Sleeping Capsule New Edition

Preface
Dear Students,
Its a general rule that no matter how well you are prepared for the exam, you
will definitely have sleepless nights wandering about the completion of your
course. The tough time is when you still cant make out what to do when you
are sleepy as well as you want to study.
To bring out productiveness in that time, a capsule or a question from this
compilation in those moments will utilize that spare time and will help you to
score some marks for your exam.
This theory compilation is an honest endeavour to cover past fifteen years
examination theory questions of CA Final and CMA Final examination (Latest syllabus) in the form of capsules. It also includes the questions which had
been asked in Revision Test Papers of ICAI and ICMAI as well as latest CaseStudy based questions that may peep in future examinations. All you have to
do is start reading these questions and make a note of points in each question. Wherever it is possible and relevant you must substantiate the explanations with suitable examples and illustrations while writing your answer in
exam.
This compilation will help you to attempt and score at least twenty percent of
your examination question paper.
Make sure that you do not leave the reading of this material for the day before your exam. Give appropriate time in your schedule for these questions
as well. A few marks which you can score from these can change your entire
score and thereby your career.
A kind suggestion is given to you that this material should not be read in isolation and your class notes of the subject should always be referred for better
understanding.
Have fun!
With Best Wishes,
Satish Jalan, ACA, CS, CIMA (ADMA)
Email id: satishjalan@sjc.co.in
Copyright: Satish Jalan Classes
Contents
Chapter Name
Basic Cost Concepts
Chapter
1.
2.
3.
Chapter
Chapter
Chapter
Page No
1
Activity Based Costing
13
Budgeting, Performance Measurement and

Theory of Constraints
24
4.
Relevant Costing, Marginal Costing and Decision

Making
41
Chapter
5.
TQM, Value Chain Analysis and Business Process

Reengineering
55
Chapter
6.
7.
8.
9.
10.
11.
12.
Pricing Decision and Pareto Analysis
69
Service Sector
80
Standard Costing
83
Target and Life Cycle Costing
92
Chapter
Chapter
Chapter
Chapter
Chapter
Chapter
Transfer Pricing
104
MRP, MRP-II, ERP and JIT
110
Quantitative Techniques (QT)
122
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Basic Cost Concepts
Chapter 1|
Basic Cost Concepts
18 Capsules
Distinguish between Marginal cost and Differential Cost.

[May 1999]
Answer
Marginal cost represents the increase or decrease in total cost which
occurs with a small change in output say, a unit of output. In Cost Accounting variable costs represent marginal cost.
Differential cost is the change (increase or decrease) in the total cost
(variable as well as fixed) due to change in the level of activity, technology or production process or method of production.
The main point which distinguishes marginal cost and differential is that
in the case of differential cost variable as well as fixed cost. i.e. both
costs change due to change in the level of activity, whereas under marginal costing only variable cost changes due to change in the level of
activity.
2
Write short notes on Period Costs and Product Costs. Why should product cost be computed?
[May 1999]
Answer
Period Costs are costs which are not assigned to the products but are
charged against the revenue of the period in which they are incurred.
Under absorption costing, Non-manufacturing costs like Selling and Distribution costs are recognized as period costs. These costs are not included in inventory valuation.
Product costs are costs which are assigned to the product and are included in inventory valuation. These are also called as Inventoriable
costs. Under absorption costing, all manufacturing costs are recognized
as product costs.
The purpose of computing product costs are as under:
(a) Preparation of financial statements with focus on inventory valuation.
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Satish Jalan Classes
(b) Pricing of product

(c) Cost plus contracts with government agencies where the focus is
on reimbursement of costs specifically assigned to the particular
job or contract.
3
Explain the concept of discretionary costs. Give three examples.

[Nov 1999]
Answer
Discretionary costs can be explained with the help of following two
important features:
(i)
They arise from periodic (usually yearly) decisions regarding the

maximum outlay to be incurred.
(ii) They are not tied to a clear cause and effect relationship between
inputs and outputs.
Examples of discretionary costs includes: advertising, public relations,
executive training, teaching, research, health care and management
consulting services. The note worthy feature of discretionary costs is
that mangers are seldom confident that the correct amounts are being spent.
4
Discuss, how control may be exercised over discretionary costs.

[Nov 1999]
Answer
To control discretionary costs control points/parameters may be established. But these points need to be devised individually. For research
and development function to control discretionary costs, dates may be
established for submitting major reports to management. For advertising and sales promotion, such costs may be controlled by pre-setting
targets. In the case of employees benefits, discretionary costs may be
controlled by calling a meeting of employees union and making them
aware that the company would meet only the fixed costs and the variable costs should be met by them.
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Basic Cost Concepts

5
Distinguish between Committed and Discretionary Fixed Costs.

[May 1996, May 1999]
Answer
Committed Fixed Costs
Discretionary Fixed Costs
These are costs that arise from the

possession of plant, building, equipment (e.g. depreciation, rent, insurance, etc) or a basic organization
(e.g. salaries of staff)
These are incurred as a result of

managements discretion and is not
tied to a clear cause and effect relationship between inputs and outputs.
These are unavoidable in nature.
These are avoidable in nature.
It remains fixed from year to year.
It changes from year to year without

disturbing the long term objectives.
Pick out from each of the following items, costs that can be classified
under committed fixed costs or discretionary fixed costs.
(a) Annual increase of salary and wages of administrative staff by 5%
as per agreement.
(b) New advertisement for existing products is recommended by the
Marketing Department for achieving sales quantities that were
budgeted or at the beginning of the year.
(c) Rents paid for the factory premises for the past 6 months and the
rents payable for the next six months. Production is going on in
the factory.
(d) Research costs on a product that has reached maturity phase in
its life cycle and the research costs which may be needed on introducing a cheaper substitute into the market for facing competition.
(e) Legal consultancy fees payable for patent rights on a new product. Patent rights have been applied for.
Answer
(a)
(b)
(c)
(d)
(e)
Committed
Discretionary
Committed
Discretionary
Committed
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What do you understand by opportunity cost? Comment on the use of

opportunity cost for the purpose of:
(i) decision-making and
(ii) cost control
[May 2001]
Answer
Opportunity cost is the value of benefit sacrificed in favour of an alternative course of action. In other words, it is the revenue foregone by
not making the best alternative use. These are also called as Imputed or
Hypothetical or Implicit Costs.
These costs are never incorporated into formal accounting systems because they do not incorporate cash receipts or cash outflows.
They are very relevant while examining alternative proposals or objects.
For instance, when deciding whether or not to allocate to a project it
is highly desirable to consider if the money could produce a better or
worse return if invested elsewhere.
If there are more than one alternative then opportunity cost is the maximum of benefits foregone.
(i)
Decision making Opportunity costs apply to the use of scarce resources, where resources are not secure, there is no sacrifice from
the use of these resources. Where a course of action requires the
use of scarce resources, it is necessary to incorporate the lost profit which will be foregone from using scarce resources.
If resources have no alternative use only the additional cash flow
resulting from the course of action should be included in decision
making as relevant cost.
(ii) Cost control The conventional variance analysis will report an
adverse usage variance and adverse sales volume variance. However, the failure to achieve the budgeted optimum level of output
may be due to inefficient usage of scarce resources. The foregone
contribution should therefore be charged to the manger responsible for controlling the usage of scarce resources and not to the
sales manager because the failure to achieve the budgeted sales
is due to the failure to use scarce resources efficiently.
Thus if resources are scarce, the usage variance should reflect the
acquisition cost plus budgeted contribution per unit of the scarce
resources. If the lost sales is made good in subsequent periods, the
real opportunity cost will consists of lost interest arising from delay
in receiving the net cash-flows and not the foregone contribution.
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Basic Cost Concepts

8
State three applications of direct costing.

[May 2001]
Answer
Three applications of direct costing are as follows:
(a) Stock valuation
(b) Minimum quantity to be produced to recover pattern or mould
cost,
(c) Close down decisions like closing down of a department or shop.
9
How has the composition of manufacturing costs changed during recent years? How has this change affected the design of cost accounting
systems?
Answer
Traditionally, manufacturing companies classified the manufacturing
costs to be allocated to the products into (a) direct materials. (b) direct
labour and (c) indirect manufacturing costs. In the present day context,
characterised by intensive global competition, large scale automation of
manufacturing process, computerization and product diversification to
cater to the changing consumer tastes and preferences has forced companies to refine their costing systems to provide better measurement of
the overhead costs used by different cost objects.
Accordingly, manufacturing costs are classified in to three broad categories as under:
(i)
Direct cost As many total costs relating to cost objects as feasible

are classified into direct cost. The objective is to trace as many
costs as possible in to direct and to reduce the amount of costs
classified into indirect because the greater the proportion of direct costs the greater the accuracy of the cost system.
(ii) Indirect cost pools Increase the number of indirect cost pools so
that each of these pools is more homogeneous. In a homogeneous cost pool, all the costs will have the same cause-and-effect
relationship with the cost allocation base.
(iii) Use cost-and-effect criterion for identifying the cost allocation
base for each indirect cost pool The change in the classification
of manufacturing costs as above has lead to the development of
Activity Based Costing (ABC). Activity Based Costing refines a costing system by focusing on individual activities as the fundamental
cost objects. An activity is an event, task or unit of work with a
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specified purpose as for example, designing, set up, etc. ABC system calculates the costs of individual activities and assigns costs to
cost objects such as products or services on the basis of the activities consumed to produce the product or provide the service.
10
Cost may be classified in a variety of ways according to their nature

and the information needs of the management. Explain
[Nov 1996, Nov 1997, RTP, May 1997]
Answer
The classification of cost is as under:
i.
ii.
iii.
iv.
v.
vi.
11
By Element: Material, Labour and Overhead.

By Cost Centre: Direct and Indirect.
By Behaviour: Fixed, Variable and Semi Variable.
By Function: Production, Administration, Research and Development, Selling and Distribution.
By Controllability: Controllable and Non Controllable.
By Normality: Normal and Abnormal.
Distinguish between cost reduction and cost control.

[RTP, Nov 2001]
Answer
Particulars
Cost Reduction
Cost Control
1. Permanence Permanent, Real and genu- Could be a temporary savine savings in cost
ing also
2. Nature of
Saving
Saving in Cost per unit
Saving either in Total Cost

or Cost per unit
3. Nature of
process
If presumes the existence

of concerned potential savings in norms or standards
and therefore it is a corrective process.
It does not focus on costs

independent of revenue
nor considers product attributes as given. It is a
wholistic control process.
4. Performance It is not concerned with

Evaluation
maintenance of performance according to standards.
The process involves setting up a target, investigating variances and taking remedial measures to correct
them.
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Basic Cost Concepts

5. Nature of
standards
Continuous process of critical examination, includes

analysis and challenge of
standards.
Control is achieved through

compliance with standards. Standards by themselves are not examined.
6. Dynamism
Fully dynamic approach.
Lacks dynamism when

compared to cost reduction.
7. Coverage
Universally applicable to all

areas of business. Does not
depend upon standards,
though target amounts
may be set.
Limited applicability to
those items of cost for
which standards can be
set.
8. Nature of
Costs
Emphasis here is partly on Emphasis on present and

present costs and largely past behaviour of costs.
on future costs.
9. Analysis
To find out substitute ways Competitive analysis of

and new means.
actual results with established norms.
10. Nature of
Function
Corrective
Action-oper- Preventive Function
ates even when efficient Costs are optimized before
cost control systems exist. they are incurred.
There is room for reduction
in the achieved costs.
11. Tools and

Techniques
Value Engineering. Work Budgetary Control

Study, Standardisation and Standard Costing.
Simplification, Variety Reduction.
Quality Measurement and
Research, Operations Research,
Market Research, Job Evaluation and Merit Rating
Improvement in Design,
Mechanisation and Automation.
and
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12
Distinguish between cost reduction and cost management.

[May 2002]
Answer
Particulars
Cost Reduction
Cost Management
Meaning
It is the permanent reduction in the unit cost of

goods or services without
affecting their quality or
suitability for their intended use.
It is a system that establishes

linkages between costs and
revenues and relates them
with the product to maximize
Firms profits.
Objective
Critical examination of Optimal utilization of resourceach aspect of business es to enhance the operating
and their analysis and re- income of the business entity.
view to improve the efficiency and effectiveness so
as to reduce costs through
techniques of value Analysis. Work study, standardisation etc.
Nature of
process
It presumes the existence

of concealed potential savings in norms or standards
and therefore it is a corrective process.
13
It does not focus on costs independent of revenue nor

considers product attributes
as given. It is a wholisti control
process.
State various approaches for cost reduction.

Answer
The possibilities of reducing the cost of a product in the applications
of cost reduction methods. The lines of approach in laying out a cost
reduction plan are suggested below:
(a) Product Design:- Cost reduction starts with the design of the product. Product design being first step in manufacturing of a product,
the impact of any economy or cost reduction effected their stage
will be felt through out the manufacturing life of the product. Design is therefore the most important field where cost reduction
may be attempted.
Efficient designing for a new product or improving the design for
an existing product, reduces cost in the following manner:-
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Basic Cost Concepts

(i)
Material Cost :- Cheaper substitute, higher yield and less

quantity and varieties of materials, cause reduction in cost.
(ii) Labour Cost :- Reduced time of operation and increased productivity reduce cost.
(iii) Cost of jigs, tools and fixtures are to minimized.
(iv) Standardisation and simplification in variety increases productivity and reduces costs.
(b) Organisation :- It is not possible to measure the extent of cost
reduction resulting from an improvement in organisation nevertheless, economies are bound to be achieved if the following considerations are looked into :(i) Definition of each function and responsibility.
(ii) Proper assignment of task and delegation of responsibility to
avoid overlapping
(iii) A suitable channel of communication between various management level.
(iv) Co-operation and closed relationship between the various
executives.
(v) Removal of doubts and fiction.
(vi) Encouragement to employees for cost reduction suggestion.
(c) Factory Lay Out Equipment :A cost reduction programme should study the factory layout and
the utilization of the existing equipment to determine whether
there is any scope of cost reduction by elimination of wastage of
men, materials and maximum utilization of the facilities available.
The necessity for replacement of Plants, introduction of new techniques or expansion of facilities should be considered and various
alternative explored with a view to reducing costs.
(d) Production Plan Programme and Method:Production control ensures proper planning of work by installing
and efficient procedure and programme ordering correct machine
and proper utilization of materials, manpower and resources so
that there is no waste of time and money due to wait for components, men, material etc. An efficient cost reduction programme
should examine the following points relating to production control.
(i) Whether wastage of manpower and material is kept to the
minimum
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(ii) Whether there is any scope for reducing idle capacity.

(iii) Whether the procedures for the control of stores and maintenance services are efficient.
(iv) Whether labour wastage may be reduced and productivity
increased by eliminating faulty production method, plant
layout and designs or introducing incentive schemes.
(v) Whether there is scope for reduction of over head, whether
a budgetary control system is in operation to ensure the control over overhead costs.
14
What are the requisites of an effective information system?

[Nov 1993]
Answer
The essential requisites of an effective information system are :
(i)
(ii)
(iii)
(iv)
(v)
15
Design Any information system should be properly designed after ascertaining the information requirements of different levels o
management and managed by professionally trained persons.
Database An information system should maintain a database
and store all types of information required for taking a variety of
decisions.
Support The system must receive support from all levels of management otherwise it will loose its value to the end users.
Flexibility It should be flexible to meet the changing information
requirements of its executives.
Reporting An information system should be supported with an
effective reporting system which should be timely, accurate, economical and in proper format.
What are the key attributes of Operational Database?

[May 2003]
Answer
Operational activities require full details about the transactions involved. Operational databases satisfy the requirements of data for day
to day operations as opposed to decision making. The attributes of operational databases for operational activities are:
(i)
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Consistency Consistent information ensures greater validity.

Information from different sources about the same transactions
should tend to confirm and support the other.
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Basic Cost Concepts

(ii) Timeliness An information is always more useful when they are
provided on a real time basis to operations as well as to managers.
(iii) Backup detail and Inquiry Capability In an operational database, if the detailed back up data is retained within an online database that has a query language, the details needed can usually
be accessed rapidly through the window provided by the database
query language.
(iv) Data sharing Sharing of data satisfies the need of multiple users
in an organization.
16
A large company makes a variety of tools for use in the course of manufacture of its products and also repairs them during the course of
manufacture of its products. Discuss the treatment of costs of tools in
pricing of the companys products and outline the procedure to control
such costs.
[RTP]
Answer
The accounting treatment of various type of tools are:
(i)
Special Purpose tools the entire cost including its repair cost is
charged to the job for which it is made.
(ii) Tools for Standard Production The life of such tools are determined in terms of hours or units of output and charged to jobs
accordingly.
The repair cost of such tools shall be charged on the same basis.
Procedure to Control Costs:
(i) A plan should be devised for classification of all tools.
(ii) The location of each tool or set of tools may be determined so that
their movement can be tracked and also the inventory thereof can
be taken at periodical intervals.
(iii) Maintain proper documentation of issue of tools to any department or a job.
(iv) Analysis of hours for which tools have been used during a period
should be made at regular intervals.
(v) Depreciation of tools should be computed and charged to the jobs
on an equitable basis.
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17
What is a Responsibility Center? What are its types?

[RTP, Nov 1994, May 1998]
Answer
It is an activity centre of a business organization entrusted with a special task. It is a unit of function of a business organization headed by an
executive responsible for its performance.
Types of Responsibility Centers:
(1) Cost Centre A Centre for which a standard amount of cost is
predetermined and used for control whose primary responsibility
is cost reduction and cost control.
(2) Revenue Centre A centre devoted to raising revenue only whose
duty is to look after the task of generating sales revenue.
(3) Profit Centre A centre whose performance is measured in terms
of income earned and cost incurred i.e. profit earning.
(4) Investment Centre A centre responsible for earning profits and
also for asset utilization.
18
What are the requisites for the installation of uniform costing?

Answer
The essential requisites for the installation of uniform costing are as under:
(i)
(ii)
(iii)
(iv)
(v)
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The firms in the industry should be willing to share / furnish relevant data or information.
A spirit of cooperation and mutual trust should prevail among the
participating firms.
Mutual exchange of ideas, methods used, special achievement
made, research and know how etc. should be frequent.
Bigger firms should take the lead towards sharing their experience
and know how with the smaller firm to enable the latter to improve their performance.
In case of accounting methods, principles, procedure and production method uniformity must be established.
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Chapter 2|
15 Capsules
What is activity based costing?

[May 2000]
Answer
It focuses on activities as the fundamental cost objects and uses the
costs of these activities as building blocks for compiling the costs of
other objects.
According to CIMA, it is defined as Cost attribution to cost units on
the basis of benefits received from indirect activities i.e. ordering,
setting-up, assuring quality etc. Under activity based costing costs are
accumulated for each activity as a separate cost object.
The collected costs are applied to products based on the benefits
received from various activities. The final product costs are built up
from the costs of the specific activities undergone. In the first stage the
activity driven overhead cost is charged to activity based cost pools and
in the second stage cost driver based rates are derived to charge cost to
product lines. The cost driver based rates are based on activities.
Activities based costing can be used for:
(a) Pricing of products;
(b) Design and development of new products.
2
Write short note on Emergence of ABC Systems.

Answer
During the 1950s the limitations of traditional product costing systems
i.e., Absorption costing was widely publicized. This system was designed
decades ago (in 1907-08) when (i)
Most companies manufactured a narrow range of products or

single product,
(ii) Direct Labour and materials were the dominant factory costs.
(iii) Overhead costs were relatively small, ( Direct Expenses : Overhead
= 100:20)
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(iv) The distortions arising from inappropriate overhead allocations

were not significant.
(v) Information processing costs were high.
It was therefore difficult to justify more sophisticated overhead allocation methods.
But present scenarios are:
(i) Companies produce a wide range of products
(ii) Direct labour represents only a small fraction of total costs, and
(iii) Overhead costs are of considerable importance (Direct Expenses :
Overhead = 1: 8)
Simplistic overhead allocations using a declining direct labour base cannot be justified, particularly when information processing costs are no
longer a barrier to introducing more sophisticated cost systems.
This is why in 1960s a committee is formed under the chair man of Mr.
Kaplan which identified the cause & effect relationship of ABC costing.
It was first introduced in Reckitt & Colman and then it was slowly accepted by the other companies.
3
Enumerate the steps to be followed in ABC.

Answer
STEP 1: Identify the chosen Cost Objects (product, service or customer)
STEP 2: Identify the Direct Costs i.e. Prime cost of the Products, service
or customer.
STEP 3: Select the Activity Bases or Cost Driver.
STEP 4: Identify the costs associated with each Activity i.e. cost pool.
STEP 5: Compute the Rate per cost driver.
STEP 6: Compute the Indirect Costs of the Products = Activity for the
product x Rate per driver
STEP 7: Compute the Total Costs of the Products.
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4
What are the benefits and weakness of ABC?

Answer
ABC is more expensive than the traditional system. So a cost-benefit
analysis is desirable.
Benefits:
a.
b.
c.
d.
e.
In ABC managers focus attention on activities rather than products

because activities in various departments may be combined and
costs of similar activities ascertained e.g. quality control, handling
of materials, repairs to machines, etc.
Because costs are identified with activities and then allocated to
products or services, based on appropriate cost drivers, more accurate product/service costs result.
Managers manage activities and not products. Change in activities
lead to changes in costs. Therefore, if the activities are managed
well, costs will fall and resulting products will be more competitive.
To manage activities better and to make wiser economic decisions,
managers need to identify the relationships of causes (activities)
and effects (costs) in a more detailed and accurate manner. ABC
focuses on this aspect.
ABC highlights problem areas that deserve managements attention and more detailed analysis. The ABC systems are useful in
setting priorities for managerial attention and action.
Limitations:
a.
b.
c.
d.
e.
ABC fails to encourage managers to think about changing work

processes to make business more competitive.
ABC does not conform to generally accepted accounting principles
in some areas.
Using ABC for short-run decisions may sometimes prove costly in
the long run.
ABC does not encourage the identification and removal of constraints creating delays and excesses.
Accounting under ABC system is not possible as activity wise ledgers are not recognized.
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How activity based cost system can be installed and operated?

Answer
The motives for pursuing an ABC implementation, or at least if investigating its feasibility, must be established at the outset. Most commonly
these will be:
1.
2.
To improve product costing where a belief exists that existing

methods undercost some products and overcost others; or
To identify non-value-adding activities in the production process
which might be a suitable focus for attention or elimination.
In practice, the former is the most quoted goal, even though the latter
may be more appropriate. This is especially so for firms which are highly
labour intensive and which do not have a great diversity of products in
their range, and where allocation of overhead based on direct labour
hours may already function efficiently.
Direct costs, like materials and direct labour, are easily assigned directly
to products. Some indirect costs, particularly those selling costs which
are product specific (e.g., advertising), may be directly assigned to the
product too. The remaining indirect costs are those which are problematical and provide the focus for ABC, with resource costs indirectly assigned to the cost object via cost pools and activity drivers.
A number of distinct practical stages in the ABC implementation are as
follows:
1.
2.
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Staff training : The co-operation of the workforce is critical to the

successful implementation of ABC. The are closest to the process
and most aware of the problems. Staff training should be, as far
as possible, jargon-free, and create an awareness of the purpose
of ABC. It should be non-threatening in nature, stressing that increased efficiencies resulting from a successful implementation
will mean rewards not redundancies. The need for the co-operation of staff in the concerted team effort, for mutual benefit, must
be emphasized throughout the training activity.
Process specification : Informal, but structured, interviews with
key members of personnel will identify the different stages of the
production process, the commitment of resources to each, processing times and bottlenecks. The interviews will yield a list of
transactions which may, or may not, be defined as activities at a
subsequent stage, but in any case provide a feel for the scope of
the process in the entirety.
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3.
4.
5.
Activity definition : The problem must be kept manageable at this

stage, despite the possibility of information overload from new
data, much of which is in need of codification. The listed transactions must be rationalized in order to aggregate those in similar
categories and eliminate those deemed immaterial. The resultant
cost pools will likely have a number of different events, or drivers,
associated with their incurrence.
Activity driver selection : A single driver covering all of the transactions grouped together in the activity probably does not exist.
Multiple driver models could be developed if the data were available, but cost-benefit analysis has rarely shown these to be desirable. The intercorrelation of probably be so strong as to suggest
that it really does not matter which one is selected. This argument
might be employed to avoid the costly collection of data items
otherwise not monitored. Nor easily accessible.
Costing: A single representative activity driver can be used to assign costs from the activity pools to be cost objects.. If, for example, the number of enginee set-ups has been identified as a driver
of process costs and the total set-up cost ` 40,000 for a company
producing four products (A, B, C, D) then the number of set-ups
per product can be used to assign these costs. It product A requires 2 set-ups; B4 set-ups; C24 and D10, then the average cost
per set-up of ` 40,000/40 set ups = ` 1,000, a misleading figure
taken at face value, which does not imply the different demands
of the set up resource made by the different products. However,
total set-up costs can be distributed to product groups in proportion to use, i.e., A : ` 2,000, B : ` 4,000, C: ` 24,000 and D : `
10,000 and then assigned to individual units of product in proportion to the total level of output.
This procedure can then be repeated for all material activities.
What are the areas in which activity based information is used for decision making?
[Nov 2000]
Answer
The areas in which Activity based information is used for making are as
under:
(i) Pricing
(ii) Market segmentation and distribution channels
(iii) Make-or-buy decisions and outsourcing
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(iv) Transfer pricing

(v) Plant closed down decisions
(vi) Evaluation of offshore production
(vii) Capital Investment decisions
(viii) Product line profitability.
7
How ABC system supports corporate strategy?

Answer
ABC supports corporate strategy in many ways such as:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
ABC system can effectively support the management by furnishing

data, at the operational level and strategic level. Accurate product
costing will help the management to compare the profits of various customers, product lines and to decide on price strategy etc.
Information generated by ABC system can also encourage management to redesign the products.
ABC system can change the method of evaluation of new process
technologies, to reduce setup times, rationalization of plant lay
out in order to reduce or lower material handling cost, improve
quality etc.
ABC system will report on the resource spending.
ABC analysis helps managers focus their attention and energy on
improving activities and the actions allow the insights from ABC to
be translated into increased profits.
Performance base accurate feedback can be provided to cost centre managers.
Accurate information on product costs enables better decisions to
be made on pricing, marketing, product design and product mix.
Why are conventional product costing systems more likely to distort

product costs in highly automated plants? How do activity-based costing systems deal with such a situation?
Answer
The conventional product cost system was in vogue when companies
manufactured narrow range of products, overhead costs were relatively
small and distortions arising from inappropriate overhead allocations
were not significant. It used volume measures like direct labour hours
or machine hours for charging overhead costs to products. In the case
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of a company using highly automated plant, direct labour is a small fraction of cost when compared with overheads (because of higher amount
of depreciation). In case where such a company is multi product, overheads which are large in proportion to direct labour are influenced by
number of set up, inspection, number of purchases etc. In these circumstances, the volume based method of recovery of overheads is no
longer appropriate and such a measure will report inaccurate product
costs. Hence, the traditional system of costing was found to over cost
high volume products and under cost low volume products.
Activity Based Costing (ABC) system aims at refining the costing system
used in automated plants in the following manner:
a.
b.
c.
ABC systems trace more costs as direct costs.

ABC systems create homogeneous cost pools linked to different
activities.
For each activity cost pool, ABC systems seek a cost allocation
base that has a cause and effect relationship with costs in the cost
pool.
Differentiate between Value-added and Non-value-added activities

in the context of Activity based costing. Give examples of Value-added
and Non-value-added activities.
Answer
A value added activity is an activity that customers perceive as adding
usefulness to the product or service they purchase. In other words, it is
an activity that, if eliminated, will reduce the actual utility or usefulness
which customers obtain from using the product or service. For example,
painting a car in a company manufacturing cars or a computer manufacturing company making computers with preloaded software.
A non-value added activity is an activity where there is an opportunity
of cost reduction without reducing the products service potential to
the customer. In other words, it is an activity that, if eliminated, will not
reduce the actual or perceived value that customers obtain by using the
product or service. For example, storage and moving of raw materials,
reworking or repairing of products, etc.
Value-added activities enhance the value of products and services in the
eyes of the organisations customers while meeting its own goals. Nonvalue added activities on the other hand do not contribute to customerperceived value.
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10
Give two examples for each of the following categories in activity based
costing:
(i) Unit level activities
(ii) Batch level activities
(iii) Product level activities
(iv) Facility level activities.
Answer
(i)
Unit level
(a) Use of indirect materials
(b) Inspection or testing of every item produced or say every
100th item produced
(c) Indirect consumable
(ii) Batch level
(a) Material ordering
(b) Machine set up costs
(c) Inspection of products like first item of every batch
(iii) Product level
(a) Designing the product
(b) Producing parts to a certain specification
(c) Advertising costs, if advertisement is for individual products
(iv) Facility level
(a) Maintenance of buildings
(b) Plant security
(c) Production managers salaries
(d) Advertising campaigns promoting the company
11
Cost can be managed only at the point of commitment and not at the
point of incidence. Therefore, it is necessary to manage cost drivers to
manage cost. Explain the statement with reference to structural and
executional cost drivers.
[Nov 2007]
Answer
A firm commits costs at the time of designing the product and deciding
the method of production. It also commits cost at the time of deciding
the delivery channel (e.g. delivery through dealers or own retail stores).
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Costs are incurred at the time of actual production and delivery. Therefore, no significant cost reduction can be achieved at the time when the
costs are incurred. Therefore, it is said that costs can be managed at the
point of commitment.
Cost drivers are factors that drive consumption of resources. Therefore,
management of cost drivers is essential to manage costs.
Structural cost drivers are those which can be managed by effecting
structural changes. Examples of structural cost drivers are scale of operation, scope of operation (i.e. degree of vertical integration), complexity, technology and experience or learning. Thus, structural cost drivers
arise from the business model adopted by the company.
Executional cost drivers can be managed by executive decisions, examples of executional cost drivers are capacity utilization, plant layout efficiency, product configuration and linkages with suppliers and customers. It is obvious that cost drivers can be managed only at the point of
structural and operating decisions, which commit resources to various
activities.
12
What is the fundamental difference between Activity Based Costing

System (ABC) and Traditional Costing System? Why more and more
organisations in both the manufacturing and non-manufacturing
industries are adopting ABC?
[Nov 2007]
Answer
In the traditional system of assigning manufacturing overheads, overheads are first allocated and apportioned to cost centres (production
and support service cost centres) and then absorbed to cost objects
(e.g. products). Under ABC, overheads are first assigned to activities or
activity pools (group of activities) and then they are assigned to cost
objects.
Thus, ABC is a refinement over the traditional costing system. Usually
cost centres include a series of different activities. If different products
create different demands on those activities, the traditional costing
system fails to determine the product cost accurately. In that situation,
it becomes necessary to use different rates for different activities or
activity pools.
The following are the reasons for adoption of ABC by manufacturing
and non-manufacturing industries:
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(i)
(ii)
(iii)
(iv)
(v)
13
Fierce competitive pressure has resulted in shrinking profit margin. ABC helps to estimate cost of individual product or service
more accurately. This helps to formulate appropriate marketing /
corporate strategy.
There is product and customer proliferation. Demand on resources by products / customers differ among product / customers.
Therefore, product / customer profitability can be measured reasonably accurately, only if consumption of resources can be traced
to each individual product / customer.
New production techniques have resulted in the increase of the
proportion of support service costs in the total cost of delivering
value to customers. ABC improves the accuracy of accounting for
support service costs.
The costs associated with bad decisions have increased substantially.
Reduction in the cost of data processing has reduced the cost of
tracking resources consumption to large number of activities.
Write short notes on Activity Based Management (ABM)

Answer
In focus on the management of activities as the route to improving value to the customers, ABM involves activity analysis and performance
measurement. Activity Based Costing serves as the major source of information in ABM. The process focuses on improvement of business by
re-engineering the way the business is conducted and by continuously
improving the effectiveness of the organisation. The activities can almost be seen as the building blocks of the process. Certain constraints,
such as shortage of funds or capacity, may exist which limits the firms
potential of profit-earning capabilities. ABM also evaluates these constraints in order to overcome, as far as possible, the constraints and to
maximise the return to the shareholders. Activity Based Budgeting is
used as one of the tools in ABM.
14
Write short notes on Activity Based Budgeting (ABB)

Answer
Brimson and John defines Activity-Based Budgeting as the process of
planning and controlling the expected activities for the organisation to
derive a cost-effective budget that meets forecast workload and agreed
strategic goals. An activity-based budget is a quantitative expression of
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the expected activities of the firm, reflecting managements forecast of
workload and financial and non-financial requirements to meet agreed
strategic goals and planned changes to improve performance.
Thus, the Key Elements of ABB are:
a. Type of work/activity to be performed;
b. Quantity of work/activity to be performed; and
c. Cost of work/activity to be performed.
ABB focuses on the activity/business processes. Resources required are
determined on the expected activities and workload. The objective is to
bring in efficiency into the system. So, in the process of budget preparation, many key questions, need to be addressed and properly answered.
15
Differentiate between ABC and ABM.

Answer
The ABC refers to the technique for determining the cost of activities
and the output that those activities produce. The aim of ABC is to generate improved cost data for use in managing a companys activities.
The ABM is a much broader concept. It refers to the management philosophy that focuses on the planning, execution and measurement of
activities as the key to competitive advantage.
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Chapter 3|
Budgeting, Performance
Measurement and Theory of
Constraints
22 Capsules
What is Zero Base budgeting?

[May 2007]
Answer
It is an expenditure control device where each divisional head has to
justify the requirement of funds for each head of expenditure and
prepare the budget accordingly, without reference to past budget or
achievements.
It is an operating planning and budgeting process which requires each
manager to justify his entire budget requests in detail from scratch i.e.
zero base.
2
What are the steps in Zero Base Budgeting?

[May 1993, Nov 2007, Nov 2010]
Answer
The Zero Base Budgeting involves the following steps:
(i)
(ii)
(iii)
(iv)
(v)
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Corporate objectives should be established and laid down in details.

Decide about the extent to which the techniques of ZBB is to be
applied.
Identify those areas where decisions are required to be taken.
Develop decision programmes and rank them in order of preferences.
Preparation of budget, that is translating decision packages into
practicable units/items and allocating financial resources.
TM
Budgeting, Performance Measurement and Theory of Constraints

3
What are the advantages and limitations of Zero base Budgeting?

[Nov 2004]
Answer
Advantages of ZBB:
(i)
It provides a systematic approach for evaluation of different activities and ranks them in order of preference for allocation of scare
resource.
(ii) It ensures that the various functions undertaken by the organisation are critical for the achievement of its objectives and are being
performed in the best way.
(iii) It provides an opportunity to the management to allocate resources for various activities only after having a thorough cost-benefit
analysis.
(iv) The area of wasteful expenditure can be easily identified and eliminated.
(v) Departmental budgets are closely linked with corporate objectives.
(vi) The technique can also be used for the introduction and implementation of the system of management by objective.
Limitations of ZBB:
(i)
Various operational problems are likely to be faced in implementing the technique.

(ii) The full support of top management is required.
(iii) It is time consuming as well as costly.
(iv) It requires proper trained managerial staff.
4
In each of the following independent situations, state with a brief reason whether Zero Base Budgeting(ZBB) or Traditional Budgeting (TB)
would be more appropriate for year II.
(i) A company producing a certain product has done extensive ZBB
exercise in year 1. The activity level is expected to marginally increase in year 2.
(ii) The sales manager of a company selling three products has the
intuitive feeling that in year 2, sales will increase for one product
and decrease for the other two. His expectations cannot be substantiated with figures.
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(iii) The top management would like to delegate responsibility to the

functional managers for their results during year 2.
(iv) Resources are heavily constrained and allocation for budget requirements is very strict.
[Nov 2013]
Answer
(i)
Traditional Budgeting would be appropriate as the company has

already done extensive ZBB in current year and moreover there
will be only slight change in the activity level for which major defalcations are not expected.
(ii) ZBB would be appropriate as it would compel the manager to substantiate and explain any changes occurring in sales.
(iii) ZBB would be appropriate as it would bind all the functional managers with their responsibilities as well as they would have to execute their work with full honesty when they know that they will
have to furnish every detail of a penny from scratch.
(iv) TB would be appropriate as resources are already in short supply
in the current year and their allocations to the budgeted activity
is strict and restricted that means that the company already has a
sound policy for achieving its plan. ZBB would not yield any new
results or hidden misappropriations.
5
What do you mean by a flexible budget? Give an example of an industry

where this type of budget is typically needed?
[May 2008]
Answer
A flexible budget is a budget which, by recognizing the difference between fixed, semi-variable and variable costs, is designed to change in
relation to the level of activity attained.
E.g. seasonal products , industries influenced by change in fashion, Industries which keep on introducing new products / new designs.
6
Write short notes on Rolling Budgets.

Answer
Rolling budgets can be particularly useful when future events cannot
be forecast reliably. A rolling budget is defined as a budget continuously updated by adding a further accounting period (month or quarter)
when the earliest accounting period has expired. Its use is particularly
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beneficial where future costs and/ or activities cannot be forecast accurately.
For example a budget may initially be prepared for January to December, year 1. At the end of the first quarter, i.e., at the end of March,
year 1, the first quarters budget is deleted. A further quarter is then
added to the end of the remaining budget, for January to March, year
2. The remaining portion of the original budget is updated in the light of
current conditions. This means that managers have a full years budget
always available and the rolling process forces them to continually plan
ahead. A system of rolling budgets is also known as continuous budgeting.
7
What is Performance Budgeting? Differentiate between Traditional

Budgeting and Performance Budgeting. What are the steps in Performance Budgeting?
Answer
Performance Budgeting provide a meaningful relationship between estimated inputs and expected outputs as an integral part of the budgeting
system. A performance budget is one which presents the purposes and
objectives for which funds are required, the costs of the programmes
proposed for achieving those objectives, and quantities data measuring the accomplishments and work performed under each programme.
Thus performance budgeting is a technique of presenting budgets for
costs and revenues in terms of functions. Programmes and activities are
correlating the physical and financial aspect of the individual items comprising the budget.
Traditional budgeting vs. Performance budgeting
i.
ii.
The traditional budgeting gives more emphasis on the financial

aspect than the physical aspects or performance. Performance
budgeting aims at establishing a relationship between the inputs
and the outputs.
Traditional budgets are generally prepared with the main basis
towards the objects or items of expenditure i.e. it highlights the
items of expenditure, namely, salaries, stores and materials, rates
rents and taxes and so on. In the PB latter the emphasis is more
on the functions of the organisation, the programmes to discharge
these function and the activities which will be involved in undertaking these programmes.
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Steps in Performance Budgeting:

According to the Administrative Reforms Commission (ARC) the following steps are the basic ones in Performance Budgeting:
(a) establishing a meaningful functional programme and activity classification of government operations;
(b) bring the system of accounting and financial management in accord with this classification
(c) evolving suitable norms, yardsticks, work units of performance
and units costs, wherever possible under each programme and
activity for their reporting and evaluation.
The Report of the ARC use the following terms in an integrated sequence:
The team function is used in the sense of objective. For achieving objectives programmes will have to be evolved. In respect of time horizon, it is essentially a replacement of traditional annual fiscal budgeting
by a more output-oriented, but still an annual, exercise.
For an enterprise that wants to adopt PB, it is thus imperative that:
(a) the objectives of the enterprise are spelt out in concrete terms.
(b) the objectives are then translated into specific functions, programmes, activities and tasks for different levels of management
within the realities of fiscal; constraints ;
(c) realistic and acceptable norms, yardsticks or standards and performance indicators should be evolved and expressed in quantifiable
physical units.
(d) a style of management based upon decentralised responsibility
structure should be adopted, and
(e) an accounting and reporting system should be developed to facilities monitoring, analysis and review of actual performance in
relation to budgets.
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8
Because a single budget system is normally used to serve several purposes, there is a danger that they may conflict with each other. Do you
agree? Discuss.
[May 2005]
Answer
A single budget system may be conflicting in planning and motivation,
and planning and performance evaluation roles as below:
(i)
Planning and motivation roles Demanding budgets that may

not be achieved may be appropriate to motivate maximum performance but they are unsuitable for planning purposes. For these, a
budget should be a set based on easier targets that are expected
to be met.
(ii) Planning and performance evaluation roles For planning purposes budgets are set in advance of the budget period based on
an anticipated set of circumstances or environment. Performance
evaluation should be based on a comparison of active performance with an adjusted budget to reflect the circumstance under
which managers actually operated.
9
Describe the process of Benchmarking.

Answer
The process of benchmarking requires a Company to identify the areas
i.e. processes, activity etc. which are central to its business and then
selects the top-performing companies in those areas.
The benchmarking process is comprised of following stages. These stages are:
1.
Planning:
(ii) Determination of benchmarking goal statement This requires identification of areas to be benchmarked. In practice, one should start with the identification of those areas
which have to be really good to be really successful.
(iii) Identification of best performance Once the benchmarked
goal statement are defined, the step is seeking the best of
the breed of best of the best.
(iv) Establishment of the benchmarking or process improvement team Ideally this should include the persons who are
most knowledgeable about the internal operations and will
be directly affected by changes due to benchmarking.
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1.
2.
3.
4.
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(v) Defining the relevant benchmarking measurement: Relevant measures will not include the measures used by the
organisation today but they will be refined measures that
comprehend the true performance differences.
Collection of data and information The data gathering for benchmarking could be done through national/international clearing
houses, mail surveys, suppliers, company visits, telephone, interviews, etc. In recent years national and international clearing
houses have been set up.
Analysing the findings The analysis of finding of step (2) requires
following:
(i) Review the findings and produce tables, charts and graphs
to support the analysts.
(ii) Identify gaps in performance between our organisation and
better performers.
(iii) Seek explanations for the gaps in performance. The performance gaps can be positive, negative or zero.
(iv) Ensure that comparisons are meaningful and credible.
(v) Communicate the findings to those who are affected.
(vi) Identify realistic opportunities for improvements.
Recommendations: This involves
(i) Deciding the feasibility of making the improvements in the
light of the conditions that apply within own organisation.
(ii) Agreement of the improvements that are likely to be feasible.
(iii) Producing a report on the Benchmarking in which the recommendations are included.
(iv) Obtaining the support of key stakeholder groups for making
the changes needed.
(v) Developing action plan(s) for implementation.
Monitoring and reviewing: This involves
(i) Evaluating the benchmarking process undertaken and the
results of the improvements against objectives and success
criteria plus overall efficiency and effectiveness.
(ii) Documenting the lessons learnt and make them available to
others.
(iii) Periodically re-considering the benchmarks
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10
What are benchmarking code of conduct? What are its types?

[RTP, Nov 2000, Nov 2003]
Answer
Bench marking is the process of identifying and learning from the best
practices anywhere in the world. It is a powerful tool for continuous
improvement. To contribute to efficient, effective and ethical bench
marking, individuals agree for themselves and their organisation to
be abided by the following principles for the benchmarking with other
organisations.
Suggested benchmarking code of conduct:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
11
Principle of legality
Principle of exchange
Principle of confidentiality
Principle of use
Principle of first party contact
Principle of third party contact
Principle of preparation
Describe the types of bench marking of critical success factors.

[Nov 2008]
Answer
The Benchmarking is of following types:
(i)
(ii)
(iii)
(iv)
(v)
Competitive benchmarking It involves the comparison of competitors products, processes and business results with own.
Strategic benchmarking It is similar to the process benchmarking in nature but differs in its scope and depth.
Global benchmarking: It is a benchmarking through which distinction in international culture, business processes and trade practices across companies are bridged and their ramification for business process improvement are understood and utilized.
Process benchmarking It involves the comparison of an organisation critical business processes and operations against best
practice organization that performs similar work or deliver similar
services.
Functional Benchmarking or Generic Benchmarking This type
of benchmarking is used when organisations look to benchmark
with partners drawn from different business sectors or areas of
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activity to find ways of improving similar functions or work processes.

(vi) Internal Benchmarking It involves seeking partners from within
the same organization, for example, from business units located in
different areas.
(vii) External Benchmarking It involves seeking help of outside organisations that are known to be best in class. External benchmarking provides opportunities of learning from those who are at
the leading edge, although it must be remembered that not every
best practice solution can be transferred to others.
Benchmarking can also be categorized into:
(1) Intra Group Benchmarking Here the groups of companies in
the same industry agree that similar units within the co-operating
companies will pool and share data on their processes. The processes are benchmarked against each other at or near operational
level. Improvement task forces are established to identify and
transfer best practice to all members of the group.
(2) Inter Industry Benchmarking In inter-industry benchmarking,
a non competing business with similar process is identified and
asked to participate in a benchmarking exercise. For example, a
publisher of schoolbook may approach a publisher of university
level books to establish benchmarking relationship.
12
Balanced score card and performance measurement system endeavours to create a blend of strategic measures, outcomes and drive measures and internal and external measures.
Discuss the statement and explain the major components of a balanced
score card.
Answer
The balanced score card translates an organizations mission and strategy into a comprehensive set of performance measures that provides
the framework for implementing its strategy. The balanced score card
does not focus solely on achieving financial objectives. It is an approach,
which provides information to management to assist in strategic policy
formulation and achievement. It emphasizes the need to provide the
user with a set of information, which addresses all relevant areas of
performance in an objective and unbiased manner. As a management
tool it helps companies to assess overall performance, improve operational processes and enables management to develop better plans for
improvements.
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Major components of a balanced scorecard The components of balanced score cards varies form business to business. A well designed balanced scorecard combines financial measures of post performance with
measures of firms drivers of future performance. The specific objectives and measures of an organization-balanced scorecard can be derived from the firms vision and strategy. Generally, balanced score card
has the following four perspectives from which a companys activity can
be evaluated.
(i)
Financial perspective Financial perspective measures the results

that the organization delivers to its stakeholders. The measures
are: operating income, revenue growth, revenues from new products, gross margin percentage, cost reduction in key areas, economic value added, return on investment.
(ii) Customer perspective The customer perspective considers the
business through the eyes of customers, measuring and rejecting
upon customer satisfaction. The measures are: - market share.
customer satisfaction, customer retention percentage, time taken
to fulfil customers requests.
(iii) Internal business perspective The internal perspective focuses
attention on the performance of the key internal processes, which
drive the business such as innovative process, operation process
and post-sales services.
(iv) Learning & growth perspective The measure are:- employee education & skills levels, employee turnover ratio, information system availability, percentage of employee suggestion implemented
etc.
13
Classify the following measures under appropriate categories in a balanced score card for a banking company which excels in its home loan
products:
(a) A new product related to life insurance is being considered for a
tie up with the successful housing loan disbursements. E.g. every
housing loan applicant to be advised to take a life policy or compelled to take a fire insurance policy.
(b) How different sectors of housing loans with different interest
rates have been sanctioned, their volumes of growth in the past 4
quarters.
(c) How many days are taken to service a loan, how many loans have
taken longer, what additional loans are to be released soon, etc.
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(d)
(e)
(f)
(g)
The company plans to capture additional market share.

Maintaining low cost of their products supported by low prices.
The company intends to become a low price leader.
An internal strategy linked with reward and recognition to employees.
(h) Increased customer satisfaction.
(i) Maintain consistent production.
(j) Promote entrepreneurial culture.
(k) Improve efficiency of employees to service the loan.
Answer
The four categories analysed in a Balanced Score Card are
1. Innovation and Internal Business Process
2. Learning and Growth of Employees
3. Customer Relations and Satisfaction
4. Financials
The above items are classifiable into above four perspectives as below:
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
(k)
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Innovation and Internal Business Process

Financial
Financial
Customer Relations
Learning and Growth
Customer Relations
Learning and Growth
TM

14
In many organisations, initiatives to introduce balanced score card

failed because efforts were made to negotiate targets rather than to
build consensus.
Elucidate the above statement.
[Nov 2007]
Answer
Balanced score card is a set of financial and non-financial measures relating
to a companys critical success factors. It is an approach which provides
information to management to assist in strategy implementation.
Therefore, the components to be included in the balanced score card
must flow from strategy. The targets should be measurable and must
flow from strategy and corporate plan of the company. It is necessary
that managers should agree to the components and targets because
in absence of a consensus, managers may not commit to the targets
established by the top management / the board of directors. Moreover,
the functions are interdependent and results in one functional area/
perspective (e.g. innovation and learning) have direct bearing on the
results in other functional area/perspective (e.g. customer perspective).
Therefore, it is not sufficient that individual managers agree to their
targets. Successful implementation requires that the top management
builds an overall consensus on the components and targets of the
balanced score card. Negotiation undermines the fundamental principle
that the components and targets should flow from strategy. As a result,
an approach to establish targets through negotiation defeats the very
purpose of balanced score card.
15
Write short notes on Feedback System.

[May 1995]
Answer
Feedback System operates by measuring some aspects of the processing, being controlled and adjusting when the measuring indicates that
the process is deviating from plan.
It is a link between planning and control.
Some examples of feedback system are: MIS Reports, Periodical Performance Reports, Variance Reports, etc. which provide information by
comparing planned and actual outcomes.
Budget may be viewed as an activity plan and Budgetory Control as a
Feedback System.
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16
Explain the Theory of Constraints advocated by Goldratt.

[Nov 2003]
Answer
The theory of constraints (TOC) describes methods to maximize operating income when faced with some bottleneck and some non bottleneck
operations. The main concept is to maximise the rate of manufacturing
output i.e. throughput of the firm.
The three key measurements in TOC:
(1) Throughput contribution = revenues minus the direct materials
cost of the goods sold.
(2) Investments = the sum of materials costs in direct materials,
workinprocess, and finished goods inventories; R & D costs; and
costs of equipment and buildings.
(3) Operating costs equal all costs of operations (other than direct
materials) incurred to earn throughput contribution. Operating
costs include salaries & wages, rent utilities, & depreciation.
The objective of TOC is to increase throughput contribution while decreasing investments and operating costs. TOC considers a short run
time horizon & assumes that operating costs are fixed costs.
The steps in managing bottleneck operations:
Step 1: Recognize that the bottleneck operation determines throughput
contribution of the entire system.
Step 2: Find the bottleneck operation by identifying operations with
large quantities of inventory waiting to be worked on.
Step 3: Keep the bottleneck operation busy and subordinate all non bottleneck operations to the bottleneck operation. That is, the needs of
the bottleneck operation determine the product schedule of non bottleneck operations.
The important concept behind TOC is that the production rate of the
entire factory is set at the pace of the bottleneck the constraining resource. Hence, in order to achieve the best result TOC emphasizes the
importance of removing bottlenecks or limiting factor. If they cannot be
removed they must be coupled with in the best to be drawn to identify
the bottlenecks or binding constraints.
TOC identifies three types of cost:
a.
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Throughput contribution = Sales revenue- direct material cost. (Direct material cost includes purchased components and materials
handling costs.)
TM

b.
c.
17
Conversion costs: These are all operating costs, excluding completely variable costs, which are incurred in order to produce the
product i.e. labour and overhead, including rent, utilities and relevant depreciation.
Investments which include all stock, raw material, work in progress, finished goods, research and development costs, cost of
equipment and buildings, etc.
Write short notes on Optimised Production Technology.

Answer
Goldratt and Cox advocated a new approach to production management called Optimised Production Technology. It is based on the principle that profits are expanded by increasing the throughput of the plant
i.e. rate at which raw material are turned into sales. The most widely
developed management accounting system developed for this purpose
is known as Throughput Accounting. The system determines what prevents throughput (Sales Direct Materials cost) being higher by distinguishing between bottleneck and non bottleneck resources.
18
What are the rules for synchronous manufacturing as proposed in TOC.

Answer
The rules of production scheduling as laid down by Goldratt are as follows:
1.
2.
3.
4.
5.
6.
7.
8.
9.
Do not balance the capacity balance the flow.

The level of utilisation of a non bottleneck resource is determined
not by its own potential but by some other constraint in the system.
Utilisation and activation of the resource are not the same.
An hour lost at a bottleneck is an hour lost for the entire system.
An hour saved at a non bottleneck is a mirage.
Bottlenecks govern both throughput and inventory in the system.
The transfer batch may not and many times should not be equal to
the process batch.
A process batch should be variable both along its route and time.
Priorities can be set only by examining the system constraints.
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19
How performance measurement is done as per TOC?

Answer
To adequately measure a firms performance, two sets of measurements
must be used one from the financial point of view and the other from
the operations point of view:
Financial Measurements
1. Net Profit
2. Return on Investment
3. Cash Flow
Operational Measurements
1.
2.
Throughput: the rate at which money is generated by the system

Investment: all the money that the organisation invested in purchasing the things it intends to sell.
3. Operating Expenses: all the money that the organisation spends
to turn inventory into throughput.
The TOC emphasizes on operational measurements rather than financial measurements.
20
Write short notes on Throughput Accounting.

Answer
The TOC was picked up and included into an accounting system in UK
where it is known as Throughput Accounting by Galloway and Waldron.
Throughput Accounting is a method of performance measurement
which relates production and other costs to throughput. Throughput
Accounting product costs relate to usage of key resources by various
products.
It assumes that a manager has a given set of resources available. These
comprise the existing buildings, capital equipment and labour force. Using these resources, purchased materials and components must be processed to generated sales revenue. To achieve this, maximum amount
of throughput is required with the financial definition.
The other costs are deemed time related rather than fixed.
Throughput is influenced by:
a.
b.
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Selling price
Direct purchase price
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c. Usage of direct materials
d. Volume of throughput
Constraints on throughput:
a.
b.
c.
d.
e.
21
the existence of an uncompetitive selling price

the need to deliver on time to particular customers
the lack of product quality and reliability
the lack of reliable materials suppliers
the existence of shortage of production resources.
What are the steps to be followed to find the optimum production mix
as per Throughput Accounting?
Answer
1.
Find throughput accounting ratio for each input or resource or department.

Throughout accounting ratio for a department =
Toal requirement 100

Total availibility
If the resource is a limiting factor, the above ratio will be greater than 1.
2. Select highest Ratio and consider that department as the only limiting factor.
3. Rank the products according to their Throughput contribution per
unit of Limiting factor
Or
Product return per time period =
4.
Sales Material cost

Time period in Bottleneck
Allocate the resource according to the rank and find the optimum
production.
For determining the most profitable product, the Throughput Accounting Ratio is calculated as below:
TA Ratio =
Value added per time period

=
(Sales Materials )
Per time period
Conversion cost or total cost per time period
If a Product has a ratio of less than one the organisation loses money
every time it is produced.
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22
Classify the following items under three measures used in the theory
of constraints:
(i) Research and Development Cost
(ii) Rent / utilities
(iii) Raw materials used for production
(iv) Depreciation
(v) Labour cost
(vi) Stock of raw materials
(vii) Sales
(viii) Cost of equipments and buildings
Answer
(i) Investments
(ii) Operating Expenses
(iii) Throughput Contribution
(iv) Operating Expenses
(v) Operating Expenses
(vi) Investments
(vii) Throughput Contribution
(viii) Investments
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Relevant Costing, Marginal Costing and Decision Making
Chapter 4|
Relevant Costing, Marginal
Costing and Decision Making
22 Capsules
Explain with one example each that sunk cost is irrelevant in making
decisions, but irrelevant costs are not sunk costs.
[May 2001]
Answer
Sunk cost is a historical cost incurred in the past. In other words it is a
cost of a resource already acquired. Future decisions in respect of this
resource will not be affected by it. For example, book value of machinery. Hence sunk costs are irrelevant in decision making. Irrelevant costs
are not necessary sunk costs. For example, when a comparison of two
alternative production methods using the same material quantity is
made, then direct material cost is not affected by the decision but this
material cost is not sunk cost.
2
Explain the concept of relevancy of cost by citing three examples each

of relevant costs and non-relevant costs.
[Nov 2008]
Answer
A relevant cost is a future cost which differs between alternatives. It can
also be defined as any cost which is affected by decisions at hand. For
any decision for an offer, usually the following costs are considered as
relevant :
a. Differential or Variable Costs
b. Avoidable or Discretionary Fixed Costs
c. Opportunity Costs
The following costs are irrelevant costs for decision making
a.
b.
c.
Historical or Sunk Costs

Committed Fixed Costs
Apportioned Fixed Costs
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A relevant cost is a future cash outflow arising as a direct consequence

of the decision under review because it is assumed that in the long run,
future profits will be maximised if the cash profits of the company is
maximised.
Hence all non cash expenditures are irrelevant costs, such as,
a.
b.
c.
Depreciation
Notional rent or interest
All overheads absorbed. Fixed OH absorption is irrelevant as they
are not incurred at the same rate that they are absorbed.
What is margin of Safety? How can margin of safety be improved?

[May 1999]
Answer
Margin of Safety Margin of safety is the excess of sales over the breakeven sales. It may also be considered as the excess of production over
break-even point. It can be expressed in value as well as in percentage.
The size of margin of safety shows the strength of the business. Small
size of margin of safety indicates that the firm has large fixed expenses
and is more vulnerable to changes in sales. In other words, if the margin
of safety is large, a slight fall in sales may not affect the business very
much but when it is small then a slight fall in sales may adversely affect
the business.
Margin of safety is also immensely useful for making inter-firm comparison. This is being done by calculating their margin of safety ratio.
Measures for improving margin of safety:
Margin of safety can be improved by taking the following measures:
(i)
(ii)
(iii)
(iv)
(v)
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Increasing the selling price, provided the demand is inelastic so as

to absorb the increased prices.
Reduction in fixed expenses.
Reduction in variable expenses
Increasing the sales volume provided capacity is available.
Substitution or introduction of a product mix such that more profitable lines are introduced.
TM

4
What are the limitations of a break-even chart?

[May 1999]
Answer
The limitations of break even chart are as follows:
(1) While preparing a break-even chart, it is assumed that revenue
and costs can be represented with the help of straight lines. It may
not always be true.
(2) The preparation of a break-even chart requires the segregation of
semi-variable costs into fixed and variable components. It may not
always be possible to segregate semi-variable costs into fixed and
variable elements accurately. There may be situations when semivariable costs cannot be split.
(3) A break-even chart assumes that selling price and variable cost
per unit are constant at all levels of activity. It may not always be
true. Selling price as well as variable cost may either increase or
decrease with the change in volume. Fixed costs also tend to vary
beyond a certain output.
(4) When a firm produces a number of products the apportionment
of fixed expenses over various products may be different and often it may be done arbitrarily.
(5) A Break-even chart assumes that business condition will not
change.
(6) A break-even chart does not consider the amount of capital employed in the business, a very important factor for determining
profitability of a concern.
5
Discuss the relationship between Angle of incidence. Break-even Level

and Margin of Safety.
Answer
Angle of Incidence It is the angle between total sales line and total
cost line drawn in the case of break-even. It provides useful information
about the rate at which profits are being made. The larger the angle, the
higher the rate of profit or vice-versa.
Break-even level It is that level of sales (or production) at which the
sales revenue exactly equals total costs, both variable and fixed. In
other words, it is the level of activity at which the firm neither earns a
profit nor suffers a loss.
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Margin of safety It is the difference between total sales and sales at

break-even point. In other words margin of safety is the amount of sales
above the break-even point. If there is a fall in the sales to the extent of
margin of safety, the firm will not be in a loss situation.
Relationship between Angle of Incidence, Break-even level and Margin of Safety:
(i)
If the break-even point is low and angle of incidence is large. The

margin of safety is large and the business enjoys financial stability.
A low break-even point indicates that the business could be run
profitably even if there is a fall in sales, unless the sales are very
low.
(ii) If the break-even point is low and angle of incidence is small, the
conditions are the same as in (i) above except that the rate of profit earning capacity is not so high as in (i).
(iii) If the Break-even point is high and angle of incidence is small, the
margin of safety is low. The business is very vulnerable, even a
small reduction in activity may result is a loss.
(iv) If the break-even point is high and angle of incidence is large, this
shows that the margin of safety is low; the business is likely to incur losses through a small reduction in activity. However, after the
break-even point, the business makes the profit at a high rate.
6
Mention any four important factors to be considered in Marginal Costing Decisions.

[Nov 1999]
Answer
Important factors to be considered in Marginal Costing Decisions are
as follows:
(i) Whether the product or production makes a contribution,
(ii) In the selection alternatives, additional fixed costs if any should be
considered.
(iii) The continuity of demand after new decision and its impact on
selling price are to be considered.
(iv) Non-cost factors such as the need to keep labour force intact and
governmental attitude are also to be taken into account.
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7
Briefly explain the methods of separating semi-variable costs into their

fixed and variable elements.
[May 2000]
Answer
Semi-variable costs as the name suggests are partly fixed and partly
variable. The methods for separating the semi-variable costs into their
fixed and variable elements have been discussed briefly as under:
(i)
Graphical method Under this method, a large number of observations regarding the total costs at different levels of output are
plotted on a graph with the output on the X-axis and the total cost
on the Y-axis. Then, draw by judgment, a line of best fit, which
passes through all or most of the points is drawn. The point at
which this line cuts the Y-axis indicates the total fixed cost component in the total cost. If a line is drawn at this point parallel to the
X-axis, this indicates the fixed cost. The variable cost at any level
of output, is derived by deducting this fixed cost element from the
total cost.
(ii) High points and low points method Under this method, the difference between the total cost at highest and lowest volume is
divided by the difference between the sales value at the highest
and lowest volume. The quotient thus obtained gives the rate of
variable cost in relation to sales value. The fixed cost is the remainder; i.e., total cost minus variable cost.
(iii) Comparison by period or level of activity method Under this
method, the variable cost per unit may be determined by comparing two levels of output with the amount of expenses at those
levels. Since the fixed element does not change, therefore the
variable elements of cost may be ascertained with the help of the
following formula:
Change in the amount of expenses
Change in Quantity
(iv) Least square method This is the best method of separating
semi-variable costs into their fixed and variable elements. It is a
statistical method and is based on finding out a line of best fit for a
number of observations. The method uses the linear equation y =
mx + c; where m represents the variable element of cost per unit,
C represents the total fixed cost, y represents the total cost, x
represents the volume of output. The total cost is thus split into
fixed and variable elements by solving this equation.
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(v) Analytical method An attempt is made under this method to

judge empirically the proportion of semi-variable cost and fixed
cost. The degree of variability is determined for each item of semivariable cost. Once this has been done, the method is easy to
apply.
8
Cost is not the only criterion for deciding in favour of shut down
Briefly explain.
[May 2000]
Answer
Cost is not only criterion for deciding in the favour of shut down. Noncost factors worthy of consideration in this regard are as follows:
(i)
Interest of workers, if the workers are discharged, it may become

difficult to get skilled workers later, on reopening of the factory.
Also shut-down may create problems,
(ii) In the face of competition it may difficult to re-establish the market for the product.
(iii) Plant may become obsolete or depreciate at a faster rate or get
rusted. Thus, heavy capital expenditure may have to be incurred
on re-opening.
9
Explain, how Cost Volume Profit (CVP) - based sensitivity analysis can
help mangers cope with uncertainty.
[Nov 2000]
Answer
Sensitivity analysis focuses on how a result will be changed if the original estimates or the underlying assumptions change.
Cost Volume Profit (CVP) based sensitivity analysis can help mangers
to provide answers to the following questions to cope with uncertainty.
(1) What will be the profit if the sales mix changes from that originally
predicted?
(2) What will be the profit if fixed costs increase by 10% and variable
costs decline by 5%?
The use of spreadsheet packages has enabled mangers to develop CVP
computerised models which can answer the above questions. Managers can now consider alternative plans by keying the information into
a computer, which can quickly show changes both graphically and numerically. Thus mangers can study various combinations of changes in
4-46
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selling prices, fixed costs, variable costs and product mix, and can react
quickly without waiting for formal reports from the accountant. In this
manner the use of CVP based sensitivity analysis can help mangers to
cope up with uncertainty.
10
Enumerate the limitations of using the marginal costing technique.

[May 2001]
Answer
Marginal costing is defined as the ascertainment of marginal cost and of
the effect on profit of changes in volume or type of output by differentiating between fixed costs and variable costs.
Limitations of Marginal Costing Techniques:
The limitations of using the marginal costing technique are as follows:
(1) It is difficult to classify exactly the expenses into fixed and variable category. Most of the expenses are neither totally variable
nor wholly fixed.
(2) Contribution itself is not a guide unless it is linked with the key
factor.
(3) Sales staff may mistake marginal cost for total cost and sell at a
price; which will result in loss or low profits. Hence, sales staff
should be cautioned while giving marginal cost.
(4) Overheads of fixed nature cannot altogether be excluded particularly in large contracts, while valuing the work-in-progress. In
order to show the correct position fixed overheads have to be included in work-in-progress.
(5) Some of the assumptions regarding the behaviour of various costs
are not necessarily true in a realistic situation. For example, the
assumption that fixed cost will remain static throughout is not correct.
11
Briefly discuss on curvilinear CVP analysis.

[Nov 2001]
Answer
In CVP analysis, the usual assumption is that the total sales line and
variable cost line will have linear relationship, that is, these lines will be
straight lines. However, in actual practice it is unlikely to have a linear
relationship for two reasons, namely:
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(i)
after the saturation point of existing demand, the sales value may
show a downward trend.
(ii) the average unit variable cost declines initially, reflecting the fact
that, as output increase the firm will be able to obtain bulk discounts on the purchase of raw materials and can also benefit from
division of labour. When the plant is operated at further higher
levels of output, due to bottlenecks and breakdowns the variable
cost per unit will tend to increase. Thus the law of increasing costs
may operate and the variable cost per unit may increase after
reaching a particular level of output.
In such cases, the contribution will not increase in linear proportion i.e. based on the phenomenon of diminishing marginal productivity, the total cost lie will not be straight, as assumed but will
be of curvilinear shape. This situation will give rise to two break
even points. The optimum profit is earned at the point where the
distance between sales and total cost is the greatest.
Loss
TC
TR
Curvilinear - CVP
Profit
12
Use of absorption costing method for the valuation of finished goods

inventory provides incentive for over-production. Elucidate the statement.
[May 2002]
Answer
When absorption costing method is used, production fixed overheads
are charged to products and are included in product costs. Consequently, the closing stocks are valued on total cost (including fixed overheads)
basis. The net effect is that the charge of fixed overheads to P/L account
gets reduced, if the closing stock is greater than the opening stock. This
situation has the effect of inflating the profit for the period.
Where stock levels are likely to fluctuate significantly, profits may be
distorted if calculated on absorption costing basis. If marginal costing is
used, since the fixed costs are charged off to P/L account as period cost,
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such a situation will not arise. The impact of using absorption costing on
profits can be summarised as under:
(a) When sales are equal to production, profits will be the same under absorption costing and marginal costing.
(b) If production is higher than sales, the absorption costing will post
higher profits that marginal costing.
(c) If sales are in excess of production, absorption costing will show
lower profits than marginal costing.
Since profit calculation in absorption costing can produce strange result, the managers may deliberately alter the stock levels to influence
the profits if absorption costing is used. Hence, it is true to say that if
absorption costing method is used managers have the incentive to over
produce to show better result.
13
Enumerate the factors involved in decisions relating to expansion of

capacity.
[May 2001]
Answer
The factors involved in decisions relating to expansion of capacity are
enumerated as below:
(i) Additional fixed overheads involved should be considered.
(ii) Possible decrease in selling price due to increased production capacity.
(iii) Whether the demand id sufficient to absorb the increased production.
14
Discuss the role of costs in product-mix decisions.

Answer
All types of cost involved in cost accounting system are useful in decision
making. The cost which plays a major role in product mix decision is the
relevant cost. Costs to be relevant should meet the following criteria:
(i) The costs should be expected as future costs.
(ii) The costs differ among the alternatives course of action.
While making decision about product mix using the facilities and other
available resources, the end results should always aim at profit minimisation. Variable costs are relevant costs in product mix decisions and
consequently contribution plays a major role in minimisation of profit.
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In addition to the relevancy of costs, the other factors and costs that
should be taken into account at the time of deciding the products mix
are:
(i)
(ii)
(iii)
(iv)
(v)
15
The available production capacity

The limiting factor(s)
Contribution per unit of the limiting factor
Market demand for the products.
Opportunity costs
State the relative economics of the make vs. buy decision in management control.
[Nov 2001]
Answer
Generally for taking a make vs. buy decision comparison is made between the suppliers price and the marginal cost of making plus the opportunity cost. Make vs. buy decision is a strategic decision, and, therefore, both short-term as well as well as long-term thinking about various
cost and other aspects needs to be done.
A company generally buys a component instead of making it under following situations:
(1) If it costs less to buy rather than to manufacture it internally;
(2) If the return on the necessary investment to be made to manufacture is not attractive enough;
(3) If the company does not have the requisite skilled manpower to
make;
(4) If the concern feels that manufacturing internally will mean additional labour problem;
(5) If adequate managerial manpower is not available to take charge
of the extra work of manufacturing;
(6) If the component shows much seasonal demand resulting in a
considerable risk of maintaining inventories;
(7) If transport and other infrastructure facilities are adequately available;
(8) If the process of making is confidential or patented;
(9) If there is risk of technological obsolescence for the component
such that it does not encourage capital investment in the component.
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16
Is it justifiable to sell at a price below marginal cost at any time? Mention the circumstances in which it is justifiable.
[May 2008]
Answer
It is justifiable to sell at a price below marginal cost for a limited period.
The circumstances may be:
(i) Where materials are of perishable nature.
(ii) Where stocks have been accumulated in large quantities and the
market prices have fallen. This will save the carrying cost of stocks,
e.g., electronic goods market prices fall due to quick obsolescence or advanced technological replenishment.
(iii) It is essential to reduce the prices to such an extent in order to
popularize a new product.
(iv) Where such reduction enables the firm to boost the sales of other
products having larger profit margin.
17
What are the major areas of decision-making in which differential costing is used?
[May 2008]
Answer
Differential costing can be used for all short, medium and long term
decisions. When two levels of activities are being considered, or while
choosing between competing alternatives differential cost analysis is
essential. The differential cost is useful for decision making in the following areas:
(a)
(b)
(c)
(d)
(e)
(f)
Capital expenditure decisions

Make or buy decision
Production planning
Sales mix decision
Production or product decision
Change in level or nature of an activity.
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18
State the characteristic features of a database created for operational

control and decision making.
[Nov 2008]
Answer
The characteristic features of a data-base created for operational control and decision making are as under:
(i)
(ii)
(iii)
(iv)
(v)
19
There should be a file structure that facilitates the association of

one internal record with other internal records.
There should be cross functional integration of files.
Independence of program / data file for ease of updating and
maintenance of data base.
There must be common standards throughout with respect to
data definitions, record formats and other data descriptions.
A data dictionary should be available.
What are the applications of incremental cost techniques in making

managerial decisions?
[May 2000]
Answer
Incremental cost technique: It is a technique used in the preparation
of ad-hoc information in which only cost and income differences between alternative courses of action are taken into consideration. This
technique is applicable to situations where fixed costs alter.
The essential pre-requisite for making managerial decisions by using
incremental cost technique, is to compare the incremental costs with
incremental revenues. So long as the incremental revenue is greater
than incremental costs, the decision should be in favour of the proposal.
Applications of incremental cost techniques in making managerial decisions:
The important areas in which incremental cost analysis could be used
for managerial decision making are as under:
(i) Introduction of a new product
(ii) Discontinuing a product, suspending or closing down a segment of
the business
(iii) Whether to process a product further or not
(iv) Acceptance of an additional order form a special customer at lower than existing price
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(v) Opening of new sales territory and branch.
(vi) Optimizing investment plan out of multiple alternatives.
(vii) Make or buy decisions
(viii) Submitting tenders
(ix) Lease or buy decisions
(x) Equipment replacement decisions
(xi) Transfer Pricing decisions.
(xii) Purchasing vs Lease financing decisions.
20
Write short notes on Product Distribution Decisions.

[Nov 1990]
Answer
The objective of distribution is getting the right goods to the places at
the right time for the optimal cost. The basic output of a distribution
system is that the customers should get the delivery of their orders in
minimum number of days keeping in mind the cost of deliveries.
The decision making tools for this purpose are (a) Linear Programming
(Transportation Models) (b) Inventory Models.
21
Briefly explain the relevant considerations involved in taking managerial decisions in respect of choosing a channel of distribution for a product.
[Nov 1990]
Answer
The relevant considerations are:
(1) Type of product Large manufacturers of consumer goods may
find it profitable to sell their products direct to consumers through
their own retail or chain stores. For certain other products, normal
route of manufacture to wholesaler and then to retailer may be
used.
(2) Type of market In the sellers market, the product or service
should be distributed at the least cost. In a buyers market the
product should penetrate the market by adopting cost effective
channels of distribution since the competition would be intense.
(3) Industry Practices Any firm in any industry will have to follow
the industry practices in deciding the channel of distribution.
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22
It is prudent to hold large inventories in an inflationary economy. Comment.

[Nov 2005]
Answer
In an inflationary situation, prices rise rapidly and the firm may decide
to buy large quantities immediately and hold inventories anticipating
further increase in prices. However it is not prudent to hold large
inventories even in an inflationary situation due to the following
reasons:
(i)
Increase in stockholding costs like interest on capital, wastages,

etc.
(ii) Possible availabilities of cheaper substitutes at a later date in
future.
(iii) Possible new sources of supply at a competitive rate.
(iv) Possibility of fall in prices.
Therefore, even in an inflationary condition, it is sufficient if the firm
hold the normal level of inventory in order to operate its business
without incurring stock out costs.
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TQM, Value Chain Analysis and Business Process Reengineering
Chapter 5|
TQM, Value Chain Analysis and
Business Process Reengineering
17 Capsules
Define Total Quality Management?

Answer
The total quality management is a set of concepts and tools for getting
all employees focused on continuous improvement in the eyes of the
customer. Quality is an important aspect of world-class manufacturing.
The success of Japanese companies is grass rooted in their long term
commitment to improvement of quality. A world class manufacturing
approach demands that the quality must be designed into product and
the production process, rather than an attempt to remove poor quality
by inspection. This means that the objectives of quality assurance in
a world- class-manufacturing environment, is not just reject defective
product, but to systematically investigate the cause of defects so that
they can be gradually eliminated. Though the goal is zero defect, the
methodology is one of continuous improvement.
What are the essential requirements fr successful implementation of

TQM?
[May 2007]
Answer
The essential requirements for successful implementation of TQM are:
(a) Commitment Quality improvement must be everyones job.
Clear commitment from the top management, steps necessary to
provide an environment for changing attitudes and breaking down
barriers to quality improvement must be provided. Support and
training for this must be extended.
(b) Culture Proper training must be given to effect changes in culture and attitude.
(c) Continuous Improvement Recognition of room for improvement
continually as a process, and not merely a one-off programme.
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(d) Cooperation Must be ensured by involving employees by resorting to mutually agreeable improvement strategies and associated
performance measures.
(e) Customer Focus Perfect service with zero defectives with satisfaction to end user whether external customer or internal customer.
(f) Control Documentation, procedures and awareness of current
practices ensure checking deviation from the intended course of
implementation.
3
Discuss the benefits accruing from the implementation of a Total Quality Management programme in an organization.
[Nov 2008]
Answer
The benefits accruing from the implementation of a Total Quality Management programme in an organisation are:
a.
b.
c.
d.
4
There will be increased awareness of quality culture in the organization.

It will lead to commitment to continuous improvement.
It will focus on customer satisfaction.
A greater emphasis on team work will be achieved.
What are the critical success factors of TQM?

[Nov 2009]
Answer
The critical success factors of TQM are:
a.
b.
c.
d.
e.
f.
g.
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Focus on customer needs.

Everyone in the organisation should be involved.
Focus on continuous improvement.
Design quality in product and production process.
Effective performance measurement system.
Rewards and performance measurements should be renewed.
Appropriate training and education to everyone to understand the
aim of TQM.
TM

5
What are the six Cs for successful implementation of TQM?

Answer
(i)
(ii)
(iii)
(iv)
(v)
(vi)
Commitment If a TQM culture is to be developed, so that quality improvement becomes normal part of everyones job, a clear
commitment, from the top must be provided. Without this all else
fails.
Culture Training lies at the centre of effecting a change -in culture and attitudes. Negative perceptions must be changed to encourage individual contributions.
Continuous improvement TQM is a process, not a program, necessitating that we are committed in the long term to the never
ending search for ways to do the job better.
Co-operation The on-the-job experience of all employees must
be fully utilized and their involvement and co-operation sought in
the development of improvement strategies and associated performance measures.
Customer focus Perfect service with zero defects in all that is
acceptable at either internal or external levels.
Control Documentation, procedures and awareness of current
best practice are essential if TQM implementations are to function appropriately The need for control mechanisms is frequently
overlooked, in practice.
Explain four Ps of Quality improvement principles.

[Nov 2009]
Answer
The Four Ps quality improvement principles are as below:
(a) People It will quickly become apparent that some individuals
are not ideally suited to the participatory process. Lack of enthusiasm will be apparent from a generally negative approach and a
tendency to have prearranged meeting which coincide with the
meetings of TQM teams.
(b) Process The rhetoric and inflexibility of a strict Deming approach
will often have a demotivating effect on group activity.
(c) Problem Experience suggests that the least successful groups
are those approaching problems that are deemed to be too large
provide meaningful solutions within a finite time period.
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(d) Preparation A training in the workings of Deming- like processes

is an inadequate preparation for the efficient implementation of a
quality improvement process.
Note: Deming Process is founded by W. Edwards Deming in the 1950s
who proposed that business processes should be analysed and measured to identify sources of variations that cause products to deviate
from customer requirements. He recommended that business processes be placed in a continuous feedback loop so that managers can
identify and change parts of the process that need improvements. The
process can be implemented through a cycle know as PDCA Cycle (i.e.
Plan, Do, Check and Act).,
7
Write short notes on Six Sigma.

Answer
Six Sigma refers to the philosophy and methods which the companies
such as Motorola and General Electric had used to eliminate defects in
their products and processes.
Six Sigma is a business management strategy, originally developed by
Motorola, USA in 1986, that is widely used in many sectors of industry.
The core of Six Sigma was born at Motorola in the 1970s out of senior
executive Art Sundrys criticism of Motorolas bad quality. As a result of
this criticism, the company discovered a connection between increases
in quality and decreases in costs of production. At that time, the prevailing view was that quality costs extra money. In fact, it reduced total costs by driving down the costs for repair or control. Six Sigma was
heavily inspired by the quality improvement methodologies of the six
preceding decades, such as quality control, Total Quality Management
(TQM), and Zero Defects. Originally, it referred to the ability of manufacturing processes to produce a very high proportion of output within
specification. Processes that operate with six sigma quality over the
short term are assumed to produce long-term defect levels below 3.4
defects per million opportunities (DPMO). Six Sigmas implicit goal is to
improve all processes to that level of quality or better.
Six Sigma is a registered service mark and trademark of Motorola Inc. As
of 2006 Motorola reported over US$17 billion in savings from Six Sigma.
It can be achieved by:
(a) DMAIC While Six sigma methods include many of the statistical
tools that were employed in other quality movements, here they
are employed in a systematic project oriented fashion through the
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define(D), measure(M), analyze(A), improve(I) and control(C) cycle. This cycle was developed by General Electric.
(b) PDCA Cycle of Mr. Deming It is a detailed version of DMAIC cycle
above consisting of four steps Plan (P), Do (D), Check (C) and Act
(A).
(c) Continuous Improvement KAIZEN It seeks continual improvement of machinery, materials, labour utilisation, and production
methods through applications of suggestions and ideas of company teams.
The focus of methodology, however, is understanding and achieving
what the customer wants, since that is seen as the key to profitability of
a production process. In fact, to get across this point, some use of the
DMAIC as an acronym for Dumb Managers Always Ignore Customers.
8
What are various kinds of costs associated with Quality Control?

Answer
The costs associated with delivering Quality are:
(a) Appraisal Costs: - These are connected with measuring conformity with requirements and include
1. Cost of incoming inspections (note that if suppliers adopt a
total quality approach, this cost can be eliminated)
2. Cost of set up inspections
3. Cost of acquiring and operating the process control and
measuring equipment.
(b) Prevention Costs: - These are the costs of ensuring that defects do
not occur in the first place. These may be
1. Routine preventive repairs and maintenance to equipment
2. Quality training for operatives to improve skills and efficiency. Training employees works provided the employee also
understand and accept the benefits of such training. Training
can occur both inside and outside the workplace. Internal
training may include the ideas of team working and quality
discussion groups, which are known as QUALITY CIRCLES.
3. Building of quality into the design and manufacturing process. When a product is designed, its specification should
consider factors that will minimise future rectification costs.
Production methods should be as simple as possible and use
the skills and resource existing within the sphere of knowledge of the organisation and its employees.
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(c)
Internal Failure Costs:- These costs are:

1. Costs of scrap
2. Reworking costs
3. Manufacturing and process engineering required to correct
the failed process.
It is contended that, in many companies, the costs of internal failure are so great that a total quality programme can be financed
entirely from the savings that are made from it hence the expression quality is free.
(d) External Failure Costs:- These costs are:
1. Marketing costs associated with failed products and loss of
customer goodwill.
2. Manufacturing or process engineering costs relating to failed
products.
3. Compensation or replacement for units returned by customers.
4. Repair costs
5. Travel costs to visit sites with faulty products
9
Classify the following items under the appropriate category of quality

costs viz. Prevention cost, appraisal cost, internal failure cost and external failure cost:
(a) Rework
(b) Disposal of scrap
(c) Warranty repairs
(d) Revenue loss
(e) Repairs to manufacturing equipment
(f) Discount on defective sale
(g) Raw material inspection
(h) Finished product inspection
(i) Establishment of quality circles
(j) Packaging inspection
Answer
(a) Internal Failure Cost
(b) Internal Failure cost
(c) External Failure Cost
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(d)
(e)
(f)
(g)
(h)
(i)
(j)
10
External Failure cost

Prevention Cost
Internal Failure Cost
Appraisal Cost
Appraisal Cost
Prevention Cost
Appraisal Cost
What is the concept of Value-chain and why is it important for Cost

Management?
Answer
Value chain is the linked set of value creating activities from the basic
raw materials and components sources to the ultimate end use of the
product or service delivered to the customer.
The idea of a value chain was first suggested by Michael Porter (1985) to
depict how customer value accumulates along a chain of activities that
lead to an end product or service.
Porters Definition : He described the value chain as the internal processes or activities a company performs to design, produce, market,
deliver and support its product. He further stated that a firms value
chain and the way it performs individual activities are a reflection of its
history, its strategy, its approach of implementing its strategy, and the
underlying economics of the activities themselves.
Porter classified business activities under two heads viz., Primary activities line activities and support activities .Primary activities are directly
involved in transforming inputs into outputs and delivery and after-sales
support to output. In other words they include:
material handling and warehousing
transforming inputs into final product
order processing and distribution
communication, pricing and channel management, and
installation, repair and parts replacement.
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THE VALUE CHAIN
The six business functions contained in the value chain are (i) Research
and Development, (ii) Design (iii) Production (iv) Marketing (v) Distribution and (vi) Customer service.
The objective of value chain is to serve as means of increasing the
customer satisfaction and managing costs effectively. Coordination of
the individual parts of the value chain activities creates conditions to
improve customer satisfaction in terms of cost efficiency, quality and
delivery. A firm which performs value chain activities more efficiently
and at a lower cost than its competitors will be able to gain competitive
advantage. The following methodology should be adopted.
a.
The firm should identify the industry value chain and then assign
costs, revenues and assets to value activities.
b. Diagnose the cost drivers regulating each value activity.
c. Develop sustainable cost advantage either by controlling cost drivers better than competitors or by reconfiguring the chain value.
By analyzing costs, revenues and assets in each activity systematically
a company can achieve low cost. Thus value chain helps managers in
deciding how to apply the organizations valuable physical and human
resources to each linked process so as to achieve cost effectiveness.
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11
What steps are involved in value chain analysis approach for assessing
competitive advantages?
Answer
Most corporations define their mission as one of creating products and
services. In contrast, the other companies are acutely aware of the strategic importance of individual activities within their value chain, They
are concentrating on those activities that allow them to capture maximum value for their customers and themselves. These firms use the
value chain analysis approach to better understand which segments,
distribution channels, price points, product differentiation, selling prepositions and value chain configuration will yield them the greatest competitive advantage.
The way the value chain approach helps these organizations to assess
competitive advantage includes the use of following steps of analysis:
(i)
Internal cost analysis to determine the sources of profitability

and the relative cost positions of internal value creating processes;
(ii) Internal differentiation analysis to understand the sources of
differentiation with internal value-creating process; and
(iii) Vertical linkage analysis to understand the relationships and associated costs among external suppliers and customers in order
to maximize the value delivered to customers and to minimize the
cost.
The value chain approach used for assessing competitive advantages
is an integral part of the strategic planning process. Like strategic planning, value chain analysis is a continuous process of gathering, evaluating and communicating information for business decision-making.
12
State the limitations of value chain analysis.

Answer
Value chain analysis is neither an exact science nor it is easy. It is more
art than preparing precise accounting reports. There are several
limitations to the implementation and interpretation of value chain
analysis.
(a) First, the internal data on costs, revenues and assets used for
value chain analysis are derived from one periods financial information. For long term strategic decision-making, changes in cost
structures, market prices and capital investments from one period
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(b)
(c)
(d)
(e)
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to the next may alter the implications of value chain analysis. Organisations, should ensure that the value chain analysis is valid
for future periods. Otherwise, the value chain analysis must be
repeated under new conditions.
Identifying stages in an industrys value chain is limited by the ability to locate at least one firm that participates in a specific stage.
Breaking a value stage into two or more stages when an outside
firm does not compete in these stages is strictly judgement.
Finding the costs, revenues and assets for each value chain activity
sometimes presents serious difficulties. There is much experimentation underway that may provide better approaches. Having at
least one firm operate in each value chain activity helps to identify
external prices for goods and services transferred between value
chains. For intermediate products or services with no external or
competitive market information, transfer prices must be estimated on the basis of the best information available.
Isolating cost drivers for each value-creating activity, identifying
value chain linkages across activities, and computing supplier and
customer profit margins present serious challenges. The use of
full cost assumes that the full capacity of the value chain activitys
facilities is used to derive the costs. Plant and manufacturing personnel and vendors of equipment are good sources for capacity
information. They can also be helpful in estimating the current or
replacement cost of the assets. Independent companies, for valuation services for assets must exist.
Despite the calculational difficulties, experience indicates that
performing value chain analysis can yield firms invaluable information for their competitive situation, cost structure, and linkages
with suppliers and customers.
TM

13
Differentiate between Traditional Management Accounting and Value

Chain Analysis in a strategic framework.
[Nov 2010]
Answer
Traditional Management
Accounting
Value Chain Analysis
It focuses on internal informations.
It focuses on external informations.
Application of single cost driver at Application of multiple cost drivers

the overall firm level is taken.
i.e. structural and executional are
taken for each value added activity.
It assumes that cost reduction must Exploits linkages throughout the valbe found in the value added process. ue chain i.e. within firm, with suppliers and customers.
Insights for strategic decisions some- Identity cost driver at the individual
what limited in traditional manage- activity level and develop cost / difment accounting.
ferentiation advantage either by
controlling those drivers better than
competitors by reconfiguring the
value chain.
14
How can value analysis achieve cost reduction?

[Nov 2009]
Answer
Value analysis can do cost reduction in the following manner:
a.
b.
c.
d.
By identifying and removing unnecessary components in a product which had utility earlier.
By introducing component substitution at a lesser cost without affecting the quality of the product.
By simplifying the product design.
By introducing alternative methods with less cost but improved
efficiency.
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15
Write short notes on Business Process Re-Engineering

Answer
Business process re-engineering is a business management strategy,
Originally pioneered in the early 1990s, focusing on the analysis and
design of workflows and processes within an organization. BPR aimed
to help organizations fundamentally rethink how they do their work in
order to dramatically improve customer service, cut operational costs,
and become world-class competitors. In the mid-1990s, as many as 60%
of the Fortune 500 companies claimed to either have initiated reengineering efforts, or to have plans to do so.
BPR seeks to help companies radically restructure their organizations by
focusing on the ground-up design of their business processes. According to Davenport (1990) a business process is a set of logically related
tasks performed to achieve a defined business outcome. Re-engineering
emphasized a holistic focus on business objectives and how processes
related to them, encouraging full-scale recreation of processes rather
than iterative optimization of sub-processes.
Business process re-engineering is also known as business process redesign, business transformation, or business process change management.
The globalization of the economy and the liberalization of the trade
markets have formulated new conditions in the market place which
are characterized by instability and intensive competition in the business environment. Competition is continuously increasing with respect
to price, quality and selection, service and promptness of deliver. Removal of barriers, international cooperation, technological innovations
cause competition to intensify. All these changes impose the need for
organizational transformation, where the entire processes, organization
climate and organization structure are changed. Hammer and Champy
provide the following definitions:
Reengineering is the fundamental rethinking and radical redesign of
business processes to achieve dramatic improvements in critical contemporary measures of performance such as cost, quality, service and
speed.
Process is a structured, measured set of activities designed to produce a
specified output for a particular customer or market. It implies a strong
emphasis on how work is done within an organization. (Davenport
1993).
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Each process is composed of related steps or activities that use people,
information, and other resources to create value for customers as it is
illustrated in the following example
An example of a business process: Credit card approval in a bank.
An applicant submits an application. The application is reviewed first
to make sure that the form has been completed properly, if not it is
returned for completion. The complete form goes through a verification
of information. This is done by ordering a report from a credit company
and calling references. Once the information is verified, an evaluation is
done. Then, a decision (yes or no) is made. If the decision is negative,
an appropriate rejection letter is composed. If the decision is positive,
an account is opened, and a card is issued and mailed to the customer.
The process, which may take a few weeks due to workload and waiting
time for the verifications, is usually done by several individuals Business processes are characterized by three elements : the inputs, (data
such customer inquiries or materials), the processing of data or materials (which usually go through several stages and may necessary stops
that furns out to be time and money consuming), and the outcome (the
delivery of the expected result). The problematic part of the process
is processing. Business process is processing. Business process reengineering mainly intervenes in the processing part, which is reengineered
in order to become less time and money consuming.
The term Business Process Reengineering has, over the past couple
of year, gained Increasing circulation. As a result, many find themselves
faced with the prospect of having to learn, plan, implement and successfully conduct a real Business Process Reengineering endeavor, whatever
that might entail within their own business organization. Hammer and
Champy (1993) define business process reengineering (BPR) as:
the fundamental rethinking and radical redesign of the business process to achieve dramatic improvements is critical, contemporary measures of performance, such as cost, quality, service and speed.
16
What are 3 RS of Re-Engineering?

Answer
Redesign, retooling and reorchestrating form the key components of
BPR that are essential for an organization to focus on the outcome that
it needs to achieve. The outcome pursued should be an ambitious outcome (as for instance, are a 24 hour delivery to any customer anywhere
in the world, approval of mortgage loans within 60 minutes of application. Or ability to have an-line access to a patients medical records no
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matter where they are in any major city in the world). These types of
visionary goals require rethinking the way most organizations do business, careful redesign, They will additionally need very sophisticated
supporting information systems and a transformation from a traditional
organizational structure to a network type organization.
In resuming, the whole process of BPR in order to achieve the above
mentioned expected results is based on key steps-principles which include redesign, retool, and reorchestrate. Each step-principle embodies
the actions and resources as presented in the table below.
REDESIGN

Simplify

Standardize

Empowering

Employeeship

Groupware

Measurements
17
RETOOL

Networks

Intranets

Extranets

WorkFlow
REORCHESTRATE
Synchronize

processes

IT

Human resources
Compare TQM and Reengineering.

Answer
TQM
BPR
Case for action
Assumed to be necessary
Goals
Small-scale improvements Outrageous

in many places with cumulative effects
Scope and focus
Attention to tasks, steps, Select but broad busiand processes across the ness processes
board
Degree of change
Incremental and continual
Order of magnitude
and periodic
Senior management
involvement
Important up front
Intensive throughout
Role of information
technology
Incidental
Cornerstone
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Compelling
TM
Chapter 6|
Pricing Decision and Pareto
Analysis
14 Capsules
Enumerate the circumstances which are favourable for the adoption of

a penetrating pricing policy.
[May 1999, May 2001]
Answer
Penetrating pricing Policy means a pricing policy for penetrating mass
market as quickly as possible through lower price offers. This method
is also used for pricing a new product. In order to popularise a new
product penetrating pricing policy is used initially. The company may
not earn profit by resorting to this policy during the initial stage. Later
on, the price may be increased as and when the demand picks up. Penetrating pricing policy can also be adopted at any stage of the product
life cycle for products whose market is approached with low initial price.
The use of this policy by the existing concerns will discourage the new
concerns to enter the market. The pricing policy is also known as stayout-pricing.
Features:
(i)
It is a policy of using a low price as the principal instrument for

penetrating mass markets early.
(ii) This method is used for pricing a new product and to popularize it
initially.
(iii) Profits may not be earned in the initial stages. However, prices
may be increased as and when the product is established and its
demand picks up.
(iv) The low price policy is introduced for the sake of long term survival and profitability and hence it has to receive careful consideration before implementation. It needs an analysis of the scope
for market expansion and hence considerable amount of research
and forecasting are necessary before determining the price.
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Circumstances:
The circumstances in which penetrating pricing can be adopted are:
(1) Elastic demand The demand of the product is high when price
is low. Hence, lower prices mean large volumes and hence more
profits.
(2) Mass Production When there are substantial savings in largescale production, increase in demand is sustained by the adoption of
low pricing policy.
(3) Frighten off competition The prices fixed at a low-level acts as
an entry barrier to the prospective competitors. The use of this
policy by existing concerns will discourage the new concerns to
enter the market. This pricing policy is also known as stay-outpricing.
2
Explain Skimming pricing strategy.

Answer
It is a policy where the prices are kept high during the early period of
a products existence. This can be synchronised with high promotional
expenditure and in the latter years the prices can be gradually reduced.
The reasons for following such a policy are as follows:
(a) The demand is likely to be inelastic in the earlier stages till the
product is established in the market.
(b) The gradual reduction in price in the latter years will tend to increase the sales.
(c) This method is preferred in the beginning because in the initial
periods when the demand for the product is not known the price
covers the initial cost of production.
(d) High initial capital outlays needed for manufacture, results in high
cost of production. In addition to this, the producer has to incur
huge promotional activities resulting in increased costs. High initial prices will be able to finance the cost of production particularly when uncertainties block the usual sources of capital.
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3
Explain the concept of cost plus pricing. What are its advantages and
disadvantages?
[May 2000]
Answer
The most common method of price fixing in a business is to arrive at full
cost, add a margin of profit and then set the selling price. During the
world wars, the concept of cost plus pricing became very much prevalent, as most of the defence contracts were priced at full cost plus a
pre-agreed quantum of profit.
In cost plus pricing, the capacity utilisation of the concern has an important bearing and unless the same is considered on a realistic basis the
determination of cost would get vitiated.
At present, in Government sometimes Tariff Commission, Bureau of Industrial Cost & Prices (BICP) are required to fix prices of certain products
and services. They mainly adopt a system of cost plus pricing. Similarly,
government has also set up a separate agency to fix prices for pharmaceutical products.
Advantages:
(i) It is a fair method and recovery of full costs is assured under it.
(ii) It leaves out scope for any uncertainty.
(iii) After arriving at full cost, the profit percentage can be flexibly adjusted to take care of market competition.
Disadvantages:
(i) Covering full cost all the time may ignore the competition.
(ii) It can lead to a distorted price fixation unless the cost is determined in a scientific manner.
(iii) It ignores the concepts of Marginal Costing, Incremental Costing
etc.
(iv) It is difficult to predetermine capacity utilization.
4
In what circumstances it may be justifiable to sell at a price below marginal cost?

[May 2000]
Answer
It may be justifiable to sell at a price below marginal cost for a limited
period under the following circumstances:
(i)
Where materials are of perishable nature

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(ii) Where stocks have been accumulated in large quantities and the
market prices have fallen.
(iii) To popularize a new product
(iv) Where such reduction enables the firm to boost the sale of other
products having larger profit margin.
(v) To capture foreign markets
(vi) To obviate shut down costs
(vii) To retain future market
5
Describe two pricing practices in which non-cost reasons are important,

when setting prices.
[Nov 2000]
Answer
Two pricing practices in which non-cost reasons are important when
setting price are:
(i)
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Price discrimination This is the practice of charging to some customers a higher price than that charged to other customers e.g.
Airlines tickets for business travellers and economy travellers are
priced differently.
These are illustrated as under :
(a) Price discrimination on the basis of customer : In this case,
the same product is charged at different prices to different
customers. It is, however, potentially disruptive of customer
relations.
(b) Price discrimination based on product version : In this case,
case, a slightly different product is charged at a different
price regardless of its cost-price relationship. If, for example,
a table with wooden top can be sold at ` 400, a table with
sunmica top costing ` 175 extra is sold at ` 575. The higher
premium in the latter case does not necessarily reflect the
higher production cost.
(c) Price discrimination based on place : An example of this
method is the sets in cinema theatre where the front seats
are charged at lower rates than the back seats.
(d) Price discrimination based on time : An example of this
method is the practice of giving off-season concession in sale
of fans or refrigerators just after the summer season.
TM

Price discrimination is possible if the following conditions are satisfied:
(a) the maker must be capable of being segmented for price discrimination;
(b) the customers should not be able to resell the product of the
segment paying higher price; and the chance of competitors
underselling in the segment of higher prices should not be
possible.
(ii) Peak load pricing This pricing system is based on capacity constraints. Under this pricing system a higher price for the same service or product is demanded when it approaches physical capacity
limits e.g. telephones, telecommunication, hotel, car rental and
electric utility industries are charged higher price at their peak
load.
6
What are the various techniques of pricing?

Answer
The various techniques are:
(a) Absorption Costing or Traditional Pricing technique for establish
product :
S.P = prime cost (actual) + overhead recovered + mark up
(b) Conversion cost method :
S.P = total cost + mark up on conversion cost
(c) Standard Cost Method :
S.P = Standard Cost + mark up
(d) Marginal Cost Method :
S.P = total variable cost + mark up on variable cost
(e) Differential Cost Method :
S.P = Differential Cost + mark up.
(f) Relevant cost technique :
Minimum sale price = variable cost + discretionary cost +
opportunity cost.
(g) Learning Curve Method or Experience curve method :
S.P = Static cost + Reducible cost + Mark up
(h) Return on investment method : (ROCE or ROI)
S.P = total cost + mark up on capital employed
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(i)
Activity Based Costing :

S.P = Prime cost + overhead on cost driver + mark up
(j) Life Cycle Costing :
S.P = total cost on estimated life + mark up
(k) Target Costing :
Target SP = Target Cost + Target Profit
7
Write short notes on Competitive Pricing.

Answer
Where a company sets its price mainly on the consideration of what its
competitors are charging, its pricing under such situation is called competitive pricing. Two types of competitive pricing are:
(i)
Going rate pricing Under this method, the firm tries to keep its
price at the average level charged by the industry. Such pricing
is useful where it is difficult to measure costs. Adoption of such
pricing will not only yield fair return but would be least disruptive for industrys harmony. Under highly competitive conditions
in homogenous product market (such as food; raw materials and
textiles) the company has no pricing decision to make.
(ii) Sealed bid pricing competitive pricing is adopted in situations
where firms compete for jobs on the basis of bids. The bid is the
firms offer price, and it is a prime example of pricing based on
the expectations of how competitors will price rather than on a
rigid relation based on the concerns own costs or demand. The
objective of the firm in bidding situation is to get the contract and
therefore it tries to set its prices lower than the other bidding
firms.
8
Write short notes on Geographical Pricing.

Answer
In pricing, a seller must consider the costs of shipping goods to the
buyer. These costs grow in importance as freight becomes a larger part
of total variable costs. Pricing policies may be established whereby the
buyer pays all the freight expense, the seller bears the entire cost, or the
seller and buyer share this expense. The strategy chosen can influence
the geographic limits of a firms market, locations of its production facilities, sources of its raw materials, and its competitive strength in various
geographic markets. It can be understood under the following heads:
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(a) Point-of-Production Pricing : In a widely used geographic pricing
strategy, the seller quotes the selling price at the point of production and the buyer selects the mode of transportation and pays all
freight costs.
This method of pricing is referred as FOB factory pricing.
(b) Uniform Delivered Pricing: Under uniform delivered pricing, the
same delivered price is quoted to all buyers regardless of their
locations.
Uniform delivered pricing is typically used where freight costs are
a small part of the sellers total cost. This strategy is also used by
many retailers who believe free delivery is an additional service
that strengthens their market position.
(c)
Zone-Delivered Pricing : Zone-delivered pricing divides a sellers

market into a limited number of broad geographic zones and then
sets a uniform delivered price for each zone.
(d) Freight-Absorption Pricing : Under freight-absorption pricing, a
manufacturer will quote to the customer a delivered price equal
to its factory price plus the freight costs that would be charged by
a competitive seller located near that customer.
9
Write short notes on Loss Leader

Answer
Where a product can be enriched by a series of optional extras, which
a customers of the main product are at liberty to add on for additional
advantages, the main product may be offered at a relatively low price.
If the price is set below cost, the product becomes a loss leader. It leads
the customers to buy the extras or optional advantageous spare parts
which are highly priced.
When a product range consists of one or more main products and a
series of related optional extract, which the customer can add on to
the main product, the supplier can set a relatively low price for the main
product and a high one for the extras. Obviously, the aim is to stimulate sufficient demand for the former to ensure the target return from
sales of the latter. The strategy has been used successfully by aircraft
engine, gas turbine manufacturers, who win an order with a very competitively priced main product that can only be serviced by their own,
highly priced spare parts.
Gillette did not invent the safety razor but the market strategy Gillette
adopted helped to build market share. Gillette razors were sold at 1/5 of
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the cost to manufacture them but only Gillette blades fitted and these
were sold at a price of 5 cents. The blades cost only 1 cent to manufacture and so Gillette made large profits once it had captured the customer.
10
State the pricing policy most suitable in each of the following independent situations:
(i) The company makes original equipments and does defence contract work. There are other companies which also undertake such
projects.
(ii) The product made by a company is new to the market. It is expected to enjoy a long term demand. Competition is expected very
soon, since the product will be desirable to most customers.
(iii) Stock of processed ready to eat products, whose shelf life will
soon be over in the next 2 months. The product is going to be
discontinued.
(iv) A company sells a homogeneous product in a highly competitive
market.
(v) A is a new product for the company and the market and meant
for large scale production and long term survival in the market.
Demand is expected to be elastic.
(vi) B is a new product for the company, but not for the market. Bs
success is crucial for the companys survival in the long term.
(vii) C is a new product to the company and the market. It has an
inelastic market. There needs to be as assured profit to cover high
initial costs and the usual sources of capital have uncertainties
blocking them.
(viii) D is a perishable item, with more than 80% of its shelf life over.
Answer
(i) Sealed bid pricing or Cost Plus Pricing
(ii) Penetration pricing
(iii) Marginal cost pricing
(iv) Going rate pricing
(v) Penetration pricing
(vi) Going rate pricing
(vii) Skimming the cream pricing
(viii) Marginal cost pricing
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11
State the general guidelines to be used in adopting a pricing policy in a

manufacturing organization.
[Nov 2008]
Answer
The general guidelines to be used in adopting a pricing policy are as
under:
(i)
(ii)
(iii)
(iv)
(v)
12
The pricing policy should encourage optimum utilization of resources.

The pricing policy should work towards a better balance between
demand and supply.
The pricing policy should promote exports.
The pricing policy should serve as an incentive to the manufacturers to maximize production by adopting improved technology.
The pricing policy should avoid adverse effects on the rest of the
economy.
What are the necessities of pricing policy?

Answer
Pricing is primarily the top managements exercise in Profit Planning by
Profit center. The necessity for pricing decision may arise when
(a) Market entry strategies are to be developed.
(b) Quotations or bids are to be made for the products.
(c) Inter Departmental Transfer
13
What is Pareto Analysis? State its usefulness, applications and limitations.

[May 2008, Nov 2008]
Answer
Pareto analysis is based on the 80.20 rule that was a phenomenon observed by Vilfred Pareto. According to him 80% of wealth of Milan in Italy was owned by 20% of its citizens. The phenomenon can be observed
in many different business situations & the management can follow it in
various circumstances to direct management attention to the key control mechanism or planning aspects.
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Usefulness of Pareto analysis:

It helps to establish top priorities & to identify both profitable and unprofitable targets it helps to:
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
Prioritize problems, goals and objectives

Identify root causes
Select and define key quality improvement programs
Select key customer relations and service programs
Select key employee relations improvement programs
Select and define key performance improvement programs
Maximize research and product development time
Verify operating procedures and manufacturing processes
Product or services sales and distribution
Allocate physical, financial and human resources.
Applicability of Pareto analysis to business situations:

The Pareto analysis is generally applicable to the following business
situation.
a.
b.
c.
d.
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Pricing of a product In practice, it has been observed that 20%

of products of a firm may account for 80% of total sales revenue.
Under such circumstances the firm can adopt more sophisticated
pricing method for small portion of products that jointly accounts
for approximately 80% of total sales revenue. For the remaining
80% of the products the firm may use cost bases pricing method.
Customer profitability Customers can also be analyzed instead
of products, for their relative profitability It has been often found
that 20% of customers may generate 80% of sales revenue profit.
Such an analysis is useful for the evaluation of portfolio of customer profile.
Stock control Approximately 20% of the total investment in
quantity of stock may account for about 80% of its investment.
Since the number of items is small therefore the management of
a firm may be able to control most of the monetary investment in
them.
Applicability in activity based costing In ABC it is often said that
20% of an organisation cost drivers are responsible for 80% of
the total overhead cost. By analyzing, monitoring and controlling
those cost drivers that cause most cost a better control and understanding of overheads may be obtained.
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e.
Quality control Pareto analysis seeks to discover from an analysis of defect report or customer complaints which vital few causes are responsible for most of the reported problems. Often 80%
of underlying problems can usual be traced to 20% of the various
underlying causes.
Limitations of Pareto Analysis:
ii.
iii.
14
Potential cost is involved.

Product & customer of low rank is neglected.
How Pareto analysis is helpful in pricing of product in the case of firm

dealing with multi-products?
Answer
In the case of firm dealing with multi products, it would not be possible
for it to analyse price volume relationship for all of them. Pareto Analysis is used for analysing the firms estimated sales revenue from various
products and it might indicate that approximately 80% of its total sales
revenue is earned from about 20% of its products. Such analysis helps
the top management to delegate the pricing decision for approximately
80% of its product to the lower level of management, thus freeing them
to concentrate on the pricing decisions for products approximately 20%
of which is essential for the companys survival. Thus, a firm can adopt
more sophisticated pricing methods for small proportion of products
that jointly account for 80% of total sales revenue. For the remaining
80% products, which account for 20% of the total sales value the firm
may use cost based pricing method.
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Chapter 7|
Service Sector
5 Capsules
Explain features of service organizations which may create problems

for the applications of Activity Based Costing.
[May 2005]
Answer
Service organizations predominantly have indirect costs and are hence
ideal for implementation of ABC. However, the following features of service organizations may create problems for application of ABC
(1) Production and consumption of many services are inseparable.
Hence the specific costs of rendering each service cannot be ascertained with reasonable accuracy. Also, difficulties are faced in
apportionment of common expenses incurred over various services.
(2) Most services are intangible. This creates problems in the identification of appropriate cost driver in respect of each activity or
service rendered.
(3) Service outputs vary from day to day. Hence the quantity of cost
driver has to be carefully determined by recording, observing and
averaging out the service outputs over a considerable period of
time.
(4) Pricing strategies depend on customer in case of service organization. Such ad hoc pricing strategies may render the application of
ABC system infructuous.
(5) Many service organisations have not previously had a costing system and much of the information required to set up a ABC system
will be non-existent. Therefore introduction of ABC may be expensive.
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Service Sector
2
Write a brief note on Pricing in Service Sector.

[Nov 2003, Nov 2005]
Answer
The different methods used are:
(1) Supply and Labour Billing Service companies such as appliance
repair shops, automobile repair shops arrive at prices by using two
computations, one for labour and other for materials and parts.
(2) Pure Labour Billing If materials and parts are not part of service
being performed, then only direct labour costs are used as basis
for determining price.
(3) Cost plus pricing with a cost based approach, a mark up percentage is used to cover overhead costs and profit margin, in addition
to the direct costs of labour, material and parts.
(4) Service oriented based billing Using ABC techniques, Direct Labour and Overhead costs are ascertained. The desired margin is
added to determine the service charges.
3
Discuss with examples, the basic costing methods to assign costs to

services.
[May 2007]
Answer
a.
b.
c.
4
Job costing method The cost of a particular service is obtained

by assigning costs to a distinct identifiable service. e.g. Job Costing
method is used in service sectors like Accounting Firm, Advertisement campaign.
Process Costing method Cost of a service is obtained by assigning costs to masses of similar unit and then computing cost per
unit on an average basis. e.g. Retail banking, postal delivery, credit
card etc.
Hybrid method Combination of both (a) & (b) above.
Explain the importance of cost units in service sector.

Answer
In case of operating costing, it is necessary to first collect all the cost
data over a period of time and then select the appropriate base for
which the cost is to be computed.
There are two types of cost units in operating costing:
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(i) Single Cost Unit, and

(ii) Composite Cost Unit
In case of single cost unit, only one factor is considered but in case of
Composite unit a number of highly effected factors are taken up. Composite units are adopted by concerns for more accurate results in cost
calculation.
Examples:
Nature of
Industries
Single Cost Units
Transport
Per Km, Per Tonne, Per Tonne Km, Passenger Km, Seat
Per passenger
Km
Electricity
Per Kilowatt, Per Per Kilowatt Hour

Hour
Hospital
Per Bed, Per Pa- Per Patient Day, Per Bed Day
tient, Per Day
Professional
Firm
Per Client,
Hour
School or College
Per Student
Per Student Hour
Cinema
Per Show, Per Seat
Per Seat Per Show
Canteen
Per Meal, Per Cup
Per Meal Cup
Hotels
Per Bed, Per Day
Per Room Occupancy Day
Swimming
Pool
Per Attendant, Per Per Attendant Per Hour

Hour
Composite Cost Units
Per Per Client Hour
What do you understand by standard load in transportation service?

Answer
In case of transport companies, the calculation of tonne-kilometres gets
complicated when the goods to be transported are of varying bulk (i.e.
quantity) and weight.
In such a case, standard load is computed as a cost unit by multiplying
the respective weight and quantity.
Therefore, it is the total weight which a lorry would carry. This unit takes
into consideration both the quantity and the weight and is most appropriate for distribution of transport costs over the different departments
of the company.
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Standard Costing
Chapter 8|
Standard Costing
9 Capsules
Explain the procedure for setting up physical or quantity standards for

material and labour.
[Nov 1990]
Answer
MATERIAL QUANTITY STANDARDS:
The following procedure is usually followed for setting material quantity
standards:
(a) Standardisation of products Detailed specifications, blueprints,
norms for normal wastage etc., of products along with their designs are settled.
(b) Product classification Detailed classified list of products to be
manufactured are prepared.
(c) Standardisation of material Specifications, quality, etc., of materials to be used in the standard products are settled.
(d) Preparation of bill of materials A bill of material for each product or part showing the symbol or code, description and quantity
of each material to be used is prepared.
(e) Test runs Sample or test runs under regulated conditions may be
useful in setting quantity standards in a precise manner.
LABOUR QUANTITY STANDARDS:
The following are the steps involved in setting labour quantity standards:
(a) Standardisation of product, as explained above.
(b) Product classification, as defined earlier.
(c) Standardisation of methods: Selection of proper machines to use
proper sequence and method of operations.
(d) Manufacturing layout: A plan of operation for each product listing
the operations to be performed is prepared.
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(e) Time and motion study is conducted for selecting the best way of
completing the job or motions to be performed by workers and
the standard time which an average worker will take for each job.
(f) The operator is given training to perform the job or operations in
the best possible manner.
2
Calculation of variances in standard costing is not an end in itself, but

a means to an end. Discuss.
[May 1999]
Answer
The crux of standard costing lies in variance analysis. Standard costing
is the technique whereby standard costs are predetermined and subsequently compared with the recorded actual costs. It is a technique
of cost ascertainment and cost control. It establishes predetermined
estimates of the cost of products and services based on managements
standards of efficient operation. It thus lays emphasis on what the cost
should be. These should be costs are when compared with the actual
costs. The difference between standard cost and actual cost of actual
output is defined as the variance. The variance in other words in the
difference between the actual performance and the standard performance. The calculations of variances are simple. A variance may be favourable or unfavourable. If the actual cost is less than the standard
cost, the variance is favourarable but if the actual cost is more than
the standard cost, the variance will be unfavourable. They are easily expressible and do not provide detailed analysis to enable management of
exercise control over them. It is not enough to know the figures of these
variances from month to month. We infact are required to trace their
origin and causes of occurrence for taking necessary remedial steps to
reduce / eliminate them.
A detailed probe into the variance particularly the controllable variances help the management to ascertain:
(i)
(ii)
(iii)
(iv)
the amount of variance

the factors or causes of their occurrence
the responsibility to be laid on executives and departments and
corrective actions which should be taken to obviate or reduce the
variances.
Mere calculation and analysis of variances is of no use. The success of
variance analysis depends upon how quickly and effectively the corrective actions can be taken on the analysed variances. In fact variance
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Standard Costing
gives information. The manager needs to act on the information provided for taking corrective action. Information is the means and action
taken on it is the end. In other words, the calculation of variances in
standard costing is not an end in itself, but a means to an end.
3
Describe three distinct groups of variances that arise in standard costing.

[May 2000]
Answer
The three distinct groups of variances that arise in standard costing are:
(i)
Variances of efficiency These are the variance, which arise due

to efficiency or inefficiency in use of material, labour etc.
(ii) Variances of prices and rates These are the variances, which
arise due to changes in procurement price and standard price.
(iii) Variances due to volume These represent the effect of difference between actual activity and standard level of activity.
4
Standard costing variances centre around comparison of actual Performance with the standard and the standards or plans are normally
based on the environment anticipated when the targets are set and if
the current environment is different from that anticipated, such analysis cannot measure managerial performance. Comment on the statement and how will you deal with the situation with reference to material, labour and sales variances.
[Nov 2000]
Answer
The statement give in the question highlights practical difficulties faced
by our industries today.
When the current environmental conditions are different from the anticipated environmental conditions (prevailing at the time of setting
standard or plans) the use of routine analysis of variance for measuring
managerial performance is not desirable / suitable.
The variance analysis can be useful for measuring managerial performance if the variances computed are determined on the basis of revised
targets / standards based on current actual environmental conditions.
In order to deal with the above situation i.e. to measure managerial
performance with reference to material, labour and sales variances, it is
necessary to proceed and compute the following variances.
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Material variances In the case of material purchase price variance,

suppose the standard price of raw material determined was ` 5 per unit,
the general market price per unit at the time of purchase was `5.20 and
actual price paid per unit was ` 5.18 on the purchase of say 10,000 units
of raw material.
In this case the variances to be computed should be:
Uncontrollable material purchase price planning variance:
= (Standard price p.u. General market price p.u.) Actual quantity purchased
= (` 5 ` 5.20) 10,000 units = ` 2,000 (Adverse)
Controllable material purchase price operating variance:
= (General market price p.u. Actual price paid p.u.) Actual quantity
purchased
= (` 5.20 5.18) 10,000 units
= ` 200 (Fav.)
In the case of material usage variance, suppose the standard quantity
per unit be 5 kgs, actual production units be 250 and actual quantity of
material used is 1,450 kgs. Standard cost of material per kg. was Re.1.
Because of shortage of skilled labour it was felt necessary to use unskilled labour and that increased material usage by 20%. The variances
to be computed to deal with the current environmental conditions will
be:
Uncontrollable material usage planning variances:
= (Original std. quantity in kgs. Revised std. quantity in kgs.) Standard
price per kg.
= (1,250 kgs. 1,500 kgs) Re.1
= `250 (Adverse)
Controllable material usage operating variance:
= (Revised standard quantity in kgs. Actual quantity used in kgs.) Standard price per kg.
= (1,500 kgs. 1,450 kgs.) `1
= `50 (Favourable)
Labour variances Like material variances, here also labour efficiency
and wage rate variances should also be adjusted to reflect changes in
environmental conditions that prevailed during the period. The labour
efficiency variances would be equivalent to the following two variances.
(a) Uncontrollable labour efficiency planning variance
(b) Controllable labour efficiency operating variance
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Standard Costing
The above variances would arise when unskilled labour is substituted
for skilled labour. Similarly, one uncontrollable and other controllable
variance would arise in the case of wage rate variance as well under
current environmental conditions.
Sales variances The conventional sales volume variance reports the
difference between actual and budgeted sales, priced at the budgeted
contribution per unit. The variance merely indicates whether sales volume is greater or less than expected. It does not indicate how well sales
management actual sales volume should be compared with an expert
estimate that reflects the market conditions prevailing during that period.
Total sales margin variance (planning element):
= {Experts budgeted sales volume (Experts selling price Standard
cost) Original budgeted sales volume (Budgeted selling price
Standard cost)}
Total sales margin variance (appraisal element):
= {Actual sales volume (Actual selling price Standard cost)}
= Experts budgeted sales volume (Experts selling price Standard
cost)}
The figure of Experts budgeted sales volume for a particular product
can be determined by estimating the total market sales volume for the
period and then multiplying the estimate by the target percentage of
market share.
5
Overhead variances should be viewed as interdependent rather than

independent. Explain.
Answer
The operations of a firm are so inter linked that the level of performance in one area of operation will affect the performance in other
areas. Improvements in one area may lead to improvements in other
areas. A sub-standard performance in one area may be compensated
by a favourable performance in another area. Because of such interdependency among activities in the firm, the managers should not jump to
conclusions merely based on the label of variances namely favourable
or unfavourable. They should remember that there is a room for trade
off amongst variances. Hence, variances need to be viewed as attention directors rather than problem solvers. Thus, a better picture will
be captured when overhead variance are not viewed in isolation but in
an integrated manner.
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Write short notes on

(a) Ideal Standards
(b) Normal Standards
(c) Basic or Bogey Standards
(d) Current Standards
Answer
(a) Ideal Standards These represent the level of performance
attainable when prices for material and labour are most favourable,
when the highest output is achieved with the best equipment
and layout and when the maximum efficiency in utilisation of
resources results in maximum output with minimum cost.
These type of standards are criticised on three grounds:
(i) Since such standards would be unattainable, no one would
take them seriously.
(ii) The variances disclosed would be variances from the ideal
standards. These would not, therefore, indicate the extent
to which they could have been reasonably and practically
avoided.
(iii) There would be no logical method of disposing of these
variances.
(b) Normal Standards These are standards that may be achieved
under normal operating conditions.
The normal activity has been defined as the number of standard
hours which will produce at normal efficiency sufficient goods to
meet the average sales demand over a term of years.
These standards are, however, difficult to set because they require
a degree of forecasting.
(c) Basic Or Bogey Standards These standards are used only when
they are likely to remain constant or unaltered over a long period.
According to this standard, a base year is chosen for comparison
purposes in the same way as statisticians use price indices.
Since basic standards do not represent what should be attained
in the present period, current standards should also be prepared
if basic standards are used. Basic standards are, however, well
suited to businesses having a small range of products and long
production runs.
Basic standards are set, on a long-term basis and are seldom
revised.
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Standard Costing
When basic standards are in use, variances are not calculated as
the difference between standard and actual cost. Instead, the actual cost is expressed as a percentage of basic cost. The current
cost is also similarly expressed and the two percentages are compared to find out how much the actual cost has deviated from the
current standard. The percentages are next compared with those
of the previous periods to establish the trend of actual and current
standard from basic cost.
(d) Current Standards These standards reflect the managements
anticipation of what actual costs will be for the current period.
These are the costs which the business will incur if the anticipated
prices are paid for the goods and services and the usage corresponds to that believed to be necessary to produce the planned
output.
The variances arising from expected standards represent the degree of efficiency in usage of the factors of production, variation in
prices paid for materials and services and difference in the volume
of production.
7
Explain Various plans for accounting of Variances.

[May 2001]
Answer
The variances computed can be accounted in three different ways which
are illustrated as below:
(1) PARTIAL PLAN:
The following points are noteworthy:
(a) Variances are computed at the end of the period.
(b) No separate account is opened to record the variances.
(c) The Work in Progress Control account records all its cost at
actual cost price only.
(d) The difference in WIP Control account at the end of the period represents the variance, the reason of which is analysed
then only.
(e) The closing value of WIP and FG is shown at standard cost
price.
(f) Raw material inventories are valued at actual cost.
(g) Material price variance is calculated for the actual quantity
consumed in production.
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(2) SINGLE PLAN:

The following points are noteworthy:
(a) Variances are computed at the point of transaction purchase of materials, payment of wages, etc.
(b) Separate account is opened to record the variances.
(c) The Work in Progress Control account records all its cost at
standard cost price.
(d) The closing value of WIP and FG is shown at standard cost
price.
(e) Raw material inventories are valued at standard cost.
(f) Material price variance is calculated for the actual quantity
purchased in production.
(3) DUAL PLAN:
Dual plan is a method of recognition of variances by use of Basic
and Current standards unlike Partial and Single plan where only
Current standards are used.
Here the variances are not computed by amounts of cost. Instead,
the variances are expressed in the form of efficiency indices, using
ratio analysis.
The procedure to be followed is as under:
Step 1: Express the actual cost as a percentage of Basic cost.
Step 2: Express the current cost as a percentage of Basic cost.
Step 3: Compare the two percentage to find out the extent of
deviation from Current standards.
Step 4: Compare the above percentage with those of previous
periods to establish the trend of actual and current
standard from Basic cost.
8
How variances are disposed of from books of accounts?

Answer
Variances may be disposed off in any of the following three methods:
1. Write off all the variances to Costing Profit and Loss account at the
end of the period.
2. Distribute all variances proportionately to units sold, closing stock
of WIP and closing stock of Finished Goods.
3. Write off quantity variances to Costing Profit and Loss account and
apportion the price variances over cost of sales, WIP and Finished
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Standard Costing
Goods stock. Here the assumption made is that the quantity variance is abnormal and price variance is normal.
Sometimes favourable variances may also be carried forward to subsequent years for adjustment against the adverse variances instead of the
above treatments.
9
Differentiate between Standard Costing and Budgetary Control.

[RTP, Nov 1997]
Answer
Standard Costing
Budgetary Control
It is a system of accounting where

predetermined costs are used for
analysis of variances and control of
the entire organizations.
It is a planning exercise made by the

management in setting budgets for
the forthcoming period and analysis
of actual with the budgeted figures
and corrective action is initiated if
any deviations are identified.
Standard may be expressed both in Budgets are mainly expressed in

quantitative and monetary meas- monetary terms.
ures.
It is concerned with ascertainment It is concerned with the overall profand control of costs.
itability and financial position of the
concern.
Any variance adverse or favour- It puts emphasis more on excess
able is investigated.
over the budget.
It is determined for each element of It is determined for a specific period.
cost.
It is introduced primarily to ascer- It is introduced to state in figures as
tain the efficiency and effectiveness approved plan of action relating to a
of cost performance.
particular period.
Standards are usually limited to Budgets are set for all departments
manufacturing activities only.
in the organization.
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Chapter 9|
14 Capsules
Write a note on emergence of Target Costing?

Answer
In Japan, target costing is widely practised, in more than 80 percent
of companies in the assembly industries and more than 60 percent of
companies in processing industries. It emerged in Japan in 1960s as a
response to difficult market conditions. A proliferation of consumer and
industrial products of western firms were overcrowding the markets in
Asia. Also, Japanese companies were experiencing shortages of resources and skills needed for the development of new concepts, tools and
techniques, which were required to achieve parity with the toughest
western competitor in terms of quality, cost and productivity.
Many Japanese companies considered modified cross-functional activities, as used by western firms for manufacturing and achieving effective
results. They believed that there were advantages in combining employees from strategy, planning, marketing, engineering, finance and
production into expert teams. These teams were able to examine new
methods and techniques for the design and development of new products, and aimed at enhancing the degree of integration between the
upstream and downstream activities of a firms operations. Target costing thus emerged from this environment. A range of specialized tools,
including functional analysis, value engineering, value analysis and
concurrent engineering were introduced to support target costing. This
made Japanese companies particularly effective in the areas of product
design and development, where they were able to identify all relevant
elements to formulate a holistic management approach, in order to
achieve performance levels to meet the firms objectives.
ADVANTAGES OF TARGET COSTING
1.
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It reinforces-to-bottom commitment to process and product innovation, and is aimed at identifying issues to be resolved, in order
to achieve some competitive advantage.
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2.
3.
It helps to create a companys competitive future with marketdriven management for designing and manufacturing products
that meet the price required for market success.
It uses management control systems to support and reinforce
manufacturing strategies; and to identify market opportunities
that can be converted into real savings to achieve the best value
rather than simply the lowest cost.
Discuss the procedure to implement a target costing system.

Answer
A target costing initiative requires the participation of several departments. Because there are so many participants in the process from so
many departments, some of whom have different agendas in regard to
what they want the program to produce. Design projects can be delayed by squabbling or by an inability to drive down design or production costs in a reasonably efficient manner. This delay may lead to serious cost overruns in the cost of the design team itself, which can lead to
abrupt termination of the entire targets costing system by the management team. However, these problems can be mitigated or completely
eliminated by ensuring that the steps listed here are completed when
the target costing system is first installed:
1.
2.
3.
Create a project charter: The target costing effort should begin

with a document, approved by senior management, that describes its goals and what it is authorized to do. This document,
known as the project charter, is essentially a subset of the corporate mission statement and related goals as they pertain to the
target costing initiative. Written approval of this document by the
senior management group provides the target costing effort with
a strong basis of support and direction in all subsequent efforts.
Obtain a management sponsor: The next step is to obtain the
strongest possible support from a management sponsor. This
should be an individual who is well positioned near the top of
the corporate hierarchy, believes strongly in the goals of target
costing, and will support the initiative in all respectsobtaining
funding, lobbying other members of top management, working
to eliminate road blocks, and ensuring that other problems are
overcome in timely manner. This person is central to the success
of target costing.
Obtain a budget: The target costing program requires funds to
ensure that one or more well-staffed design teams can complete
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4.
5.
6.
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target costing tasks. The funding should be cased on a formal allocation of money through the corporate budget, rather than a
parsimonious suballocation grudgingly granted by one or more
departments. In the first case the funds are unreservedly given
to the target costing effort, whereas in the latter case, they can
be suddenly withdrawn by a department manager manager who
is not is not fully persuaded of the need for target costing or who
suddenly finds a need for the money elsewhere.
Assign a strong team manager: Because the typical target costing
program involves so many people with different backgrounds and
represents so many parts of a company, it can be difficult to weld
the group together into a smoothly functioning team focused on
key objectives. The best way to ensure that the team functions
properly is to assign to the effort a strong team manager skilled in
dealing with management, the use of project tools, and working
with a diverse group of people. This manager should be a fulltime employee, so that his or her complete attention can be directed toward the welfare of the project.
Enroll full-time participants: A target costing team member puts
the greatest effort into the program when he or she is focused
only target costing. Thus, it is essential that as many members of
the term as possible be devoted to it full-time rather than also
trying to fulfil other commitment elsewhere the company at the
same time. This may call for the replacement of these individuals
in the departments they are leaving so that there are no emergencies requiring their sudden withdrawal back to their home departments to deal with other work problems. It may even be necessary to permanently assign them to a target costing program,
providing them with a single focus on ensuring the success of the
target costing program because their livelihood are now tied to it.
Use project management tools: Target costing can be a highly
complex effort especially for high-cost products with many features and components. To ensure that the project stays on track,
the team should use all available project management tools, such
as Microsoft Project (for tracking the completion of specific tasks),
a company database containing various types of costing information, and a variety of product design tools.
All these items require assured access to many corporate database, as well as a budget for whatever computing equipment is
needed to access this data.
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The main focus of the step described in this section is to ensure
the fullest possible support for target costing by all available
meansmanagement, money and staff. Only when all these elements are in place and concentrated on the goals at hand does a
target costing program have the greatest chance for success.
3
What is Target Costing and what are the stages to the methodology?
[Nov 2000]
Answer
Target Costing is a management tool used for reducing a product cost
over its entire life cycle. It is driven by external Market factors. Marketing management prior to designing and introducing a new product determines a target market price. This target price is set at a level that will
permit the company to achieve a desired market share and sales volume. A desired profit margin is then deducted to determine the target
maximum allowable product cost. Target costing also develops methods
for achieving those targets and means to test the cost effectiveness of
different cost-cutting scenarios.
Stages to the methodology:
(1) Conception (planning) Phase Under this stage of life cycle, competitors products are to be analysed, with regard to price, quality,
service and support, delivery and technology. The features which
consumers would like to have like consumer value etc. established.
After preliminary testing, the company may be asked to pinpoint a
market niche, it believes, is under supplied and which might have
some competitive advantage.
(2) Development phase The design department should select the
most competitive product in the market and study in detail the
requirement of material, manufacturing process along with competitors cost structure. The firm should also develop estimates of
internal cost structure based on internal cost of similar products
being produced by the company.
If possible the company should develop both the cost structures
(competitors and own) in terms of cost drivers for better analysis
and cost reduction.
(3) Production phase This phase concentrates its search for better and less expensive products, cost benefit analysis in different
features of a product priority wise, more towards less expensive
means of production, as well as production techniques etc.
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It is said that implementation of the target costing technique requires

intensive marketing research. Explain why intensive marketing research
is required to implement target costing technique.
[Nov 2007]
Answer
Target cost is the difference between estimated selling price of a proposed product with specified functionality and quality and the target
margin. This is a cost management technique that aims to produce and
sell products that will ensure the target margin. It is an integral part of
the product design. While designing the product, the company needs to
understand what value target customers will assign to different attributes and different aspects of quality. This requires use of techniques like
value engineering and value analysis. Intensive marketing research is
required to understand customer preferences and the value they assign
to each attribute and quality parameter. This insight is required to be
developed must before the product is introduced. The company plays
within the space between the maximum attributes and quality that the
company can offer and the minimum acceptable to target customers.
Therefore in absence of intensive marketing research, the target costing
technique cannot be used effectively.
5
Discuss, how target costing may assist a company in controlling costs

and pricing of products.
[Nov 2008]
Answer
Target costing may assist control of costs and pricing of product as
under:
(i)
Target costing considers the price that ought to be charged by a

company to achieve a given market share.
(ii) Target costing should take life cycle costs in to consideration.
(iii) If there is a gap between the target cost and expected cost, ways
and means of reducing or eliminating it can be explored.
(iv) The target cost may be used for controlling costs by comparison.
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6
List the steps involved in Target Costing approach to pricing.

[May 2003, Nov 2006]
Answer
The main steps are:
Step 1: Identify the market requirements as regards design, utility, and
need for a new product or improvements of existing product.
Step 2: Set Target selling price based on customers expectations and
sales forecasts.
Step 3: Set Target Production Volume based on relationships between
price and volume.
Step 4: Establish Target Profit Margin for each product, based on the
companys long term profit objectives, projected volumes,
course of action, etc.
Step 5: Set Target cost or Allowable cost per unit for each product. Target cost is the difference between Target SP and Target Profit
Margin.
Step 6: Determine Current Cost of producing the new product, based
on available resources and conditions.
Step 7: Set Cost Reduction targets in order to reduce the current cost
to the target cost.
Step 8: Analyse the cost reduction target into various components and
identify cost reduction opportunities using Value Engineering
and Value Analysis and Activity Based Costing.
Step 9: Achieve Cost Reduction and Target Profit by Effective Implementation of cost reduction decisions.
Step 10: Focus on further possibilities of cost reduction i.e. continuous
improvement program.
7
Define Value Engineering and Value Analysis. What are the issues that
need to be dealt with during a value engineering review.
[May 1993, May 1996, May 2000]
Answer
Value Engineering involves searching for opportunities to modify the
design of each component or part of a product to reduce cost, but without reducing the functionality or quality of the product.
Value Analysis entails studying the activities that are involved in producing the product to detect non value adding activities that may be elimi9-97
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nated or minimized to save costs, but without reducing the functionality

or quality of the product. Non value added activities are those which if
eliminated, would not affect the value or utility of product or service to
customers.
Some issues analysed during Value Engineering are:
1.
2.
3.
4.
5.
6.
8
Elimination of unnecessary functions from the production process.

Elimination of unnecessary product qualities.
Design minimization.
Better product design to suit manufacturing process.
Substitution of parts.
Search for better way of doing things.
What is the relationship between Target Costing and Life Cycle Costing?
Answer
Target costing and life cycle costing can be regarded as relatively modern
advances in management accounting, so it is worth first looking at the
taken by conventional costing.
Typically, conventional costing attempts to work out the cost of producing an item incorporating the costs of resources that are currently used
or consumed. Therefore, for each unit made the classical variable costs
of material direct labour and variable overheads are included (the total
of these is the marginal cost of productional, together with a share of
the fixed production costs. The fixed production costs can be included using a conventional overhead absorption rate or they can be accounted for using activity-based costing (ABC). ABC is more complex but
almost certainly more accurate. However, whether conventional overhead treatment or ABC is used the overheads incorporated are usually
based on the budgeted overheads for the current period.
Once the total absorption cost of units has been calculated, a mark-up
(or gross gross profit percentage) is used to determine the selling price
and the profit per unit. The mark-up is chosen so that if the budgeted
sales are achieved, the organization should make a profit.
There are two flaws in this approach:
1.
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The products price is based on its cost, but no one might want to
buy at that price. The product might incorporate features which
customers do not value and therefore do not want to pay for, and
competitors products might be cheaper, or at least offer better
value for money. This flaw is addressed by target costing.
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2.
The costs incorporated are the current costs only. They are marginal costs plus a share of the fixed costs for the current accounting period. There may be other important costs which are not
part of these categories, but without which the goods could not
have been made. Examples include the research and development
costs and any close down costs incurred at the end of the products life. Why have these costs been excluded, particularly when
selling prices have to be high enough to ensure that the product
makes a profit. To make a profit, total revenue must exceed total
costs in the long term.
Write short notes on Kaizen Costing.

Answer
Kaizen costing is a process wherein a product undergoes cost reduction
even when it is already on the production stage. In Japanese terminology, it means Ways of Continuous Improvement (KAI = Continuous,
Zen = Improvement). The cost minimization can include strategies in
effective waste management, continuous product improvement or better deals in the acquisition of raw materials.
Yashihuro Moden defines kaizen costing as the maintenance of present
cost levels for products currently being manufactured via systematic efforts to achieve the desired cost level. The word kaizen is a Japanese
word meaning continuous improvement.
Moden has described two types of kaizen costing :

Asset and organisation specific kaizen costing activities planned

according to the exigencies of each deal
Product model specific costing activities carried out in special projects with added emphasis on value analysis
Kaizen costings is applied to products that are already in production phase. Prior to kaizen costing, when the products are under
development phase, target costing is applied.
Kaizen costing is based on the belief that nothing is ever perfect,
so improvements and reductions in the variable costs are always
possible.
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10
What is Product Life-cycle Costing? Describe its characteristics and

benefits.
Answer
Product life cycle costing is an approach used to provide a long-term
picture of product line profitability, feedback on the effectiveness of
the life cycle planning and cost data to clarify the economic impact on
alternatives choices in the design, engineering phase etc. It is also considered as a way to enhance the control of manufacturing costs. It is
important to track and measure costs during each stage of a products
life cycle.
Characteristics:
(i)
Product life cycle costing involves tracing of costs and revenues of

each product over the several calendar periods throughout their
entire life cycle.
(ii) Product life cycle costing traces research and design and development costs and total magnitude of these costs for each individual
product and compared with product revenue.
(iii) Report generation for costs and revenues.
Benefits:
(i)
The product life cycle costing results in earlier actions to generate

revenue or to lower cost than otherwise might be considered.
(ii) Better decision should follow from a more accurate and realistic
assessment of revenues and costs, at least within a particular life
cycle stage.
(iii) Product life cycle thinking can promote long-term rewarding in
contrast to short-term profitability rewarding.
(iv) It provides an overall framework for considering total incremental
costs over the life span of a product.
11
What is total-life-cycle costing approach? Why is it important?

Answer
Life cycle costing estimates, tracks and accumulates the costs over a
products entire life cycle from its inception to abandonment or from
the initial R & D stage till the final customer servicing and support of the
product. It aims at tracing of costs and revenues on product by product
basis over several calendar periods throughout their life cycle. Costs are
incurred along the products life cycle starting from products design,
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development, manufacture, marketing, servicing and final disposal. The
objective is to accumulate all the costs over a product life cycle to determine whether the profits earned during the manufacturing phase will
cover the costs incurred during the pre and post manufacturing stages
of product life cycle.
Importance:
Product life cycle costing is important for the following reasons:
(i)
When non-production costs like costs associated with R & D, design, marketing, distribution and customer service are significant,
it is essential to identify them for target pricing, value engineering
and cost management. For example, a poorly designed software
package may involve higher costs on marketing, distribution and
after sales service.
(ii) There may be instances where the pre-manufacturing costs like
R & D and design are expected to constitute a sizeable portion of
life cycle costs. When a high percentage of total life cycle costs are
likely to be so incurred before the commencement of production,
the firm needs an accurate prediction of costs and revenues during the manufacturing stage to decide whether the costly R & D
and design activities should be undertaken.
(iii) Many costs are locked in at R & D and design stages. Locked in or
Committed costs are those costs that have not been incurred at
the initial stages of R & D and design but that will be incurred in
the future on the basis of the decisions that have already been
taken. For example, the adoption of a certain design will determine the products material and labour inputs to be incurred during the manufacturing stage. A complicated design may lead to
greater expenditure on material and labour costs every time the
product is produced. Life cycle budgeting highlights costs throughout the product life cycle and facilitates value engineering at the
design stage before costs are locked in.
Total life-cycle costing approach accumulates product costs over the
value chain. It is a process of managing all costs along the value chain
starting from products design, development, manufacturing, marketing, service and finally disposal.
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12
What are the phases in Product Life Cycle?

Answer
The length of product life cycle is governed by the rate of technological
change, market acceptance and competition.
The different phases in Product life cycle are:
(1) Introduction Phase (Childhood Phase) Here sales volume is low.
Prices are high to cover the initial promotional costs. No profits
are earned due to heavy initial costs. Negligible competition is
faced.
(2) Growth Phase (Adulthood Phase) Here sales volume rises at increasing rate. High price of products are retained except in the
case where competitors enter the market, prices may be reduced.
Profits from the product increase at a rapid pace.
(3) Maturity Phase (Manhood phase) Here sales volume rises at a
decreasing rate. Prices fall closer to cost due to effect of competition. Normal rate of profits are earned from the products as costs
and prices are normalized.
(4) Decline Phase (Old Age and Death) Here sales level starts decreasing and gap between price and cost is further reduced. No
sales promotion is done as product is no longer in demand. Competition also starts disappearing due to withdrawal of products.
13
What are the costs that you would include in product life cycle cost?
[May 2007]
Answer
The costs are included in different stages of the product life cycle :
Development phase R & D cost / Design cost.
Introduction phase Promotional cost / Capacity costs.
Growth phase / Maturity Manufacturing cost / Distribution costs /
Product support cost.
Decline / Replacement phase Plants reused / sold / scrapped / related
costs.
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14
Explain the various stages in Product Life Cycle.

[Nov 2003]
Answer
The various stages in Product Life Cycle are:
(i)
Market research It identifies the products which customers

want, how much they are prepared to pay for it and how much
quantity they intend to buy.
(ii) Specification It provides details such as required life; maximum
permissible maintenance costs, manufacturing costs, units required, delivery date, expected performance of the product.
(iii) Design Proper drawings and process schedules are defined.
(iv) Prototype manufacture Prototype may be used to develop the
product and eventually to demonstrate that it meets the requirements of the specifications.
(v) Development Testing and changing to meet the requirements
after the initial run as a product when first made rarely meets the
specification.
(vi) Tooling Tooling up for production means building a production
line, building expensive jigs, buying the necessary tool and equipments.
(vii) Manufacture It involves the purchase of raw material and components, use of labour to make and assemble the product.
(viii) Selling Stimulating and creating demand for the product when
the product is available for sale.
(ix) Distribution The product should be distributed to the sales outlets and to the customers.
(x) Product support The manufacturer or supplier should make sure
that spares and expert servicing facilities are available for the entire life of the product.
(xi) Decommissioning or Replacement When a manufacturing
product comes to an end, the plant used to build the product
must be sold, scrapped, or replaced in way that is acceptable to
the society.
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Chapter 10|
Transfer Pricing
9 Capsules
Transfer pricing is a widely debated and contested topic Discuss,

[Nov 1999]
Answer
Usually a conflict between a division of the company and the company
as a whole is faced by the management of decentralized units when
products or services are exchanged among different divisions of the
company. Such a conflict becomes more significant in the case of those
concerns where profitability is used as criteria for evaluating the performance of each division.
The essence of decentralization is reflected in the freedom to make decisions. Under such a set up it is expected. That the top management
should not interfere with the decision making process of its subordinates beading different units. In other words, management of decentralized units is given autonomy with regard to decision-making. In this
system top management is expected to preserve autonomy in decision
making. The management of such companies also expects that each
division should not only achieve its own objective necessary for evaluating the performance but should also achieve the objective of goal
congruence.
A divisional head in a company under aforesaid set up is free to use
a price as a transfer price for goods and services, which may provide
incentive. Such a transfer price may fail to achieve the objective of
Goal congruence (which means a perfect congruence between divisions goal and the goal of the company. In case of failure of a division
to achieve the objective of Goal congruence the management of the
company may dictate their transfer price. Such a interference of management of the company is usually the main basis of conflict between a
division and the company as a whole.
Further this conflict is aggravated if the management advocates the
transfer of goods and services at cost. As such, the transfer price will
not reflect a good picture about the performance of the transferring
division. The profitability of the transferring division will not be known
by the use of such a transfer price.
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Transfer Pricing
Each division appreciates the transfer of its goods/services at usual selling price/market price so as to arrive at the correct return / profitability
figure, used for measuring the performance.
There is no incentive to the transferring division if goods and services
are transferred at variable cost.
2
What should be the basis of transfer pricing, if unit variable cost and
unit selling price are not constant?
[Nov 1999]
Answer
If unit variable cost and unit selling price were not constant then the
main problem that would arise while fixing the transfer price of a product would be as follows:
There is an optimum level of output for a firm as a whole. This is so because there is a certain level of output beyond which its net revenue will
not rise. The ideal transfer price under these circumstances will be that
which will motivate these managers to produce at this level of output.
Essentially, it means that some division in a business house might have
to produce its output at a level less than its full capacity and in all such
cases a transfer price may be imposed centrally.
3
What will be the marketable transfer pricing procedure regarding the

goods transferred under the following conditions (each condition is
independent of the other)?
(i) When division are not captives of internal divisions and the divisions are free to do business both internally and externally and
when there are reasonably competitive external markets for the
transferred products.
(ii) If the external market for the transferred good is not reasonably
competitive.
Answer
Marketable Transfer Pricing Procedure
(i)
When division are not captives of internal divisions and the divisions are free to do business both internally and externally and
when there are reasonably competitive external markets for the
transferred products, then the most suitable transfer price would
be, the market price, as it generally leads to optimal decisions.
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(ii) In case, the external market for the transferred good is not reasonable competitive, following two situations may arise in this case:
If there is idle capacity Under this situation opportunity cost will be
zero hence minimum transfer price should be equal to the additional
outlay costs incurred upto the point of transfer (sometimes approximated by variable costs).
If there is no idle capacity Under this situation opportunity cost should
be added to outlay costs for determining minimum transfer price.
4
Discuss the potential for maximization of income by a multinational

through the use of transfer pricing mechanism.
Answer
The potential for maximization of income by a multinational through
the use of transfer pricing mechanism is based on the successful implementation of the following steps:
(i)
(ii)
(iii)
(iv)
(v)
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Transfer pricing may be set relatively higher for affiliates in relatively high-tax countries that purchase inputs from affiliates located in relatively low-tax countries.
Transfer prices to affiliates in countries which are subject to import duties for goods or services purchase may be set low so as to
avoid host country taxes.
Transfer prices to an affiliate in a country that is encountering relatively high inflation may be set relatively high to avoid some of the
adverse effects of local currency devaluation that are related to
the high inflation.
Transfer prices may be set high for goods and services purchased
by an affiliate operating in a country that has imposed restriction
on the repatriation of income to foreign companies.
Transfer prices may be set low for an affiliate that is trying to establish a competitive advantage over a local company either to
break into a market or to establish a higher share of the companys business.
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Transfer Pricing
5
Indicate the possible disadvantages of treating divisions as profit

centres.
[Nov 2001]
Answer
The Possible disadvantages of treating divisions as profit centres are as
follows:
(1) Divisions may compete with each other and may take decisions to
increase profits at the expense of other divisions thereby overemphasizing short term results.
(2) It may adversely affect co-operation between the divisions and
lead to lack of harmony in achieving organizational goals of the
company. Thus it is hard to achieve the objective of goal congruence.
(3) It may lead to reduction I the companys overall total profits.
(4) The cost of activities, which are common to all divisions, may be
greater for decentralized structure than centralized structure. It
may thus result in duplication of staff activities.
(5) Top management looses control by delegating decision making to
divisional managers. There are risks of mistakes committed by the
divisional managers, which the top management, may avoid.
(6) Series of control reports prepared for several departments may
not be effective from the point of view of top management.
(7) It may under utilize corporate competence.
(8) It leads to complications associated with transfer pricing problems.
(9) It becomes difficult to identity and defines precisely suitable profit
centres.
(10) It confuses divisions results with managers performance.
6
What are some goals of a transfer-pricing system in an organization?

[Nov 2002, May 2006]
Answer
The goals of transfer pricing are that it should:
(1) provide information that motivates divisional managers to take
good economic decisions which will improve the divisional profits
and ultimately the profits of the company as a whole.
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(2) provide information which will be useful for evaluating the divisional performance.
(3) seek to achieve goal congruence.
(4) ensure that divisional autonomy is not undermined.
7
What are various methods of Transfer Pricing?

[May 1998, Nov 2005]
Answer
The method of transfer pricing depends on whether the transferor is a
cost centre or a profit centre. If it is a cost centre then transfer will take
place at cost (may or may not include fixed cost). If it is a profit centre
then transfer will take place at a sale price. For the determination of
selling price, different techniques are available:
A.
B.
C.
D.
Absorption Costing Pricing The transfer price comprises of (Actual prime costs + Overhead recovered + Mark up).
Marginal Costing Pricing Here transfer price is = Variable Costs +
Contribution.
Pricing at Market Price The transfer prices of goods and services
are based on competitive market prices.
Pricing at Bargained or Negotiated Price Each decentralised unit
is considered as an independent unit and transfer price are arrived at by negotiations or bargaining between the buying division
and the selling division. This system fosters a business like attitude
amongst the divisions of the company.
What do you mean by dual rate transfer pricing system?

Answer
This system uses two separate transfer prices to price each inter divisional transaction.
(a) The transferring division is credited with the full cost plus a
markup on each transaction. This price is intended to approximate
the market price of the goods or services transferred. The mark
up provides the transferring division sufficient contribution to recover its fixed costs and report profits. This price is used even if
the intermediate product is not marketable.
(b) The recipient division is debited with the Marginal cost of the
transfers. Alternatively, the relevant costs may be substituted for
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Transfer Pricing
the Marginal costs. The use of Relevant costs will automatically
lead into optimal decision making from the company view point.
This means that the selling division is allowed to earn profit and the receiving division has the correct information in order to make the correct
selling decision to maximize the groups profit. The difference between
the two prices will be debited to a group account named transfer price
adjustment account.
At the end of the year, the profits of the two divisions and hence of the
group will be overstated to the extent of the price difference. In order
to correct this the total amount in the transfer price adjustment account
must be subtracted from the two profits to arrive at the correct profit
for the group as a whole.
9
Write short notes on Two Part Transfer Pricing System.

Answer
In this system, all transfers are made at marginal cost but the supplying division charges the receiving division a fixed fee for the privilege
of obtaining the transfers at a low price. The fixed fee should cover the
supplying divisions fixed costs and allow it to earn an adequate profit.
This system also has a number of drawbacks, two of which are
1.
2.
The supplying division has no incentive to supply units swiftly as

quantum of profit cannot be increased.
The profit is made whenever the fixed fee is transferred.
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Chapter 11|
14 Capsules
Write short notes on Computer-Aided Manufacturing.

Answer
The manufacturing process is carried out by a range of machinery that,
together with its concomitant software, comes under the collective
heading of computeraided manufacturing (CAM).
Maximum elements of CAM are computer numerical control (CNC) and
robotics.
CNC machines are programmable machine tools. These are capable of
performing a number of machining tasks, e.g. cutting, grinding, moulding, bending etc.
A program stores all the existing manufacturing activities and set-up
instructions for a particular machine or bank of machines, providing
facility of changing its configuration in a matter of seconds via the key
board; changes to existing configurations and new configurations are
easily accommodated. CNC therefore offers great flexibility, and reduces set-up times.
Human operators will tire and are error prone. CNC machines are able
to repeat the same operation continuously in identical manner, with
high accuracy level.
For Example the car producer, found that the time taken to completely retool car body panel jigs in their intelligent body assembly system
(IBAS) fell from 12 months to less than 3 months by reprogramming the
process machinery by reprogramming the process machinery by computer and using computerized jig robots.
How MRP developed into ERP?

Answer
Material requirements planning (MRP) and manufacturing resource
planning (MRPII) are predecessors of enterprise resource planning
(ERP), a business information integration system. The development of
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these manufacturing coordination and integration methods and tools
made todays ERP systems possible. Both MRP and MRPII are still widely
used, independently and as modules of more comprehensive ERP systems, but the original vision of integrated information systems as we
know them today began with the development of MRP and MRPII in
manufacturing.
MRP ( and MRPII ) evolved from the earliest commercial database management package developed by Gene Thomas at IBM in the 1960s.
The original structure was called BOMP ( bill-of-materials processor ),
which evolved in the next generation into a more generalized tool called
DBOMP (Database Organization and Maintenance Program). These
were run on mainframes, such as IBM/360.
Joseph Orlickydeveloped Material Requirements Planning (MRP) in response to the TOYOTA Manufacturing Program. The first company to
use MRP was Black & Decker in 1964, with Dick Alban as project leader.
In 1983Oliver Wightdeveloped MRP intomanufacturing resource planning(MRP II).Orlickys book is entitledThe New Way of Life in Production and Inventory Management(1975). By 1975, MRP was implemented in 150 companies. This number had grown to about 8,000 by 1981. In
the 1980s, Joe Orlickys MRP evolved into Oliver Wights manufacturing
resource planning (MRP II) which brings master scheduling, rough-cut
capacity planning,capacity requirements planning, S&OP in 1983 and
other concepts to classical MRP. By 1989, about one third of the software industry was MRP II software sold to American industry ($1.2 billion worth of software).
The vision for MRP and MRPII was to centralize and integrate business
information in a way that would facilitate decision making for production line managers and increase the efficiency of the production line
overall. In the 1980s, manufacturers developed systems for calculating
the resource requirements of a production run based on sales forecasts.
In order to calculate the raw materials needed to produce products and
to schedule the purchase of those materials along with the machine and
labor time needed, production managers recognized that they would
need to use computer and software technology to manage the information. Originally, manufacturing operations built custom software programs that ran on mainframes.
Material requirements planning (MRP) was an early iteration of the integrated information systems vision. MRP information systems helped
managers determine the quantity and timing of raw materials purchases. Information systems that would assist managers with other parts of
the manufacturing process, MRPII, followed. While MRP was primarily
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concerned with materials, MRPII was concerned with the integration of

all aspects of the manufacturing process, including materials, finance
and human relations.
Like todays ERP systems, MRPII was designed to tell us about a lot of
information by way of a centralized database. However, the hardware,
software, and relational database technology of the 1980s was not advanced enough to provide the speed and capacity to run these systems
in real-time, and the cost of these systems was prohibitive for most
businesses. Nonetheless, the vision had been established, and shifts in
the underlying business processes along with rapid advances in technology led to the more affordable enterprise and application integration
systems that big businesses and many medium and smaller businesses
use today (Monk and Wagner).
3
What is MRP and what are its objectives and benefits?

[May 2004]
Answer
It is a management information system providing a basis for production
decisions when what is manufactured has a composite structure and
when lead items are important features. Obviously, the ability of the
system to deliver what is required in the correct place at the correct
time will be dependent on the quality of information which is put into
the computer model.
Aims of material requirement planning :
1.
Determine for final products namely, what should be produced

and at what time.
2. Ascertaining the required units of production of sub-assemblies.
3. Determining the requirement for materials based on an up-todate bill of materials file (BOM).
4. Computing inventories, WIP, batch sizes and manufacturing and
packaging lead times.
5. Controlling inventory by ordering bought-in components and raw
materials in relation to the order received or forecast rather than
the more usual practice of ordering from stock-level indicators.
Benefits:
Detailed forecast of the inventory position is highlighted period by
period.
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4
What are the important data requirements to operate material requirement planning system?
Answer
The important files and records required to implement an MRP system
are:
1.
2.
3.
4.
5.
The Master Production schedule : This schedule specifies the

quantity of each finished unit of products to be produced, and the
time at which each unit will be required.
The Bill of Material file : The bill of material file specifies the subassemblies, components and materials required for each finished
good.
The Inventory file : This maintains details of items in hand for each
sub-assemblies, components and materials required for each finished goods.
The Routing file : This file specifies the sequence of operations required to manufacture components, sub-assemblies and finished
goods.
The Master parts file : This file contains information on the production time of sub-assemblies and components produced internally and lead times for externally acquired items.
Write note on MRP II.

Answer
When the scope of MRP-1 is developed further which includes
1.
2.
3.
4.
Planning of raw material

Planning of component & sub-assemblies
Compute the other resources e.g. machine or labour capacity
To create a full integrated plan for management then it is known
as Manufacturing resources planning (MRP-2)
MRPII (also written MRP-2) adds the MRP schedule into a capacity planning system and then builds the information into a production schedule.
It is also seen as a link between strategic planning and manufacturing
control. The sequence of events is as follows:
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From that document, a manufacturing, plan is developed based upon

inputs from purchasing & production. Adjustments may be necessary to
allow for production rates. Possible inventory levels in seasonal trades
& the size of the workforce. The manufacturing plan leads into a detailed master production schedule which is akin to the original philosophy of MRP already outlined.
6
What do you mean by ERP? Name six benefits of ERP in an enterprise

[May 2004, Nov 2006]
Answer
Enterprise resource planning (ERP) software attempts to integrate all
departments and functions across a company into a single computer
system that can serve all those different departments particular needs.
In fact ERP combines all computerized departments together with the
help of a single integrated software that runs off a single database so
that various departments can more easily share information and communicate with each other
Benefits of ERP:
a. Product costing.
b. Inventory management.
c. Distribution and delivery of products.
d. E-commerce.
e. Automatic control of quality.
f.
Sales service.
g. Improved production planning.
h. Quick response to change in market condition.
i.
Competitive edge by improving business process.
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7
Explain the main features on Enterprise Resource Planning.

[Nov 2007]
Answer
Some of the major features of Enterprise Resource Planning (ERP) areas are as follows:
(i)
ERP facilitates company-wide integrated information system covering all functional areas like manufacturing, selling and distribution, payables, receivables, inventory etc.
(ii) It performs core activities and increases customer services thereby augmenting the corporate image.
(iii) ERP bridges the information gap across organization.
(iv) ERP provides complete integration of systems.
(v) It is a solution for better project management.
(vi) It allows automatic induction of latest technologies like electronic
fund transfer (EFT), Electronic Data Interchange (EDI), Internet, Intranet, Video Conferencing, E-commerce etc.
(vii) ERP eliminates most business problems like material shortage,
productivity enhancements, customer service, cash management
etc.
(viii) It provides business intelligence tools.
8
Define JIT Production and JIT Purchasing.

Answer
The CIMA Official Terminology defines JIT as A system whose objective is to produce or procure products or components as and when they are required by a customer or for use, rather
than for inventory. A just in time system is a pull system which responds to demand, in contrast to a push system, in which inventory
acts as a buffer between the different elements of the system, such as
purchasing, production and sales.
JIT Production is defined as a production system which is driven by demand for finished products whereby each component on a production
line is produced only when needed for the next stage.
JIT Purchasing is defined as a purchasing system in which material purchases are contracted so that the receipt and usage of material to the
maximum extent possible, coincide.
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Describe the salient features of JIT.

Answer
The features of a JIT system are:
(a) Pull System of Production: As against traditional Push system,
here a product is not made until the customer requests it and
components are not made until they are required by the next production stage.
(b) Minimum Inventory Level of Raw Materials, WIP and Finished
Goods: The concept of just-in-time inventory aims at reducing
cost of inventory control and control of purchase and supplies for
production without running any risk of bottleneck being created
in the production flow. The inventory level is aimed at lowering to
the absolute minimum and the safety stock is eliminated.
In a full JIT system, virtually no inventory is held, that is no raw material inventory and no finished goods inventory is held, but there
will be a small amount of WIP, say one tenth of a days production.
(c) Loyalty and Close Contact with Suppliers: To fulfill the above aims
and objectives the delivery of components and materials as and
when they are needed must have to be ensured. The suppliers
of components and materials are to be in close contact with the
buyer so that no much time is lost between placing of order and
actual supplies. On the part of the suppliers there should be guarantee for supply on time.
On-time delivery should not be the only criteria, the quality of
components and materials must be maintained and prices kept
within reasonable limits. Long-term contracts with the supplies
are needed to achieve the objectives.
(d) Co-ordination and Synchronisation of Process: Just-in-time inventory, therefore, requires ensuring co-ordination and synchronisation of all operations from demand being placed to suppliers,
supplies being received from suppliers, issues being made to production.
(e) Multi skilled Work force: JIT requires that the labour force must
be versatile so that they can perform any job to keep production
flowing as required. Workers in JIT cell are trained to operate all
the machines within it and perform routine preventive maintenance on them.
In JIT, production is only required when demand requires it and so
production labour will be paid regardless of activity. This is why JIT
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eliminates direct labour as a cost category and considers labour
cost as an indirect fixed cost or overheads.
(f) Flexible Work Cells: A work cell is a cluster or machine whereby
a worker can move easily to complete the entire production work
all by himself. JIT system requires the manufacturing work cells to
be very flexible so that it can be changed as and when required
as per customer needs and specification without involving much
time and cost.
(g) Production Line: Production process must be grouped by production line rather than by function in order to eliminate inventory
movements between workstations and to speed flow.
(h) KANBAN Authorisation: A simple, infallible information system is
required. Originally, the Japanese used a system based on cards
which were called KANBANS. There would be a small container of
components between each workstations with a Kanban card resting on top. When the container was taken for use by the following workstation the card would be taken off and left behind. This
would be act as a trigger for the previous workstation to produce
another container of that component. Nowadays, computer systems are likely to be used instead of cards but the basic simplicity
of the system should not change.
(i) Zero Defects Policy: A get it right on first time approach and an
aim of zero defects. Defect cause breakdowns in the value chain,
they stop the flow of production, create expensive rework and
lead to late deliveries to customers.
(j) Preventive Maintenance: For regularity in production flow, this
system culminates the policy of preventive maintenance i.e. to
take measures to prevent the breakdown or defects before they
actually occur. For e.g. Painting the machines to prevent rust.
(k) Continuous Improvement KAIZEN: Kaizen is the Japanese term
for continuous improvement in all aspects of a companys performance at every level. As per JIT policy, an organization must always be keen to innovate means to improve quality and reduce
cost through regular efforts and active participation of workers
ideas.
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10
Discuss about Time Analysis under JIT.

Answer
In many Western organizations in the past it took several months to
make a product from start to finish, despite the fact that if worked on
continuously it could be made in say, two days. The difference in time is
largely due to non value adding time like set up time, movement time,
waiting time and inspection time. It is apparent that value is only added
to the product during the actual processing time. These have been estimated to represent as little as 10% of the total manufacturing lead time
in many companies and thus up to 90% of production time adds costs
and no value.
The objective of JIT is to organize the production system in such a way
that the manufacturing lead time becomes equal to process time.
Manufacturing Lead time = Setup time + Movement Time + Process
Time + Waiting Time + Inspection Time.
11
What are the advantages and disadvantages of JIT?

[May 2007]
Answer
Just-in-time inventory concept aims at giving the following advantages:
1.
2.
3.
Drastic reduction in investment on inventories can be achieved.

Total cost of operations can be reduced substantially.
Quality of components and materials can be maintained with the
help of quality control system.
4. Storage cost can be saved to the maximum.
5. Loss due to evaporation, sublimation, deterioration, obsoletion,
pilferage, theft can be brought to the minimum.
6. Cost of inventory accounting can also be reduced.
7. Prices of components and materials can be kept within reasonable
limits with the help of long-term contracts with the suppliers.
8. Production flow can be maintained un-interrupted on the guarantee of on time supplies being given by the suppliers.
The following disadvantages may also come up:
1.
2.
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A break in the flow of supplies for a very short period shall lead to
stoppage of production due to stock out.
Un-mended wrong supply may either spoil the production or
cause its stoppage.
TM

3.
4.
5.
6.
12
The concept cannot be applied in practice, if reliability of the suppliers is not there.
Requirement at every moment is to be carefully assessed and ordered for. This requires a continuous vigilance on the operations.
Materials produced seasonally may be scarce in the market in offseason, thus rendering regular on-time delivery very difficult on
the part of the suppliers.
A problem in any part of the production line will halt the entire
system, as earlier workstations will not receive the pull signals and
later stations will not have their pull signals answered.
Write short notes on Accounting for Pull System Back Flush Costing
and discuss the problems associated with it.
Answer
Traditional cost accounting systems track the sequence of raw materials
and components moving through the production systems, and as a consequence are called sequential tracking systems. As JIT system is different, it requires own cost accounting system. The absence of stock makes
choices about inventory valuation systems unnecessary and the rapid
conversion of direct material into cost of goods sold simplifies the cost
accounting system. The approach is known as back flush accounting.
Backflush accounting delays the recording of costs until after the events
have taken place, then standard costs are used to work backwards to
flush out the manufacturing costs.
The event that triggers the records kept in backflush accounting is the
sale of goods.
This is the system used by TOYOTA in its UK factory. In true Japanese
style it manipulates employees to behave in a certain way. First, employees must concentrate on achieving sales because cost of sales is
the trigger nothing gets recorded until the sale is made. Second, there
is no benefit in producing goods for inventory. In traditional systems,
which have a finished goods inventory, managers can increase profit by
producing more goods than are sold in a period because an increase in
finished goods inventory reduced the cost of sales in traditional financial accounts.
The back flush accounting model cannot be applied in all organizations.
It can only be applied where a JIT type system is in operation.
The advantages of it is that it is less time consuming and less expensive
than traditional system.
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The disadvantages may be that with JIT, defects must be eliminated if

the system is to work and so no accounts for this will exist in backflush
accounting whereas they are required in traditional system. Similarly, JIT
system practices no WIP policy as a result of which backflush accounting
also does not report WIP Inventory. This can be countered by claiming,
quite rightly, immateriality. If only one tenth of one days production is
held in work in progress then it is immaterial. It can also be claimed that
it is immaterial if the work in progress does not change from one period
to the next as opening and closing inventory will cancel each other out.
Backflush accounting can be criticized because of the lack of information that it provides. Some argue, quite rightly, that in reality it is impossible to eliminate all inventory as a truck arriving with raw material
creates inventory until it is moved to and used in production. If back
flush accounting is used in a system where a substantial amount of inventory is held, a physical stock take will be needed, because the system
does not record the quantity of inventory, instead, it is derived on paper
by the difference between the standard cost of material in the goods
sold and the amount of materials purchased. This must be checked by a
physical stock take from time to time.
13
Explain, how the implementation of JIT approach to manufacturing can

be a major source of competitive advantage.
[Nov 2008]
Answer
JIT provides competitive advantage in the following ways:
(i)
(ii)
(iii)
(iv)
(v)
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Stocks of raw materials and finished goods are eliminated, stock

holding costs are avoided.
JIT aims at elimination of non-value added activities and elimination of cost in this direction will improve competitive advantage.
It affords flexibility to customer requirements where the company
can manufacture customized products and the competitive advantage is thereby improved.
It focuses the direction of performance based production of high
quality product.
It minimize waiting times and transportation costs.
TM

14
How does the JIT approach help in improving an organisations profitability?

[May 2007]
Answer
JIT approach helps in the reduction of costs/increase in prices as follows:
(i)
(ii)
(iii)
(iv)
(v)
Immediate detection of defective goods being manufactured so

that early correction is ensured with least scrapping.
Eliminates/reduces WIP between machines within working cell.
OH costs in the form of rentals for inventory, insurance, maintenance costs etc. are reduced.
Higher product quality ensured by the JIT approach leads to higher premium in the selling price.
Detection of problem areas due to better production/scrap reporting/labour tracing and inventory accuracy lead to reduction in
costs by improvement.
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Chapter 12|
20 Capsules
LINEAR PROGRAMMING
1
What is Linear Programming? What are the conditions for its applicability? State its applications and limitations.
[Nov 2000, May 2007]
Answer
Linear Programming is a mathematical technique for determining the
optimal allocation of resources and obtaining a particular objective,
when there are alternative uses of resources. The resources may be as
materials, machines, manpower, time or various inputs. The objective
may be profit maximisation or cost minimization.
Conditions for a linear programming problem:
The term linear programming problem defines a particular class of programming problems which should meet the following conditions:
(a) There must be decision variables or processes which the decision
maker may use at different levels. These decision variables must
be non negative.
(b) The decision maker must have a maximisation (profit) or minimization (cost) objective that he wishes to achieve. Further, the decision maker should be able to describe his objective by using a
linear function involving decision variables.
(c) The action of the decision maker must be constrained that is the
decision variables must be operated at levels which do not violate
the limitations placed on the decision variables.
(d) The decision variables must be interrelated and must be expressed
in terms of linear mathematical equations or inequalities.
Applicability or uses of linear programming:
Linear programming can be used to find optional solutions under constraints.
(a) In production Product mix under capacity constraints to minimise costs/maximise profits along with marginal costing, Inven12-122
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tory management to minimise holding cost, warehousing / transporting from factories to warehouses, etc.
(b) Sensitivity Analysis By providing a range of feasible solutions to
decide on discounts on selling price, decisions to make or buy.
(c) Blending Optional blending of raw materials under supply constraints.
(d) Finance Portfolio management, interest/receivables management.
(e) Advertisement mix In advertising campaign analogous to production management and product mix.
(f) Assignment of personnel to jobs and resource allocation problems.
However, the validity will depend on the managers ability to establish a
proper linear relationship among variables considered.
Limitations of linear programming:
(a) Existence of non linear equations: The primary requirement of
linear programming is that the objective function and constraint
function should be linear. Practically, linear relationships do not
exist in all cases.
(b) Interaction between variables Linear Programming fails in a situation where non linearity in the equations emerges due to joint
interactions between some of the activities like total measure of
effectiveness or total usage of some resource.
(c) Fractional Values In linear programming problems, fractional
values are permitted for the decision variables. However, many
decision problems require the solution for decision variable to be
in non-fractional values. Rounding-off the values obtained by linear programming techniques may not result in an optimal solution
in such cases.
(d) Knowledge of co-efficient of the equations It may not be possible to state all co-efficient in the objective function and constraints with certainty. Also, variables in most cases are random
variables with an individual probability distribution for the values.
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What are the steps for obtaining a Graphical Solution of a Linear Programming Problem along with the formulation.
Answer
Step 1: Define an Objective Function it is generally denoted by the
letter Z. It is a linear equation that has to be maximised or minimised.
Step 2: Identify the Constraints These are a set of linear equalities or
inequalities that express the restrictions on the resources. The
solution to the problem must satisfy all the constraints.
Step 3: Graphical Solution:
(a)
(b)
(c)
(d)
Convert the inequations of constraints into equations.

Plot the equations on the plane of graph.
Obtain the feasible region and ensure that it is bounded.
Construct matrix E of the extreme points and matrix C from
the co efficient of the objective function.
(e) Find matrix product EC. For maximisation select row having
the largest element and for minimisation select row having
the smallest element.
(f) The objective function is optimised corresponding to the
same row elements.
A multiple solution to the problem may exist. The optimised value of Z,
however, remains the same.
SIMPLEX
1
1.
2.
Special Cases in Simplex Method?

Answer
Idle or Slack Capacity in a resource. The quantity elements against the
slack variables in the optimal solution indicate the idle capacity of the
corresponding resource.
Marginal Value or Shadow Price or Opportunity Cost of a Resource:
The magnitude of the NER elements corresponding to the slack or surplus variables in the optimal solution is called marginal value or shadow
price or opportunity cost. It represents the amount by which the profit
is reduced or the cost is increased when one unit of the resource become unavailable at the optimum level.
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3.
4.
5.
Marginal Value or Shadow Price or Opportunity Cost of producing a

product: The magnitude of the NER elements corresponding to a non
basic variable which represents a product in original problem is called
opportunity cost of manufacturing the product. It represents the
amount by which the profit is reduced or the cost is increased when
one unit of such product is produced at the optimum level.
Surplus Resource Consumed Over Minimum Requirement: The quantity elements against the surplus variables in the optimal solution indicate the excess amount of the corresponding resource used above the
least allowable value.
Degeneracy: This means that the solution cannot be proceeded further.
It occurs if there is a tie in the minimum RR or any RR becomes zero in
any iteration.
If there is a tie in the minimum RR This degeneracy can be removed
by:
(a) Select any of the minimum RRs to identify the KR. If the optimum
solution is reached, the problem is solved. If it is not, then there
will be a 0 RR in the next iteration.
(b) Select this 0 RR for the next iteration to identify the KR.
(c) If the 0 persists in the next iteration, select the least non zero
positive value of RR to identify the KR and proceed with the solution.
If RR becomes zero This degeneracy can be removed by:
This may be due to quantity of any basic variable being zero.
6.
7.
(a) Select the zero RR to identify the KR.

(b) If zero persists in the next iteration, select the least non zero positive value of RR to identify the KR.
In graphical solution this happens when a point with x = 0 or y = 0 gives
the minimum profit or minimum cost
MULTIPLE SOLUTIONS: This happens when we get a 0 NER for a non
basic variable in the optimal solution. To find an alternate solution, take
this column as the KC and reiterate.
In Graphical solution, this happens when the maximum profit or minimum cost is achieved at more than one extreme point of the feasible
region.
UNBOUNDED SOLUTION:
This happens when at any stage the RRs become all negative. Such problems cannot be solved.
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8.
In graphical solution, this happens when the feasible region is in an

open unbounded area.
NO FEASIBLE SOLUTION: This happens when we get an artificial slack
variable in the optimal solution with a non-zero profit (-M) or cost (+M)
per unit, or When the quantity of basic variable become negative in any
iteration. Such problems cannot be solved.
In Graphical solution, this happens when the shaded area of constraints
does not meet at a common region.
ASSIGNMENT
1
What are the steps for Hungrarian Rule of Assignment?

Answer
The objective of an assignment algorithm is to determine the optimal
assignment of tasks amongst the performers. It seeks to minimise the
total time taken by the assignees to perform the tasks.
Step 1: Check whether the given problem is a balanced assignment
problem.
A problem is balanced if number of task to be assigned is equal to number of performers.
For unbalanced problems refer a situation later.
Step 2: Subtract the minimum value in each row from all the figures
in that row. Subtract the minimum value in each column from all the
figures in that column.
Step 3: Find the minimum number of lines that can be drawn to cover
all the
zeros in the matrix. This is done by drawing lines through the rows or
columns containing the largest number of zeros and repeating the process.
If the minimum number of lines that can be drawn is exactly equal to
the order of the matrix then the optimum solution can be derived directly as discussed in Step 4,
Step 4: Boxing the zeroes: Starting from the first row examine all the
rows one after the other to locate a row containing only one zero. Box
that zero and draw a line through the column containing the zero. After
processing the rows apply the same process for columns (if necessary)
this time passing a line through the row containing the zero, till all the
zeros are either boxed or are covered by a line.
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If no row or column containing only one zero can be located then box
any zero arbitrarily and draw two lines one passing through the row
and the other through the column of the boxed zero. Repeat this process till all the zeros are either boxed or are covered by a line.
If however, you are not able to box all the zeros even after applying the
process as given above, then it indicates that the lines drawn in the previous step to cover the zeros was not the minimum. Recheck that step
and then follow through.
In case, the number of lines that can be drawn is less than the order of
the matrix then apply the following procedure:
a.
b.
c.
Locate the smallest uncovered element

Subtract this value from all the uncovered elements and add this
value to the junction elements.
Repeat these steps till the minimum number of lines that can be
drawn to cover all the zeros is exactly equal to the order of the
matrix.
Special Cases in Assignment Method of Linear Programming:

Answer
1.
2.
3.
Maximisation Assignment Problem

The assignment algorithm is a minimization algorithm. Some assignment problems, however seek to maximise the profits that result from optimal use of resources. The profit table in such problems is converted to a loss table by subtracting all the figures in
the profit table from the maximum in that table.
Unbalanced Assignment Problem
If the number of tasks in an assignment problem is not equal to
number of performers then the problem is said to be unbalanced.
To balance the problem we introduce dummy tasks or dummy
performers considering the time consumed for these dummies
to be 0. If it is a maximisation problem then first introduce the
dummy and then prepare the loss table.
Implication of Dummy Task
When the number of performers exceeds the number of tasks,
a dummy task is introduced. The performer who is assigned this
dummy task in the final solution, will actually not be performing
any task.
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4.
5.
Implication of Dummy Performer

When the number of performers falls short of the number of
tasks, a dummy performer is introduced. The task that is assigned
to this dummy performer in the final solution, will actually not be
performed.
Prohibited Assignment
If an assignment is prohibited we consider the time taken to perform that task to be infinitely large value. It is better to simply put
a dash ( ) or M in the time of such tasks.
TRANSPORTATION
1
State the methods in which initial feasible solution can be arrived at in

a transportation problem.
[Nov 2008]
Answer
The methods by which initial feasible solution can be arrived at in a
transportation model are as under:
(a) North West Corner Method.
(b) Least Cost Method.
(c) Vogels Approximation Method (VAM).
2
What are the steps in initial solution by North West Corner Rule for a LP
Transportation problem?
Answer
The following steps are followed:
(a) Allocate the top left hand corner (North West Corner) with the
minimum of the availability and requirement.
(b) Proceed right along the row allocating successive cells till the row
exhausts.
(c) Proceed downwards along the column allocating successive cells
till the column exhausts.
(d) Repeat the process till all rows and columns are exhausted.
Limitation of this method: It does not consider the cost of transportation from origin to destination.
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3
What are the steps in initial solution by Least Cost Method for a LP
Transportation problem?
Answer
In this method the cost of transportation from each origin to all the destinations are taken into consideration. The following steps are followed:
(a) Locate the least cost cell and allocate as much as possible to that
cell.
(b) Proceeding with progressively higher cost cells, repeat the process
till all the rows and columns are exhausted, hatching each row or
column that is exhausted.
Note: If at any point there is a tie in the lowest cost cell then select the
one where maximum allocation is possible.
What are the steps in initial solution by Vogels Approximation Method

for a LP Transportation problem?
Answer
In this method also the cost of transportation from each origin to all the
destinations are taken into consideration. Unless otherwise mentioned,
always use this method to find the initial solution.
(a) Check whether the problem is balanced. If it isnt then balance it
by selecting a dummy origin or a dummy destination.
(b) Find the difference between the least cost and the second most
least cost for each row and column. If there are two or more minimum equal costs then take the difference as 0.
(c) Of these differences select the maximum * to identify the rows
and/or column. Allocate the maximum possible to the cell having
the least cost** in this row and/or column. If the row and/or column is exhausted then hatch it.
* If there is a tie in the maximum differences then examine all the
rows and columns to identify the least cost.
** If there is a tie in the least cost then select the cell where the
maximum allocation can be made.
(d) Repeat the process for the reduced table till all the rows and columns are exhausted.
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Special Cases in the Transportation Method of Linear Programming.

Answer
1.
2.
3.
4.
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Unbalanced Transportation Problem

If the total availability differs from total requirement then the
problem is unbalanced. When this happens, introduce a dummy
destination if the total availability exceeds the total requirement
and introduce a dummy origin if the total availability falls short of
the total requirement. The costs (minimization problem) or profits
(maximisation problem) are taken as 0 for a cell in the dummy.
If in the final allocation there is an amount allocated to the dummy
origin or destination it indicates that the availability at that origin
is surplus or the requirement of that destination will not be met.
Degeneracy in Transportation Problem
If at any stage there are less than (m + n 1) allocations then the
solution degenerates. This may happen in the initial solution or
after any reallocation.
Degenerates at Initial Solution:
Introduce infinitely small allocation e to the least cost independent cell to make (m + n 1) allocations. If there are two or more
least cost independent cells then select the cell having the lowest
(or nearest to the lowest) cost in that row.
Degenerates after reallocation:
If after reallocating it is found that the numbers of allocations has
fallen short of (m + n 1) then introduce small allocation e to
the unallocated, independent cell having the least value of i.e. if
the most negative cell has already been used as a ticked cell then
choose the next higher value, in the previous matrix. Start with
the most negative and progress upwards. If there is a tie in the
least value of then select any one of them.
Independent Cell
A cell is said to be independent if it is not possible to form a loop
with the cell as a corner.
Maximisation Transportation Problem
In some cases profits may be given and thus total profit has to
be maximised. Such questions are converted to a minimization
problem by preparing the Loss table and then solved in usual way.
The Loss table is prepared by subtracting all figures of the profit
table from the maximum value of the profit table. If the problem
TM
5.
is unbalanced then first introduce a dummy and then prepare the

Loss table.
Prohibited Transportation
Sometimes in a given transportation problem, some routes may
not be available. There could be several reasons for this such as
bad road conditions or strike, etc. In such situations, there is a restriction on the route available for transportation. To handle such
type of a situation, a very large cost (or negative profit for the
maximisation problem) represented by or M is assigned to each
of such routes which are not available. Due to assignment of very
large cost, such routes would automatically be eliminated in the
final solution. The problem is solved in its usual way.
CPM AND PERT

1
What are the different kinds of floats in a network?

Answer
(a) Total float: It implies the idle time in a path or in its non critical
activities. For critical activities there will not be any idle time. In
other words, the non critical activities in total can be delayed by
some time without affecting or increasing the project duration.
It can be computed in two different ways:
Total float = Latest Finish Time Earliest Finish Time

= Latest Start Time Earliest Start Time
(b) Free float: The time by which the actual completion of an activity can be delayed without affecting the total float of succeeding
activities.
Free Float = Total Float Slack of Head Event
(Slack implies L- E of the event)
(c)
Interfering Float The idle time which if consumed in completion

of an activity, it is sure to affect the start of succeeding activity.
Interfering Float = Total Float Free Float.
(d) Independent Float: The time by which the actual completion of an

activity can be delayed without affecting the total float of preceding activities.
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Independent Float = Free float Slack of Tail Event or 0 whichever is larger.

(Slack implies L- E of the event)
For Critical activities, there would never be any float in their
completion.
2
How Projects are Crashed? Explain.

Answer
If costs are associated with activities it becomes pertinent to investigate
the effect of the increase or decrease in the total duration of a project
on the total cost of the project. The different types of times and costs
involved are:
(a) Normal Time: The minimum time required to complete an activity
at normal cost.
(b) Crash Time: The minimum time required to complete an activity.
(c) Normal Cost: The direct cost of completing the activity in normal
time.
(d) Crash Cost: The direct cost of completing the activity within the
crash time.
(e) Cost Slope: The increase in cost for every unit of time saved by
crashing the activity.
(f) Optimum Duration: The duration of the project corresponding to
the optimum cost.
(g) Optimum Cost: The minimum possible cost to complete the project.
(h) Total Direct Cost: Total Normal cost + Total Crash cost
(i) Total Project Cost: Total Normal cost + Total Crash cost + Total Indirect cost
1.
2.
3.
4.
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Prepare the project network.

Find the critical path and the normal duration of the project.
Calculate the cost slope for all the activities given in the network.
First identify those activities on the critical path which have a cost
slope less than the indirect cost. The overall cost can be reduced
only if the cost slope of the crashed activity is less than the indirect cost.
TM

5.
Start by crashing that activity which has the least crashing cost
slope and progress with ones in order of increasing cost slopes
(Keeping in mind that an activity can be crashed only till its crash
time).
6. If at any point there happens to be more than one critical path
then select different sets of activities such that crashing all the
activities in each set reduces all the critical paths at the same time.
To make the sets select an activity from each path. If the same activity exists in any other path, put a dash there. If you cannot put
a dash, discard that particular combination. Crash that set which
has the least total crashing cost.
7. Stop crashing if any one of the longest path is exhausted fully i.e.
crashed till its crash time.
8. Prepare a cost table which shows the direct crashing cost, the
direct normal cost and the total indirect cost for all the reduced
project durations. The duration which gives the least cost is the
optimum project duration and the corresponding total cost is the
optimum project cost.
9. To find the Optimum cost of the project, stop crashing at the point
where total crashing cost is more than the indirect cost.
10. To find the Minimum Duration of the project, regardless of cost,
continue crashing even if the crashing cost is more than the indirect cost. However, crashing will stop the moment any one of the
longest path is fully exhausted.
Write short notes on Resource Smoothing and Levelling.

Answer
Resource Smoothing:
It is a network technique used for smoothening peak resource requirement during different periods of the project network. Under this technique the total project duration is maintained at the minimum level. For
example, if the duration of a project is 15 days, then the project duration is maintained, but the resources required for completing different
activities of a project are smoothened by utilising floats available on
non critical activities. These non critical activities having floats are rescheduled or shifted so that a uniform demand on resource is achieved.
In other words, the constraint in the case of resource smoothing operation would be on the project duration time. Resource smoothing is a
12-133
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useful technique for business managers to estimate the total resource

requirements for various project activities.
In resource smoothing, the time scaled diagram of various activities and
their floats (if any), along with resource requirements are used. The periods of maximum demand for resources are identified and non critical
activities during these periods are staggered by rescheduling them according to their floats for balancing the resource requirements i.e. the
activities having floats are shifted in such a way that the demand for
resources is smoothened out.
Resource Levelling:
It is also a network technique which is used for reducing the requirement of a particular resource due to its paucity. The process of resource
levelling utilizes the large floats available on non critical activities of the
project and thus cuts down the demand on the resource. In resource
levelling, the maximum demand of a resource should not exceed the
available limit at any point of time. In order to achieve this, non critical
activities are rescheduled by utilising their floats. Sometimes, the use
of resource levelling may lead to increase in the completion time of the
project.
4
Write short notes on distinction between PERT and CPM.

[Nov 2000]
Answer
The PERT and CPM models are similar in terms of their basic structure,
rationale and mode of analysis. However, there are certain distinctions
between PERT and CPM networks which are enumerated below:
(1) CPM is activity oriented i.e. CPM network is built on the basis of
activities. Also results of various calculations are considered in
terms of activities of the project. On the other hand, PERT is even
oriented.
(2) CPM is a deterministic model i.e. it does not take into account
the uncertainties involved in the estimation of time for execution
of a job or an activity. It completely ignores the probabilistic element of the problem. PERT, however, is a probabilistic model. It
uses three estimates of the activity time; optimistic, pessimistic
and most likely, with a view to take into account time uncertainty.
Thus, the expected duration for each activity is probabilistic and
expected duration indicates that there is fifty percent probability
of getting the job done within that time.
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(3) CPM lays dual emphasis on time and cost and evaluates the tradeoff between project cost and project item. By deploying additional
resources, it allows the critical path project manager to manipulate project duration within certain limits so that project duration
can be shortened at an optimal cost. On the other hand, PERT is
primarily concerned with time. It helps the manger to schedule
and coordinate various activities so that the project can be completed on scheduled time.
(4) CPM is commonly used for those projects which are repetitive in
nature and where one has prior experience of handling similar
projects. PERT is generally used for those projects where time required to complete various activities are not known as prior. Thus,
PERT is widely used for planning and scheduling research and development project.
5
What do you mean by a dummy activity? Why is it used in networking?

[May 2008]
Answer
Dummy activity is a hypothetical activity which consumes no resource
or time. It is represented by dotted lines and is inserted in the network
to clarify an activity pattern under the following situations.
(i)
To make activities with common starting and finishing events distinguishable i.e. to remove duplicate errors.
(ii) To identify and maintain the proper precedence relationship between activities that are not connected by events i.e. to remove
dangling errors.
(iii) To bring all loose ends to a single initial and single terminal
event.
SIMULATION
1
What is simulation? What are the steps in simulation?

Answer
Simulation is a quantitative procedure which describes a process by developing a model of that process and then conducting a series of organized trial and error experiments to product the behaviour of the process
over time.
Steps in the simulation process:
(i)
Define the problem and system you intend to simulate.

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(ii) Formulate the model you intend to use.

(iii) Test the model, compare with behaviour of the actual problem
environment.
(iv) Identify and collect data to test the model.
(v) Run the simulation.
(vi) Analyse the results of the simulation and, if desired, change the
solution you are evaluating.
(vii) Rerun the simulation to tests the new solution.
(viii) Validate the simulation i.e., increase the chances of valid inferences.
2
How would you use the Monte Carlo Simulation method in inventory
control?
[May 2008]
Answer
Monte Carlo Simulation is the earliest mathematical Model of real situations in inventory control:
The steps involved in carrying out Monte Carlo simulation are:
Step 1 : Define the problem and select the measure of effectiveness of
the problem that might be inventory shortages per period.
Step 2 : Identify the variables which influence the measure of effectiveness significantly for example, number of units in inventory.
Step 3 : Determine the proper cumulative probability distribution of
each variable selected with the probability on vertical axis and
the values of variables on horizontal axis.
Step 4 : Get a set of random numbers.
Step 5 : Consider each random number as a decimal value of the cumulative probability distribution with the decimal enter the cumulative distribution plot from the vertical axis. Project this point
horizontally, until it intersects cumulative probability distribution curve. Then project the point of intersection down into
the vertical axis.
Step 6 : Then record the value generated into the formula derived from
the chosen measure of effectiveness. Solve and record the value. This value is the measure of effectiveness for that simulated
value. Repeat above steps until sample is large enough for the
satisfaction of the decision maker.
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LEARNING CURVE
1
Explain the concept Learning curve. How can it be applied for Cost
management?
[May 2007]
Answer
The first time when a new operation is performed, both the workers
and the operating procedures are untried. As the operation is repeated
and the workers become more familiar with work, labour efficiency increases and the labour cost per unit declines. This process continues for
some time and a regular rate of decline in cost per unit can be established. This rate can be used to predict future labour costs. The learning process starts from the point when the first unit comes out of the
production line. In other words Learning curve is a function that measures how labour hours per unit decline as units of production increase
because workers are learning and becoming better at their jobs.
Cost Management Application:
a.
b.
c.
d.
e.
f.
2
Learning curve is useful in analysing cost volume profit relationship. The company can set low price of its product to generate
high demand. As the production increases, cost per unit drops.
It helps in budgeting and profit planning.
It enables the company in price fixation. In particular, the company can fix a lower price for repeat orders.
It helps the design engineers to take suitable decisions based on
expected rates of improvement.
It helps in price negotiations.
It is useful in setting standards and in performance evaluation.
What are the distinctive features of learning curve theory in manufacturing environment? Explain the learning curve ratio.
[Nov 2007]
Answer
As the production quantity of a given item is doubled, the cost of the
item decreases at a fixed rate. This phenomenon is the basic premise on
which the theory of learning curve has been formulated. As the quantity
produced doubles, the absolute amount of cost increase will be successively smaller but the rate of decrease will remain fixed. It occurs due to
the following distinctive features of manufacturing environment:
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(i) Better tooling methods are developed and used.

(ii) More productive equipments are designed and used to make the
product.
(iii) Design bugs are detected and corrected.
(iv) Engineering changes decrease over time.
(v) Earlier teething problems are overcome.
(vi) Rejections and rework tend to diminish over time.
In the initial stage of a new product or a new process, the learning effect
pattern is so regular that the rate of decline established at the outset
can be used to predict labour cost well in advance. The effect of experience on cost is summarized in the learning curve ratio or improvement
ratio.
Learning curve ratio = Average labour cost of first N units / Average labour cost of first 2N units
For example, if the average labour cost for the first 500 units is ` 25
and the average labour cost for the first 1,000 units is ` 20, the learning
curve ratio is (` 20/25) or 80%. Since the average cost per unit of 1,000
units is ` 20, the average cost per unit of first 2,000 units is likely to be
80% of ` 20 or Rs 16
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TM

3
The following information is provided by a firm. The factory manager

wants to use appropriate average learning rate on activities, so that he
may forecast costs and prices for certain levels of activity.
(i) A set of very experienced people feed data into the computer for
processing inventory records in the factory. The manager wishes
to apply 80% learning rate on data entry and calculation of inventory.
(ii) A new type of machinery is to be installed in the factory. This is
patented process and the output may take a year for full fledged
production. The factory manager wants to use a learning rate on
the workers at the new machine.
(iii) An operation uses contract labour. The contractor shifts people
among various jobs once in two days. The labour force performs
one task in 3 days. The manager wants to apply an average learning rate for these workers.
You are required to advise to the manager with reasons on the applicability of the learning curve theory on the above information.
[Nov 2009]
Answer
The learning curve does not apply to very experienced people for the
same job, since time taken can never tend to become zero or reduce
very considerably after a certain range of output. This is the limitation
of the learning curve.
(i)
Data entry is a manual job so learning rate theory may be applied.

Calculation of inventory is a computerized job. Learning rate applies only to manual labour.
(ii) Learning rate should not be applied to a new process which the
firm has never tried before.
(iii) The workers are shifted even before completion of one unit of
work. Hence learning rate will not apply.
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NOTE
NOTE

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Preface

Activity Based Costing

Budgeting, Performance Measurement and

Relevant Costing, Marginal Costing and Decision

TQM, Value Chain Analysis and Business Process

Pricing Decision and Pareto Analysis

Target and Life Cycle Costing

MRP, MRP-II, ERP and JIT

Quantitative Techniques (QT)

Basic Cost Concepts

Distinguish between Marginal cost and Differential Cost.

Satish Jalan Classes

(b) Pricing of product

Explain the concept of discretionary costs. Give three examples.

They arise from periodic (usually yearly) decisions regarding the

Discuss, how control may be exercised over discretionary costs.

Basic Cost Concepts

Distinguish between Committed and Discretionary Fixed Costs.

Discretionary Fixed Costs

These are costs that arise from the

These are incurred as a result of

These are unavoidable in nature.

These are avoidable in nature.

It remains fixed from year to year.

It changes from year to year without

Satish Jalan Classes

What do you understand by opportunity cost? Comment on the use of

Basic Cost Concepts

State three applications of direct costing.

Direct cost As many total costs relating to cost objects as feasible

Satish Jalan Classes

Cost may be classified in a variety of ways according to their nature

By Element: Material, Labour and Overhead.

Distinguish between cost reduction and cost control.

Saving in Cost per unit

Saving either in Total Cost

If presumes the existence

It does not focus on costs

4. Performance It is not concerned with

Basic Cost Concepts

Continuous process of critical examination, includes

Control is achieved through

Fully dynamic approach.

Lacks dynamism when

Universally applicable to all

Emphasis here is partly on Emphasis on present and

To find out substitute ways Competitive analysis of

11. Tools and

Value Engineering. Work Budgetary Control

Satish Jalan Classes

Distinguish between cost reduction and cost management.

It is the permanent reduction in the unit cost of

It is a system that establishes

It presumes the existence

It does not focus on costs independent of revenue nor

State various approaches for cost reduction.

Basic Cost Concepts

Material Cost :- Cheaper substitute, higher yield and less

Satish Jalan Classes

(ii) Whether there is any scope for reducing idle capacity.

What are the requisites of an effective information system?

What are the key attributes of Operational Database?

Consistency Consistent information ensures greater validity.

Basic Cost Concepts