COST AND MANAGEMENT ACCOUNTING (May-June’ 2013)
Full Marks: 80
Time Allowed: 3 hours
GROUP – A (COST ACCOUNTING)
Marks: 40
Answer either in English or Assamese
The figures in the margin indicate full marks for the questions
ANSWER ALL THE QUESTIONS AS DIRECTED
1. Answer the following as directed: 1x4=4
a) Fixed Costs depend mainly on the Effluxion of time and do vary directly with volume or rate of output. (State whether the statement is true or false)
Ans: False
b) Name the cost which is not useful for decision making.
Ans: Irrelevant Costs
c) The time taken in processing the order and then executing it is known as _____. (Fill in the blank)
Ans: Lead Time
d) Mention the standard which is fixed on the basis of scientific studies but adjusted for current subjective factors.
Ans:
2. Distinguish any three of the following: 2x3=6
a) Product Costs and Period Costs.
Ans: Period costs are commonly described as those which remain fixed in total amount with increase or decrease in the volume of output or productive activity for a given period of time. Examples of fixed costs are rent, insurance of factory building, factory manager’s salary etc.
Product costs are those which vary in total in direct proportion to the volume of output. Examples are direct material costs, direct labour costs, power, repairs etc. Such costs are known as product costs because they depend on the quantum of output rather than on time.
b) Normal and Abnormal idle time.
Ans: Normal idle time is inherent in any job situation and thus it cannot be eliminated or reduced. For example: time gap between the finishing of one job and the starting of another; time lost due to fatigue etc.
Abnormal idle time is defined as the idle time which arises on account of abnormal causes; e.g. strikes; lockouts; floods; major breakdown of machinery; fire etc. Such an idle time is uncontrollable.
c) Over and Under absorption of overheads.
Ans: Overhead expenses are usually applied to production on the basis of predetermined rates. The pre-determined rate may present estimated or actual cost. The actual overhead cost incurred and overhead applied to the production will seldom be the same. But due to certain reasons the difference between two may arise.
Over absorptions: If the amount applied exceeds, the actual overhead, it is said to be an over absorption of overheads.
Under absorption: If the amount applied is short fall of the actual overhead in production it is said to be the under absorption of overheads. The over or under absorption of overheads may be termed as overhead variance.
d) Standard Cost and Target Cost.
Ans: Standard Cost: Standard cost is predetermined cost or forecast estimate of cost. I.C.M.A. Terminology defines Standard Cost as, “a predetermined cost, which is calculated from management standards of efficient operations and the relevant necessary expenditure. It may be used as a basis for price-fixing and for cost control through variance analysis”.
Target cost: Target cost of a product is a cost which is obtained by deducting desired profit from selling price of the product.
3. Write short note on any two of the following: 5x2=10
a) Relationship between Cost Accounting and Financial Accounting.
Ans: Relationship between Cost and Financial Accounting
Cost accounting is very closely-related to financial accounting. Some authorities on the subject consider cost accounting to be the branch of financial accounting. But it may be said that cost accounts is complementary to financial accounts, i.e., a subject which is necessary to make financial accounts whole or complete. Financial accounts and cost accounts are both similar in certain respects. But in some other respects they differ from one another. These points of similarities and dissimilarities and enumerated below:
1) The fundamental principles of double entry are applicable in both the systems of accounts.
2) The invoices and vouchers constitute the common basis for recording transactions under both the systems of accounts.
3) The results of business are revealed by both the systems of accounts.
4) The causes for losses and wastages of a business are provided by both these systems of accounts.
5) The determination of future business policy is guided by both these systems of accounts.
6) A basis for comparison of expenses is being provided by both the accounting systems.
7) Accuracy of accounts is maintained under both the systems by means of exercising check over errors and commissions which might creep in either of accounts.
b) ABC Analysis.
Ans: ABC Analysis: In this technique, the items of inventory are classified according to the value of usage. Materials are classified as A, B and C according to their value.
Items in class ‘A’ constitute the most important class of inventories so far as the proportion in the total value of inventory is concerned. The ‘A’ items constitute roughly about 5-10% of the total items while its value may be about 80% of the total value of the inventory.
Items in class ‘B’ constitute intermediate position. These items may be about 20-25% of the total items while the usage value may be about 15% of the total value.
Items in class ‘C’ are the most negligible in value, about 65-75% of the total quantity but the value may be about 5% of the total usage value of the inventory.
The numbers given above are just indicative, actual numbers may vary from situation to situation. The principle to be followed is that the high value items should be controlled more carefully while items having small value though large in numbers can be controlled periodically.
Advantages of ABC analysis
a. Reduction in investment: under ABC analysis, the materials from group 'A' are purchase in lower quantities as much as possible. With this, the effort to reduce the delivery period is also made. These in turn help to reduce the investment in material.
b. Optimization of Inventory management function: Each class of the inventory gets management attention as per its value and accordingly, manpower is allocated and expenses are incurred to manage it. It ensures that most important items are regularly monitored and closely observed whereas such efforts are expended with for the less important items.
c. Control on high value material: under ABC analysis, strict control can be exercised to the materials in group 'A' that have higher value.
d. Reduction in Storage cost: Since Class “A” material is of high value and are purchase in lower quantities as much as possible, it reduces the total storage cost.
e. Saving in time and cost: Since a signification effort is made for management of the material from group 'A', it helps to save time as well as cost.
c) Methods of measuring Labour turnover.
Ans: Measurement of Labor Turnover: It is essential for any organisation to measure the labor turnover. This is necessary for having an idea about the turnover in the organisation and also to compare the labor turnover of the previous period with the current one. The following methods are available for measurement of the labor turnover.
a) Additions Method: Under this method, number of employees added during a particular period is taken into consideration for computing the labor turnover. The method of computing is as follows:
b) Labour Turnover = Number of additions/Average number of workers during the period X 100
c) Separations Method: In this method, instead of taking the number of employees added, number of employees left during the period is taken into consideration. The method of computation is as follows:
d) Labour Turnover = Number of separations/Average number of workers during the period X 100
e) Replacement Method: In this method neither the additions nor the separations are taken into consideration. The number of employees replaced is taken into consideration for computing the labour turnover.
f) Labour Turnover = Number of replacements/Average number of workers during the period X 100
g) Flux Method: Under this method labor turnover is computed by taking into consideration the additions as well as separations. The turnover can also be computed by taking replacements and separations also. Computation is done as per the following methods:
h) Labor Turnover = ½ [Number of additions + Number of separations] /Average number of workers during the period X 100
4. Explain the various cost concepts that are very useful for analytical and decision making purposes. 10
Ans: Classification of Cost – Elements of Cost – Cost Concepts
Cost classification is the process of grouping costs according to their common characteristics. It is the placement of like items together according to their common characteristics. A suitable classification of costs is of vital importance in order to identify the cost with cost centers or cost units. Costs may be classified according to their nature, i.e. material, labour and expenses and a number of other characteristics. The important ways of classification are:
a) By Nature or Element or Analytical Classification
According to this classification, the costs are divided into three categories i.e. Materials, Labour and Expenses. There can be further sub classification of each element; for example, material into raw material components, and spare parts, consumable stores, packing material etc. This classification is important as it helps to find out the total cost, how such total cost is constituted and valuation of work in progress.
b) By Functions
According to this classification costs are divided as follows:
Manufacturing and Production Cost: This is the total of costs involved in manufacture, construction and fabrication of units of production.
Commercial Cost: This is the total of costs incurred in the operation of a business undertaking other than the cost of manufacturing and production. Commercial cost may further be sub-divided into (a) administrative cost and (b) selling and distribution cost.
c) As Direct and Indirect
According to this classification, total cost is divided into direct costs and indirect costs.
Direct costs are those which are incurred for and may be conveniently identified with a particular cost centre or cost unit. Materials used and labour employed are common examples of direct costs.
Indirect costs are those cost which are incurred for the benefit of number of cost centers or cost units and cannot be conveniently identified with a particular cost centre or cost unit. Examples of indirect cost include rent of building, management salaries, machinery depreciation etc.
d) By Variability
According to this classification, costs are classified into three groups viz. fixed, variable and semi-variable.
Fixed or period costs are commonly described as those which remain fixed in total amount with increase or decrease in the volume of output or productive activity for a given period of time. Examples of fixed costs are rent, insurance of factory building, factory manager’s salary etc.
Variable or product costs are those which vary in total in direct proportion to the volume of output. Examples are direct material costs, direct labour costs, power, repairs etc. Such costs are known as product costs because they depend on the quantum of output rather than on time.
Semi-variable costs are those which are partly fixed and partly variable. For example, telephone expenses included a fixed portion of annual charge plus variable charge according to calls; thus total telephone expenses are semi-variable. Other examples of such costs are depreciation, repairs and maintenance of building and plant etc.
e) By Controllability
Under this, costs are classified according to whether or not they are influenced by the actions of a given member of the undertaking. On this basis it is classified into two categories:
Controllable costs are those which can be influenced by the action of a specified member of an undertaking, that is to say, costs which are at least partly within the control of management. Generally speaking, all direct costs including direct material, direct labour and some of the overhead expenses are controllable by lower level of management.
Uncontrollable costs are those which cannot be influenced by the action of a specified member of an undertaking that it is to say, which are within the control of management. Most of the fixed costs are uncontrollable. For example, rent of the building is not controllable and so are managerial salaries.
f) By Normality
Under this, costs are classified according to whether these are cost which are normally incurred as a given level of output in the conditions in which that level of activity is normally attained. On this basis, it is classified into two categories:
Normal cost: It is the cost which is normally incurred at a given level of output in the conditions in which that level of output is normally attained. It is a part of cost of production.
Abnormal cost: It is the cost which is not normally incurred at a given level of output in the conditions in which that level of output is normally attained. It is not a part of cost of production and charged to Costing Profit and Loss Account.
g) By Capital and Revenue or Financial Accounting Classification
The cost which is incurred in purchasing assets either to earn income or increasing the earning capacity of the business is called capital cost. For example, the cost of a rolling machine in case of steel plan. Such cost is incurred at one point of time but the benefits accruing from it are spread over a number of accounting years.
It any expenditure is done in order to maintain the earning capacity of the concern such as cost of maintaining an asset or running a business it is revenue expenditure e.g. cost of materials used in production, labour charges paid to convert the material into production, salaries, depreciation, repairs and maintenance charges, selling and distribution charges etc.
h) By Time
Cost can be classified as (i) Historical costs and (ii) Predetermined costs.
i) Historical costs: The cost which is ascertained after their incurrence is called historical costs.
ii) Predetermined costs: Such costs are estimated costs i.e. computed in advance of production taking into consideration the previous period’s costs and the factors affecting such costs. Predetermined cost determined on scientific basis becomes standard cost.
i) According to Planning and Control
Planning and control are two important functions of management. Cost accounting furnishes information to the management which is helpful is the due discharge of these two functions. According to this, costs can be classified as budgeted costs and standard costs.
i) Budgeted costs: Budgeted costs represent an estimate of expenditure for different phases of business operations such as manufacturing, administration, sales, research and development etc. coordinated in a well conceived framework for a period of time in future which subsequently becomes the written expression of managerial targets to be achieved.
ii) Standard Cost: Standard cost is the predetermined cost based on a technical estimate for materials, labour and overhead for a selected period of time and for a prescribed set of working conditions.
j) For Managerial Decisions
On this basis, costs may be classified into the following costs:
i) Marginal cost: Marginal cost is the total of variable costs i.e. prime cost plus variable overheads.
ii) Out of pocket costs: This is that portion of the cost which involves payment to outsiders i.e., gives rise to cash expenditure as opposed to such costs as depreciation, which do not involve any cash expenditure.
iii) Differential costs: The change in costs due to change in the level of activity or pattern or method of production is known as differential costs.
iv) Sunk costs: A sunk cost is an irrecoverable cost and is caused by complete abandonment of a plant. It is the written down value of the abandoned plant less its salvage value.
v) Imputed costs: These costs are those costs which appear in cost accounts only e.g. national rent charged on business premises owned by the proprietor, interest on capital for which no interest has been paid. These costs are also known as notional costs.
vi) Opportunity cost: It is the maximum possible alternative earning that might have been earned if the productive capacity or services had been put to some alternative use.
vii) Replacement cost: It is the cost at which there could be purchased an asset or material identical to that which is being replaced or revalued. It is the cost of replacement at current market price.
viii) Avoidable and unavoidable cost: Avoidable costs are those which can be eliminated if a particular product or department, with which they are directly related, is discontinued. Unavoidable cost is that cost which will not be eliminated with the discontinuation of a product or department.
Or
Annual usage is 3200 units
The unit cost is Rs. 6/-
Inventory carrying charges is 25% p.a.
The cost of procurement is Rs. 150 per order.
From the above particulars calculate
a) Economic Order Quantity.
b) Number of orders per year.
c) Time between two consecutive orders. 6+2+2=10
5. What are the steps involved in standard costing and also state its limitations. 6+4=10
Ans: Steps in Standard Costing: Introducing standard costing in any establishment requires the fulfillment of following preliminaries:
a) Establishment of cost centers: A cost centre is a location, person or item of equipment for which costs may be ascertained and used for the purpose of cost control. The cost centers divide an entire organisation into convenient parts for costing purpose. The nature of production and operations, the organisational structure, etc. influence the process of establishing cost centres. No hard and fast rule can be laid down in this regard. Establishment of the cost centres is essential for pin pointing responsibility for variances.
b) Classification and codification of accounts: The need for quick collection and analysis of cost information necessitates classification and codification. Accounts are to be classified according to different items of expenses under suitable headings. Each of the headings is to be given a separate code number. The codes and symbols used in the process facilitate introduction of computerization.
c) Determining the types of standards and their basis: Standards can be classified into two broad categories on the basis of the length of use:
Ø Current standards: These are standards which are related to current conditions, particularly of the budget period. They are for short-term use and are more suitable for control purpose. They are also more amenable for combining with budgeting.
Ø Basic standards: These are long-term standards; some of them intended to be in use for even decades. They are helpful for planning long-term operations and growth.
There can be significant difference in the standards set depending on the base used for them. The following are the different bases for setting standard, whether they are current standards for short-term or basic standards for long-term use.
Ø Ideal standards: These standards reflect the best performance in every aspect. They are like 100 marks in a paper for students taking up examinations. What is possible under ideal circumstances in all aspects is reflected in these standards. They are impractical and unattainable in practice. There utility for control purpose is negligible.
Ø Past performance based standards: The actual performance attained in the past may be taken as basis and the same may be retained as standard. Such standards do not provide any incentive or challenge to the employees. They are too easy to attain. Their value from cost control point of view is minimal.
Ø Normal standard: It is defined as “the average standard which, it is anticipated can be attained over a future period of time, preferably long enough to cover one trade cycle”. They are average standard reflecting the average performance over a complete trade cycle which may take three to five years. For a specific period, say a budget period, their relevance is negligible.
Ø Attainable high performance standards: They are based on what can be achieved with reasonable hard work and efforts. They are based on the current conditions and capability of the workers. These standards are considered to be of great practical value because they provide sufficient incentive and challenge to the workers to attain them. Any variances from such standard are really significant because the standard which is attainable with effort is not attained.
d) Determining the expected level of activity: Capacity of operation or level of activity expected over a future period is vital in fixing current or short-term standards. When the activity level is decided on the basis of sales or production, whichever is the limiting factor; all standard can be developed with the activity level as the focal point. The purchase of material, usage of material, labour hours to be worked, etc. are solely governed by the planned level of activity.
e) Setting standards: Standards may be either too strict or too liberal because they may be based on theoretical maximum efficiency attainable good performance or average past performance. Setting standards may also be called developing standards or establishment of standard cost because as a consequence of setting standards for various aspects, standard cost can be computed.
Material quantity standards: The following procedure is usually followed for setting material quantity standards.
(a) Standardization 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) Standardization 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 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) Standardization 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) Standardization 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.
(e) Time and motion study is conducted for selecting the best way of completing the job.
(f) The operator is given training to perform the job or operations in the best possible manner.
Or
From the following particulars calculate:
a) Material Cost Variance.
b) Material Price Variance. 5+5=10
Materials | Standard Units | Price (per-unit) | Actual Units | Actual Price (per unit) |
A B C | 1010 410 350 | 1.0 1.5 2.0 | 1080 380 380 | 1.2 1.8 1.9 |
GROUP – B (MANAGEMENT ACCOUNTING)
Marks: 40
6. Write short note on any three of the following: 2x3=6
a) Budgetary Control.
Ans: Budgetary control is the process of preparation of budgets for various activities and comparing the budgeted figures for arriving at deviations if any, which are to be eliminated in future. Thus budget is a means and budgetary control is the end result. Budgetary control is a continuous process which helps in planning and coordination. It also provides a method of control.
b) Angle of incidence.
Ans: Angle of incidence is an indicator of profit earning capacity above the break-even point. A wider angle will indicate higher profitability, while a narrow angle will indicate very low profitability. If margin of safety and angle of incidence are considered together, they will provide significant information to management regarding profit earning position of the undertaking. A high margin of safety with a wider angle of incidence will indicate the most favourable condition of the business.
c) Master Budget.
Ans: When the functional budgets have been completed, the budget committee will prepare a master budget for the target of the concern. Accordingly a budget which is prepared incorporating the summaries of all functional budgets. It comprises of budgeted profit and loss account, budgeted balance sheet, budgeted production, sales and costs. The ICMA England defines a Master Budget as ‘the summary budget incorporating its functional budgets, which is finally approved, adopted and employed’. The master budget represents the activities of a business during a profit plan. This budget is also helpful in coordinating activities of various functional departments.
d) Profitability ratio.
Ans: Profitability ratios show relationship between profits and sales and profit & investments. It reflects overall efficiency of the organizations, its ability to earn reasonable return on capital employed and effectiveness of investment policies. Example : i) Profits and Sales : Operating Ratio, Gross Profit Ratio, Operating Net Profit Ratio, Expenses Ratio etc. ii) Profits and Investments : Return on Investments, Return on Equity Capital etc.
7. State whether the following statements are true or false: 1x4=4
a) The management accountant places the data in narrow perspective than the cost accountant.
Ans: False
b) Financial statements are prepared on the basis of realisable values.
Ans: False
c) The increase in P.V. ratio means lower break-even point and higher margin of safety.
Ans: True
d) Flow of funds mean increase or decrease of working capital.
Ans: True
8. Answer any two of the following: 5x2=10
a) What are the limitations of management accounting?
Ans: Limitations of Management Accounting: Management accounting, being comparatively a new discipline, suffers from certain limitations, which limit its effectiveness. These limitations are as follows:
1. Limitations of basic records: Management accounting derives its information from financial accounting, cost accounting and other records. The strength and weakness of the management accounting, therefore, depends upon the strength and weakness of these basic records. In other words, their limitations are also the limitations of management accounting.
2. Persistent efforts. The conclusions draws by the management accountant are not executed automatically. He has to convince people at all levels. In other words, he must be an efficient salesman in selling his ideas.
b) Distinguish between fixed and flexible budget.
Ans: Difference between Fixed Budget and Flexible Budget
Fixed Budget | Flexible Budget | |
1. | It does not change with actual volume of activity achieved. Thus it is known as rigid or inflexible budget. | It can be recasted on the basis of activity level to be achieved. Thus it is not rigid. |
2. | It operates on one level of activity and under one set of conditions. It assumes that there will be no change in the prevailing conditions, which is unrealistic. | It consists of various budgets for different levels of activity. |
c) Distinguish between funds flow statement and cash flow statement.
Ans: Difference between Funds Flow Statement and Cash Flow Statement
Basis of Difference | Funds Flow Statement | Cash Flow Statement |
Basis of Analysis | Funds flow statement is based on broader concept i.e. working capital. | Cash flow statement is based on narrow concept i.e. cash, which is only one of the elements of working capital. |
Objective | The object funds flow statement is to disclose the magnitude, direction and causes of changes in working capital. | The object of cash flow is to disclose the magnitude, direction and causes of changes in cash and cash equivalents. |
Source | Funds flow statement tells about the various sources from where the funds generated with various uses to which they are put. | Cash flow statement starts with the opening balance of cash and reaches to the closing balance of cash by proceeding through sources and uses. |
9. What are the tools and techniques of management accounting? How they assist in decision making? 5+5=10
Ans: Tools and Techniques Used in Management Accounting
Management accountant supplies information to the management so that latter may be able to discharge all its functions, i.e., planning organization, staffing, direction and control sincerely and faithfully. For doing this, the management accountant uses the following tools and techniques.
a) Financial planning: Financial planning is the act of deciding in advance about the financial activities necessary for the concern to achieve its primary objectives. It includes determining both long term and short term financial objectives of the enterprise, formulating financial policies and developing the financial procedure to achieve the objectives. The role of financial policies cannot be emphasized to achieve the maximum return on the capital employed. Financial policies may relate to the determination of the amount of capital required, sources of funds, govern the determination and distribution of income, act as a guide in the use of debt and equity capital and determination of the optimum level of investment in various assets.
b) Analysis of financial statements: The analysis is an attempt to determine the significance and meaning of the financial statement data so that a forecast may be made of the prospects for future earnings, ability to pay interest and debt maturities and profitability of a sound dividend policy. The techniques of such analysis are comparative financial statements, trend analysis, funds flow statement and ratio analysis. This analysis results in the presentation of information which will help the business executive, investors and creditors.
c) Historical cost accounting: The historical cost accounting provides past data to the management relating to the cost of each job, process and department so that comparison may be make with the standard costs. Such comparison may be helpful to the management for cost control and for future planning.
d) Standard costing: Standard costing is the establishment of standard costs under most efficient operating conditions, comparison of actual with the standard, calculation and analysis of variance, in order to know the reasons and to pinpoint the responsibility and to take remedial action so that adverse things may not happen again. This aspect is necessary to have cost control.
e) Budgetary control: The management accountant uses the total of budgetary control for planning and control of the various activities of the business. Budgetary control is an important technique of directing business operations in a desired direction, i.e. achieve a satisfactory return on investment.
f) Marginal costing: The management accountant uses the technique of marginal costing, differential costing and break even analysis for cost control, decision-making and profit maximization.
g) Funds flow statement: The management accountant uses the technique of funds flow statement in order to analyze the changes in the financial position of a business enterprise between two dates. It tells wherefrom the funds are coming in the business and how these are being used in the business. It helps a lot in financial analysis and control, future guidance and comparative studies.
h) Cash flow statement: A funds flow statement based on increase or decrease in working capital is very useful in long-range financial planning. It is quite possible that these may be sufficient working capital as revealed by the funds flow statement and still the company may be unable to meet its current liabilities as and when they fall due. It may be due to an accumulation of investments and an increase in trade debtors. In such a situation, a cash flow statement is more useful because it gives detailed information of cash inflow and outflow. Cash flow statement is an important tool of cash control because it summarizes sources of cash inflow and uses of cash outflows of a firm during a particular period of time, say a month or a year. It is very useful tool for liquidity analysis of the enterprise.
i) Decision making: Whenever there are different alternatives of doing a particular work, it becomes necessary to select the best out of all alternatives. This requires decision on the part of the management. The management accounting helps the management through the techniques of marginal costing, capital budgeting, differential costing to select the best alternative which will maximize the profits of the business.
j) Revaluation accounting: The management accountant through this technique assures the maintenance and preservation of the capital of the enterprise. It brings into account the impact of changes in the prices on the preparation of the financial statements.
k) Statistical and graphical techniques: The management accountant uses various statistical and graphical techniques in order to make the information more meaningful and presentation of the same in such form so that it may help the management in decision-making. The techniques used are Master Chart, Chart of sales and Earnings, Investment chart, Linear Programming, Statistical Quality control, etc.
l) Communication (or Reporting): The success for failure of the management is dependent on the fact, whether requisite information is provided to the management in right form at the right time so as to enable them to carry out the functions of planning controlling and decision-making effectively. The management accountant will prepare the necessary reports for providing information to the different levels of management by proper selection of data to be presented, organization of data and selecting the appropriate method of reporting.
Or
What is zero base budget? How is it different from traditional budget? What are the advantages of such a technique of budgeting? 2+4+4=10
Ans: Zero Based Budgeting: ZBB is defined as ‘a method of budgeting which requires each cost element to be specifically justified, as though the activities to which the budget relates were being undertaken for the first time. Without approval, the budget allowance is zero’.
Zero – base budgeting is so called because it requires each budget to be prepared and justified from zero, instead of simple using last year’s budget as a base. In Zero Based budgeting no reference is made to previous level expenditure. Zero based budgeting is completely indifferent to whether total budget is increasing or decreasing.
‘Zero base budgeting’ was originally developed by Peter A. Pyher at Texas Instruments. Peter A. Pyher has defined ZBB as “an operating, planning and budgeting process which requires each manager to justify his entire budget request in detail from scratch (hence zero base) and shifts the burden of proof to each manager to justify why we should spend any money at all”.
CIMA has defined it “as a method of budgeting whereby all activities are revaluated each time a budget is set."
Difference between traditional budget and zero base budgeting
Traditional budget | Zero base budgeting |
1. Previous year’s data is taken as base for preparation of a budget. | 1. Each budget is prepared and justified from zero. |
2. Traditional budget are accounting oriented. | 2. ZBB is project oriented. |
3. Clarity and responsiveness is very low in traditional budget. | 3. Clarity and responsiveness is high are compared to traditional budget. |
4. It is a routine approach. | 4. It is a straight forward approach. |
Benefits of Zero Base Budgeting
The major benefits of the use of zero base budgeting can be the following:
a) Zero base budgeting examines all existing and new programmes and activities. It also makes the managers analyse their functions, establish priorities and rank them. This exercise helps in identifying inefficient or obsolete functions within the area of responsibility. In this way resources are allocated from low priority programmes to high priority programmes.
b) This system facilitates identification of duplication of efforts among organisational units. Such inefficient activities are eliminated and some other activities are merged.
c) All expenditures, under this system are critically reviewed and justified and all operations activities are evaluated in greater detail in terms of their cost- effectiveness and cost-benefits. This requires managers to find alternative ways of performing their activities which may result in more efficient procedures.
d) ZBB promotes the tendency to initiate studies and improvements during the period of operation as the persons at the helm of affairs know that the process would be exercised next year and their knowledge and training would enhance efficiency and cost-effectiveness.
e) ZBB provides for quick budget adjustments during the year. If revenue falls short in this process, it offers the capability to quickly and rationally modify goals and expectations to correspond to a realistic and affordable plan of operations.
f) ZBB ensures greater participation of personnel in formulation and ranking processes. This helps in promoting level of job satisfaction and thus resulting in better control and operational efficiency in the organisation.
g) Zero base budgeting is a flexible tool that can be applied on a selective basis. It does not have to be applied throughout the entire organisation or even in all the service departments. Keeping in view the limitations of time, money and persons available to install, operate and monitor it the management thus can select priority areas to which zero base budgeting may be applied.
10. State the application of marginal costing in pricing decisions and profit planning. 10
Ans: “Marginal Costing” is a valuable aid to Management: Marginal costing and Beak even analysis are very useful to management. It helps the management in taking pricing decision and profit planning in the following ways:
1) Fixation of selling price: Generally prices are determined by demand and supply of products and services. But under special market conditions marginal costing is helpful in deciding the prices at which management should sell. When marginal cost is applied to fixation of selling price, it should be remembered that the price cannot be less than marginal cost. But under the following situation, a company shall sell its products below the marginal cost:
Ø To maintain production and to keep employees occupied during a trade depression.
Ø To prevent loss of future orders.
Ø To dispose of perishable goods.
Ø To eliminate competition of weaker rivals.
Ø To introduce a new product.
Ø To help in selling a co-joined product which is making substantial profit?
Ø To explore foreign market
2) Profit Planning: It helps in short-term profit planning by making a study of relationship between cost, volume and Profits, both in terms of quantity and graphs. An analysis of contribution made by each product provides a basis for profit-planning in an organisation with wide range of products. In order to enhance profit, management must control its cost and take some important decisions such make or buy decision or closing down of unproductive department or selecting a suitable product mix. These important decisions relating to profit planning are listed below:
1. Cost control: Marginal costing divides total cost into fixed and variable cost. Fixed Cost can be controlled by the Top management to a limited extent and Variable costs can be controlled by the lower level of management. Marginal costing by concentrating all efforts on the variable costs can control total cost.
2. Make or Buy: Marginal costing helps the management in deciding whether to make a component part within the factory or to buy it from an outside supplier. Here, the decision is taken by comparing the marginal cost of producing the component part with the price quoted by the supplier. If the marginal cost is below the supplier’s price, it is profitable to produce the component within the factory. Whereas if the supplier’s price is less than the marginal cost of producing the component, then it is profitable to buy the component from outside.
3. Closing down of a department or discontinuing a product: The firm that has several departments or products may be faced with this situation, where one department or product shows a net loss. Should this product or department be eliminated? In marginal costing, so far as a department or product is giving a positive contribution then that department or product shall not be discontinued. If that department or product is discontinued the overall profit is decreased.
4. Selection of a Product/ sales mix: The marginal costing technique is useful for deciding the optimum product/sales mix. The product which shows higher P/V ratio is more profitable. Therefore, the company should produce maximum units of that product which shows the highest P/V ratio so as to maximize profits.
5. Evaluation of Performance: The different products and divisions have different profit earning potentialities. The Performance of each product and division can be brought out by means of Marginal cost analysis, and improvement can be made where necessary.
6. Limiting Factor: When a limiting factor restricts the output, a contribution analysis based on the limiting factor can help maximizing profit. For example, if machine availability is the limiting factor, then machine hour utilisation by each product shall be ascertained and contribution shall be expressed as so many rupees per machine hour utilized. Then, emphasis is given on the product which gives highest contribution.
Or
From the following information find out the P.V. Ratio, Break-even point and the sales required to earn a profit of Rs. 50,000. 3+4+3=10
a) Selling price – Rs. 100 per unit.
b) Variable Cost Rs. 75/-
c) Fixed Cost Rs. 2,00,000/-
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