PGP/SS/07-09 Saurabh Jain

THE INDIAN INSTITUTE OF PLANNING AND MANAGEMENT

MANAGEMENT ACCOUNTING – TRIMESTER 1

THEORITICAL CONCEPTS IN COST ACCOUNTING

CHAPTER 1: INVENTORY COSTING

1. Introduction
It is the systematic control over the procurement, storage and usage of materials.

Operations:
a. Purchasing of materials
b. Receiving of materials
c. Inspection of materials
d. Storage of materials
e. Issuance of materials
f. Maintenance of inventory records
g. Stock audit

2. Inventory systems
a. Periodic Inventory System
A method of recording stores balances after every receipt and issue of materials or
inventory found at the end of the accounting period. The cost of material = total value of
inventory purchased during the period + value of inventory in the beginning of the
period – value of inventory in the end of the period. No accounting is done for shortages,
losses, theft & wastages.
b. Perpetual Inventory System or Automatic Inventory System
A system of recording stores balances which reflects the physical movement of stocks &
their current balances. The objective is to make available details about the quantity and
value of stock of each item at all times.

CHAPTER 2: BUDGETARY CONTROL

1. Introduction
A budget is a plan of operations. The various uses of budgetary control are:
a. Economical use of capital resources
b. Co-ordination
c. Reduction of variations
d. Uniformity
PGP/SS/07-09 Saurabh Jain

2. Methods of Budgeting/Budgets
a. Fixed Budget
A budget which is prepared on the basis of a standard or fixed level of activity is a fixed
budget i.e. it does not change with a change in the level of activity and is therefore not
widely practiced because it does not give a true assessment of the performance &
position of the company.
b. Flexible Budget
A budget which is prepared for any level of activity. It considers fixed, variable and semi-
variable elements of cost. It is desirable when:
(1) Sales are unpredictable
(2) Venture is a new one
(3) Shortage of labour etc.

3. Performance Budgeting
It is the evaluation of the performance of organization in context of objectives. It is done
by fixing responsibility of the each executive in organization and reviewing it.
Features:
a. Prepared at each managerial level.
b. It is continous
c. It involves regular reporting

4. Zero Base Budgeting (ZBB)

a. It examines a programme or function from scratch.
Assumption
Nothing is to be allowed simply because it was being done earlier.

b. Steps of ZBB:
(1) Determination of objectives
(2) Determination of scope (to which ZBB is to be introduced)
(3) Development of decision units.
(4) Decision package must be made (with questions on how decision will be taken and
reviewed)
(5) Rank the decisions and calculate costs

c. Advantages of ZBB:
(1) Systematic way to evaluate
(2) Identify areas of wasteful expenditures
(3) Links budget with corporate objectives

CHAPTER 3: MARGINAL COSTING

1. Introduction
Overheads:
a. Fixed (remain fixed per unit of time)
b. Variable (remain constant per unit of output)
PGP/SS/07-09 Saurabh Jain

With an increase or decrease in production/output, fixed overheads remain constant

while variable overheads changes.

Thus, Fixed overheads should not be allocated to each individual department (i.e.
apportion to production), rather they should be charged against the total funds arising
out of excess of selling price over total variable cost. This concept is known as Marginal
Costing.
It is the amount at any given volume of output – by which aggregate costs change if the
volume of output increases or decreases by one unit.

Marginal Cost = (Total Cost – Fixed Cost) OR (Direct material + direct labour + other
variable costs)

2. Concepts

a. Marginal Costing and Direct Costing

Some accountants say direct costs = variable costs but Electricity, Rent etc. are direct
costs but not variable for one product.

b. Marginal Costing and Differential Costing

(1) Differential Cost – Net increase of decrease in total cost resulting from a variation in
production. Here, fixed costs may also get affected besides the variable costs. (When
cost increases, it is known as Incremental Costs whereas when cost decreases, it is known
as Decremental cost). Under this, costs of various alternatives are compared with the
different revenues and decisions are taken on the basis of the maximum net gain. It helps
while checking the viability of different projects.
(2) Marginal Costing – Under this, fixed cost are also considered at some stage, it
assumes the form of differential costing.

c. Marginal Costing and Absorption Costing

Under AC
Full costs i.e. Fixed Cost + Variable Cost are charged to production
Under MC
Only Variable costs are charged to production, fixed costs are ignored.

d. Differences

BASIS ABSORPTION COSTING MARGINAL COSTING

Valuation of stocks
Absorption of Overheads
Stocks of work-in-progress of The two stocks are valued
finished goods are valued at Marginal Costing.
at works cost (including
fixed work overheads) and
total cost of production
(including fixed work
overheads and office
overheads respectively)
Result: - Undervaluation of
stocks.
All variable and fixed Actual fixed overheads are
overheads are absorbed to wholly transferred to costing
production. profit and loss account.
PGP/SS/07-09 Saurabh Jain

3. Advantages of Marginal Costing

Managerial decisions can be taken regarding:

(a) What to produce
(b) How much to produce
(c) Whether to produce or not
(d) How to produce – whether a method if profitable or not
(e) When to produce
(f) At what cost to produce (i.e. Break Even Point etc)

4. Limitations of Marginal Costing

(a) Classification into fixed and variable elements is a difficult task.
(b) Faulty decisions
(c) Difficult applications
(d) Under or over recovery of overheads
(e) Better techniques like standard costing and budgetary control are available

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