CA FINALADVANCED MANAGEMENT

ACCOUNTING

Few concepts at a quick glance………

MARGINAL COSTING

MARGINAL COST STATEMENT

SALES XXX

(-) VARIABLE COST XXX

CONTRIBUTION XXX

(-) FIXED COST XXX

PROFIT XXX

LOSS REPRESENTS UNRECOVERED FIXED COST

RATIOS

P/V RATIO

V/C RATIO

CONTRIBUTION X 100 SALES

VARIABLE COST X 100 SALES

P/V RATIO = 100% - V/C RATIO

BREAK EVEN POINT(BEP)

LEVEL OF SALES WHERE THERE IS NO PROFIT NO LOSS SITUATION

i.e. CONTRIBUTION = FIXED COST

BREAK EVEN POINT(in Rs.) = FIXED COST

P/V RATIO

BREAK EVEN POINT(in Units) = FIXED COST CONTR. P . u.

SIGNIFICANCE OF BREAK EVEN POINT

LEVEL OF SALES IMPACT ON PROFITS

LESS THAN BEP FIRM INCURS LOSSES (CONTRIBUTION < F.C.)

EQUAL TO BEP NO PROFIT NO LOSS (CONTRIBUTION = F.C.)

GREATER THAN BEP FIRM EARNSPROFIT (CONTRIBUTION > F.C.)

MARGIN OF SAFETY (MOS)

IT IS THE DIFFERENCE B/W TOTAL SALES AND BREAK EVEN SALES

MOS (in Rs.) = TOTAL SALES – BREAK EVEN SALES

OR PROFIT / PV RATIO

MOS (in Qty.) = PROFIT / CONTRIBUTION PER UNIT

INDIFFERENCE POINTIT IS THAT LEVEL OF SALES WHERE THE COSTS AND

PROFITS OF TWO OPTIONS ARE EQUAL.

PROFIT OF OPTION 1

PROFIT OF OPTION 2

INDIFFERENCE POINT

---------------------------- ------------------------

AMO

UN

T (

in R

s.)

QUANTITY

FORMULA:

A)INDIFFERENCE POINT (in Rs.) = DIFFERENCE IN

FIXED COST DIFFERENCE IN V/C

RATIO

OR

= DIFFERENCE IN FIXED COST

DIFFERENCE IN P/V RATIO

FORMULA:

B) INDIFFERENCE POINT (in Units) = DIFFERENCE IN FIXED

COST DIFFERENCE IN

VARIABLE COST p.u

OR

= DIFFERENCE IN FIXED COST

DIFFERENCE IN CONTR. p.u.

LEVEL OF SALES MOST PROFITABLE

OPTION

REASON

BELOW INDIFFERENCE POINT

OPTION WITH LOWER FIXED COST

LOWER THE FIXED COST, LOWER THE BEP, HENCE MORE PROFIT BEYOND BEP

AT INDIFFERENCE POINT

BOTH OPTIONS ARE EQUALLY PROFITABLE

INDIFFERENCE POINT

ABOVE INDIFFERENCE POINT

OPTION WITH HIGHER PV RATIO (LOWER VARIABLE COST)

THE HIGHER THE PV RATIO, THE BETTER IT IS.

SIGNIFICANCE OF INDIFFERENCE POINT

SHUT DOWN POINTIT INDICATES THE LEVEL OF OPERATIONS BELOW WHICH IT IS NOT JUSTIFIED TO PURSUE PRODUCTION.

FOR THE ABOVE PURPOSE DIVIDE THE FIXED COST

AVOIDABLE OR DISCRETIONARY FIXED COST

UNAVOIDABLE OR COMMITTED FIXED COST

FORMULAS:

SHUT DOWN POINT (in Rs.) = AVOIDABLE FIXED COST P/V RATIO

SHUT DOWN POINT (in Qty.) = AVOIDABLE FIXED COST CONTRIBUTION p.u.

AVOIDABLE F.C. = TOTAL F.C. – UNAVOIDABLE F.C.

LEVEL OF SALES

DECISION REASON

BELOW SHUT DOWN POINT

CLOSE DOWN OPERATIONS

AVOIDABLE FIXED COSTS ARE NOT BEING RECOVERED

AT SHUT DOWN POINT

CONTINUE OPERATIONS

AVOIDABLE FIXED COSTS ARE JUST RECOVERED

ABOVE SHUT DOWN POINT

CONTINUE OPERATIONS

AVOIDABLE F.C. ARE RECOVERED, FURTHER CONTR. RECOVERS BALANCE F.C.

SIGNIFICANCE OF SHUT DOWN POINT

KEY FACTOR OR THE LIMITING FACTOR

• IT REPRESENTS A RESOURCE WHOSE AVAILABILITY IS LESS THAN ITS REQUIREMENT.

• IT IS ALSO CALLED CRITICAL FACTOR OR BUDGET FACTOR.

• EXAMPLES OF KEY FACTOR:1. SHORTAGE OF RAW MATERIAL2. LABOUR SHORTAGE3. RESTRICTIONS IN PLANT CAPACITY4. DEMAND OR SALE EXPECTANCY5. CASH AVAILABILITY

KEY FACTOR- DECISION MAKING STEPS

IDENTIFY THE KEY FACTOR. COMPUTE TOTAL CONTRIBUTION OR CONTRIBUTION PER UNIT OF PRODUCT. COMPUTE CONTRIBUTION PER UNIT OF THE KEY FACTOR i.e. CONTRIBUTION per DIRECT LABOUR HOUR. RANK THE PRODUCTS BASED ON CONTRIBUTION PER UNIT OF THE KEY FACTOR ALLOCATE THE KEY RESOURCES BASED ON RANKS GIVEN ABOVE.

RELEVANT COSTING

MATERIAL COST

ALREADY AVAILABLE TO BE PURCHASED

REGULARLY USED

RARELY USED

CURRENT REPLACEMENT

COST IS RELEVANT AS INCREMENTAL

COST

NET REALISABLE VALUE IS RELEVANT

AS OPPURTUNITY COST

PURCHASE PRICE, BEING OUT OF POCKET

COST IS RELEVANT

SITUATION RELEVANT COST

1. LABOUR FORCE ALREADY AVAILABLE A) EXCESSIVE LABOUR FORCE- NO

RETRENCHMENT POLICY NIL

B) EXCESSIVE LABOUR FORCE- REDUCTION IN IDLE TIME COST

NIL

C) USED FOR SPECIAL CONTRACT NECESSITATES REPLACEMENT

REPLACEMENT COST i.e. WAGES OF NEW WORKERS

D) YIELDING CONTRIBUTION IN A DIFFERENT DEPARTMENT

VARIABLE COST + OPPORTUNITY COST (CONTR. FOREGONE)

2. WORKERS TO BE APPOINTED OUT OF POCKET COST i.e. WAGES OF NEW WORKERS

3. LABOUR SHORTAGE SITUATIONS VARIABLE COST + OPPORTUNITY COST (CONTR. FOREGONE)

LABOUR COST

NATURE OF COST

RELEVANT COST

VARIABLE OVERHEADS • IRRELEVANT IF ALREADY INCURRED• RELEVANT, ONLY IF SUCH COSTS ARE TO BE INCURRED IN FUTURE

FIXED OVERHEADS RELEVANT ONLY UNDER SPECIFIC SITUATIONS. (REFER NEXT SLIDE)

DEPRECIATION IRRELEVANT AS IT IS AN APPORTIONMENT OF HISTORICAL COST

OTHER DEPARTMENT COSTS

• IRRELEVANT IF ALREADY INCURRED• RELEVANT IF THEY ARE TO BE INCURRED SPECIFICALLY FOR ANY CONTRACT

OVERHEAD & OTHER COSTS

FIXED COSTFIXED COSTS ARE IRRELEVANT FOR DECISION

MAKING

EXCEPTIONS:

1. SPECIFICALLY INCURRED FOR A CONTRACT

2. INCREMENTAL3. INCREASE DUE TO CHANGE IN LEVEL OF

ACTIVITY4. AVOIDABLE OR DISCRETIONARY FIXED COST5. ONE COST IS INCURRED IN LIEU OF

ANOTHER (DIFFERENCE IN COSTS WILL WE RELEVANT)

OPPORTUNITY COST

VALUE OF SACRIFICE MADE/BENEFIT OF OPPORTUNITY FOREGONE BY SELECTING ONE ALTERNATIVE IN PREFERENCE TO OTHERS.

FEATURES OF OPPORTUNITY COST:

• TAKEN INTO CONSIDERATION ONLY WHEN ALTERNATIVES ARE COMPARED.• ARISES ONLY IN RESOURCE SHORTAGE SITUATIONS i.e. KEY FACTOR SITUATION.• USEFUL ONLY FOR DECISION MAKING & NOT FOR ACCOUNTING, REPORTING & COST CONTROL.• ARISES ONLY IN SHORT RUN.

TRANSFER

PRICING

TRANSFER DIVISION

RECIPIENTDIVISION

PRODUCT / SERVICES TRANFERED

CONSIDERATION = TRANSFER PRICE

OBJECTIVE: TO SELL INTERNEDIATE

PRODUCT & MAXIMISE REVENUE

OBJECTIVE: TO BUY INTERNEDIATE

PRODUCT & MAXIMISE REVENUE

REVENUE COST

FIXATION OF MINIMUM & MAXIMUM TRANSFER PRICE

MINIMUM TRANSFER PRICE (ALWAYS FROM TRANSFER DIVISION VIEW):

IT IS THE TOTAL OF FOLLOWING ITEMS:a) VARIABLE COST UPTO THE POINT OF

INTERNAL TRANSFER.b) FIXED COST, IF SPECIFIC.c) OPPORTUNITY COST, IF APPLICABLE.

NOTES:

1. SELLING OVERHEADS ARE INCURRED FOR EXTERNAL SALES ONLY.2. OPPORTUNITY COST ARISES ONLY IF- - TRANSFERRING DIVISION PRODUCES MARKETABLE

PRODUCTS - TRANSFERRING DIVION OPERATES AT FULL CAPACITY

FIXATION OF MINIMUM & MAXIMUM TRANSFER PRICE

MAXIMUM TRASFER PRICE (ALWAYS FROM RECIPIENT DIVISION VIEW):

IT IS THE LEAST OF FOLLOWING ITEMS:

1. MARKET PRICE OF INTERMEDIATE PRODUCT (AS QUOTED BY OUTSIDE SUPPLIER)

2. INTERNAL TRANSFER PRICE (AS QUOTED BY TRANSFERRING DIVISION)

NOTES:IF THE PRICE QUOTED BY THE TRANSFERRING DIVISION IS MORE THAN THE PRICE QUOTED BY THE OUTSIDE SUPPLIER THEN IT IS ALWAYS BETTER TO PURCHASE FROM OUTSIDE.

ACTIVITY BASED

COSTING

COST OBJECTS:

ITEM FOR WHICH COST MEASUREMENT IS REQUIRED.

ACTIVITY BASED COSTINGMEANING:

IT IS THE IDENTIFICATION OF COST WITH EACH COST DRIVING ACTIVITY AND MAKING IT AS THE BASIS FOR APPORTIONMENT / ASSIGNMENT OF COSTS OVER DIFFERENT COST OBJECTS /JOBS/ PRODUCTS/ CUSTOMERS/SERVICES.

COST DRIVER:IT IS THE FACTOR THAT CAUSES A CHANGE IN THE COST OF AN ACTIVITY.

RESOURCE COST DRIVERS: MEASURE OF QUANTITY OF RESOURCES CONSUMED BY AN ACTIVITY & USED TO ASSIGN THE COST OF A RESOURCE TO AN ACTIVITY/COST POOL

ACTIVITY COST DRIVER: MEASURE OF FREQUENCY AND INTENSITY OF DEMAND, PLACED ON ACTIVITES BY COST OBJECTS & USED TO ASSIGN ACTIVITY COSTS TO COST OBJECTS.

STEP PARTICULARS

1. IDENTIFY VARIOUS ACTIVITES WITHIN FIRM INTO- PRIMARY AND SECONDARY.

2. RELATE THE OVERHEADS TO ACTIVITIES USING RESOURCE COST DRIVERS.

3. APPORTION THE COST OF SUPPORT ACTIVITIES OVER PRIMARY ACTIVITIES.

4. DTERMINE ACTIVITY COST DRIVERS FOR EACH ACTIVITY / COST POOL.

5. COMPUTE ABC RATE = TOTAL COST OF ACTIVITY ACTIVITY COST DRIVER

6. ASSIGN COSTS TO THE COST OBJECTS USING THE FORMULA = RESOURCES CONSUMED X ABC RATE

STAGES IN ABC

THANK YOU&

ALL THE BEST