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Reference Books

 Cost Management : Ravi M. Kishore


 Cost Management – A Strategic
Emphasis: Bolcher, Chen/Lin
 Cost Management : Jawahar Lal
 Cost Accounting: Khan & Jain
COST MANAGEMENT
INFORMATION
Cost management information is
required for major management
functions:
 Strategic management
 Planning and decision making
 Management and Operational
Control
 Preparation of Financial statements
A Manager Quoted in Cost
Accounting Desk Reference
by Dudick, Best and Kraus
“When I first took over as General Manager,
I Asked the cost accountant for some cost
information. What I received was several
computer output reports containing
unanalyzed raw data. There as no question
about the accuracy of the numbers, but
what surprised me was how unfamiliar this
individual was with the manufacturing
process for making the products. He had
difficulty in associating the figures
contained in the reports with the factory
operations behind the figures”
STRATEGIC MANAGEMET

 A strategy is a set of goals and


specific action plan which if
achieved will provide the desired
competitive advantage.

 Strategic Management involves


identification and
implementation of these goals
and action plan.
Strategic Cost
Management
 SCM is the development of cost
management information to facilitate
the principal management function,
strategic management
COST

 Amount of expenditure actual or


notional relating to cost object.

 Fixed Cost
Variable cost
COST FOR DECISION MAKING

OPPORTUNITY COST-
An opportunity cost is the benefit
given up or sacrificed when one
alternative is chosen over another.
They are not recorded in the
accounting system as they are not
based on the past payment or
commitments to pay in future.
 SUNK COST:
A cost that has already been incurred. It
is a past or committed cost which is gone
for forever. It’s a historical cost.
 RELEVANT COST: Cost which differs
between alternatives. Cost which
may also be defined as the costs
which are affected and changed by
the decision.
 DIFFRENTIAL COST:
It is the difference in total cost
between any two alternatives. It is
the only difference in amount of two
cost.
 SHUT DOWN COST:
Cost which have to be incurred under
all situations in the case of stopping
manufacture of a product or closing
down a department or a division.
 CONTROLLABLE &NON
CONTROLLABLE COST:
A cost which can be influenced by
the action of a specified member of
an undertaking
(Controllable cost) A cost which
cannot be influenced by the action of
a specified member of an
undertaking ( Non controllable)
MARGINAL COSTING

According to Institute of Cost


&Management Accountants London
Marginal Cost represents “the
amount of any given volume of
output by which aggregate costs are
changed if the volume of output is
increased by one unit”
For example:

 Cost of production of 1000 units


=Rs.200,000
 Cost of production for 1001
units=Rs.200,150
 difference= Rs. 150 (Marginal Cost)
 Decipher this one:

7 I of I
 Hint
 There are also seven books in the
set.
 Answer
 7 Incarnations of Immortality
 Every now and then you cut my head
Yet I don't complain but obey instead

I am a way for your thoughts and


feelings to be spread
Despite the fact that I am totally dead

A double edged weapon that is easily


lead
So don't always believe me: use your
head
 Answer
 The pencil.

Cut my head: by sharpening


Obey instead: write whatever you want
Way for your thoughts and feelings to be
spread: by expressing them through writing
 Can you decipher this phrase?

ch poorri

 
 Hint
 Think Robin Hood.
 Answer
 Take from the rich and give to the
poor.
 What phrase is shown below?

The Hamburgler Horse Rustlers


Bonnie & Clyde Honor Ali Baba
The Great Train Robbers Billy the Kid
 Answer
 Honour amongst thieves
MARGINAL COSTING

According to Institute of Cost


&Management Accountants London
Marginal Cost represents “the
amount of any given volume of
output by which aggregate costs are
changed if the volume of output is
increased by one unit”
ASSUMPTIONS:

 Elements of Cost: Production,


Administration and Selling Expenses are
divided into fixed and variable cost
 Variable cost fluctuates directly in
proportion to changes in volume of
output.
 Selling price remains constant
 Fixed cost remains constant
 Volume of production Influences cost
 Volume cost are regarded as cost of the
products.
Break Even Analysis/Cost
Volume Profit Analysis
 According to Herman C. Heiser “ The
most important single factor in profit
planning of Average business is the
relationship between volume of
business, cost & profit”
CVP Analysis

 Two aspects:
 Broad Aspect: Study of Relationship
between CVP
 Narrow Aspect: Technique of
determining level of operations
where Total Revenue=Total Expense
MAJOR CONCEPTS FOR BREAK
EVEN ANALYSIS
 CONTRIBUTION: Contribution is the
excess of selling price over variable
cost is the amount contributed
towards fixed expenses and profit.
 Contribution= Sales-variable cost
 Example: Selling Price: Rs.20 per unit
 Variable Cost : Rs 15 per unit
Contribution Rs. 5 per Unit
For Example:
 Fixed Expenses : Rs 50,000
 Total units Sold : 8000 units
 Total Contribution : 8000*5= 40,000(in
contin)( not sufficient to meet Fixed
Expenses)
 If increase total output by 10,000 units,
total contribution 50,000 ( No profit No
loss)
 Any output beyond 10,000 Units will give
profits ( total output increased by 15000
units, total contribution 75,000)
 Contribution = sales – variable cost
 Contribution = fixed cost +/- profit (loss)
 Contribution per unit= selling price – variable cost per
unit
 We can derive marginal costing equation:

 Sales-variable cost= contribution
 Sales- variable cost= fixed cost +/- profit
 In case three factors known fourth factor can be
known:
 Example: sales: 2,40,000/-
 Profit : 50,000/-
 Direct material : 80,000/-
 Direct labor : 50,000/-
 Variable overheads : 20,000
 Variable cost: 1,50,000
 Sales – Variable Cost = Fixed Cost +/- Profit
 2,40,000-1,50,000 -50,000 = 40,000
 Fixed Cost = 40,000
 Profit/ Volume Ratio (contribution
Ratio)
P/V ratio = Contribution/ sales
= sales- variable cost / sales
= Fixed Cost +/- Profit (loss) / sales
= Change in profit or contribution /
change in sales
This can be shown in the form of
percentage by multiplying by100.
Example: selling price = 15/-
Variable cost = 10/-
 P/V ratio = 15-10/15 = 1/3*100 = 33 1/3%
 It establishes relationship between
contribution and sales:
 High P/V ratio reflects high profit
 Low P/V ration reflects low profit
 Ratio can be increased by increasing
contribution:
 Increasing selling price per unit
 Reducing variable cost per unit
 Switching the production to more
profitable products.
 For example:
 Sales: 100,000/-
 Profit: 10,000/-
 Variable Cost =70%
 Calculate PV ratio, Fixed Cost, Sales volume to
earn profit of 40,000/-
 70% *100,000 = 70,000
 P/V Ratio= 100,000-70,000 / 100,000 *100 =
30%
 Contribution = Fixed Cost +/- Profit (loss)
 30,000 = Fixed Cost + 10,000
 Fixed Cost = 20,000
 Sales volume required to earn given profit : FC
+ Profit / pv ratio
 20,000+40,000 /30% = 60,000 /30% = 200,000
 BREAK EVEN POINT
 It is defined as that point of sales volume at which
total revenue is equal to total cost. (No profit No loss)
 Sales revenue at B.E.P. = fixed cost + variable Cost
 Algebraic form
 Break even point in units = Fixed Cost / Contribution
per unit
 Break Even point in terms of money value =
 Total sales= TFC = TVC
 S= F+ VC
 S-VC =FC
 Dividing by S-VC
 S-VC / S-VC = FC / S-VC
 1= FC / S-VC (multiplying by S)
 S= (FC / S-VC )*S
 break Even point as percentage of estimated
capacity:
 Fixed Cost / total contribution
 For Example: Output : 3000 units
 Selling price per unit : Rs. 30/-
 Variable cost per unit : Rs. 20/-
 Total fixed cost : Rs 20,000/-
 Calculate B.E.P. in units and Sales value
 B.E.P. (units) 20,000/ 30-20 = 2000 units
 Sales = FC*S / S-VC = 20,000* 90,000 / 90,000-
60,000 = 60,000
 Margin Of Safety: Excess of actual
sales over break even sales is known
as Margin of safety.
 MOS : Total sales – Sales at B.E.P.
 Angle of Incidence

 Angle between sales line and total cost line


formed at B.E.P. where sales line and total
cost line intersect each other. AOI indicates
the profit earning capacity of business.
 AOI and MOS indicate the soundness of
business.
MANGERIAL DECISION
 PRICING DECISION:
◦ Under normal conditions prices are based on total cost of
sales so as to cover both fixed and variable cost and to
certain extent profit.
◦ Other circumstances like stiff competition, exploring
new markets etc. Products are sold at price below total
cost.
◦ During depression prices can be reduced to an extent
which covers the variable cost and contribute something
towards fixed cost.
◦ Accepting bulk order and exploring foreign markets is
generally made to utilize the idle capacity. The order
from the local merchants should not be accepted at a
below normal price it affects the relationship of the
concern with the other customers. In case of foreign
markets goods may be sold at prices below normal price.
 Operate or shutdown cost:
Differential cost analysis is used
when the business is confronted
with the possibility of temporary
shutdown.. This type of analysis has
to determine whether in the short
run a firm is better off operating than
not operating.
 For Example: an analysis of a possible
temporary shutdown ,assume that company
operating below 50% of its capacity expects that
the volume of sales will drop below the present
level of 10,000 units per month. Management is
concerned that further drop in sales volume will
create a loss and has under consideration, a
recommendation that operation be suspended
until better market condition prevail and also a
better selling price available. The present
operating statement:
 Sales revenue (10,000 units @30/-)
300,000
 Less variable cost@20 per unit
200,000
 Fixed cost
100,000
 (fixed cost at shut down is 40,000/-)
 Net Income :
0
 Make or Buy decision: the clear distinction
must be made between fixed cost and
variable cost. The variable cost must be
compared with the purchase price of the
product available in the market. If
variable cost is less than the purchase
price it’s preferred to make the product
and if the variable price is more than the
purchase rice its preferred to buy the
product.
 For Example:: A machine manufactures
10,000 units of a part at a total cost of Rs21 of
which Rs 18 is variable. This part is readily
available in market at Rs 19 per unit. If the
part is purchased from the market then the
machine can either be utilized to manufacture
a component in same quantity contributing
Rs2 per component or it can be hired out at
Rs21000
 Key or Limiting Factor: Factor which
puts limit on production and profits
of business generally it is sales.
Production can be limited due to
shortage of material, labor, and plant
capacity.
 Example: If there is a limited
material which is used on two
products X and Y. 3 units used for X
and 5units of Y. Contribution per unit
is 12 for X and 15 for Y. X gives
contribution (12/3) 4 per unit and Y
gives contribution(15/5) 3 per unit. X
makes more contribution per unit.
 Selection of suitable product or sales
mix: Best product mix which yield
maximum contribution should be
retained and production should be
increased. This can be done by
comparing the PV ratio and break
even point of various alternatives.
 Effect of changes in sales price:
Change in sales price effect the
profitability of the concern.
 Example: Sales:60,000 per unit
 Variable Cost : 30,000 per unit
 Fixed Cost: 15,000
 Calculate: a) pv ratio, BEP, MOS
 b) effect of 10% increase in sales
 c) 10% decrease in sales price.
 a) PV Ratio: 50%
 BEP: Fixed Cost / PV Ratio = 30,000
 MOS: present sales- Sales at BEP=30,000
 b) Sales= 60,000+10% = 66,000
 PV Ratio = 54.55%
 BEP = 27,500
 MOS = 38500
 Sales= 60,000-10% = 54,000
 PV Ratio: 44.4%
 BEP = 33,750
 MOS = 20,250
 Alternative Methods of Production :
Employing machine 1 or Machine 2, if
to choose among them marginal
costing technique can be applied
highest contribution can be adopted
keeping in view limiting factor.
 Determine the optimum level of
activity. To determine this activity
contribution at different levels of
activity can be found.