PERFORMANCE MANGEMENT

STUDY NOTES

Bangalore University
th
6 Sem B.Com (Finance Elective)

Prepared and Compiled By:

Gowtham Kumar C. K CMA (Inter), M.Com, K.SET, B.ED
Assistant professor
 BANGALORE UNIVERSITY
REVISED SYLLABUS

FN 6.5 PERFORMANCE MANAGEMENT

UNIT 1: SPECIALIST COST AND MANAGEMENT ACCOUNTING TECHNIQUES 12 HRS

Activity-based costing - Target costing - Life cycle costing - Throughput accounting - Environmental
accounting

UNIT 2: DECISION MAKING TECHNIQUES 12 HRS

Relevant cost analysis - Cost volume profit analysis - Limiting Factors Pricing decisions - Make-or- buy
and other short-term decisions - Dealing with risk and uncertainty in decision making

Unit 3: BUDGETING AND CONTROL 10 HRS

Budgetary systems and types of budget - Quantitative analysis in budgeting Standard costing - Material mix
and yield variances - Sales mix and quantity variances - Planning and operational variances

Unit 4: PERFORMANCE MEASUREMENT AND CONTROL 12 HRS

Performance management information systems - Sources of management Information - Management

reports - Performance analysis in private sector organizations - Divisional performance and transfer pricing
- Performance analysis in not-for-profit organizations and the public sector - External considerations and
behavioral aspects

2 Years Question Paper Solved in Last Sheet

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Unit 1

Specialist cost and management accounting techniques

ACTIYTTY BASED COSTING

ABC is an accounting Methodology that assign costs to activities rather than product and services.
ABC can track the flow of activities in organization by creating a link between the activity and cost
objects. This enables resources and over heads cost to be more accurately assigned to products and
services that consume them. ABC assigns cost to activities based on their recourses.

ABC aims at rectifying the in accurate cost information. It is modem approach of indirect cost
allocation. ABC is a new term developed for finding out the cost the basic feature of ABC is focusing
on activities as the fundamental cost objects.

"ABC is not an alternative costing system to job costing or process costing. Further ABC is an
approach to developing costing numbers used in job costing or process costing systems. The ABC
approach is more expressive than traditional approaches. ABC has the potential, however, to provide
Managers with information they find more useful for costing purposes"

Definition:

The CIMA official terminology defines ABC as "Cost attribution to cost units on the basis of benefits
received from indirect activities e.g., ordering, setting up, assuring quality"

ABC has defined CAM-1 organization of arlinaton texas as “ The collection of financial and
operation performance information tracing the significant activity of the firm to product costs"

Need for emergence of ABC:

Manufacturing organization need ABC for product costing where

1. Production overheads arc high in relation to direct costs.
2. There is great diversity (scope) in the product range.
3. Product use different amount of overhead resources.
4. Consumptions of over head resources are not primarily driven by volume or hours.

Objectives of ABC:-

1. To eliminate the distortions & bring more accuracy in computation of cost of products &
services.
2. To help in decision making by accurately computing the costs of products & services.
3. To identify various activities in the production process.
4. To distribute overheads on the basis of activities.
5. To focus on high cost activities.

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6. To identify the opportunities for improvement & reduction costs.

7. To eliminate non value adding activities.
Characteristics of ABC:-

1. Simple traditional distinction made b/w fixed cost & variable cost is not enough as it guides to
provide quality information to design a cost system.
2. The more appropriate distinction b/w cost behavior patterns are volume (scale) related,
diversity (scope) related, events (decisions) related & time related.
3. Cost drivers need to be identified. A cost driver is a structural determinant of cost related
activity. The logic behind is that the cost behavior pattern must be understood so that behavior
pattern is dictated by cost drivers. In tracing o/h cost to product, a cost to behavior pattern
must be understood so that appropriate cost driver could be identified.
4. It signifies non-value added activities & thereby is helpful to the Mgt to eliminate such
activities & reduce the cost of the product.

Uses of ABC:-

 Optimum utilization of resources: - Activity based costing sets the base for allocation of
resources to activities, thus there will be efforts to improve the utilization of resources in the
activities that will improve the worth of share holders.
 Price fixation: - ABC provides a more accurate method of ascertainment of cost of product or
service as it helps in improvising costing of a product & problem of over/ under absorption
faced under traditional costing system.
 Cost control: - The understanding of cost driver & activity cost drivers for each activity gives
better control over the factors that causes costs.
 Elimination of non value added activities: - It helps in identifying & eliminating value adding
activities in the process of production.
 Guides Mgt: - It supports other mgt techniques such a continuous improvement, score cards &
performance mgt.
 Measure performance: - It establishes link b/w profitability analysis & operational activities,
there by facility performance appraisal.
 Determines Accurate cost: - It helps in better understanding of o/h costs & its assignment to
various products / services. Etc, It also enables cost profiles to be managed as costs are
transparent & actionable.

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Limitation of ABC:-

1. Activity Based Costing system suffers from the following disadvantages:-

2. Activity definition may become too detailed & the model may become too complex & difficult
to maintain.
3. It is difficult & time consuming to collect the data about activities & cost drivers.
4. It can be costly to implement, run & manage an ABC system.
5. Underestimation of the task of collecting activity driver data.
6. It does not consider opportunity cost which may result into lower sales because of greater
emphasis on producing cheaper goods.
7. Even in ABC some o/h costs are difficult to assign to products & customers. These costs still
have to be arbitrarily applied to products & customers.

In spite of all the above limitations ABC system helps in strengthening costing system of organisation.
The success of ABC depends upon choice of cost driver, cost pools installation of cost centers.

Categories in Activity Based Costing (ABC):

1. Unit level activities:- The of some activities (Mainly primary activities ) are strongly co-related to
the number of units produced .These activities are known as Units level activities.

Ex: - The use of indirect materials

2. Batch level activities: - The cost of some activities (mainly manufacturing support activities) arc
driven by the number of batches of units produced. These activities are known as batch level activities
(B.L.A)

Ex: -
1. Material ordering
2. Machine set up cost
3. Inspection or products - like first item of every batch.

3. Product level activities: - The cost of some activities are driven by the creation of a new product
line & its maintenance. These activities are known as Product level activities.

Ex: -
1. Designing the product
2. Producing parts to a certain specified limit
3. Advertising cost, if advertising is for individual products

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4. Facility level activities: - He cost of some activities cannot be related to a particular product line,
instead they are related to maintaining the building and facilities.

Ex: -
1. Maintenance of building
2. Plant security
3. Production manager’s salary
4. Advertising Co's promoting the Co.

Terms used in ABC and cost drivers and cost pools:-

In order to understand ABC, one should be familiar "with the meaning of the following terms.

Activity: - It may be define as a particular task or unit of work with a specific purpose.

Ex: - placing of a purchase order, after sales service, setting up of a machine.

Cost object: - It is an item for which cost measurement is required. The tangible input for a product
manufactured or services provided

Ex: A product, a service, labour, material, a job or a customer

Cost pool: - the point of focus for the costs relating to a particular activity in an activity based costing
system. The allocation of Overheads cost associated with activities that have the same process, have
the same level and can the same activities derives to assign costs to products.

Ex: Grouping of Overheads cost items for the purpose of allocating those costs to cost objects.

Cost driver: - It is a factor that causes a change in the cost of an activity. Cost derives can be defined
as those activities or transactions that are significant determinants of costs.

Ex:-Number of set ups, Number of orders etc,

Cost drivers are two types. They are

Resources cost drivers: - It measures the quantity of resources consumed by an activity. It is used to
assign the cost of a resource to an activity or cost pool.

Ex: - Number of purchase order placed will determine the cost of purchasing the material.

Activity Cost Driver: - It measures frequency & intensity of demand placed on the activities by cost
objects. It’s used for assigning activity cost to cost objects consuming the activity.

Ex: - Cost drivers for various business function

Distinguish B/w Traditional Absorption costing & ABC:

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SL
Traditional Absorption Costing Activity Based Costing
no.
1 Cost identification Overhead are related to Cost identification O/Hs are related to activities or
activities to place /cost centers /dept grouped in to costs pools.

2 Activates ascertainment only unit level(variable) All four levels like unit level, batch level and facility
and facility level activities(fixed) may be identified level activities are identified

3 Cost ascertainments are not realistic of cost Cost ascertainments are more realistic of cost
behaviour. behaviour.
Cost are assigned to cost units, i.e., Costs are assigned to cost objects, e.g., customer,
4
products/jobs/hours. services, products, dept and customer segments.

5 Recovery rates used multiple or single rates, for Specific activity-wise recovery rates arc used. There
each dept or entire factory respectively. is no single or overall ABC rate.

Cost drivers time(hours) is assumed as the only Activity-wise cost drivers or identified. Time may
6
‘casual factor’ governing cost in all dept. also be a cost drivers.

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Activities and Cost Drivers.

Activities Cost Drivers
Materials planning/acquisition No. of material transactions
Volume of material order and/or receipt

Purchase of raw materials No. of purchase order placed and processed

Receiving materials No. of consignments received
No. of receipts
Stores delivery No. of stores deliveries
Materials handling No. of materials and parts requisitioned
No. of movements
Inspection Inspection time per item
No. of items inspected or inspections carried out
No. of machine break downs
Capital cost of machines
Machine set-up No. of set-ups
No. of production runs
Production No. of machine hours
Quality testing Hours of quality testing time
No. of inspection
Inspection plans
Ware housing Items in stock
Customer order processing No. of order processed
Value of customer order processed
Packing No. of boxes packed
Line item ordering No. of line items
No. of machine breakdowns
Maintenance Capital cost of machines
Research and Development Number of Research projects
Personnel hours on a project
Customer service Number of service calls
Number of product serviced
Hours spent on Servicing products
Number of advertisements
Marketing Number of sales personnel
sales revenue
Number of items distributed
Distribution Number of customer
weight of items distributed

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STEPS TO IMPLEMENT ACTIVITY BASED COSTING

1. Identify Activities: - The organization needs to undertake an in depth analysis of the operating
processes of each responsibility centre .Each process might consist of one or more activities required
producing an output.

For example purchasing department may undertake the following procedures like

 Receiving purchase requisition from concerned department

 Inviting quotation from various suppliers

 Placing an order

 Receiving and inspecting the goods

 Finally issuing the goods to concerned department or handling to stores department.

2. Identify Cost Drivers: - once the activities are identified, the next is to identify cost drivers. The
cost driver is the factor which causes the change in costs of an activity. It is the factor which causes
the incurrence of the cost related to an activity .identifying cost drivers requires gathering information
and interviewing key personnel in various areas of the organization, such as purchasing, production,
quality control, and accounting.

For example: Cost Drivers in the purchasing department are:

Activities Cost drivers Estimated Annual Cost Drivers

Purchase requisition No. of requisitions 4000 requisition
Inviting quotation Processing the no. of supplies 30 quotations
Placing an order No. of orders 500 orders
Receiving and inspecting the Inspection hours 15000 hours
goods
3. Assign Overhead Costs to the Activities Identified: - this steps requires that overheads costs
associated with each activity be assigned to the activity (i.e. a cost pool is formed for each activity)
the overhead cost is apportioned to each activity is found.

For example, the cost pool for the purchasing materials activity will include costs for

Activities Cost of Activity(Rs)

Purchase requisition 20000
Inviting quotation 4500.
Placing an order 5000
Receiving and inspecting the goods 30000

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4. Assigning costs of Activities to products /services based on Cost driver: - activity cost driver are
used to assign costs of an activity to cost objects, just as the overhead absorption rate .it is the rate
which is obtained by dividing the total costs of activity by the total quantity of activity driver. It is
calculated as follows:
Total cost of an activity
Activity Cost Driver Rate -----------------------------------------
No. of activity cost driver

For example: the activity cost driver rate for purchasing departments are

Activities Cost of Annual cost Activity cost driver

activity driver rate
Purchase requisition 20000 4000 Requisitions 5

Inviting quotation 4500 30 Quotations 150

Placing an order 5000 500 Order 10
Receiving and inspecting the goods 30000 15000 Hours 2

5. Apply The Cost Of Products /Services (Cost Object):- The activity cost driver rate obtained as
per fourth step will be multiplied by different quantum of each activity that each product /services cost
object users or consumers activity drivers assign activity costs to outputs (cost objects )based on the
consumption demand for activities

Two Marks question and Answers

1. Define ABC.

The CIMA official terminology defines ABC as "Cost attribution to cost units on the basis of
benefits received from indirect activities e.g., ordering, setting up, assuring quality"

2. What are the features of ABC?

1. Simple traditional distinction made b/w fixed cost & variable cost is not enough as it guides to
provide quality information to design a cost system.
2. The more appropriate distinction b/w cost behavior patterns are volume (scale) related,
diversity (scope) related, events (decisions) related & time related.
3. Cost drivers need to be identified. A cost driver is a structural determinant of cost related
activity. The logic behind is that the cost behavior pattern must be understood so that behavior
pattern is dictated by cost drivers. In tracing o/h cost to product, a cost to behavior pattern
must be understood so that appropriate cost driver could be identified.

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

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4. It signifies non-value added activities & thereby is helpful to the Mgt to eliminate such
activities & reduce the cost of the product.

3. State the benefits of ABC costing.

 Optimum utilization of resources

 Price fixation - Cost control
 Elimination of non value added activities
 Guides Mgt
 Measure performance
 Determines Accurate cost

4. What do you mean by activity?

It may be define as a particular task or unit of work with a specific purpose. Ex: - placing of a
purchase order, after sales service, setting up of a machine.

5. Define cost pool.

According to CIMA, “cost pool is the point of focus for the costs relating to a particular
activity in an activity in an activity based costing system”. The cost pool is the total cost
assigned to an activity i.e. it is the sum of all the cost elements

6. What is cost object? Give two examples.

It is an item for which cost measurement is required. The tangible input for a product
manufactured or services provided. Ex: a product, a service, labour, material, a job or a
customer

7. Define Cost Driver.

According to CIMA, “cost driver is any factor which causes a change in the cost of an activity,
e.g. the quality of parts received by an activity is a determining factor in the work required by
that activity and therefore affects the resources required”.

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8. What are the difference between traditional costing and ABC?

SI No. Traditional absorption costing Activity' based costing

1 cost identification o/h arc related to activities to Cost identification O/Hs are related to activities
place /cost centers /dept or grouped in to costs pools.
Activates ascertainment only unit level(variable) All four levels like unit level, batch level and
2 and facility level activities (fixed) may be facility level activities are identified
identified

3 Cost ascertainments are not realistic of cost Cost ascertainments are more realistic of cost
behaviour. behaviour.
Costs are assigned to cost objects, e.g.,
4 Cost are assigned to cost units, customer, services, products, dept and customer
i.e., products/jobs/hours. segments.

Problem no. 1

Compute the recovery rates of overheads from the following information under ABC method.

Overheads Costs (Rs.) Cost drivers (cost pools)

Set-ups 60,000 No. of production runs (60)
Machines 15,20,000 No. of orders (1080)
Receiving 8.70.0 No. of delivered (64)
Packing 5,00,000 No. of products delivered (100)
Engineering 7,46,000 Machines hours (2,94,000 hours)

Problem no. 2 [Dec-2014]

The budgeted overheads and cost driver volumes of Murthy Ltd. are as follows:
Cost pool Budgeted overheads (Rs.) Cost driver Budgeted
Material purchase 57,970 No. of orders 110
volumes
Material handling 25,024 No. of movement 68
Set-up 41,600 No. of set-ups 52
Maintenance 96,600 Maintenance hours 840
Quality control 17,100 No. of inspections 90
Machinery 72,000 No. of machine hours 2400

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The company has produced a batch of 260 components of products ‘X’. Its material cost were Rs.
65,000 and labour cost Rs. 1,22,500.

The usage activities of the said batch are as follows:

1. Material order-13
2. Maintenance hours - 345
3. Materials movement - 09
4. Inspection - 14
5. Set-ups – 12.5
6. Machine hours - 900

Calculate cost driver rates and ascertain the cost of the batch of components of product ‘X’ using
activity based costing.

Problem no. 3

The budgeted overheads and cost driver volumes of Kumar Ltd. are as follows:

Cost pool Budgeted overheads Cost driver Budgeted volumes

Material purchase 1,15,940 No. of orders 220
Material handling 50048 No. of movement 136
Set-up 83,200 No. of set-ups 104
Maintenance 1,93,200 Maintenance hours 1,680
Quality control 34,200 No. of inspections 180
machinery 1,44,000 No. of machine hours 4,800
The company has produced a batch of 520 components of products ‘X’. Its material cost were Rs.
1,30,000 and labour cost Rs. 2,45,000.

The usage activities of the said batch are as follows:

Material order-26
Maintenance hours - 690
Materials movement - 18
Inspection - 28
Set-ups - 25
Machine hours - 1,800
Calculate cost driver rates and ascertain the cost of the batch of components of product ‘X’ using
activity based costing.

Problem no. 4 [Dec-2014]

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The budgeted overheads and cost driver volumes of Xylo Ltd. are as follows:

Cost pool Budgeted overheads Cost driver Budgeted volumes

Material purchase 4,05,000 No. of orders 900
Material Set-up 3,60,000 No. of set-ups 450
Maintenance 2,40,000 Maintenance hours 3000
Quality control 1,40,000 No. of inspections 700
machinery 4,80,000 No. of machine hours 2400
The company has produced a batch of 2500 components of products ‘X’. Its material cost were Rs.
1,10,000 and labour cost Rs. 1,90,000. The usage activities of the said batch are as follows:
Material order 21
Maintenance hours 510
Inspection 26
Set-ups 19
Machine hours 1300
Calculate cost driver rates and ascertain the cost of the batch of components of product ‘X’ using
activity based costing.

Problem no.5 (May/June-2019)

The budgeted overhead and cost driver volumes of Suresh ltd are as follows.

Cost pool Budgeted O/Hs Cost driver Budgeted volume

Material procurement 3,20,000 No. of orders 800

Machine set-up 3,00,000 No. of set ups 500
Maintenance 1,95,000 Maintains hrs 3,000
Quality control 1,70,000 No. of inspections 850
Machinery 4,25,000 No. of machine hours 25,000

The company has produced a batch of 2500 components of AZ. its material cost was Rs. 1,50,000 and
labour cost Rs.2,00,000.

The usage of activities of this batch is as follows. Material orders 20 Setups of machine 25
Maintenance hours 6,000 No. Of inspections 30 Machine hours 2,000

Calculate cost driver rates that are used for computing appropriate amount of overhead to this batch
and ascertain the cost of the batch of the component using ABC.

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Target costing
What is Target Costing?

Target costing is not just a method of costing, but rather a management technique wherein prices are
determined by market conditions, taking into account several factors, such as homogeneous products,
level of competition, no/low switching costs for the end customer, etc. When these factors come into
the picture, management wants to control the costs, as they have little or no control over the selling
price.

CIMA defines target cost as “a product cost estimate derived from a competitive market price.”

Target Costing = Selling Price – Profit Margin

Why Target Costing?

In industries such as FMCG, construction, healthcare, and energy, competition is so intense that prices
are determined by supply and demand in the market. Producers can’t effectively control selling prices.
They can only control, to some extent, their costs, so management’s focus is on influencing every
component of product, service, or operational costs.

The key objective of target costing is to enable management to use proactive cost planning, cost
management, and cost reduction practices where costs are planned and calculated early in the design
and development cycle, rather than during the later stages of product development and production.

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Key Features of Target Costing:

1. The price of the product is determined by market conditions. The company is a price taker
rather than a price maker.
2. The minimum required profit margin is already included in the target selling price.
3. It is part of management’s strategy to focus on cost reduction and effective cost management.
4. Product design, specifications, and customer expectations are already built-in while
formulating the total selling price.
5. The difference between the current cost and the target cost is the “cost reduction,” which
management wants to achieve.
6. A team is formed to integrate activities such as designing, purchasing, manufacturing,
marketing, etc., to find and achieve the target cost.

Advantages of Target Costing:

1. It shows management’s commitment to process improvements and product innovation to gain

competitive advantages.
2. The product is created from the expectation of the customer and, hence, cost is also based on
similar lines. Thus, the customer feels more value is delivered.
3. With the passage of time, the company’s operations improve drastically, creating economies of
scale.
4. The company’s approach to designing and manufacturing products becomes market-driven.
5. New market opportunities can be converted into real savings to achieve the best value for
money rather than to simply realize the lowest cost.

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Example:

1. ABC Inc. is a big FMCG player that operates in a very competitive market. It sells packaged
food to end customers. ABC can only charge Rs 20 per unit. If the company’s intended profit
margin is 10% on the selling price, calculate the target cost per unit.

Solution:

Target Profit Margin = 10% of 20 = Rs 2 per unit

Target Cost = Selling Price – Profit Margin (Rs 20 – Rs 2)

Target Cost = Rs 18 per unit

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Life cycle costing

1. Meaning of Life Cycle Costing:

Life cycle costing is a system that tracks and accumulates the actual costs and revenues attributable to
cost object from its invention to its abandonment. Life cycle costing involves tracing cost and
revenues on a product by product base over several calendar periods.

The Life Cycle Cost (LCC) of an asset is defined as: “The total cost throughout its life including
planning, design, acquisition and support costs and any other costs directly attributable to owning or
using the asset”.

Life Cycle Cost (LCC) of an item represents the total cost of its ownership, and includes all the cots
that will be incurred during the life of the item to acquire it, operate it, support it and finally dispose it.
Life Cycle Costing adds all the costs over their life period and enables an evaluation on a common
basis for the specified period (usually discounted costs are used).

This enables decisions on acquisition, maintenance, refurbishment or disposal to be made in the light
of full cost implications. In essence, Life Cycle Costing is a means of estimating all the costs involved
in procuring, operating, maintaining and ultimately disposing a product throughout its life.

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 product’s life cycle.

Characteristics of Life Cycle Costing:

1. Product life cycle costing involves tracing of costs and revenues of a product over several
calendar periods throughout its life cycle.
2. 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.
3. Each phase of the product life-cycle poses different threats and opportunities that may require
different strategic actions.
4. Product life cycle may be extended by finding new uses or users or by increasing the
consumption of the present users.

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3. Stages of Product Life Cycle Costing:

Following are the main stages of Product Life Cycle:

(i) Market Research:

It will establish what product the customer wants, how much he is prepared to pay for it and
how much he will buy.

(ii) Specification:

It will give details such as required life, maximum permissible maintenance costs,
manufacturing costs, required delivery date, expected performance of the product.

(iii) Design:

Proper drawings and process schedules are to be defined.

(iv) Prototype Manufacture

From the drawings a small quantity of the product will be manufactured. These prototypes will
be used to develop the product.

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(v) Development:

Testing and changing to meet requirements after the initial run. This period of testing and
changing is development. When a product is made for the first time, it rarely meets the
requirements of the specification and changes have to be made until it meets the requirements.

(vi) Tooling:

Tooling up for production can mean building a production line; building jigs, buying the
necessary tools and equipment’s requiring a very large initial investment.

(vii) Manufacture:

The manufacture of a product involves the purchase of raw materials and components, the use
of labour and manufacturing expenses to make the product.

(viii) Selling

(ix) Distribution

(x) Product support

(xi) Decommissioning:

When a manufacturing product comes to an end, the plant used to build the product must be
sold or scrapped.

4. Benefits of Product Life Cycle Costing:

1. It results in earlier action to generate revenue or lower costs than otherwise might be
considered. There are a number of factors that need to be managed in order to maximise return
in a product.
2. Better decision should follow from a more accurate and realistic assessment of revenues and
costs within a particular life cycle stage.
3. It can promote long term rewarding in contrast to short term rewarding.
4. It provides an overall framework for considering total incremental costs over the entire span
of a product.

5. Life Cycle Costing Process:

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Life cycle costing is a three-staged process. The first stage is life cost planning stage which includes
planning LCC Analysis, Selecting and Developing LCC Model, applying LCC Model and finally
recording and reviewing the LCC Results. The Second Stage is Life Cost Analysis Preparation Stage
followed by third stage Implementation and Monitoring Life Cost Analysis.

The three stages are:

LCC Analysis is a multi-disciplinary activity. An analyst, involved in life cycle costing, should be
fully familiar with unique cost elements involved in the life cycle of asset, sources of cost data to be
collected and financial principles to be applied.
He should also have clear understanding of methods of assessing the uncertainties associated with cost
estimation. Number of iteration may be required to perform to finally achieve the result. All these
iterations should be documented in detail to facilitate the interpretations of final result.

Stage 1: LCC Analysis Planning:

The Life Cycle Costing process begins with development of a plan, which addresses the purpose, and
scope of the analysis.

The plan should:

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i. Define the analysis objectives in terms of outputs required to assist a management decision.

Typical objectives are:

a) Determination of the LCC for an asset in order to assist planning, contracting, budgeting or
similar needs.
b) Evaluation of the impact of alternative courses of action on the LCC of an asset (such as
design approaches, asset acquisition, support policies or alternative technologies).
c) Identification of cost elements which act as cost drives for the LCC of an asset in order to
focus design, development, acquisition or asset support efforts.

Stage 2: Life Cost Analysis Preparation:

The Life Cost Analysis is essentially a tool, which can be used to control and manage the ongoing
costs of an asset or part thereof. It is based on the LCC Model developed and applied during the Life
Cost Planning phase with one important difference: it uses data on real costs.

The preparation of the Life Cost Analysis involves review and development of the LCC Model as a
“real-time” or actual cost control mechanism. Estimates of capital costs will be replaced by the actual
prices paid. Changes may also be required to the cost breakdown structure and cost elements to reflect
the asset components to be monitored and the level of detail required.

Targets are set for the operating costs and their frequency of occurrence based initially on the
estimates used in the Life Cost Planning phase. However, these targets may change with time as more
accurate data is obtained, from the actual asset operating costs or from the operating cost of similar
other asset.

Stage 3: Implementing and Monitoring:

Implementation of the Life Cost Analysis involves the continuous monitoring of the actual
performance of an asset during its operation and maintenance to identify areas in which cost savings
may be made and to provide feedback for future life cost planning activities.

For example, it may be better to replace an expensive building component with a more efficient
solution prior to the end of its useful life than to continue with a poor initial decision.

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21 PERFORAMANCE MANAGEMENT VI SEM B.COM BU

Through put accounting

Throughput Accounting is a modern management accounting technique that offers an alternative view
to the more traditional cost accounting.

It’s all about identifying the constraint or limiting factor in the production process and exploiting it to
maximise profit. It allows management to focus efforts to make the best possible use of the limitation.

Theory of Constraints “TOC”

Goldratt’s Theory of Constrains is a methodology that is covered in the CIMA P2 syllabus and can be
applied to systems that are unable to full fil their goals or targets. Goldratt suggests that any process is
only as strong as it’s weakest link and all effort should be focused on removing the constraint by
following a five step process.

The constraint in a manufacturing environment is also referred to as a “bottleneck”

1. Identity Constraint
2. Decide how to exploit the constraint
3. Sub ordinate other activities/non-constraints
4. Elevate the constraint
5. Repeat the process

These five steps ensure the organisation has an ongoing improvement that is based on the identified
constraints or weak links. And it’s measurements are given via Throughput Accounting – which
Goldratt describes as key performance measure.

Formula and Ratios

Throughput Rs = Sales Revenue less Direct Material Costs

Throughput Accounting Ratio (TPAR) = Return per factory hour/Cost per factory hour

Return per factory hour = Throughput $ per unit/Time per unit

Cost per factory hour = Total factory cost/Total time available

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22 PERFORAMANCE MANAGEMENT VI SEM B.COM BU

The two key formulas here are the Throughput $ and the TPAR – the other formulas are
required to understand how to calculate the TPAR. Below is a scenario of limiting factors and how
throughput accounting can be applied as how to maximise profit.

Production Plan to Maximise Profit

The TOC Theory of Constraints in this scenario is the fact the total machine hours is just 32,500 yet to
fulfill the demand required we would need 35,000 hours (15,000*2)+(5000*1).

To calculate the production plan to achieve the maximum profit we need to find the Throughput value
per machine hour, which we know is the Selling Price less the Materials/the total machine hours per
unit.

Product A Rs 175 (275-90)/2 hours = Rs 92.50

Product B Rs 125 (325-165)/1 hour = Rs 160

With this mind, we need to exploit the constraint by maximizing the production of Product B as it
gives the highest throughput value and filling the rest of the time with Product A to achieve the
maximum profit in these conditions.

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23 PERFORAMANCE MANAGEMENT VI SEM B.COM BU

Proposed Production Plan

Product B: 5000 units x 1 hours = 5,000 machine hours

Product A: 13,750 units x 2 hours = 27,500 machine hours

Below is a summary of the financials based on this production plan.

You can see the total throughput profit (which is considering just the direct materials as a variable
cost) gives over 2m profit.

TPAR – Throughput Accounting Ratio

Finally, let’s look at the TPAR based on the above scenario and see what that tells us The TPAR ratio
is calculated on each product and is done by dividing the Return Per Factory Hour against the Cost
Per Factory.

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

24 PERFORAMANCE MANAGEMENT VI SEM B.COM BU

Environmental accounting

Environmental accounting is a field that identifies resource use, measures and communicates costs of
a company's or national economic impact on the environment.

Objectives of Environmental accounting:

1. To Segregation and Elaboration of all Environment related Flows and Stocks of Traditional
Accounts:
2. To Linkage of Physical Resource Accounts with Monetary Environmental Accounts:
3. To Assessment of Environmental Costs and Benefits:
4. To Accounting for the Maintenance of Tangible Wealth:
5. To Elaboration and Measurement of Indicators of Environmentally Adjusted Product and
Income:

Advantages of Environmental Accounting

1. The accounting system helps to detect any leakages spills or any such problems with the
operation and process at an early stage, thus reducing the risk of future problem.
2. It helps to measure the environmental problem impact of each and every process and operation
on the air, water, soil, worker’s health and safety and society at large
3. It helps to measure the organization environmental performance
4. It gives an indication of the effectiveness of the environmental management and suggests how
it can be improved.
5. It provides a database for corrective action and future places it identifies the area where the
steps have to be taken to reduce the waste, raw material and energy consumptions.
6. The result of the environmental accounting system helps the management to develop its
environment strategy for moving toward a greener corporate culture.
7. Environmental accounting leads substance to verify compliance to local, national and
international standards or best available techniques as well as company’s own standard as
stated in company’s environmental policy

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

25 PERFORAMANCE MANAGEMENT VI SEM B.COM BU

Limitations of Environmental Accounting

1. Valuation techniques for environmental goods and services are imperfect and shadow prices
are only partial valuations. This applies to both deductive and interrogative techniques.
2. Social values for environmental goods and services are uncertain and change very rapidly.
3. .Non-economic values are also important in political processes.
4. Aggregation of individual preferences may not yield a meaningful net social preference.
5. Economic values are marginal and incremental, not absolute and total
6. Reliable industry data are not readily available.
7. Assumptions underlying standard economic theory and analytical models are often not met.

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26 PERFORAMANCE MANAGEMENT VI SEM B.COM BU

SECTION –A (2 Marks)

UNIT-1

1. What is activity based costing?

Activity based costing (ABC) is a method of assigning the organization’s resource costs through
activities to the products and services provide to its customer it is generally used as a tool for
understanding product and customer cost and profitability.

2. What is cost control?

Cost control is a series of steps that a business uses to maintain proper control over its costs.
Implementing this level of control can have a profound positive impact on profits over the long
term.

3. Define cost control?

CIMA, London has defined cost control as “The regulation by executive action of the cost of
operating an undertaking particularly where action is guided by cost accounting”.

4. What do you mean by cost reduction?

Cost reduction is a process, aims at lowering the unit cost of a product manufactured or service
rendered without affecting its quality by using new and improved methods and techniques. It
ascertains substitute ways to reduce the cost of a unit. It ensures savings in per unit cost and
maximization of the profits of the organization.

5. State the elements of cost reduction?

To Identify cost reduction, the following are the major elements:

1. Savings in per unit cost.

2. No compromise with the quality of the product.

3. Savings are non-violable in nature.

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27 PERFORAMANCE MANAGEMENT VI SEM B.COM BU

6. Define product design?

One area in which manufactures are finding ways to meet this challenge is the often-overlooked area
of product design. The design of the product provides the greatest scope for the cost reduction.

7. What is Target costing?

Target costing is a system under which a company plans in advance for the product price points,
product costs, and margins that it wants to achieve. If it cannot manufacture a product at these planned
levels, then it cancels the product entirely.

8. What do you mean by value analysis?

Value analysis can be defined as, a process of systematic review that is applied to existing product
designs in order to compare the function of the product required by a customer to meet their
requirements at the lowest cost consistent with the specified performance and reliability needed.

9. What is Life cycle costing?

Life cycle costing estimates and accumulates cost over a product’s entire life cycle in order to
determine whether the profits earned during the manufacturing phase will cover the costs incurred
during the pre and-post manufacturing stage.

10. What is Throughput accounting?

Throughput, defined as the rate of producing goal units usually money and translates as reserve or
sales minus totally variable expenses in accounting terms.

Throughout, Accounting offers a simplified way to identify and use the divers to achieve the goal,
assuming the goal is to make money now and in the future.

11. What is environmental accounting?

A field that identifies the use of resources, measures and communicates costs of a company or
national economic impact on the environment is known as environmental accounting.

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28 PERFORAMANCE MANAGEMENT VI SEM B.COM BU

12. What is green accounting?

A new system of sustainable accounting , has emerged .”It permits the computation of income for a
nation by taking into account the economic damage and depletion in the natural resource base of an
economy”.

SECTION-B (6 MARKS)

1. State the objectives of activity based costing?

The objectives of activity based costing are as follows:

1. Identify significant activities and assign overhead costs of each activity in proportion to
resources used.
2. Identify cost drivers appropriate to each activity and allocate overhead to the products.
3. Remove nonmanufacturing costs from product costing.
4. Determine the single best measure for allocating all overhead costs to products or services.

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1 PERFORAMANCE MANAGEMENT VI SEM B.COM

Unit -2
DECSION MAKING TECHNIQUES
COST-VOLUME-PROFIT (CVP) ANALYSIS
It is a managerial tool showing the relationship between various ingredients of profit planning viz.,
cost, selling price and volume of activity. As the name suggests, cost volume profit (CVP) analysis is
the analysis of three variables cost, volume and profit. Such an analysis explores the relationship
between costs, revenue, activity levels and the resulting profit. It aims at measuring variations in cost
and volume.

BREAK-EVEN ANALYSIS

Break-even analysis is a widely used technique to study cost-volume-profit relationship. The narrower
interpretation of the term break-even analysis refers to a system of determination of that level of
activity where total cost equals total selling price. The broader interpretation refers to that system of
analysis which determines probable profit at any level of activity. It portrays the relationship between
cost of production, volume of production and the sales value. It may be added here that CVP analysis
is also popularly, although not very correctly, designated as ‘Break-even Analysis’.

The difference between the two terms is very narrow. CVP analysis includes the entire gamut
(complete rage I scope) of profit planning, while break-even analysis is one of the techniques used in
this process. However, as stated above, the technique of break-even analysis is so popular for
studying.

CVP Analysis that the two terms are used as synonymous terms. For the purposes of this study, we
have also not made any distinction between these two terms. In order to understand the concept of
break-even analysis, it will be useful to know about certain basic terms as given below:

I. Contribution

This refers to the excess of selling price over the variable cost. It is also known as, ‘gross margin’ The
amount of profit (loss) can be ascertained by deducting the fixed cost from contribution. In other
words, fixed cost plus profit is equivalent to contribution. It can be expressed by the following

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2 PERFORAMANCE MANAGEMENT VI SEM B.COM

formula:—

Contribution = Sales — Variable cost

Contribution = Fixed cost + Profit

Profit = contribution - Fixed cost

2. Profit/Volume Ratio (P/V Ratio)

This term is important for studying the profitability of operations of a business, Profit volume ratio
establishes a relationship between the contribution and the sale value. The ratio can be shown in the
form of a percentage also. The formula can be expressed thus

P/V Ratio = Contribution

Sales

This ratio can also be called Contribution/Sales’ ratio. This ratio can also be known by comparing the
change in contribution to change in sales or change in profit due to change in sales. Any increase in
contribution would mean increase in profit only because fixed costs are assumed to be constant at all
levels of production. Thus.

P/V Ratio = Changes in contribution

Changes in sales

P/V Ratio = Changes in profit

Changes in sales

This ratio would remain constant at different levels of production since variable costs as a proportion
to sales remain constant at various levels.

3. Break-even Point

The point which breaks the total cost and the selling price evenly to show the level of output or sales
at which there shall be neither profit nor loss, is regarded as break-even point. At this point, the
income of the business exactly equals its expenditure. If production is enhanced beyond this level,

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3 PERFORAMANCE MANAGEMENT VI SEM B.COM

profit shall accrue to the business, and if it is decreased from this level, loss shall be suffered by the
business.

BEP (of units) = Total fixed cost

Contribution per unit

BEP (of sales) = Total fixed cost X Selling price per unit

Contribution per unit

BEP (in Rs.) = Total fixed cost X sales

Contribution

At break- even point the desired profit is zero. In case the volume of output or sales is to be computed
for a ‘desired profit’, the amount of ‘desired profit’ should be added to fixed cost in the formulae
given above.

For example:

Units for a desired profit = Fixed cost + Desired Profit

Contribution per unit

Sales for a desired profit (in Rs.) = Fixed cost + Desired Profit

P/V Ratio

4. Margin of Safety

Total sales minus the sales at break-even point are known as the ‘margin of safety’. Thus, the
formula is:

M/S Ratio = Actual sales — BEP

Margin of Safety = Total Sales - Break even Sales.

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4 PERFORAMANCE MANAGEMENT VI SEM B.COM

Margin of safety can also be computed according to the following formula:

Margin of safety (in Rs.) = Profit

P/V Ratio

Margin of safety can also he expressed as a percentage of sales:

Margin of safety in % of sales = Margin of safety x 100

Actual sales

ASSUMPTIONS OF BREAK EVEN ANALYSIS

The break-even analysis is based upon the following assumptions:

1. All elements of cost, i.e., production, administration and selling and distribution can be
segregated into fixed and variable components

2. Variable cost remains constant per unit of output irrespective of the level of output and

3. thus fluctuates directly in proportion to changes in the volume of output.

4. Fixed cost remains constant at all volumes of output.

5. Selling price per unit remains unchanged or constant at all levels of output.

6. Volume of production is the only factor that influences cost.

7. There will be no changes in the general price-level.

8. There is only one product or case of multi-products. the sales mix remains unchanged.

9. There is synchronization between production and sales.

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5 PERFORAMANCE MANAGEMENT VI SEM B.COM

BREAK EVEN CHART

According to the Chartered Institute of Management Accountants, London. The break-even chart
means ‘a chart which shows profit or loss at various levels of activity. The level at which neither
profit nor loss is shown being termed the break—even point’.

On the X-axis of (lie graph is plotted the number of units produced. sold and on the

Y-axis are shown costs and sales revenues.

BREAK EVEN CHART

The fixed cost line is drawn parallel to X-axis. This line indicates that fixed expenses remain the same
with any volume of production. The variable costs for different levels of activity are plotted over the
fixed cost line. The variable cost line is joined to fixed cost line at zero volume of production. This
line can also be regarded as the total cost line because it starts from the point where fixed cost has
been incurred and variable cost is zero. Sales values at various levels of output are plotted, joined and
the resultant line is the sales line.

The sales line will cut the total cost line at a point where the total costs are equal to total revenues and
this point of intersection of two lines is known as breakeven point is determined by drawing a

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6 PERFORAMANCE MANAGEMENT VI SEM B.COM

perpendicular to the X—axis from the point of intersection and measuring the horizontal distance
from the zero point to the point at which the perpendicular is drawn.

The sales value at breakeven point is determined by drawing a perpendicular to the Y-axis from the
point of intersection and measuring the vertical distance from the zero point to the point at which the
perpendicular is drawn.

FORMULAS IN B-E-P ANALYSIS

1. P/V Ratio or Profit/volume ratio = Sales –Variable Cost × 100

Sales

2. P/V Ratio or Profit/volume ratio = Contribution × 100

Sales

3. P/v Ratio ( when two years data given) = Change in profit ×100

Change in sales

4. P/V Ratio or Profit/volume ratio = fixed Cost + profit X 100

Sales

Profit = (Sales –Variable Cost ) + Fixed Cost

5. Contribution = Sales – Variable cost (or) Fixed Cost + Profit

Contribution = Sales – V.C = F.C + Profit

6. Breakeven point in Units = Fixed Cost

Contribution per unit

7. Breakeven point in Sales = Fixed Cost

PVratio

8 B.E.P (value) = BEP in Units × Selling price per unit

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7 PERFORAMANCE MANAGEMENT VI SEM B.COM

9. Margin of Safety (MOS) = Actual sales – BEP sales

Margin of Safety (MOS) = Profit

P/V Ratio

MOS Ratio = MOS × 100

Sales

Note: MOS is the safety margin how much output or sales level can fall before a business
reaches its BEP.

9. Variable cost or Marginal cost = Direct Material + Direct Labor +Direct Expenses

10 . F.C and V.C is calculated with help of following formulas:

Fixed cost = Sales × P/v Ratio – Profit

Variable cost = Sales × (1 – P/v Ratio)

Number of units required to earn Desired profit = Fixed Cost + Desired profit

Contribution

Sales required for Desired profit = Fixed cost + Desired profit

Sales

Sales required for Desired profit with the help of P/v Ratio = Fixed cost +Desired profit

P/V Ratio

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

8 PERFORAMANCE MANAGEMENT VI SEM B.COM

MAKE OR BUY DECISIONS

MARGINAL COSTING AND MANAGERIAL DECISIONS

Marginal costing helps in decision making. It is a powerful tool for making policy decision, profit
planning and cost control. Some of the important managerial problems where marginal costing
techniques can be used are as follows:

Decision to Make or Buy

An organization has to decide whether a particular product or a component should be made in the
factory or bought from outside. The decision is to be taken on the basis of the profitability of each
alternative. If the marginal cost of the product is lower than the price of buying from outside then the
firm can make the product. The decision has to be taken on the basis of marginal cost. The decision is
according to the assumptions that fixed expenses will remain constant, the production facilities cannot
be employed more profitably and there will be regular supply from outside.

Selection of a Suitable Product Mix

When an enterprise manufactures more than one product the management has to decide the proportion
in which these products should be manufactured. This Proportion is known as product mix or sale
mix. The production and sales of those products which gives the maximum profits should be pushed
up and comparatively less profitable product should be reduced. Marginal costing helps the
management to decide best product mix. Generally on the basis of the contribution of each product the
decision will be made. Other things being the same the product which yields the highest contribution
is best one to produce. When there is any key factor or limiting factor the contribution is linked with
such a key factor for taking a decision.

ILLUSTRATION 1

In a manufacturing company the cost of producing a component is 10 each and the same
component is available in the market at 8.50 with an assurance of continuous supply. What is
your suggestion regarding making the product or buy from outside. The following further
details are given:

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9 PERFORAMANCE MANAGEMENT VI SEM B.COM

Materials 5, Labour 2, variable overheads 1 and fixed expenses are 2.

Solution:

The decision to make or buy mainly depending up on the marginal cost, marginal cost statement is to
be prepared.

Marginal cost statement

Material 5

Labour 2

Variable overheads 1

Total Marginal cost 8

Analysis: As the marginal cost of making the component is lower than the market price it is advisable
to make the product in the factory.

ILLUSTRATION 2

In a machine shop it takes 4 labour hours to machine and complete the component. The selling
price of the component is 200 per unit. Its marginal cost amounts to 80 per unit. Another
component can be either made or purchase from outside. It can be made in 2 hours at a
marginal cost 40 per unit. The price of the component in the market is 75 each. What do you
advice?

Solution:

Step 1: Calculation of Marginal Cost Statement

Particulars Component 1 Component 2

Selling Price 200

Variable cost per unit 80 40

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10 PERFORAMANCE MANAGEMENT VI SEM B.COM

Contribution per unit 120

Contribution per labour hours

(4 labour hours required 120/4) 30

Contribution that will be lost if component 2 is made

(30+2) (opportunity cost) 60

Total cost of manufacture 100

Purchase price of the component 75

Analysis: If there is more spare capacity in the machine shop and demand for component 1 has been
fully met then component 2 can be made in the machine shop. Otherwise purchasing component 2 is
profitable.

LLUSTRATION 3

A mobile manufacturing company finds that while it costs 12.50 each to make a component RG –
2000. The same is available in the market at 11.50 with an assurance of continued supply. The break-
up cost is:

Direct Material 5.50 per unit

Direct Labour 3.50 per unit

Other Variable Expenses 1.00 per unit

Depreciation & Other Fixed expenses 2.50 per unit

Total 12.50 per unit

A. You are asked to advice whether to make or buy?

B. If the supplier is ready to offer the product at 9.70 each what would be your decision?

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11 PERFORAMANCE MANAGEMENT VI SEM B.COM

Solution:

Marginal Cost Statement

Particulars Amount

Direct Materials 5.50

Direct Labour 3.50

Other Variable expenses 1.00

Total Variable Cost (Marginal Cost) 10.00

Analysis:

 The marginal cost of the product per unit is 10 and the market price is 11.50 each. As
the marginal cost is less it is advisable to manufacture the component in the factory.

 If the supplier is ready to offer the product at 9.70 which is lower than the marginal
cost, it is advisable to buy it from outside supplier provided proper quality and regular
supply are guaranteed.

Illustration – 4 (Make or Buying Decision).

A manufacturing company finds that while the cost of making a component for 10, the same is
available in the market at 9 with an assurance of continuous supply, Give your suggestion whether to
make or buy this part, Give also your views in case the suppliers reduses the price from 9 – 8. The
cost information is as follows:

Material 3.50

Direct Labour 4.00

Other Variable Expenses 1.00

Fixed expenses 1.50

Total 10.00

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12 PERFORAMANCE MANAGEMENT VI SEM B.COM

Solution:

Calculation of Variable cost per Unit:

Particulars

Material 3.50

Direct Labour 4.00

Other Variable Expenses 1.00

8.50

 Price coated by the supplier 9.

 From the above it is clear that it is better to make the component internally so that the
company can save 0.50 on each component.

 If the price is coated by the supplier is 8. It is better to buy the component from outside
supplier because the company can save 0.50 on each component purchased.

ILLUSTRATION 5

Godrej Ltd., engaged in the manufacture of the two products A’ and B’ provides you the
following information:

Product A Product B

Selling price per unit 60 100

Direct materials per units 20 25

Direct wages per unit @ 0.50 per hour 10 15

variable overhead 100% of direct wages

Fixed overheads 10.000 per annum

Maximum capacity 1.000 units

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13 PERFORAMANCE MANAGEMENT VI SEM B.COM

Show the contribution of each of the products A and B and recommend which of the following
sales mix should be adopted:

I. 300 units of product A and 600 units of product B;

II. 450 units of product A and 450 units of product B;

III. 600 units of product A and 300 units of product B;

Particulars Product A Product B

Selling price (A) 60 100

Variable cost :

a. Direct material 20 25

b. Direct wages 10 15

c. variable overhead( 100% of Direct wages ) 10 15

Total Variable cost ( B) 40 55

Contribution (A-B) 20 45

Calculation of total contribution and profit under different alternatives

Particulars Alternative I Alternative II Alternative III

Contribution 300 x 20 = 6000 450 x 20 = 9,000 600 x 20 = 12,000

600 x 45 = 27,000 450 x 45 = 20250 300 x 45= 13,500
Total contribution 33,000 29,250 25,500
Less: Fixed cost 10,000 10,000 10,000

Profit 23,000 19,250 15,500

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14 PERFORAMANCE MANAGEMENT VI SEM B.COM

Decision-Making under Certainty, Risk and Uncertainty

Decision-making under Certainty:

A condition of certainty exists when the decision-maker knows with reasonable certainty what the
alternatives are, what conditions are associated with each alternative, and the outcome of each
alternative. Under conditions of certainty, accurate, measurable, and reliable information on which to
base decisions is available.

The cause and effect relationships are known and the future is highly predictable under conditions of
certainty. Such conditions exist in case of routine and repetitive decisions concerning the day-to-day
operations of the business.

Decision-making under Risk:

When a manager lacks perfect information or whenever an information asymmetry exists, risk arises.
Under a state of risk, the decision maker has incomplete information about available alternatives but
has a good idea of the probability of outcomes for each alternative. While making decisions under a
state of risk, managers must determine the probability associated with each alternative on the basis of
the available information and his experience.

Decision-making under Uncertainty:

Most significant decisions made in today’s complex environment are formulated under a state of
uncertainty. Conditions of uncertainty exist when the future environment is unpredictable and
everything is in a state of flux. The decision-maker is not aware of all available alternatives, the risks
associated with each, and the consequences of each alternative or their probabilities.

The manager does not possess complete information about the alternatives and whatever information
is available, may not be completely reliable. In the face of such uncertainty, managers need to make
certain assumptions about the situation in order to provide a reasonable framework for decision-
making. They have to depend upon their judgment and experience for making decisions.

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15 PERFORAMANCE MANAGEMENT VI SEM B.COM

Modern Approaches to Decision-making under Uncertainty:

There are several modern techniques to improve the quality of decision-making under conditions of
uncertainty.

The most important among these are:

(1) Risk analysis,

(2) Decision trees and

(3) Preference theory.

Risk Analysis:

Managers who follow this approach analyze the size and nature of the risk involved in choosing a
particular course of action. For instance, while launching a new product, a manager has to carefully
analyze each of the following variables the cost of launching the product, its production cost, the
capital investment required, the price that can be set for the product, the potential market size and
what percent of the total market it will represent.

Risk analysis involves quantitative and qualitative risk assessment, risk management and risk
communication and provides managers with a better understanding of the risk and the benefits
associated with a proposed course of action. The decision represents a trade-off between the risks and
the benefits associated with a particular course of action under conditions of uncertainty.

Decision Trees:

These are considered to be one of the best ways to analyze a decision. A decision-tree approach
involves a graphic representation of alternative courses of action and the possible outcomes and risks
associated with each action.

By means of a “tree” diagram depicting the decision points, chance events and probabilities involved
in various courses of action, this technique of decision-making allows the decision-maker to trace the
optimum path or course of action.

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Preference or Utility Theory:

This is another approach to decision-making under conditions of uncertainty. This approach is based
on the notion that individual attitudes towards risk vary. Some individuals are willing to take only
smaller risks (“risk averters”), while others are willing to take greater risks (“gamblers”). Statistical
probabilities associated with the various courses of action are based on the assumption that decision-
makers will follow them.

For instance, if there was a 60 percent change of a decision being right, it might seem reasonable that
a person would take the risk. This may not be necessarily true as the individual might not wish to take
the risk, since the chances of the decision being wrong are 40 percent. The attitudes towards risk vary
with events, with people and positions.

Top-level managers usually take the largest amount of risk. However, the same managers who make a
decision that risks millions of rupees of the company in a given program with a 75 percent chance of
success are not likely to do the same with their own money.

Moreover, a manager willing to take a 75 percent risk in one situation may not be willing to do so in
another. Similarly, a top executive might launch an advertising campaign having a 70 percent chance
of success but might decide against investing in plant and machinery unless it involves a higher
probability of success.

Though personal attitudes towards risk vary, two things are certain.

Firstly, attitudes towards risk vary with situations, i.e. some people are risk averters in some situations
and gamblers in others.

Secondly, some people have a high aversion to risk, while others have a low aversion.

Most managers prefer to be risk averters to a certain extent, and may thus also forego opportunities.
When the stakes are high, most managers tend to be risk averters; when the stakes are small, they tend
to be gamblers.

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

17 PERFORAMANCE MANAGEMENT VI SEM B.COM

SECTION –A (2 Marks)

1.What is relevant cost analysis?

Relevant cost is a managerial accounting term that describes avoidable costs that are incurred only
when making specific business decisions .The concept of relevant cost is used to eliminate
unnecessary data that could complicate the decision making process .

2. Define marginal costing ?

According to CIMA it is” the accounting system in which variable cost charged to cost units and
fixed costs of the period are written off in full against the contribution. Its special value in decision
making.”

3. What do you mean by absorption costing?

Absorption costing (also known as full absorption costing) indicates that all of the manufacturing
costs has been assigned to the units of goods produced in other words the cost of finished product
indicates the following costs: Direct materials, Direct labour, Variable manufacturing overhead, fixed
manufacturing overhead

4. What is product cost ?

Product cost are those cost which become a part of production cost

5. What is period cost?

Period cost are those cost which are not incurred for production and not incurred in the cost of
product or stocks.

6. What is cost –volume – profit analysis ?

CIMA , London has defined CVP analysis as “ the study of the effects on liquid profits of changes in
fixed cost , variable cost , sales price , quality and studies the resources of three basic factors

a. Cost of production b . volume of production or sales c. profits

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

18 PERFORAMANCE MANAGEMENT VI SEM B.COM

7. What is contribution?

The difference between sales and variable cost is called contribution . Excess of sales over the
variable cost is contribution So contribution = Sales – variable cost

8. Write any two advantages of contribution?

The advantages of contribution has follows:

1. It helps the management to control cost as it classifies the sales and variables.
2. It helps to management the relative profitability of product is base a study of contribution
made by each of the product.

9. What is PV ratio?

Profit volume ratio is the ratio of contribution denoting the difference between sales and variable cost.
Since in short term fixed cost does not change profit volume ratio also measures the rate of change
profit due to change in the sales.

PV Ratio = CONTRIBUTION/ SALES*100

10. How can PV ratio be improved ?

PV ratio is the relationship between the profit and sales . In formula it is expressed as

p/v Ratio =contribution /sales*100.

The higher the PV ratio better is for company prospects.

11. State the features of profit volume ratio?

1. 1. It makes relationship between contribution and sales.

2. It helps to calculate profitability of business.

12. What is break even point analysis?

The break even point is the production level where total reserves equals to total expenses science
reserves equal expenses the net income for the period will be zero.

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

19 PERFORAMANCE MANAGEMENT VI SEM B.COM

13. What is break even point ?

Break even point can be written as BEP . It is a point of production level where all the expenses are
equal to all the revenue It means at break even point there is no loss or gain.

14. Expand BEP?

BEP stands for Break even point which indicates the production level where the total sales become
equal to total cost.

BEP= Total cost –Total sales =0

15. Name any two profitability ratios?

The profitability ratios are:

1. Return on Equity.

2. Earnings per shares.

3. Dividend per share.

4. Price earnings ratio.

16. What is break even chart?

Chart where sales revenue . variable costs, and fixed costs are plotted on Vertical axis while volume
is plotted on the horizontal axis . The break even point the point where the total sales revenue line
intersects the total cost line.

17. What do you mean by margin of safety?

The break even sales are known as margin of safety. The differences between actual sales and sales of
Break even is called margin of safety.

Margin of safety = Actual sales – sales at break even point.

18. Define angle of Incidence?

Transaction of sales line and total cost line at the break even point is angle of incidence. These angle
shows the rate of profit earning rate on the break point when it has been reached.

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

20 PERFORAMANCE MANAGEMENT VI SEM B.COM

19. What are non- operating incomes and expenses?

Non business operational increase & decrease of income and expenses are decrease in non operational
incomes & expenses.

20. What is trend analysis ?

Another name of trend analysis is trend ratio which refers to ascertainment the arithmetical
relationship among each item is several years to the same of base year. It means one particular year
out of many financial years, it is percentage of converting to ratio or percentage from one particular
item out of several item shown in financial statement.

21. What is marginal cost equation ?

MC = DTC/DQ

The marginal cost (MC) function is expressed as the derivative of the cost (TC) function with respect
to quantity (Q).

22. What is make or buy decision ?

Make or buy is a valid consideration in any cost reduction and improvement programme. It is the
choice that identifies the minimum cost makes or the financial decision.

23. What is short term decision ?

A short term decision is consideration in any cost reduction or product improvement programme for a
shorter duration.

24. What is decision making under risk ?

It implies a degree of uncertainty and an inability to fully control the outcomes or

consequences of such an action is known as decision making under risk. However, in some instances
the elimination of one risk may increase some other risks.

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

21 PERFORAMANCE MANAGEMENT VI SEM B.COM

SECTION –B (6 Marks)

1. Explain the limitations of relevant cost analysis ?

1. Relevant cost is a cost that will be incurred in the future not relevant to present.
2. Historical costs are sunk costs which has no relevancy in the decision making.
3. The costs must differ between alternatives . If a cost is the same whether we choose
alternative A or B then this is an irrelevant cost . A good example is factory rental which
remains the same irrespective of management wanting to manufacture product A or B.
4. Only cash flow items and Incremental fixed costs are relevant. Non cash item like depreciation
and absorbed fixed overheads are not relevant costs as they do not involve any additional cash
flow.

2. What are the characteristics of marginal costing?

The characteristics of marginal costing are :

1. Segregation of costs into fixed variable elements:

In marginal costing , all costs are classified into fixed and variable elements.

2. Marginal costs as product costs:

Only marginal (variable) costs are charged to products produced during the period.

3. Fixed costs as period costs:

Fixed costs are treated as period costs and are charged to the costing profit and loss account of
the period in which they are incurred.

4. Valuation of inventory:

The work in progress and finished stocks are valued at marginal cost only.

5. Contribution:

Contribution is the difference between sales value and marginal cost of sales .The relative
profitability of products or departments is based on a study of contribution made by each of
the products or departments.

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

1 PERFORMANCE MANAGEMENT VI SEM B.COM

UNIT 3

BUDETING AND CONTROL

Meaning Budgetary Systems

Budgetary systems which are tools of planning and control occur at various levels in the performance
hierarchy and to different degrees. Plans made at the higher level provide a guideline for the plans at
the lower levels. Plans made at the lower level essentially carry out the plans made at the higher level

CLASSIFICATION / TYPES OF BUDGETS

The budgets are usually classified according to their nature. The following are the types of budgets
which are commonly used.

(A) CLASSIFICATION ACCORDING TO TIME

1. Long-term budgets: - The budgets are prepared to depict long term planning of the business. The
period of long term budgets vanes between five to ten years. The long term planning is done by the
top level management; it is not generally known to lower levels of management. Long time budgets
are prepared for some sectors of the concern such as capital expenditure, research and development,
long term finances, etc.

These budgets are useful for those industries where gestation period is long i.e., machinery, electricity,
engineering, etc.

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Gowtham Kumar C. K M.Com, KSET | Assistant Professor
2 PERFORMANCE MANAGEMENT VI SEM B.COM

2. Short-term budgets: - These budgets are generally for one or two years and are in the form of
monetary terms. The consumers goods industries like sugar, cotton, textile, etc. use short term
budgets.

3. Current budgets: - The period of current budgets is generally of months and weeks. These budgets
relate to the current activities of the business.

According to I.C.W.A .London. ‘current budget is a budget which is established for use over a short
period of time and is related to current conditions.”

(B) CLASSIFICATION ON THE BASIS OF FUNCTIONS

I. Operating budgets: - These budgets relate to the different activities or operations of a firm. The
number of such budgets depends upon the size and nature of business. The commonly used operating
budgets are:

1. Sales budget
2. Production budget
3. Production cost budget
4. Purchase budget
5. Raw material budget
6. Labour budget
7. Plant utilization budget
8. Manufacturing expenses or works overhead budget
9. Administrative and selling expenses. budget

The operating budget for a firm may be constructed in terms of programmes or responsibility areas
hence may consist of Programme budget, and Responsibility budget.

I. Programme Budget - It consists of expected revenues and costs of various products or projects that
arc termed as the major programmes of the firm, Such a budget can be prepared for each product line
or project showing revenues, costs and the relative profitability of the various programmes.
Programme budgets are, thus, useful in locating areas where efforts may be required to reduce costs
and increase revenues. They are also useful in determining imbalances and inadequacies in
programmes so that corrective action may be taken in future.

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Gowtham Kumar C. K M.Com, KSET | Assistant Professor
3 PERFORMANCE MANAGEMENT VI SEM B.COM

ii. Responsibility Budget: - When the operating budget of a firm is constructed in terms of’
responsibility areas it is called the responsibility budget.

Such a budgets how is the plan in terms of persons responsible for achieving them. It is used by the
management as a control device to evaluate the performance of executives who are in charge of
various cost centers. Their performance is compared to the targets (budgets), set for them and proper
action is taken for adverse results, is any.

Responsibility areas may be classified under three broad categories:

(a) Cost/Expense center

(b)Profit center

(c) investment center

2. Financial budgets: - Financial budgets are concerned with cash receipts and disbursements,
working capital, capital expenditure, financial position and results of business operations. The
commonly used financial budgets are

1. Cash budget
2. Working capital budget
3. Capital expenditure budget
4. Income statement budget
5. Statement of retained earnings budget
6. Budgeted balance sheet or position statement budget.

3. Master budget: - Various functional budgets are integrated into master budget. This budget is
prepared by the ultimate integration of separate functional budgets.

According to I.C.W.A. London, The Master budget is the summary budget incorporating its
functional budgets”.

Master budget is prepared by the budget officer and it remains with the top level management. This
budget is used to co-ordinate the activities of various functional departments and also to help as a
control device.

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Gowtham Kumar C. K M.Com, KSET | Assistant Professor
4 PERFORMANCE MANAGEMENT VI SEM B.COM

CLASSIFICATION ON The BASIS OF FLEXIBILITY

1. Fixed budget: - The fixed budgets are prepared for a given level of activity, the budget is prepared
before the beginning of the financial year. II’ the financial year starts in January then the budget will
be prepared a month or two earlier, i.e.. November or December.

According to I.C.W.A. London, “Fixed budget is a budget which is designed to remain unchanged
irrespective of the level of activity actually attained.”Fixed budgets are suitable tinder static
conditions. If sales, expenses and costs can be forecasted with greater accuracy then this budget
can be advantageously used.

2. Flexible budget: - A flexible budget consists of a series of budgets for different level of activity. It,
therefore, varies with the level of activity attained. A flexible budget is prepared after taking into
consideration unforeseen changes in the conditions of the business.

A flexible budget is defined as a budget which by recognizing the difference between fixed, semi-
fixed and variable cost is designed to change in relation to the level of activity”. -

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Gowtham Kumar C. K M.Com, KSET | Assistant Professor
5 PERFORMANCE MANAGEMENT VI SEM B.COM

Cash budget

Cash:

Cash is the amount of assets that a company has available to spend at any given time. These include
bank balances, bank account deposits, and more. Liquidity is another word for cash,

Cash budget

Cash budget is one of the most important budget and is detailed estimate of cash receipts from all
sources and cash payment for all purposes and the resultant cash is the balance during the budget
period. It makes certain that the business has sufficient cash available to meet its needs as and when
required.

“The cash budget is an analysis’ of flow of Cash In a business over a future, short or long period of
time. It is a forecast of expected cash intake and outlay”.

Definition of Cash budget

Chartered Institute of Management Accountant (C1MA) defines “cash budgets as a short-tern, fiscal
plan expressed in money which is prepared in advance. It helps to determine the cash -inflow and
cash-outflow of the business”.

Features of Cash Budget

1. The cash-budget period is broken down into periods, mainly in months.

2. The cash-budget is always in columnar form i.e. column showing each month.
3. Payments and receipts of cash are identified in different heading and showing total for each
month.
4. The surplus of total cash payment over receipts or of receipts over payment for each month is
shown.
5. The running balances of cash. which would be determined by taken the balance at the end of
the previous month and adjusting it for either deficit or surplus of receipts over payments for
current month, is identified.

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Gowtham Kumar C. K M.Com, KSET | Assistant Professor
6 PERFORMANCE MANAGEMENT VI SEM B.COM

FORAMAT OF CASH BUDGET

BRUNDA Ltd

CASH BUDGET
For The Period Ended ---------------------

Particulars Jan Feb Mar April

Opening balance: XXX XXX XXX XXX
 Cash in hand XXX XXX XXX XXX
 Cash in bank XXX XXX XXX XXX
Add: Receipts: XXX XXX XXX XXX
 Cash sales XXX XXX XXX XXX
 Collection from Debtors (Credit sales ) XXX XXX XXX XXX
 Dividend income XXX XXX XXX XXX
 Issue of shares or borrowings XXX XXX XXX XXX
 Sales of assets or investments XXX XXX XXX XXX
 Rent or commission received XXX XXX XXX XXX
Total available Receipt (A) XXX XXX XXX XXX
Les s Payments:
XXX XXX XXX XXX
 Cash purchases
XXX XXX XXX XXX
 Payments to Creditors & suppliers
XXX XXX XXX XXX
 Wages and salaries
XXX XXX XXX XXX
 Overhead expenses
XXX XXX XXX XXX
 Capital expenditure
XXX XXX XXX XXX
 Payment of income tax
XXX XXX XXX XXX
 Dividend payable
XXX XXX XXX XXX
 Payment of loan
XXX XXX XXX XXX
Total Payments (B)
XXX XXX XXX XXX
Closing Balance (A - B = C)

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Gowtham Kumar C. K M.Com, KSET | Assistant Professor
7 PERFORMANCE MANAGEMENT VI SEM B.COM

Quantitative Analysis in Budgeting

A. Analyze fixed and variable cost elements from total cost data using high/low method.
B. Estimate the learning rate and learning effect
C. Apply the learning curve to a budgetary problem, including calculations on steady states.
D. Discuss the reservations with the learning curve.
E. Apply expected values and explain the problems and benefits.
F. Explain the benefits and dangers inherent in using spreadsheets in budgeting.

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Gowtham Kumar C. K M.Com, KSET | Assistant Professor
8 PERFORMANCE MANAGEMENT VI SEM B.COM

STANDARD COSTING

Meaning of Historical Cost:

Historical cost means the actual cost or past cost and historical costing is a system in which actual
costs incurred in the past are determined.

Limitation of Historical Cost:

1) Such costs are obtained too late and cannot be used for price quotations.
2) Historical costs do not serve’ the object of cost control, for the cost has already been incurred
before cost records are available for management control.
3) Historical costs do ho, provide any yardstick / benchmark against which efficiency can be
measured
4) Historical costing is comparatively an expensive and uneconomical system of costing as it involves
the maintenance of larger volume of records.
These limitations encouraged the development of a more satisfactory standard costing approach based
on predetermined costs.
STANDARD COSTING

Definition of Standard cost

According to CIMA. “Standard cost is the pre-determined cost based on technical estimates for
materials, labour and overhead for a selected period of time for a prescribed set of working
conditions.”

Definition of Standard costing:

According to CIMA, “The preparation of standard costs and applying them to measure the
variations from actual costs and analyzing the causes of variations with a view to maintain
maximum efficiency in production”.

According to D. Joseph, “Standard costing involves the preparation of cost based on pre-determined
standards and continuous comparison of actual with them for the purpose of guidance and
control”.

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9 PERFORMANCE MANAGEMENT VI SEM B.COM

Objectives of Standard Costing:

1. To institute a control mechanism on all the elements of costs that affect production and sales

2. To measure different operational efficiencies and check the wastages

3. To improve the delegation of authority and generate a sense of responsibility among the employees

4. To develop a cost consciousness in the employees

5. To presume the production costs, sales and profit

6. To avail the benefits of “Management by exception.”

7. To bring about a vivid progressive vision and sagacious decision making at each managerial level.

THE PROCESS OF STANDARD COSTING:

The process of standard cost is as below:

Step 1: Setting of Standards: The first step is to set standards which are to be achieved, the process
of standard setting is explained above.

Step 2: Ascertainment of actual costs: Actual cost for each component of cost is ascertained. Actual
costs are ascertained from books of account, material invoices, wage sheet, charge slip etc.

Step 3: Comparison of actual cost and standard cost: Actual costs ate compared with the standards
costs and variances are determined.

Step 4: Investigation of variances: Variances arises are investigated for further action. Based on this
performance is evaluated and appropriate actions are taken.

Step 5: Disposition of variances: Variances arise are disposed of by transferring it the relevant
accounts (costing profit and loss account) as per the accounting method (plan) adopted.

Advantages of Standard Costing:

1. Proper Planning: - It helps to apply the “Principle of Management by exception”. That is, the
management need not worry over those activities which proceed in tandem plans. It is only on the
issues of exceptions that they have to concentrate.

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Gowtham Kumar C. K M.Com, KSET | Assistant Professor
10 PERFORMANCE MANAGEMENT VI SEM B.COM

2. Efficient Cost Control: - Standard Costing is a tool For the management to gain reduction in the
cost and control over it. tinder this technique. differences are analyzed based on actual & standard
performance and responsibilities are determined on the basis of variances so revealed.
3. Motivational Factor: - Labour efficiency is promoted and they are destined to be cost conscious.
Standards provide incentives and motivation to work with greater effort. This increases efficiency and
productivity.

4. Comparison of Forecasting and Outcome: - A target of efficiency is set for the employees and
the cost consciousness is stimulated. Since the process of standard costing allow an appraisal to be
made of personnel, machines and method of working, current inefficiencies come to the notice and get
eliminated.

Variance Analysis
Variance means the deviation of the actual cost or actual sales from the standard cost or profit or sales.
Calculation of variances is the main object of standard costing. This calculation shows that whether
costs are under controlled or not. A variance may be favorable or adverse.

“A variance is the difference between a standard cost and the comparable actual cost incurred
during a period”

According to C.I.M.A. London, “The process of computing the amount of variance and isolate the
causes of variance between actual and standard”

Importance of Variance:

There is a lot importance of analysis of variance. There are many objects fulfilled with their analysis.
Without analysis of variance, there is no use of standard costing. The important points of variances are
as under:

1) Check and control of wastage is possible.

2) Ii improves the efficiency of the organization by the use of standard costing.
3) It exercises control over all cost centers including department, individuals and so on.
4) Responsibility of a particular person or department can he fixed.
5) In the prediction of production cost, sales and profit, variance analysis is very useful.

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Gowtham Kumar C. K M.Com, KSET | Assistant Professor
11 PERFORMANCE MANAGEMENT VI SEM B.COM

6) On the basis of variance analysis. Delegation of authority could be made effective.

7) Variance analysis is easy to introduce, apply and orient result.
8) Various operational efficiencies can be measured.

Types of Variances:

1. Controllable and un-controllable variances: Variances are broadly of two types, timely.
controllable and uncontrollable. Controllable variances are those which can be controlled by the
departmental heads whereas uncontrollable variances are those which are beyond their control.
Responsibility centers are answerable for all adverse variances which are controllable and are
appreciated for favorable variances. Controllability is a subjective matter and varies from situation to
situation. If the uncontrollable variances arc of significant nature and are persistent, the standard may
need revision.

2. Favorable and Adverse variance: Favorable variances are those which are profitable for the
company and adverse variances are those which causes loss to the company. While computing cost
variances favorable variance means actual cost is less than standard cost. On the other hand adverse
variance means actual cost is exceeding standard cost. The situation will be reversed for sales
variance.

Favorable variances means actual is more than budgeted and on contrary adverse variance is where
actual is less than budgeted. These arc credited and debited in the costing profit and loss account
respectively. Favorable variance in short denoted by capital ‘F’ and adverse variances by capital “A’.

CLASSIFICATION OF VARIANCES:

Material Cost Variances

Labour Cost Variances

Overhead Cost Variances

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Gowtham Kumar C. K M.Com, KSET | Assistant Professor
12 PERFORMANCE MANAGEMENT VI SEM B.COM

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Gowtham Kumar C. K M.Com, KSET | Assistant Professor
13 PERFORMANCE MANAGEMENT VI SEM B.COM

STANDARD COSTING
FORMULAS IN ANALYSIS

Step 1: Basic calculation for computing the material cost variance

1 2 3 4
SQ SP SQ X SP AQ AP AQ X AP AQ X SP RSQ RSQ X SP

Computation of RSQ:

RSQ = SQ for that product X AQ for that product

SQ for all products

Tricks to Remember “CPU MY” 13141-22334”

Material COST Variance 1-2

Material PRICE Variance 3-2
Material USAGE Variance 1-3
Material MIX Variance 4-3
Material YIELD Variance 1-4

Verification of you Answers

MCV = MUV +MPV

MCV= MPV+MMV+MMV

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Gowtham Kumar C. K M.Com, KSET | Assistant Professor
14 PERFORMANCE MANAGEMENT VI SEM B.COM

Two marks

I. What do you mean by Historical Cost?

Historical cost means the actual cost or past cost and historical costing is a system in which actual
costs incurred in the past are determined.

2. Define Standard cost

According to CIMA. “Standard cost is the pre-determined cost based on technical estimates for
materials, labour and overhead for a selected period of time for a prescribed set of working
conditions”

3. Define Standard costing

According to CIMA, “the preparation of standard costs and applying them to measure the variations
from actual costs and analyzing the causes of variations with a view to maintain maximum efficiency
in production

4. State four objectives of Standard costing

1. To institute a control mechanism on all the elements of costs that affect production and sales
2. To measure different operational efficiencies and check the wastages
3. To improve the delegation of authority and generate a sense of responsibility among the
employees
4. To develop a cost consciousness in the employees
5. To presume the production costs, sales and profit
6. To avail the benefits of “Management by exception”

5. State any four benefits of standard costing.

 Proper Planning:
 Efficient Cost Control:
 Motivational Factor:
 Comparison of Forecasting and Outcome:
 Inventory Control:
 Economical System:
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Gowtham Kumar C. K M.Com, KSET | Assistant Professor
15 PERFORMANCE MANAGEMENT VI SEM B.COM

6. Define Variance.

According to C.I.M.A. London. “The process of computing the amount of variance and isolate the
causes of variances between actual and standard”.

7. Mention any two types of variances.

 Controllable and un-controllable variances:

 Favorable and Adverse variance;

8. What is material cost variance? Give its formula.

Material cost variance is the difference between standard material cost allowed for the overheads
achieved and the actual material cost. Mathematically it is written as

Material Cost Variance = Standard Cost - Actual Cost

9. What is labour cost variance? Give its formula.

Labour cost variance is the difference between standard labour cost allowed for actual output achieved
and actual labour cost. It is also known as wages variance.

Labour Cost Variance = Standard Labour Cost of Actual output — Actual labour =Costs

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Gowtham Kumar C. K M.Com, KSET | Assistant Professor
16 PERFORMANCE MANAGEMENT VI SEM B.COM

LABOUR COSTING

FORMULAS IN ANALYSIS

Step 1: Basic calculation for computing the Labour cost variance

When the absence of IDLE TIME

1 2 3 4
SH X SR AH X AR AH X SR RSH X SR

Computation of RSPH:

RSH = Total Actual Hours X SH

Total SH

Tricks to Remember “CREMY” 13141-2234”

CREMY

Labour Cost Variance 1-2

Labour Rate Variance 3-2

Labour Efficiency Variance 1-3

Labour Mix Variance 4-3

Labour Yield Variance 1-4

Verification of you Answers

LCV = LUV +LPV

LCV= LPV+LMV+LMV

Space for formulas

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Gowtham Kumar C. K M.Com, KSET | Assistant Professor
17 PERFORAMANCE MANAGEMENT VI SEM B.COM

When there is IDLE TIME

Step 1: Basic calculation for computing the Labour cost variance

1 2 3 4 5
SH X SR AH X AR AH X SR APH X SR RPH X SR

Computation of RSPH:

RSH = Total Actual Hours X SH APH = SH of Actual Hours –Idle Time

Total SH

Tricks to Remember “CREMIY” 131541-223435”

CREMIY

Labour Cost Variance 1-2

Labour Rate Variance 3-2

Labour Efficiency Variance 1-3

Labour Mix Variance 5-4

Labour Idle Time Variance 4-3

Labour yield Variance 1-5

Verification of you Answers

LCV = LUV +LPV

LCV= LPV+LMV+LMV

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

Gowtham Kumar C. K M.Com, KSET | Assistant Professor
18 PERFORAMANCE MANAGEMENT VI SEM B.COM

Illustration – 1

Calculate Labour Cost Variance with the information given below:

Actual rate – Rs. 4 per hour

Actual Hours – 16.000 hours

Actual Production – 1.200 units

Standard Rate – Rs. 4.60 per hour

Standard hours per unit – 20.

Solution:

Labour Cost Variance = (Standard Hours for actual output * Standard Rate) - (Actual Hours * actual
Rate)

= (1,200*20) * 4.60) – (16,000*4)

= 1,10,000-64,000

= Rs. 46,000 (Favorable)

Illustration – 2

M/S Anandi Ltd manufactures a particular article, the standard direct labour cost which is Rs. 120 per
unit as given below:

Type of workers Hours Rate Amount Rate

X 20 3 60

Y 30 2 60

50 120

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

Gowtham Kumar C. K M.Com, KSET | Assistant Professor
19 PERFORAMANCE MANAGEMENT VI SEM B.COM

During a period, 110 units of the article were manufactured, the actual labour cost of which was as
follows:

Type of workers Hours Rate Amount (Rs)

X 4,000 2 8,000

Y 2,000 3 6,000

6,000 14,000

Calculate labour Rate Variance.

Solution:

X = 4,000 (3 - 2) = Rs. 4,000 (Favorable)

Y = 2,000 (2 – 3) = Rs. 2,000 (Adverse)

Total Labour rate Variance = Rs. 2,000 (Favorable)

Illustration – 3

Sri Shanmugam & Sons Furnishes you the following data compute labour Variance.

Standard labour hours unit 50 hours

Standard labour rate per hour Rs. 4

Actual production 100 units

Actual labour rate per unit Rs. 5

Actual labour for production 4,000 hours

Solution: Standard Time = 100 units * 50 = 5,000 hours

Labour Efficiency Variance = SR (ST – AT) = 4(5,000 – 4,000) = Rs.4,000(Favorable)

Illustration – 4

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

Gowtham Kumar C. K M.Com, KSET | Assistant Professor
20 PERFORAMANCE MANAGEMENT VI SEM B.COM

100 workers are working in a factory at a standard wage rate of Rs. 4.80 per hour. The standard
performance is set at 360 units per hour. The actual production was 56.000 units. There was a power
failure which stopped production for 2 hours. Calculate idle time variance.

Solution:

Idle time variance = idle hours * Standard rate per hour

Idle hours = 100 workers @ 2 hours = 200 hours

Idle time variance = 200 hours * 4.80 = Rs. 960 Adverse

Illustration – 5

A reputed firm gives the detail of grade A & B worker the standard direct labour cost which is
Rs. 100 per unit. The details are given below:

Grade of workers Hours Rate (Rs.) Amount (Rs)

A 25 2.5 62.50

B 20 2 40.40

45 102.50

During a period 80 unit of the product were produced, the actual labour cost of which are as
follows:

Grade of workers Hours Rate (Rs.) Amount (Rs)

A 3,000 2 6,000

B 1,600 3 4,800

4,600 10,800

Calculate labour mix Variance.

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

Gowtham Kumar C. K M.Com, KSET | Assistant Professor
21 PERFORAMANCE MANAGEMENT VI SEM B.COM

Solution:

Labour Mix Variance = Standard Rate * (Revised Standard Hours – Actual Hours)

Revised Standard Hours = Standard Hours of the grade * Total Actual Hours

Total Standard Hours

Standard hours of the Grade

A = 25 * 80 = 2,000

B = 20 * 80 = 1,600
Total = 3,600

Revised Standard hours: Grade A = 2000 * 4,600 = 2,556 hrs.

3,600

Grade B = 1,600 * 4,600 = 2,044 hrs.

3,600

Labour Mix Variance

Grade A = 2.5 (2.556 – 3,000) = 1110 (Adverse)

B = 2 (2,044 – 1, 600) = 888 (Favorable)

Total Labour Mix Variance = Rs. 222 (Adverse)

Illustration – 6

Standard Time 1,500 hours

Standard Rate Rs. 15 per hour

Actual Output 450 units

Standard Output 500 units

Calculate Labour Yields Variance.

Solution:

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

Gowtham Kumar C. K M.Com, KSET | Assistant Professor
22 PERFORAMANCE MANAGEMENT VI SEM B.COM

Standard Time per unit = 1,500 hours + 500 units = 3 hours

Standard Cost per unit = 3 Hours @ Rs. 15 = Rs. 45

Labour Yield Variance = (Actual Yield – Standard Yield) * Standard Output Rate

= (450 – 500) * 45 = Rs. 2,250 (Adverse)

Illustration – 07

The details regarding the composition and the weekly wages rates of labour force engaged on a job
scheduled to be completed in 30 weeks are as follows.

Standard Actual

weekly wage weekly wage

Category of
workers No. of Labour Rate per labour No. of Labour rate per Labour

Skilled 75 60 70 70

Semi-skilled 45 40 30 50

Unskilled 60 30 80 20

The work is actually completed in 32 weeks calculate the various labour variances.

Solution:

1. Labour Cost Variance = Standard Cost of Labour – actual Cost of Labour

Skilled = (75 * 30 * 60) – (70 * 32 * 70)

= 1,35,000 – 1,56,800 = Rs. 21,800 (Adverse)

Semi-skilled = (45 * 30 * 40) – (30 * 32 * 50)

= 54,000 – 48,000 = Rs. 6,000 (Favourable)

Unskilled = (60 * 30 * 30) – (80 * 32 * 20)

= 54,000 – 51,200 = Rs. 2,800 (Favorable)

Total Labour Cost Variance = Rs. 13,000 (Adverse)

2. Labour Rate Variance = Actual Hours * (Standard Rate – Actual Rates)

Skilled = 70 * 32 * (60 – 70) = Rs. 22,400 (Adverse)

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

Gowtham Kumar C. K M.Com, KSET | Assistant Professor
23 PERFORAMANCE MANAGEMENT VI SEM B.COM

Semi-skilled = 30 * 32 * (40 – 50) = Rs. 9,600 (Adverse)

Unskilled = 80 * 32 * (30 – 20) = Rs. 25,600 (Favourable)

Total Labour Rate Variance = Rs. 6,400 (Adverse)

3. Labour Mix Variance = Standard Rate * (Revised Standard Time –Actual Time

Revised Standard Time is calculated as follows:

Revised Standard Time = Standard Hour of the Grade *Total actual Hours
Total Standard Hours
Skilled = 2250 * 5,760 = 2,400 hours
5400
Semi-skilled = 1,350 * 5,760 = 1,440 hours
5,400
Un-skilled = 1,800 * 5,760 = 1,920 hours
5,400

Calculation of Standard Weeks and Actual Weeks

Standard Actual

Skilled 75 * 30 = 2,250 90 * 32 = 2,240

Semi-Skilled 45 * 30 = 1,350 30 * 32 = 960

Unskilled 60 * 30 = 1.800 80 * 32 = 2,560

Total 5,400 5,760

Labour Mix Variance = (Revised Standard Time – Actual Time) * Std Rate

Skilled = (2,400 – 2,240) * 60 = Rs. 9,600 (Favorable)

Semi-Skilled = (1,400 – 900) * 40 = Rs. 19,200 (Favorable)

Unskilled = (1,920 – 2,560) * 30 = Rs. 19,200 (Adverse)

Total Material Mix Variance = Rs. 9,600 (Favorable)

Illustration: 8

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

Gowtham Kumar C. K M.Com, KSET | Assistant Professor
24 PERFORAMANCE MANAGEMENT VI SEM B.COM

The following information is obtained from a standard Cost Card.

Labour Rate = Rs. 1.80 per hour

Hours – 4 hours per unit

Actual Production data are: Units produced – 400 units

Labour Rate – Rs. 1.90 per hour

Hour worked – 1,500

Calculate:

a) Labour Cost Variance

b) Labour Rate Variance
c) Labour efficiency Variance.

Solution:

Standard Rate = Rs. 1.80

Standard Time = 4 hrs @ 400 units = 1,600 hrs

Actual Time = 1,500 hrs

Actual Rate = Rs. 1.9.

1) Labour Cost Variance = Standard Cost – Actual Cost

= (1,600 * 1.80) - (1,500 * 1.9)
= 2,880 – 2,850 = Rs. 30 (Favourable)

2) Labour Rate Variance = Actual Time (Standard Rate – Actual Rate)

= 1,500 (1.80 - 1.90) = Rs. 150 (Adverse)

3) Labour Efficiency Variance = Standard Rate * (Standard Time – Actual Time)

= 1.80 * (1,600 – 1,500) = Rs. 180 (Favourable)

Illustration – 09

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

Gowtham Kumar C. K M.Com, KSET | Assistant Professor
25 PERFORAMANCE MANAGEMENT VI SEM B.COM

In a factory 100 workers are engaged and the average rate of wage is 50 paise per hour. Standard

working hour per week are 40 and the standard performances is 10 units per gang hour. During a week

in March, wages paid for 50 workers were at the rate of 50 paisa per hour. 10 workers at 70 paise per

hour and 40 workers at 40 paise per hour. Actual output was 380 units. The factory did not work for

five hours due to breakdown of machinery. Calculate appropriate labour Variance.

Solution:

1 Labour Cost Variance = Standard Cost – Actual Cost

Standard Cost of Labour is calculated as follows:

Standard performances = 10 units per gang hour

Actual output = 380 units

Standard Hour = 380 = 38 hrs per workers

10
Standard hour = 38 * 100 = 3,800 hrs

For 100 workers

Standard Cost of Labour = Standard Hours * Standard Rate
= 3,800 * 0.50 = Rs. 1,900

Actual Cost of Labour for 40 hrs is calculated as follows:

50 workers for 40 hrs @ 50 paise = Rs. 1,000
10 workers for 40 hrs @ 70 paise = Rs. 280
40 workers for 40 hrs @ 40 paise = Rs. 640
= Rs. 1,920

Therefore, Labour Cost Variance = Standard Cost – Actual Cost

= 1,900 – 1,920 = Rs. 20 (Adverse)

2 Labour Rate Variance = Actual hours * (Standard Rate – Actual Rate)

= 50 * 40 (0.50 – 0.50) = 0
= 10 * 40 (0.50 – 0.70) = Rs. 80 (Adverse)
= 40 * 40 (0.50 – 0.40) = Rs. 160 (Favorable)
Total Labour Rate variance = Rs. 80 (Favorable)
3 Labour efficiency Variance = Standard Rate * (Standard hours – Actual hours)

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

Gowtham Kumar C. K M.Com, KSET | Assistant Professor
26 PERFORAMANCE MANAGEMENT VI SEM B.COM

= 0.50 * (3,800 – 3,500)

= 0.50 * 300 = Rs. 150 (Favorable)

Where actual time is calculated as follows:

Actual hours = 2,000hrs + 400 hrs + 1,600hrs
= 4,000 hrs – Idle time (5 hrs * 100 workers) = Idle time
Idle time = 500 hrs

Therefore, Actual hours = 4,000 hrs – 500 hrs = 3,500 hours

4 Idle hour = Idle time * Std Rate

= 500 hrs * 0.50 = Rs. 250 (Adverse)

Illustration – 10

The following details are available from the records of ABC Ltd engaged manufacturing article A for
the week ended 28th September.

Hours Rate per hour Total

Skilled Labour 10 3-00 30

Semi-Skilled Labour 8 1-50 12

Unskilled Labour 16 1-00 16

58

The actual production was 1,000 articles of A for which the actual hours worked article rates are
given below:

Hours Rate per hour Total

Skilled Labour 9,000 4-00 36,000

Semi-Skilled Labour 8,400 1-50 12,600

Unskilled Labour 20,000 0-90 18,000

66,600

From the above set of data you are asked to calculate. 1) Labour Cost Variance

2) Labour Rate Variance 3) Labour Efficiency Variance 4) Labour Mix Variance.

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

Gowtham Kumar C. K M.Com, KSET | Assistant Professor
27 PERFORAMANCE MANAGEMENT VI SEM B.COM

1) Labour Cost Variance = Standard Cost – Actual Cost rate

Standard Cost = Standard Hours * Standard rate
Skilled = 1,000 article @ 10 hrs = 10,000 hrs * 3 – Rs. 30,000
Unskilled = 1,000 article @ 16 hrs = 16,000 hrs * 1 – Rs. 16,000
Actual Cost = Actual hours * Actual Rate
Skilled Labour = 9,000 hours @ 4 = Rs. 36,000
Semi-Skilled = 8,400 hours @ 1.50 Rs. 12,600
Unskilled = 20,000 hours @ 0.90 = Rs. 18,000
Labour Cost Variance for
Skilled Labour = 30,000 – 36,000 = Rs. 6,000 (Adverse)
Semi-Skilled Labour = 12,000 – 12,600 = Rs. 600 (Adverse)
Unskilled Labour = 16,000 – 18,000 = Rs. 2,000 (Adverse)
Total Labour Cost Variance = Rs. 8,600 (Adverse)

2) Labour Price Variance = Actual hours * (Standard Rate – Actual Rate)

Skilled Labour = 9,000 * (3 – 4) = Rs. 9,000 (Adverse)
Semi-Skilled Labour = 8,400 * (1.50 – 1.50)= Nil
Unskilled Labour = 20,000 * (1 – 0.90) = Rs. 2,000 (Favorable)
Total Labour Price Variance = Rs. 7,000 (Adverse)

3) Labour Efficiency Variance = Standard Rate (Standard hours – Actual hours)

Skilled Workers = 3(10,000 – 9,000) = Rs. 3,000 (Favorable)
Semi-Skilled Workers = 1.5 (8,000 – 89,400)= Rs. 600 (Adverse)
Unskilled = 1.0 (16,000 – 20,000)= Rs. 4,000 (Adverse)
Total Labour Efficiency Variable = Rs. 1,600 (Adverse)

4) Labour Mix Variance = Standard Rate * (Revised Standard mic of actual hours
worked – Actual mix)
Revised Standard mix of Actual work = Standard mix * Total Actual Hours
Total Standard Hours
Skilled Workers = 10,000 * 37,400 = 11,000 hrs
34,000
Semi-Skilled Workers = 8,000 * 37,400 = 8,800 hrs
34,000
Unskilled Workers = 16,000 * 37,400 = 17,600 hrs
34,000
Labour Mix Variance for
Skilled workers = 3 (11,000 – 9,000) = Rs. 6,000 (Favorable)
Semi-Skilled workers = 1.50 (8,800 – 8,400) = Rs. 600 (Favorable)
Unskilled workers = 1.00 (17,600 – 20,000) = Rs. 2,400 (Adverse)
Total Labour Mix Variance = Rs. 4,200 (Favorable)

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

Gowtham Kumar C. K M.Com, KSET | Assistant Professor
28 PERFORAMANCE MANAGEMENT VI SEM B.COM

Illustration – 11

The following information is obtained from a standard cost card.

Labour Rate – Rs. 1.80 per hour

Hours – 4 hour per unit

Actual production data are:

Units produced – 400 units

Labour Rate – Rs, 1.90 per hour

Hour worked – 1,500

Calculates:

a) Labour Cost Variance

b) Labour Rate Variance ant
c) Labour Efficiency variance

Solution:

Given Standard Labour rate Rs. 1.80 per hour

Standard time hours per unit

For units = 4 * 400 = 1,600 hours

Actual rate 1.90 per hours

Actual time = 1,500 hours

a) Labour Cost Variance:

= (Standard rate – Standard time – Actual time – Actual rate)
= (1,600 * 1.80 – 1,500 * 1.90)
= (2,800 – 2,850) = Rs. 30 (Favorable)

b) Labour Rate Variance:

= Actual time (Standard rate – Actual rate)
= 1,500 (1.80 – 1.90)
= 1,500 (-0.1) = Rs. 150 (UnFavorable)

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

Gowtham Kumar C. K M.Com, KSET | Assistant Professor
29 PERFORAMANCE MANAGEMENT VI SEM B.COM

BUDGETING AND CONTROL

Section –A (2 Marks)

1. What do mean by budget?

According to Brown and Howard, “a budget is a pre-determined standard of management policy

during a given period which provides a standard comparison with the results actually achieved.”

2. What is budgetary control ?

Budgetary control is the process by which budgets are prepared for the future period and are
compared with the actual performance for finding out variances, if any. The comparison of budgeted
figures with actual figures will help the management to find out variances and take corrective actions
without any delay..

3. What are the objectives of budgetary control?

1. Planning:

Budgetary control includes all the plans for all departments like purchase selling, stock
department.

2. Co- ordination:

It also co- ordinates with different sectors of the organization to achieve the goals.

3. Control:

Control is a procedure to get done the all works according to plan formulated previously.

4. What are the types of budget?

The types of budgets are as follows:

1. Cash budget; 2. Flexible budget 3. Production budget; 4. Sales budget; 5. Overhead budget;
6. Master budget.

5. What is budget manual?

Budget manual is a small booklet that contains the details relating to budgeting organization and
procedure. These specimen forms are given in the budget manual. Briefly, the budget manual is
prepared to give full information to every employees of an organization relating to budgets and avoids
misunderstanding also.

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

Gowtham Kumar C. K M.Com, KSET | Assistant Professor
30 PERFORAMANCE MANAGEMENT VI SEM B.COM

6. What is master budget ?

The master budget expresses management's operating and financial plans for a specified. period
(usually a fiscal year) and includes a set of budgeted financial statements. It is the initial plan of what
the company intends to accomplish in the period.

7. What do you mean by cash budget?

Cash budget is detailed estimate of cash receipts from all receipts and cash payments for all purposes
and the resultant cash balance during budget period.

8. What is flexible budget? (or) What do you understand by flexible budgeting?

Flexible budget is a budget which is designed to change in relation to the level of activity attained.

9. Define key factors?

Key factor is a factor which limit the volume if output at a specified time for maximum profits . when
all the activities are undertaken at the particular period of time or over a periodical point .The key
factor will limits the volume of output . It may be called limiting factors or principal budgeting
factors which is very important to determine the profitability.

10. What do you mean by labour budget?

It represents the forecast of labour requirements to meet the demand of the company for the budget
period. It is linked with production budget and production cost budget.

11. What is raw material budget?

It shows the estimated quantities of all raw materials and components needed for production
demanded by production budget.

12. What is production budget?

Production budget is an estimate of production for the budget period. It shows all quantities of
production.

13. What is purchase budget?

Purchase budget provides the details of purchases which are planned to be made during the period to
meet the needs of the business.

14. What do you mean by selling and distribution cost budget?

Selling and distribution cost budget represents the forecast of all costs incurred in selling and
distribution the company’s products during the budget period.

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

Gowtham Kumar C. K M.Com, KSET | Assistant Professor
31 PERFORAMANCE MANAGEMENT VI SEM B.COM

15. Define standard costing?

The estimated incomes and expenses for a particular period of time is called standard cost. According
to ICMA the standard cost is a predetermined cost , which is calculated from the management
standards or efficient operation and the relevant necessary expenditure, It may be used as a basis for
price fixing and for cost control through various analysis.

16. What is standard costing?

A procedure or method for selling the pre determined cost estimation for providing basis for
comparing with the actual cost is called standard costing . According to ICMA UK, standard costing
is the preparation and use of standard cost , their comparison with actual cost and analysis of
variances to their causes and points incidence.

17. What is standard costing? Mention its steps ?

A procedure or method for selling the pre determined cost , estimation providing a basis for
comparison with actual cost is called standard cost.

Steps are:

1. Determination of standard cost.

2. Recording of actual cost.

3. Comparison the standard cost with actual cost.

4. Reporting about variance and taking corrective measures.

18. What do you mean by variance?

A variance means a deviation. A variance occurs when actual costs form standard costs. Variance
analysis is a study of such variances, and it not only measurement of variances , but also examination
of the causes for variance , explaining clearly the contribution of each cause or factor to the variance.

19. What is variance analysis?

Variance analysis is the quantitative investigation of the difference between actual and planned
behavior. This analysis is used to maintain control over business.

20. What is labour variance?

Labour variances arise when actual labour cost; are different from standard labour costs labour
variances involve calculation of labour cost variance, labour rate variance, labour time (or efficiency)
variance, Idle time variance and labour mix or gang composition variance is favorable and denotes by
a negative variance is adverse and is denoted by (A).

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

Gowtham Kumar C. K M.Com, KSET | Assistant Professor
32 PERFORAMANCE MANAGEMENT VI SEM B.COM

21. What is material cost variance ?

It is difference between the standard costs for the out put achieved by actual cost incurred for
achieving the same. It is calculated with the help of the formula

MCV = (SQ*SP) – (AQ*AP) Where

SQ = Standard Quantity for actual output

SP = Standard price

AQ = Actual quantity used

AP = Actual price

22. Give the meaning of material usage variance?

Material usage variance explains the variance in material cost caused on the account of the difference
between the standard quantity specified and the actual quantity used. It is calculated as

MUV=MQV=SP*(SQ- AQ)

Material price variance and material usage variance total up to material cost variance i.e.
MVC=MPV+MUV

23. What is labour yield variance?

The output obtained will not only be on account of material used but it will also be influenced by the
efficiency of the labour working on the material. As such, yield variance can be calculated to know
whether the output is as per the standard specified not. It is calculated as

LYV=Standard yield rate (Actual yield- Received standard yield)

Where standard yield rate =Total of RH*SR/Received standard yield.

24. Classify different types of direct material cost variance?

Material cost variance

Material price variance Material usage variance

Material mix variance Material yield variance

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Gowtham Kumar C. K M.Com, KSET | Assistant Professor
33 PERFORAMANCE MANAGEMENT VI SEM B.COM

25. Differentiate between favorable and un favorable variance?

A variance is favorable if standard cost > Actual cost Where , a variance is un favorable or adverse if
actual cost> standard cost.

26. What is material mix variance of why does it arise?

The differences between the standard mix specified and the actual mix used is called material mix
variance. The causes for arising the material cost variance.

1. Increase in demand for particular variety of material.

2. Increase or decrease or price or any parties has materials.
3. Change in the compensation or materials etc.

27. What are the causes for material usage variance?

The differences between standard quantity and the actual quantity used is material usage. The causes
are as follows:

1. Use of un skilled labour.

2. Increase in material wastage due to depreciation of plant and machinery.
3. Purchase of materials of lower quality than the standard.

28. What are the causes for labour rate variance?

The causes of labour variance are given below:

1. Change in basic wage rate

2. Use of different methods of wage payment
3. Un scheduled over time
4. Poor working conditions
5. Machine breakdown
6. Increase in labour turn over

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

Gowtham Kumar C. K M.Com, KSET | Assistant Professor
34 PERFORAMANCE MANAGEMENT VI SEM B.COM

SECTION-B (6 Marks)

1. State the objectives of budgetary control?

The objectives of budgetary control are:

1. Planning and co-ordination:

Budgeting involves preparation in detailed operational plan to achieve the objectives of the business
the of every business depends up on the planning of activities and budgeting planning to become more
effective as budget covers all the activities department of business ,It also serves as a mean of co-
ordination the of all the departments.

2. Clarification of authority and responsibility:

Budgeting enables superior to delicate the authority to his subordinates. This also clarifies the
responsibilities to each manager who can be held accountable if the not reached. Thus, budgeting
facilitates management by exception.

3. Communication :

Science all levels of management are involved in preparation of budget, It facilitates communication
process to become effective.

4. Motivation:

The preparation of budgets by middle and lower management against with performance can be judged
serves as a good motivation to them.

5. Control:

The control of various activities is achieved by controlling the achievements with the targets. If there
are any deviations, the causes the same is investigated and the remedial action is taken.

2. What are the essential requirements of budgetary control ?

1. Co – operation of top management

2. Maximum profits
3. Budget committee
4. Preparation of budgets by responsible executives
5. Constant vigilance
6. Reasonable attainable goals
7. Adequate accounting system
8. Clearly defined organization chart
9. Cost of operation

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

Gowtham Kumar C. K M.Com, KSET | Assistant Professor
1 PERFORAMANCE MANAGEMENT VI SEM B.COM

Unit 4
Performance measurement and control

Performance management information system

Performance Management Information Systems identifies the accounting information requirements
and the types of information systems used; describes and identifies the main characteristics of
transaction processing, management information and executive information systems; and defines the
good and bad of open and closed

Sources of Management Information

The different levels of decision making were discussed in the previous chapter. The information needs
of the decision makers will be different and depend on the type of decision.

1. Strategic planning
The information needed at this level is likely to be more external information and is likely to
be more forecasts of the future.
2. Management control / Tactical planning
At this level there will be a need for both external and internal information. The focus is also
more likely to be on current information.
3. Operational control
Here the information needs will almost exclusively be internal, and will be past and current
information.

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

2 PERFORAMANCE MANAGEMENT VI SEM B.COM

Sources of management information

Management Report

Management aim at informing managers of different aspects of the business, in order to help them
make better-informed decisions. They collect data from various departments of the company tracking
key performance indicators (KPIs) and present them in an understandable way

Performance Analysis in Private Sector Organizations

Performance measurement aims to find out how well something or somebody is performing in relation
to a plan. Performance measures may either be financial performance indicators (FPIs) or non-
financial performance indicators (NFPIs).

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

3 PERFORAMANCE MANAGEMENT VI SEM B.COM

Financial performance can be analysed using financial ratios:

Liquidity Ratios

Current Ratio

 Measures firm’s ability to meet its short term obligations

 Formula: Current Ratio = Currents assets ÷ Current Liabilities

Quick Ratio

 Measures firm’s liquidity

 Formula: Quick Ratio = (Cash + Short term investments + receivables) ÷ current liabilities

Inventory Days/ Inventory Turnover Period

 Indicates the average number of days that inventory is held for

 Formula: Inventory Days = (Inventory ÷ Cost of Sales) x 365 days

Accounts Receivable Payment Period

 Measures average time for receivables to be paid

 Formula: Accounts Receivable Payment Period = (Trade receivables ÷ Credit sales turnover) x
365

Accounts Payable Payment Period

 Helps assess liquidity

 Formula: Accounts Payable Payment Period = (Average trade payables ÷ Credit purchases of
cost of sales) x 365 days

Profitability Ratios

Net profit margin

 Indicates profitability of operations

 Formula: Net profit margin = Net income ÷ Net sales

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

4 PERFORAMANCE MANAGEMENT VI SEM B.COM

Gross profit margin

 Shows profits less overhead costs

 Formula: Gross profit margin = Gross profit ÷ Net sales

Return on capital employed

 Relates profit growth to the funds used to make the profits

 Formula: Return on capital employed = PBIT ÷ Capital employed

Total asset turnover

 Measures company’s ability to generate sales given its investment in total assets
 Formula: Total Asset turnover = Net sales ÷ Average total net sales

Earnings per Share

 Calculates profit for each share

 Formula: Earnings ÷ Number of shares

Gearing Ratios

 Measures the financial risk

 Formula: Gearing = Debt ÷ Debt plus equity
 Formula: Gearing = Debt ÷ Equity.

DIVISIONAL PERFORMANCE AND TRANSFER PRICING

Transfer Pricing Transfer pricing is used when divisions of an organisation need to charge other
divisions of the same organisation for goods and services they provide to them. Usually, each division
will report its performance separately. Hence, some monetary value must be allocated to record the
transfer of these goods or services.

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

5 PERFORAMANCE MANAGEMENT VI SEM B.COM

For example, division A might make a component that is used as part of a product made by division
B of the same company, but that can also be sold to the external market, including makers of rival
products to division B's product.
There will therefore be two sources of revenue for
1. External sales revenue from sales made to other organisations, valued at the selling price.
2. Internal sales revenue from sales made to other responsibility centers within the same organisation,
valued at the transfer price.

Transfer pricing is not simply buying and selling products between divisions. The term is also
used to cover:
A. head office general management charges to subsidiaries for various services
B. specific charges made to subsidiaries by, for example, head office human resource or
information technology functions
C. royalty payments between parent company and subsidiaries – among subsidiaries.
D. interest rate on borrowings between group companies.

Ethical issues in transfer pricing

There are a number of potential ethical issues for the multinational company to consider when
formulating its transfer pricing strategy:

 Social responsibility, reducing amounts paid in customs duties and tax.

 Bypassing a country’s financial regulation via remittance of dividends.
 Not operating as a ‘responsible citizen’ in foreign country.
 Reputational loss.
 Bad publicity.
 Tax evasion.

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

6 PERFORAMANCE MANAGEMENT VI SEM B.COM

Performance Analysis in Not For Profit Organizations and the Public Sector

Not for profit organisations have general objectives which include:

 “Surplus maximization (Similar to profit maximization)

 Revenue maximisation
 Usage maximisation
 Usage targeting (Matching the capacity available)
 Full/ partial cost recovery (Minimising subsidy)
 Budget maximization – Maximising what is offered
 Producer satisfaction maximization – Satisfying the wants of staff and volunteers
 Client satisfaction maximization – Generating the support of the public”

External Considerations and Behavioral Aspects

Explains the need to allow for external considerations in performance management; suggests ways in
which external considerations could be allowed for in performance; interprets performance in the light
of external considerations; and identifies and explains the behavior Performance measures vary for
each of the external considerations. Examples are:

 Employees – Motivation, morale

 Management – Salaries, profit sharing
 Shareholders – Price of shares, dividend yield, earnings per share
 Customer – Price, quality, service, value for money
 Government – Taxation, inflation, exports, employment
 Community – Environmental impact, employment, social needs

Management performance measures “should only include those items that are directly controllable by
the manager in question.” When employees know that their performance is being measured, they will
improve the standard of their performance.

Additionally, rewards for certain levels of performance can further raise the standard of performance.
Management should implement performance measures that are geared towards rewarding the behavior
that “maximizes the corporate good.”

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

7 PERFORAMANCE MANAGEMENT VI SEM B.COM

SECTION-A (2 MARKS)

1.What is performance management?

Performance management is an ongoing process of communication between a supervisor and an

employee that occurs through out the year in support of strategic objectives of the organization.

2. What is information system?

Information systems are interrelated components working together to collect , process, store and
disseminate information to support decision making , co-ordination , control, analysis and
visualization in an organization.

3. What is divisional performance?

The divisional performance is the performance measure of the employees working in the organization
of a particular division in contrast and comparison with the other to achieve better in the organization.

4. Mention the sources of management information?

The sources are mainly internal such as daily books, log books, accounting records, consumer data etc
The external sources such as magazines etc.

5. What is management reports?

Management reports aim at informing managers of different aspects of the business, in order to help
them make better-informed decisions. ... They basically show the worth of your business over a
specific time period by disclosing financial and operational information

6. What is transfer pricing?

A transfer price is the price one subunit charges for a product or service supplied to another subunit
of the same organization. Transfer price is a value at which goods and Services are Transferred
between divisions in a decentralized organizations .

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

8 PERFORAMANCE MANAGEMENT VI SEM B.COM

7. What is performance Analysis ?

Performance analysis is the process of studying or evaluating the performance of a particular scenario
in comparison of the objective which was to be achieved. In HR performance analysis can help review
to review an employee contribution towards a project or assignment, which she or he allotted.

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

1 PERFORAMANCE MANAGEMENT VI SEM B.COM

Last minute revision (LMR )

2marks and 6 marks of 2018 & 2019 Qp

1) What is Target Costing?

 Target costing is an approach to determine a products life cycle cost which should be sufficient
to develop specified functionality and quality while ensuring its desired profit.
2) Give the meaning of activity based costing
 Activity based costing (ABC) is a costing method that identifies activities in an organization
and assigns the cost of each activity to all products and services according to the actual
consumption by each.
3) What is Break-even point?
 Break-even point is the point where the total cost is equal to total revenue. It is a point of no
profit and no loss; it refers to that volume of operations at which total sales equals to total cost.
4) What do you mean by standard costing?
 According to CIMA London standard costing is a technique which uses standards for costs and
revenue for the purpose of control through variances analysis.
5) How do you calculate Debt –Equity Ratio?
 Debt equity ratio=long term debt (Or) DER=Total debt
Equity Equity
6) Give the meaning of transfer price
 Is the setting of the price for goods and services sold between controlled legal entities within
an enterprise
7) What is flexibility budget?
 It’s a budget or financial plan that varies according to the companies needs
8) State the features of budgetary control
 Planning
 Communication
 Coordination
 Control
 Performance Evaluation

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

2 PERFORAMANCE MANAGEMENT VI SEM B.COM

9) What is value analysis?

 Value analysis is one of the major techniques of cost reduction and control .It is the creative
approach to eliminate the unnecessary costs which add neither to quality nor to the appearance
of the product
10) Mention any four functional budget
 sales budget
 purchase budget
 labour cost budget
 capital expenditure budget
11) State the benefits of ABC costing
 accurate product costs
 better decision making
 cost management
 tracing of overhead costs
12) What is margin of safety?
 margin of safety refers to the excess of actual sales over the break-even sales
MOS=Actual sales-Break even sales
(Or)
MOS =Profits
P/v ratio
13) What is material cost variance?
 Marginal cost variance is the difference between the Standard cost of materials for the actual
output and the actual cost of materials used for producingactual output
14) Define marginal costing
 According to ICMAI, London has defined marginal costing as “the ascertainment of marginal
costs and of the effect on profit of changes in the volume or type of output by differentiating
between fixed costs and variable costs.
15) Give the meaning of fixed cost
 A fixed cost is an expense that does not change as production volume increases or decreases
within relevant range
 Example:- Building rent, rent, insurance premium , loan payment

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

3 PERFORAMANCE MANAGEMENT VI SEM B.COM

16) Mention any two types of variance

 variable cost variance
 material variance
 variable overhead variance
 sale variance
 fixed overhead variance
17) What is cost reduction?
 cost reduction is the process used by the companies to reduce their costs and increase their
profits
18) Name any two profitability ratio
 Net Profit Ratio
 Gross Profit Ratio
 Return On Capital Employed
 Return On Shareholder Equity
 Earnings Per Share
 Price Earning Profit
19) What is life cycle costing?
 Life cycle costing is the process of compiling all costs that the owner or producer of an assets
will increase over its lifespan
20) What is management reporting system?
 It is the information system used for decision making, and for the coordination,control,
analysis and visualization of information in an organization
21) What is budgeting?
 It is an art of building budgets for making use of budgets for further planning, coordinating
control purpose
 budgeting is simply balancing your expenses with your income
22) What is variance analysis?
 Variance analysis deals with an analysis of deviation in the budgets and actual financing
performance of a company

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

4 PERFORAMANCE MANAGEMENT VI SEM B.COM

23) What is green accounting?

 It is the identification, measurement and ,allocation of environmental costs the amalgamation
of these environmental costs into business decision ,and the subsequent communication of the
information to a company’s shareholders
24) What are variances?
 Variance can be defined as the difference between the budgeted cost and to the actual cost for
the activity
25) What is a contribution?
 Contribution is the amount of earnings remaining after all direct costs have been subtracted
from revenue
26) State two objective of budgeting
 planning
 efficiency and economy
 increase in profitability
 coordination
27) What is flexible budget?
 A flexible budget is a series of budges prepared for various level of activities ,revenues and
expenses
28) Sales Rs 200000, fixed cost Rs 40000, profit Rs 20000. calculate variable cost
 Variable cost= sales-[profit + fixed cost]
= 200000-[20000+40000]
=200000-60000
VC= 140000
29) Mention any four steps involved in standard costing
 step 1 – fixation of standards
 step 2–actual cost incurred
 step 3 – comparison of standard and actual cost
 step 4 –variance analysis
 step 5 – presentation of information to management

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

5 PERFORAMANCE MANAGEMENT VI SEM B.COM

30) Give the meaning of business process Re-engineering

 Business process reengineering [BPR] involves the examination and redesign of business
process and work flow in your organization
31) Calculate the break- even point in units fixed cost -120000, Vc per unit-10,selling price
per unit -16
 BEP=fixed cost contribution= sales-Vc
Contribution 16-10=6
=120000= 20000 units
32) What is cost driver?
 A cost driver is the unit of an activity that causes the change in activity cost. Cost driver is
any factor which causes a change in the cost of anactivity
33) A product X requires 25units of standard material at the rate of Rs 5/unit
The actual consumption of materials for the manufacture of product X is
Rs20units at the rate of Rs4/unit. Calculate material cost variance
 SQ-25AQ-20
SP-5AP-4
MCV=[1-2]
=[SQ*SP]-[AQ*AP]
=[25*5]-[20*4]=125-80
=45(F)
34) What are opportunity costs?
 The loss of the potential gain from other alternative when one alternative is chosen
(Or) it is the value of something when particular course of action is chosen
35) Define risk management
 Risk management is the process of identifying, assessing and controlling threats to an
organizations capital and earnings
36) Explain cash budget
 A cash budget is a budget or plan of expected cash receipts and disbursements during the
period. These cash inflows and outflows include revenue collected, expenses paid and loans
receipts and payments
(Or) a cash budget is an estimated projection of the company’s cash position in futures

Gowtham Kumar C. K M.Com, KSET | Assistant Professor

6 PERFORAMANCE MANAGEMENT VI SEM B.COM

37) What are the advantages of contribution?

 Contingency analysis
 Ease to use
 Existing information
 Unrealistic assumption

Gowtham Kumar C. K M.Com, KSET | Assistant Professor