost performance.

Summary
• Employee Cost: Encompasses all benefits paid to employees, classified into
direct and indirect costs.
• Importance: Essential for cost management and efficiency in production and
service provision.
• Attendance and Payroll: Critical for accurate payroll calculation and overall cost
control.
• Idle Time and Overtime: Managed to optimize labor costs and maintain
productivity.
• Turnover: Monitored to minimize costs and disruptions.
• Remuneration: Structured to motivate employees and enhance productivity.
• Direct Expenses: Identified and allocated to specific cost objects for accurate
costing.
Chapter 4: Overheads - Absorption Costing Method
Introduction

Overheads refer to expenses that cannot be directly traced to a specific product or job. These
costs are crucial for accurate cost computation and control. Examples include wages for security
staff, heating, and lighting expenses in a factory. Overheads are divided into three main
categories:

• Production Overheads: Costs incurred in the manufacturing process (e.g., machine

maintenance).
• Administrative Overheads: Costs related to the overall administration (e.g., office
salaries).
• Selling & Distribution Overheads: Costs related to selling and delivering products (e.g.,
sales commissions).

Key Terms and Concepts

Overhead Classification

1. By Function:
o Production Overhead: Indirect costs in manufacturing (e.g., machine repairs,
factory depreciation).
o Administrative Overheads: Costs for general management (e.g., office staff
salaries).
o Selling & Distribution Overheads: Costs for selling and distributing products
(e.g., sales commissions, delivery van expenses).
2. By Nature:
o Fixed Overheads: Costs that do not change with the level of activity (e.g.,
salaries of permanent employees).
o Variable Overheads: Costs that vary with the level of activity (e.g., power and
fuel).
o Semi-Variable Overheads: Costs with both fixed and variable components (e.g.,
electricity costs).
3. By Element:
o Indirect Materials: Materials not part of the finished product (e.g., lubricants).
o Indirect Employee Costs: Salaries for roles not directly involved in production
(e.g., supervisors).
o Indirect Expenses: Other indirect costs (e.g., insurance, depreciation).
4. By Control:
o Controllable Costs: Costs that can be managed (e.g., material costs).
o Uncontrollable Costs: Costs that cannot be easily managed (e.g., taxes).

Accounting and Control of Overheads

Overhead Allocation and Apportionment:

1. Estimation and Collection: Overheads are estimated based on past data and adjusted for
future changes.
2. Assignment:
o Allocation: Directly assigning costs to cost centers where feasible (e.g., specific
power costs).
o Apportionment: Distributing unallocable costs across departments based on
logical bases (e.g., work manager's salary).
o Re-apportionment: Distributing service department costs to production
departments.

Absorption: Overheads are absorbed into product costs using pre-determined rates. This helps in
immediate cost computation without waiting for actual overheads.

Treatment of Over and Under Absorption

Over-Absorption: When absorbed overheads exceed actual overheads. Under-Absorption:

When actual overheads exceed absorbed overheads.

• Adjustments are made at year-end to reconcile these differences.

Advantages of Classifying Overheads

1. Controlling Expenses: Helps in managing costs effectively.

2. Budget Preparation: Aids in creating flexible budgets by estimating costs at different
activity levels.
3. Decision Making: Facilitates important business decisions by distinguishing fixed and
variable costs.

Methods to Calculate Overhead Rate

• Pre-determined rates are calculated based on estimated overheads and activity levels.
• These rates ensure that overheads are absorbed consistently during the accounting period.

Summary

• Overheads are critical for accurate cost computation and control.

• Classification helps in managing and allocating costs effectively.
• Absorption costing ensures that overheads are included in product costs timely.
• Adjustments for over and under absorption ensure accurate financial reporting.

Questions and Answers

Q1: What are overheads, and why are they important?

A1: Overheads are indirect costs that cannot be directly traced to a specific product. They are
important because they often form a significant part of total costs and need to be managed for
accurate cost computation and control.

Q2: How are overheads classified by function?

A2: Overheads are classified by function into production overheads, administrative overheads,
and selling & distribution overheads. Each category includes costs related to specific activities
within an organization.

Q3: What is the difference between fixed, variable, and semi-variable overheads?

A3: Fixed overheads do not change with activity levels, variable overheads vary with activity,
and semi-variable overheads contain both fixed and variable components.

Q4: How are overheads allocated and apportioned?

A4: Overheads are allocated directly to cost centers where feasible. Unallocable costs are
apportioned across departments based on logical bases. Re-apportionment is used to distribute
service department costs to production departments.

Q5: What is absorption costing?

A5: Absorption costing involves including overheads in product costs using pre-determined
rates. This ensures timely and consistent overhead absorption during the accounting period.
Traditional Costing System

• Purpose: Allocates overhead costs to products based on a single cost

driver like direct labor hours or machine hours.
• Issues:
o Overhead Allocation: Often leads to over- or under-costing of
products due to using a single cost driver that may not accurately
reflect the consumption of overhead resources.
o Complexity: In modern manufacturing environments, where
overhead costs are driven by multiple factors (such as setups,
inspections, and batch processing), traditional costing can distort
product costs.
o Decision Making: Decisions based on inaccurate cost data can lead
to suboptimal pricing, product mix, and resource allocation
decisions.

Usefulness of Activity Based Costing (ABC)

• Accurate Costing: ABC traces overhead costs to activities and then

allocates them based on the drivers of those activities (e.g., number of
setups, inspections).
• Enhanced Cost Control: Provides a more accurate understanding of which
activities consume resources and helps in controlling and reducing costs.
• Decision Making: Enables better decision-making by revealing the true
costs of products, services, and processes.
• Performance Evaluation: Facilitates performance evaluation by linking
activities to costs and ultimately to performance metrics.

Cost Allocation under ABC

• Activity Pools: Categorizes overhead costs into activity pools based on

similar activities (e.g., setup costs, inspection costs).
 • Cost Drivers: Identifies cost drivers for each activity pool (e.g., number of
setups for setup costs) to allocate costs more accurately.
• Direct Tracing: Directly assigns costs that can be specifically traced to
products or services without allocation.

Different Levels of Activities under ABC

• Unit-Level Activities:
o Activities performed for each unit produced (e.g., machine
processing time per unit).
o Examples: Direct material handling, machine processing.
• Batch-Level Activities:
o Activities performed for each batch of products.
o Examples: Setup time, batch inspection.
• Product-Level Activities:
o Activities related to specific products or product lines.
o Examples: Product design, engineering changes.
• Facility-Level Activities:
o Activities that support the entire facility.
o Examples: Facility rent, security.

Stages, Advantages, and Limitations of ABC

• Stages:
o Stage 1 - Identification of Activities: Identify all activities across
the organization that consume resources.
o Stage 2 - Allocation of Overhead Costs: Assign overhead costs to
activity cost pools based on the activities identified.
o Stage 3 - Assignment of Costs to Products: Allocate costs from
activity cost pools to products or services using appropriate cost
drivers.
• Advantages:
 o Accurate Product Costs: Provides more accurate product costs by
linking them directly to activities and cost drivers.
o Better Cost Management: Helps in better management of costs by
focusing on activities that drive costs.
o Improved Decision Making: Facilitates better decision-making by
providing insights into cost behaviors and profitability.
• Limitations:
o Complexity: Implementation can be complex and time-consuming
due to the detailed data collection and analysis required.
o Costly: Can be costly to implement and maintain, especially for
smaller organizations with limited resources.
o Subjectivity: Involves subjective judgments in selecting cost drivers
and activity cost pools.

Requirements in ABC Implementation

• Management Support: Top management commitment and support are

essential for successful implementation.
• Data Collection and Analysis: Accurate and detailed data on activities and
costs are required for effective implementation.
• Employee Involvement: Involvement and cooperation across departments
to ensure accurate identification and measurement of activities.
• Training: Training employees on ABC concepts, methodologies, and the
use of new systems or tools.

Activity Based Management (ABM)

• Definition: Extends the use of ABC beyond cost allocation to include

managing activities to improve organizational performance.
• Key Areas:
o Activity Analysis: Identifies activities that do not add value and
seeks to eliminate or reduce them.
 o Performance Measurement: Uses activity-based information to
measure performance and make improvements.
o Strategic Planning: Integrates with strategic planning to align
activities with organizational goals and objectives.

Activity Based Budgeting (ABB)

• Definition: Uses ABC information for budgeting purposes to better align

budgets with activities and strategic objectives.
• Process:
o Activity Planning: Plans activities based on strategic objectives and
resource availability.
o Resource Allocation: Allocates resources based on activity
requirements and priorities.
o Budget Formulation: Develops budgets that reflect the costs of
activities and support strategic goals.

These detailed points should provide a comprehensive understanding of Activity

Based Costing (ABC), Activity Based Management (ABM), and Activity Based
Budgeting (ABB) for your exam preparation.
Detailed Notes on "Cost Sheet"

Learning Outcomes

• Classify and ascertain cost based on function.

• Prepare cost sheets/statements for production of goods and services.

1. Introduction

• Objective: Ascertainment of cost for a cost object (product, service, or cost

center).
• Process: Collect costs element-wise, accumulate them for a certain volume
or period, and arrange into a cost sheet to calculate total cost.

2. Functional Classification of Elements of Cost

• Production/Manufacturing Cost: Costs incurred for producing goods.

• Administration Cost: Costs related to the general administration of the
entity.
• Selling Cost: Costs incurred to promote and sell the product.
• Distribution Cost: Costs incurred to deliver the product to the customer.
• Research and Development Costs: Costs related to the improvement of
products or processes.

3. Cost Heads in a Cost Sheet

• Prime Cost: Sum of direct material cost, direct employee (labor) cost, and
direct expenses.
o Direct Material Cost: Cost of materials consumed (Opening stock +
Purchases - Closing stock).
o Direct Employee (Labor) Cost: Payments to employees engaged in
production (wages, salary, overtime, benefits).
 o Direct Expenses: Other directly traceable costs (utilities, royalties,
equipment hire, technical fees).
• Cost of Production: Prime cost plus factory-related costs and overheads.
o Factory Overheads: Indirect costs related to production
(consumables, depreciation, repairs, indirect labor).
o Quality Control Cost: Resources consumed for quality control
procedures.
o R&D Cost: Costs for process/product improvement.
o Administrative Overheads (related to production): Admin costs
specific to production activities.
o Primary Packing Cost: Packing material to preserve the product.
• Cost of Goods Sold (COGS): Cost of production adjusted for opening and
closing stocks of finished goods.
o Calculation: Cost of production + Opening stock of finished goods -
Closing stock of finished goods.
• Cost of Sales: Total cost to make the product available to customers.
o Includes: COGS, administrative overheads (general), selling
overheads, secondary packing cost, distribution overheads.

4. Presentation of Cost Information

• Specimen Format for Manufacturing Entity:

1. Direct materials consumed
▪ Opening Stock of Raw Material
▪ Add: Additions/Purchases
▪ Less: Closing Stock of Raw Material
2. Direct employee (labor) cost
3. Direct expenses
4. Prime Cost (1+2+3)
5. Add: Works/Factory Overheads
6. Gross Works Cost (4+5)
 7. Add: Opening Work in Process
8. Less: Closing Work in Process
9. Works/Factory Cost (6+7-8)
10. Add: Quality Control Cost
11. Add: Research and Development Cost
12. Add: Administrative Overheads (related to production activity)
13. Less: Credit for Recoveries/Scrap/By-Products

Summary

• Prime Cost: Direct materials + Direct labor + Direct expenses

• Cost of Production: Prime cost + Factory overheads - Recoveries
• COGS: Cost of production adjusted for stock changes
• Cost of Sales: COGS + General admin, selling, packing, and distribution
costs
Cost Accounting Systems

1. Introduction

• Essential for efficient business operations.

• Two main types: Integrated and Non-Integrated Accounting Systems.
o Integrated System: Cost and financial transactions recorded in the
same set of books.
o Non-Integrated System: Separate ledgers for cost and financial
transactions.

2. Non-Integrated Accounting System

• Separate ledgers for cost and financial accounts.

• Known as the cost ledger accounting system.
• Excludes certain expenses like interest, bad debts, and non-operational
income.
• Important Ledgers:
o Cost Ledger: Principal ledger for impersonal accounts.
o Stores Ledger: Accounts for each item of stores; tracks receipt,
issue, and balance in both physical and monetary terms.
o Work-in-Process Ledger: Accounts for unfinished jobs and
processes.
o Finished Goods Ledger: Accounts for completed products or jobs.

3. Principal Accounts in Non-Integrated System

• Cost Ledger Control Account (General Ledger Adjustment Account):

Completes double entry; records all expenditures and sales.
• Stores Ledger Control Account: Records purchase and issue of materials;
indicates total balance of individual stores accounts.
 • Wages Control Account: Records total wages paid; direct wages
transferred to Work-in-Process Control Account and indirect wages to
overhead accounts.
• Overhead Control Accounts: Separate accounts for different overheads
like production, administration, and selling & distribution.

4. Integrated Accounting System

• Maintains a single set of books for both cost and financial transactions.
• No need for separate cost ledger.
• Features:
o Complete analysis of cost and sales.
o Detailed records of all payments, assets, and liabilities.
o Eliminates the need for notional accounts to represent impersonal
accounts.
• Accounts Used:
o Bank Account
o Receivables (Debtors) Account
o Payables (Creditors) Account
o Provision for Depreciation Account
o Fixed Assets Account
o Share Capital Account

5. Differences Between Integrated and Non-Integrated Systems

• Non-Integrated System:
o Requires reconciliation between financial and cost accounts.
o Uses Cost Ledger Control Account or General Ledger Adjustment
Account.
• Integrated System:
o No reconciliation needed.
o Detailed accounts for all financial transactions and assets/liabilities.
6. Benefits of Integrated Accounting System

• Less Effort: Single set of books simplifies record-keeping.

• Time-Saving: Immediate availability of information.
• Economical: Reduced costs due to streamlined processes.

7. Reconciliation in Non-Integrated System

• Necessary to ensure reliability of cost accounts.

• Reasons for differences:
o Purely financial nature (e.g., incomes and expenses).
o Notional nature (e.g., accounting estimates).

8. Example Transactions in Integrated System

• Raw Materials Purchased: Debit Raw Materials Account, Credit Bank

Account.
• Direct Materials Issued to Production: Debit Work-in-Process Account,
Credit Raw Materials Account.
• Wages Paid: Debit Wages Control Account, Credit Bank Account.
• Manufacturing Overheads: Debit Manufacturing Overhead Account,
Credit Bank Account.
• Sales: Debit Bank Account, Credit Sales Account.

Key Points for Exams

• Understand the difference between integrated and non-integrated

systems.
• Familiarize yourself with the ledgers and principal accounts used in both
systems.
• Be able to prepare journal entries for transactions in an integrated
accounting system.
• Know how to reconcile cost and financial accounts in a non-integrated
system.
1. Introduction

• Purpose:
o Present and use cost accounting information as per management
needs.
o Different methods of costing are followed to provide customized
information.
o Industries are categorized into job work and mass production
industries.
• Industry Types:
o Job Work Industries:
▪ Execute special orders, each distinguishable.
▪ Examples: Shipbuilding, road construction, manufacturing
heavy machinery, etc.
▪ Methods: Job costing, contract costing, batch costing.
o Continuous/Process Industries:
▪ Produce uniform products continuously.
▪ Examples: Chemical, pharmaceutical, food products, etc.
▪ Methods: Process costing, single output costing, operating
costing.

2. Unit Costing

• Definition:
o Method where identical output units incur identical costs.
o Also known as single/output costing.
o Suitable for industries producing single or few variants of a product.
o Formula:
▪ Cost per unit = Total Cost of Production / Number of units
produced
o Applications:
▪ Industries like paper, cement, steel, mining, breweries, etc.
3. Cost Collection Procedure in Unit Costing

• Materials Cost:
o Collected from Material Requisition notes.
o Accumulated and posted in the cost accounting system.
• Employees (Labour) Cost:
o Direct labour cost from job time cards.
o Indirect labour cost from payroll books.
• Overheads:
o Collected under standing order numbers.
o Apportioned to service and production departments.
o Applied to products on bases like machine hour, labour hour,
percentage of direct wages/materials.
• Spoiled and Defective Work:
o Normal reasons:
▪ Cost within normal limits charged to the entire output.
o Abnormal reasons:
▪ Cost treated as abnormal and written off in Costing Profit and
Loss Account.

4. Batch Costing

• Definition:
o Method for calculating costs of producing a batch of identical items.
• Economic Batch Quantity (EBQ):
o Optimal number of units in a batch minimizing total cost.
• Difference from Job Costing:
o Job costing is for specific, individual orders, while batch costing is
for groups of identical items.

Detailed Components by Sections

Unit Costing

1. Definition and Application:

o Identical products, identical costs.
o Suitable for uniform production industries.
2. Formula and Calculation:
o Divide total production cost by units produced.
3. Cost Collection:
o Materials, labour, overheads collected and posted in accounting
systems.
4. Treatment of Defects:
o Normal defects charged to all units, abnormal defects written off.

Batch Costing

1. Definition and Scope:

o Costs for producing a batch of items.
2. Economic Batch Quantity (EBQ):
o Optimal batch size for cost efficiency.
3. Comparison with Job Costing:
o Batch costing for identical items, job costing for unique items.
Chapter 9: Job Costing

Key Terms and Concepts

Job Costing

• Definition: According to CIMA London, job costing is a basic costing

method applicable to work consisting of separate contracts, jobs, or
batches authorized by specific orders or contracts.
• Purpose: To ascertain the cost of each job by considering materials, labor,
and overhead costs.
• Application: Used in industries where production is carried out in batches,
such as printing, furniture making, ship-building, and more.

Principles of Job Costing

1. Cost Analysis: Analyzing and ascertaining the cost of each production

unit.
2. Cost Control: Regulating costs to ensure efficiency.
3. Profitability Determination: Calculating the profitability of each job.

Process of Job Costing

1. Cost Sheet Preparation: A separate cost sheet for each job.

2. Materials Issuance Disclosure: Documenting the materials used for the
job.
3. Employee Costs: Recording labor costs based on bills of materials and
time cards.
4. Overhead Addition: Including overhead charges to determine the total
expenditure.

Job Cost Card/Sheet

 • Purpose: To record all expenses related to a job, including materials, labor,
and overheads.
• Format: Includes job description, reference numbers, material and labor
costs, overheads, total costs, and profitability.

Collection of Costs for a Job

1. Materials Cost: Direct materials are traced to specific jobs using stores
requisitions. Any surplus materials are returned to the stores or transferred
to another job.
2. Labor Cost: Direct labor costs are recorded using job time cards or sheets,
and idle time is also tracked.
3. Overhead Collection: Overheads are collected under appropriate cost
accounts and apportioned to service and production departments.

Treatment of Spoiled and Defective Work

• Spoiled Work: Rejected production that cannot be rectified.

• Defective Work: Production that can be rectified with additional
expenditure.
o Circumstances:
▪ Normal defects are charged to the entire batch.
▪ Excessive defects are written off as a loss.
▪ Defects due to bad workmanship are treated as abnormal
costs unless a provision is made for such defects.

Questions and Answers

1. What is job costing?

o Job costing is a method of costing where costs are collected and
accumulated according to specific jobs, contracts, or work orders to
ascertain the cost of each job.
2. What are the principles of job costing?
 o The principles include analyzing and ascertaining costs, controlling
costs, and determining profitability.
3. How are materials costs collected in job costing?
o Direct materials costs are traced to specific jobs using stores
requisitions and recorded in a materials abstract or analysis book.
4. How are labor costs collected in job costing?
o Labor costs are recorded using job time cards or sheets, with all
direct labor booked against specific jobs and idle time tracked
separately.
5. How are overheads managed in job costing?
o Overheads are collected under suitable accounts, apportioned to
service and production departments, and then applied to products
on a realistic basis.
6. What is the treatment for spoiled and defective work in job costing?
o Spoiled work is written off as a loss, while defective work is either
charged to the entire batch or treated as an abnormal cost
depending on the circumstances.
Process and Operation Costing Notes
Key Terms and Concepts

Process Costing

Definition: Process costing is a method used in industries where the material has to
pass through multiple processes to become a final product. Costs are charged to
processes and averaged over units produced. This is common in industries like steel,
paper, medicines, soaps, chemicals, rubber, vegetable oil, paints, and varnish.

Key Features:

1. Divisions into Processes: Each plant or factory is divided into processes or cost
centers.
2. Continuous Production: Manufacturing is continuous and sequential.
3. Output as Input: The output of one process becomes the input for another.
4. Homogeneous Products: End products are uniform and not distinguishable
from each other.
5. Inability to Trace Specific Units: It’s not possible to trace specific units of
output back to input materials.
6. Joint and By-Products: Production may result in joint products or by-products.

Operation Costing

Operation costing is a mix of job and process costing. It is used in industries where
products pass through different operations, such as clothing manufacturing.

Normal and Abnormal Loss

Normal Loss: The inherent loss during production due to the nature of materials or
processes. It is unavoidable and absorbed by the good units produced.
Abnormal Loss: Loss exceeding the normal loss, often due to inefficiencies or
unexpected issues. It is separately accounted for and investigated.

Equivalent Units

A method of expressing partially completed units as a number of fully completed units

to accurately assign costs.

Inter-process Profits
Profits generated when one process sells its output to the next process at a transfer
price above cost.

Costing Procedure in Process Costing

Elements of Cost in Each Process

1. Materials: Drawn against Material Requisition Notes.

2. Employee Cost (Labour): Wages paid for processing activities.
3. Direct Expenses: Costs like depreciation, repairs, maintenance, insurance.
4. Production Overheads: Indirect costs like rent, power, and utilities.

Treatment of Process Losses and Gains

1. Normal Loss: Absorbed by the cost of good units.

2. Abnormal Loss: Accounted separately and investigated.
3. Abnormal Gain: When actual loss is less than expected, credited to the process
account.

Illustration

Example:

• Process I:
o Materials: ₹1,50,000
o Labour: ₹80,000
o Other Expenses: ₹26,000
o Indirect Expenses: ₹20,000
o Total: ₹2,76,000
• Process II:
o Materials: ₹50,000
o Labour: ₹2,00,000
o Other Expenses: ₹72,000
o Indirect Expenses: ₹50,000
o Total: ₹6,48,000
• Process III:
o Materials: ₹20,000
o Labour: ₹60,000
o Other Expenses: ₹25,000
o Indirect Expenses: ₹15,000
o Total: ₹7,68,000
Questions and Answers

What is Process Costing?

Answer: Process costing is a method of costing used in industries where production is

continuous, and costs are averaged over units produced. It’s useful in industries like
chemicals, steel, and paper.

How is Normal Loss Treated in Cost Accounts?

Answer: Normal loss is absorbed by the cost of good units produced. The value from
any scrap sales is credited to the process account.

What is the Difference Between Normal and Abnormal Loss?

Answer: Normal loss is inherent and unavoidable, while abnormal loss exceeds normal
loss and is usually due to inefficiencies.

How are Equivalent Units Calculated?

Answer: Equivalent units are calculated by converting partially completed units into a
number of fully completed units to accurately assign costs.

What are Inter-process Profits?

Answer: Inter-process profits are the profits generated when one process sells its
output to the next process at a transfer price above cost.
Notes on Joint Products and By-Products
Key Terms and Concepts

Joint Products

• Definition: Joint products are two or more products that are produced
simultaneously from the same process and have significant sales value. Each
product requires further processing, and none can be designated as the main
product.
• Example: In the oil industry, gasoline, fuel oil, lubricants, paraffin, coal tar,
asphalt, and kerosene are all produced from crude petroleum.

By-Products

• Definition: By-products are secondary products that are recovered incidentally

from the material used in the manufacture of main products. They have either a
net realizable value or a usable value which is relatively insignificant compared to
the main products.
• Example: Molasses in sugar production, tar, ammonia, and benzole from coal
carbonization, and glycerin from soap manufacture.

Split-Off Point

• Definition: The point in the production process where joint products become
separately identifiable. Joint costs are incurred up to this point and need to be
allocated among the products.

Apportionment of Joint Costs

Methods of Apportionment

1. Physical Units Method

o Basis: Joint costs are apportioned based on the physical volume (weight,
numbers) of the products at the split-off point.
o Example: If a coke manufacturing company uses 5,000 tonnes of coal, the
joint cost is apportioned based on the tonnage of coke, tar, sulphate of
ammonia, and benzole produced.
2. Net Realizable Value at Split-Off Point Method
o Basis: Joint costs are apportioned based on the net realizable value of the
products at the split-off point, calculated by deducting post-split-off costs
and selling expenses from the sales value.
 o Example: If the sales value of products A and B are known, and further
processing costs are subtracted, the joint cost is divided in the ratio of the
net realizable values of A and B.
3. Market Value at the Point of Separation
o Basis: Joint costs are apportioned based on the market value of the
products at the split-off point.
o Example: If the sales revenue of products A and B is known, the joint cost
is divided in the ratio of their market values.
4. Market Value after Further Processing
o Basis: Joint costs are apportioned based on the sales value of the products
after further processing.
o Example: The joint cost is divided based on the final sales value of
products A and B after further processing.
5. Average Unit Cost Method
o Basis: Total process cost up to the point of separation is divided by the
total units of joint products produced, giving a uniform cost per unit.
o Example: If 1,000 units of products A, B, and C are produced, the average
cost per unit is the total joint cost divided by 1,000.
6. Contribution Margin Method
o Basis: Joint costs are segregated into variable and fixed costs. Variable
costs are apportioned based on units produced or physical quantities, and
fixed costs are allocated based on contribution margins.
o Example: If products are further processed, the total variable cost is
calculated and deducted from sales values to determine contributions.
Fixed costs are then allocated based on these contributions.

Treatment of By-Product Cost in Cost Accounting

Cost Accounting for By-Products

• Methods:
o By-products can be valued at their net realizable value, deducted from the
total joint cost to determine the cost of the main products.
o Alternatively, by-products can be recorded as miscellaneous income,
thereby not affecting the cost of the main products.

Questions and Answers

Potential Questions and Answers

1. Q: What are joint products?

 o A: Joint products are two or more products produced simultaneously from
the same process, each having significant sales value and requiring further
processing.
2. Q: How do joint products differ from by-products?
o A: Joint products are of equal importance and produced simultaneously,
whereas by-products are secondary products with relatively insignificant
value produced incidentally.
3. Q: What is the split-off point?
o A: The split-off point is where joint products become separately
identifiable in the production process, and joint costs incurred up to this
point need to be allocated among the products.
4. Q: How is the physical units method used to apportion joint costs?
o A: Joint costs are divided based on the physical volume of the products at
the split-off point, such as weight or numbers.
5. Q: What is the net realizable value at the split-off point method?
o A: This method allocates joint costs based on the net realizable value of
the products at the split-off point, which is the sales value minus post-
split-off costs and selling expenses.
6. Q: Why might a company use the market value at the point of separation
method?
o A: This method is useful when the market value of the products at the
split-off point is known, allowing for a fair allocation of joint costs based
on these values.
7. Q: What is the contribution margin method?
o A: Joint costs are split into variable and fixed costs. Variable costs are
allocated based on units produced or physical quantities, while fixed costs
are allocated based on contribution margins.
Key Terms and Concepts

Service Costing

Service costing, also known as operating costing, is a method of costing applied to the
service sector, which plays a significant role in the GDP of India. It involves the
calculation of costs for services like transportation, hotels, financial services, insurance,
and more.

Key Features:

• Intangibility: Services are intangible and cannot be stored.

• Cost Units: Use of composite cost units for cost measurement.
• Major Cost Elements: Employee costs often constitute a major part of the total
cost.
• Indirect Costs: High proportion of indirect costs like administration overheads.

Application of Service Costing

• Internal: For in-house services like canteens, hospitals, boiler houses, IT services,
etc.
• External: For services provided to outside customers like transport, hospitality,
financial services, etc.

Service Cost Unit and KPI

• Service Cost Unit: Cost per unit of service, which can be complex to define.
Examples include passenger-km for transport, bed-days for hospitals, etc.
• Key Performance Indicators (KPIs): Metrics used to assess the performance of
an organization, like Average Return per User (ARPU) in telecom or Cost per
Occupied Room (CPOR) in hotels.

Methods of Ascertaining Service Cost Unit

Composite Cost Unit

Combines two measurement units to know the cost of service or operation, such as
tonne-km or passenger-km.

Example Calculation:
 1. Weighted Average (Absolute) Basis: Sum of products of qualitative and
quantitative factors.
2. Simple Average (Commercial) Basis: Product of average qualitative and total
quantitative factors.

Equivalent Cost Unit

Used when different grades of services use common resources, assigning weights to
convert into equivalent units.

Example:

• Hotel Rooms: Converting different types of suites into equivalent standard suites
or luxurious suites.

Statement of Costs for Service Sectors

Components:

1. Fixed Costs or Standing Charges: Costs that remain constant regardless of

service volume (e.g., insurance, salaries).
2. Variable Costs or Operating Expenses: Costs that vary with service volume.
3. Semi-variable Costs or Maintenance Expenses: Costs that have both fixed and
variable components.

Applications of Costing Methods in Service Costing

• Job Costing: Suitable for customized services like software development.

• Process Costing: Suitable for utilities like power and water supplies.
• Joint Products Costing: Suitable for bundled services like telecom and
educational institutes.

Costing of Transport Services

Goods Transport:
 • Cost Unit: Tonne-Kilometer.
• Costs: Standing charges, running charges, maintenance, etc.

Passenger Transport:

• Cost Unit: Passenger-Kilometer.

• Costs: Similar to goods transport but focused on passenger services.

Questions and Answers

1. What is service costing?

o Service costing is a method of costing used in the service sector to
determine the cost of providing services like transport, hospitality, financial
services, etc.
2. How does service costing differ from product costing?
o Service costing deals with intangible services, uses composite cost units,
has a major component of employee costs, and significant indirect costs
compared to product costing.
3. What are composite cost units?
o Composite cost units combine two measurement units to determine the
cost of a service, such as tonne-km or passenger-km.
4. What is the importance of KPIs in service costing?
o KPIs are used to assess the performance of an organization in achieving its
goals, like ARPU in telecom or CPOR in hotels.
5. How are fixed and variable costs treated in service costing?
o Fixed costs remain constant regardless of service volume, while variable
costs vary with the level of service provided.
Chapter 13: Standard Costing
Key Terms and Concepts

1. Introduction to Standard Costing

Standard costing is a cost accounting method used for cost control and performance evaluation.
It involves setting predetermined costs (standard costs) and comparing them with actual costs to
report variances to management for corrective actions.

• Standard Cost: The planned unit cost of the product, component, or service.
• Variance: The difference between the actual cost and the standard cost.

Example: If the standard cost of producing a widget is $50, but the actual cost is $55, the
variance is $5.

2. Types of Standards

There are four main types of standards:

1. Ideal Standards: Achievable under perfect conditions with maximum efficiency. These
are often criticized for being unattainable.
2. Normal Standards: Attainable under normal operating conditions and require some
degree of forecasting.
3. Basic Standards: Long-term standards used for comparison purposes, usually not
frequently revised.
4. Current Standards: Reflect the management’s anticipation of costs for the current
period.

3. The Process of Standard Costing

The standard costing process involves:

1. Setting standards.
2. Ascertainment of actual costs.
3. Comparison of actual costs with standard costs to determine variances.
4. Investigating the reasons for variances.
5. Disposing of variances by transferring them to relevant accounts.

4. Setting-Up of Standard Cost

Standard costs are based on management’s estimation, considering historical data, current
production plans, and future conditions. They are set for:

• Direct Material Cost

 • Direct Labour Cost
• Overheads

Key Procedures for Setting Standards

Material Quantity Standards

1. Standardization of Products: Decide on products to be produced.

2. Product Study: Analyze and develop the product.
3. Specification List: Prepare a list specifying types and quantities of materials.
4. Test Runs: Conduct sample runs to ensure standards meet desired quality.

Labour Time Standards

1. Labour Specification: Define types and time based on past records.

2. Standardization of Methods: Select proper machines and methods.
3. Manufacturing Layout: Prepare an operational plan.
4. Time and Motion Study: Determine the best way to perform jobs.
5. Training and Trial: Train workers and note time spent during trials.

Overheads Standards

• Variable overheads are estimated based on direct material quantity or labour hours.
• Fixed overheads are based on budgeted production volume.

Key Procedures for Setting Price or Rate Standards

Material Price Standards

1. Consider current market conditions and trends.

2. Base on average prices, stock on hand, future orders, and minimum support prices.

Wage Rate Standards

• Determine based on time or piece rates prevailing in the industry, wage agreements, and
relevant laws.

Overhead Expense Standards

• Compute considering the level of output and other operational factors.

Advantages and Criticism of Standard Costing

• Advantages: Helps in cost control, performance evaluation, budgeting, and profitability

analysis.
 • Criticism: Can be complex to set accurate standards, may not always reflect actual
conditions, and can demotivate employees if standards are too high.

Questions and Answers

Q1: What is the purpose of standard costing?

A1: The purpose is to control costs and evaluate performance by comparing actual costs with
predetermined standards and reporting variances for corrective actions.

Q2: What are the types of standards in standard costing?

A2: The types include Ideal Standards, Normal Standards, Basic Standards, and Current
Standards.

Q3: How is a standard cost set for direct materials?

A3: It involves standardizing products, conducting product studies, preparing specification lists,
and performing test runs.

Q4: What are the steps involved in setting labour time standards?

A4: Steps include labour specification, standardization of methods, preparing manufacturing

layouts, conducting time and motion studies, and training workers.

Q5: Why might standard costing be criticized?

A5: It can be criticized for being complex, not always reflective of actual conditions, and
potentially demotivating if standards are unattainable.

Summary Points

• Standard costing helps in cost control and performance evaluation.

• It involves setting predetermined costs and comparing them with actual costs to find
variances.
• There are different types of standards, each serving different purposes and contexts.
• Setting standards requires careful consideration of historical data, current plans, and
future conditions.
• Standard costing has both advantages and criticisms, making it important to implement
thoughtfully.
Marginal Costing: Comprehensive Notes

Key Terms and Concepts

Marginal Cost

• Definition: Incremental cost of producing one additional unit of a product.

• Example: If producing 10 units costs ₹10,000 and 11 units costs ₹10,500, the
marginal cost of the 11th unit is ₹500.

Marginal Costing

• Definition: A costing system where only variable costs are included in the cost of
products, and fixed costs are treated as period costs.
• Example: Arnav Ltd. produces 10,000 units with total costs of ₹4,80,000. Variable
costs include direct materials, direct labor, and variable overheads. Fixed costs are
not included in product cost but are charged against the contribution margin.

Direct Costing

• Definition: Similar to marginal costing, but focuses on direct costs related to

production, excluding fixed costs.

Differential and Incremental Cost

• Differential Cost: Difference in costs between two production levels.

• Incremental Cost: Additional cost due to an increase in production volume.

Characteristics of Marginal Costing

1. Classification of Costs: Costs are classified into fixed and variable components.
2. Product Costs: Only variable costs are considered as product costs.
3. Inventory Valuation: Finished goods and work-in-progress are valued at variable
costs only.
4. Fixed Costs: Treated as period costs and charged to profit and loss account.
5. Pricing: Determined with reference to marginal costs and contribution margin.
6. Profitability: Evaluated based on contribution margin.
Cost-Volume-Profit (CVP) Analysis
Break-even Analysis

• Definition: Determines the level of sales at which total revenues equal total
costs, resulting in no profit or loss.
• Formula: Break-even Point (units) = Fixed Costs / (Selling Price per unit - Variable
Cost per unit)
• Example: If fixed costs are ₹1,00,000, selling price per unit is ₹50, and variable
cost per unit is ₹30, the break-even point is 5,000 units.

Margin of Safety

• Definition: The excess of actual sales over break-even sales.

• Formula: Margin of Safety = (Actual Sales - Break-even Sales) / Actual Sales

Angle of Incidence

• Definition: The angle formed by the total sales line and the total cost line at the
break-even point. A larger angle indicates higher profitability.

Contribution Ratio

• Definition: The ratio of contribution margin to sales.

• Formula: Contribution Ratio = (Sales - Variable Costs) / Sales

Short-term Decision Making

Make or Buy Decisions

• Consideration: Compare the marginal cost of manufacturing internally versus the

purchase price.

Discontinuation Decisions

• Consideration: Evaluate the contribution margin of a product to decide if it

should be discontinued.
Product Mix Decisions

• Consideration: Determine the optimal mix of products based on their

contribution margins and production constraints.

Differences between Marginal Costing and Absorption

Costing
1. Cost Inclusion:
o Marginal Costing: Only variable costs included.
o Absorption Costing: Both variable and fixed costs included.
2. Inventory Valuation:
o Marginal Costing: Valued at variable costs.
o Absorption Costing: Valued at total costs.
3. Profit Measurement:
o Marginal Costing: Profit varies with changes in sales volume.
o Absorption Costing: Profit can be influenced by changes in inventory
levels.

Potential Questions and Answers

Q1: What is the main advantage of marginal costing?

A1: Marginal costing provides a simplified pricing policy and helps in decision-making
by focusing on the variable costs, which remain constant per unit, unlike fixed costs
which vary with the volume of output.

Q2: How is the break-even point calculated?

A2: The break-even point is calculated by dividing the fixed costs by the difference
between the selling price per unit and the variable cost per unit.

Q3: What is the contribution margin?

A3: Contribution margin is the difference between sales revenue and total variable costs.
It represents the amount available to cover fixed costs and generate profit.
Q4: Why is the margin of safety important?

A4: The margin of safety indicates the level of risk associated with a business. It shows
how much sales can drop before the company reaches its break-even point.

Advantages and Limitations of Marginal Costing

Advantages

1. Simplified Pricing Policy: Easier decision-making with constant marginal costs.

2. Proper Recovery of Overheads: Avoids under or over-recovery of overheads.
3. Realistic Profit Measurement: Fixed costs are treated as period costs.
4. Production Guidance: Assists in break-even analysis for production decisions.
5. Expenditure Control: Helps in managing variable expenses.
6. Decision Making: Useful for make or buy, discontinuation, and other business
decisions.
7. Short-term Profit Planning: Aids in planning with break-even charts.

Limitations

1. Classification Difficulty: Challenges in classifying fixed and variable costs.

2. Dependence on Key Factors: Contribution alone isn't sufficient for profitability
without considering limiting factors.
3. Potential for Low Profitability: Risk of sales staff misunderstanding marginal
cost as total cost.
4. Valuation Issues: Fixed costs are excluded, which can affect overall cost accuracy.
Budgets and Budgetary Control
Key Terms and Concepts

1. Budget

• Definition: A budget is a financial or quantitative statement prepared for a

defined period, often outlining planned income, expenditure, and capital use.
• Example: A company's annual budget might include projected sales revenue,
operational costs, and capital investments.

2. Budgetary Control

• Definition: The continuous comparison of actual performance with budgeted

performance to ensure that the objectives are achieved or to provide a basis for
revising plans.
• Example: Monthly performance reviews to compare actual sales against
budgeted sales figures.

3. Forecast

• Definition: An assessment of probable future events used to prepare budgets.

• Example: Estimating next quarter's sales based on market trends.

Essentials of Budgeting ✅

Characteristics of Budgeting

1. Definite Future Period: A budget is concerned with a specific future period.

2. Written Document: A budget is a formal written plan.
3. Detailed Plan: It covers all economic activities of a business.
4. Cooperation: Requires collaboration across all departments.
5. Means to Achieve Objectives: It helps achieve business goals.
6. Continuous Process: Budgets are updated and controlled regularly.
7. Tool for Planning, Coordination, and Control: It integrates these management
functions.
8. Variety of Budgets: Different types tailored to business needs.

Objectives of Budgeting

1. Planning
 o Establishing specific targets and devising plans to achieve them.
o Example: Setting sales targets and planning marketing strategies.
2. Directing and Coordinating
o Directing business activities and ensuring all units work towards common
goals.
o Example: Coordinating production schedules with sales forecasts.
3. Controlling
o Monitoring performance, comparing it with the budget, and taking
corrective actions.
o Example: Implementing cost-control measures if expenses exceed
budgeted amounts.

Types of Budgets

1. Fixed Budget

• Prepared for a specific level of activity, not adjusted for variations.

• Example: A fixed budget for a manufacturing plant regardless of production
changes.

2. Flexible Budget

• Adjusts according to activity levels or volume changes.

• Example: Adjusting budget allocations based on actual sales volume.

Steps for Preparing a Budget

1. Define Organizational Structure: Clearly outline responsibility units.

2. Set Objectives and Targets: Establish reasonable and clear goals.
3. Communicate Objectives: Ensure everyone understands their role and targets.
4. Prepare Budgets Based on Expected Actions: Create budgets reflecting future
activities.
5. Update Budgets for Unforeseen Events: Allow flexibility for mid-term revisions.
6. Ensure Organization-wide Commitment: Engage all departments in the
budgeting process.
7. Quantify Budgets: Break down the master budget into functional budgets.
8. Monitor Budgets Periodically: Compare actual outcomes with the budget and
analyze variances.
9. Link Performance to Rewards: Connect budgetary performance with incentives.

Budgetary Control
Establishing Budgetary Control

1. Setting Budgets: Define budgets related to responsibilities.

2. Comparing Actuals with Budgets: Continuously compare to achieve targets.
3. Revising Budgets: Adjust budgets for changing circumstances.
4. Fixing Responsibility: Assign accountability for achieving budget targets.

Objectives of Budgetary Control

1. Define Business Aims: Establish clear business goals.

2. Set Performance Targets: Determine performance benchmarks.
3. Facilitate Comparison: Compare actual performance with targets.
4. Optimize Resource Use: Ensure effective use of resources.
5. Coordinate Activities: Align various business activities.
6. Encourage Forethought: Promote careful planning and assessment.
7. Revise Policies: Update current and future policies based on performance.
8. Provide Measurement Yardstick: Measure actual results against plans.

Feedback and Feedforward Control

Feedback Control

• Definition: Comparing actual results with the budget after the period ends and
taking corrective actions.
• Example: Analyzing quarterly sales data to adjust future sales strategies.

Feedforward Control

• Definition: Continuously monitoring actual results during the budget period and
making adjustments as needed.
• Example: Real-time tracking of production costs to prevent budget overruns.

Budget Committee and Budget Officer

Roles and Responsibilities

• Budget Committee: Comprises representatives from various functions to ensure

coordinated budgeting.
• Budget Officer: Supervises the preparation, implementation, and monitoring of
budgets.

Advantages of Budgetary Control System

 1. Efficiency: Enhances the efficient conduct of business activities.
2. Expenditure Control: Provides a powerful tool for controlling expenditures.
3. Deviation Identification: Highlights deviations from the budget for corrective
action.
4. Resource Utilization: Ensures effective use of resources like manpower,
materials, machinery, and money.
5. Plan Revision: Helps in reviewing current trends and framing future policies.

Questions and Answers ❓

1. What is the primary purpose of budgeting?

o To plan, direct, and control financial and operational activities to achieve
business objectives.
2. How does budgetary control help in achieving business goals?
o By continuously comparing actual performance with budgeted
performance and taking corrective actions to stay on track.
3. What are the main characteristics of a budget?
o A definite future period, a written document, a detailed plan, requires
cooperation, a means to achieve objectives, a continuous process, aids in
planning, coordination, and control, and varies by business needs.
4. What is the difference between fixed and flexible budgets?
o A fixed budget does not adjust for activity levels, while a flexible budget
adjusts according to changes in activity or volume.
5. What are the steps for preparing a budget?
o Define organizational structure, set objectives and targets, communicate
objectives, prepare budgets based on expected actions, update budgets
for unforeseen events, ensure organization-wide commitment, quantify
budgets, monitor periodically, and link performance to rewards.