Unit – II

Costing for Decision making:

Syllabus : Unit Costing, Job Costing, Cost Sheet and Tender and Process Costing and their
Variants, Treatment of Normal Losses and Abnormal Losses, Inter- process Profits,
Costing for By-products and Equivalent Production. Application of Managerial Costing
for Control, Profit Planning, Closing down of a Plant, Dropping a Product line, Charging
General and Specific Fixed Costs, Fixation of Selling Price, Make or Buy Decisions, Key
or Limiting Factor. Selection of Suitable Product Mix, Desired level of Profits,
Diversification of Products, Closing down or Suspending activities.

Course Objective:
 To elucidate the role of cost accounting for better managerial decision making.

Costing for Decision making:Introduction:

Costing for decision making is a critical aspect of managerial accounting that focuses on
providing relevant and accurate cost information to aid in making informed business
decisions. This unit typically covers various costing techniques and tools that assist
management in evaluating and selecting the best course of action. Here are some key topics
and concepts often included in a unit on costing for decision making:
1. Relevant Costs and Irrelevant Costs:
 Relevant Costs: These are costs that will change as a result of a specific
decision and will have an impact on the decision's outcome. Relevant costs
should be considered when making decisions.
 Irrelevant Costs: These are costs that will not change regardless of the
decision made and do not affect the decision's outcome. Irrelevant costs are
typically not considered in decision-making.
2. Differential Analysis:
 Differential analysis, also known as incremental analysis, is a technique used
to identify and analyze the differences in costs and revenues between different
decision alternatives. It helps in evaluating the financial impact of various
choices.
3. Cost-Volume-Profit (CVP) Analysis:
 CVP analysis examines the relationships between costs, volume, and profit. It
helps in understanding how changes in sales volume, pricing, and costs affect
profitability and break-even points.
4. Make-or-Buy Decisions:

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  Make-or-buy decisions involve evaluating whether to produce a component or
product in-house (make) or purchase it from an external supplier (buy).
Relevant costs, such as production costs and purchase prices, are considered in
this decision.
5. Special Order Decisions:
 Special order decisions involve evaluating whether to accept or reject a one-
time, non-recurring order that falls outside the normal course of business. The
decision considers incremental revenues and costs associated with the special
order.
6. Limiting Factor Analysis:
 When resources are constrained (e.g., limited machine hours, labor, or
materials), managers use limiting factor analysis to determine which product
or project should be prioritized based on the contribution margin per unit of
the limiting factor.
7. Cost Estimation:
 Cost estimation techniques are used to predict future costs, particularly when
planning for new projects, products, or services. Methods such as regression
analysis or the high-low method may be taught in this context.
8. Product Life Cycle Costing:
 Product life cycle costing involves tracking and analyzing costs at different
stages of a product's life cycle, from development to production, marketing,
and eventual discontinuation. This helps in making decisions related to
product pricing and investment.
9. Profitability Analysis:
 Managers use various tools and models to assess the profitability of different
products, customers, or business segments. This includes techniques like
activity-based costing (ABC) and customer profitability analysis (CPA).
10. Risk and Uncertainty in Decision Making:
 Costing for decision making also considers the impact of risk and uncertainty
on decision outcomes. Techniques like sensitivity analysis and decision tree
analysis may be introduced.
11. Capital Budgeting Decisions:
 Capital budgeting involves evaluating long-term investment decisions, such as
whether to invest in new equipment or expand facilities. Concepts like net
present value (NPV), internal rate of return (IRR), and payback period
analysis may be covered.
12. Strategic Cost Management:

Strategic Cost and Management Accounting MBA I Year IISem (R22)

  Integrating cost information into the broader strategic decision-making process
is important. Managers may learn how to align cost analysis with the
organization's strategic goals.
Costing for decision making is a practical and valuable aspect of managerial accounting that
equips managers with the tools and techniques needed to make sound financial decisions that
support the organization's overall objectives. This unit typically involves case studies,
exercises, and real-world scenarios to apply these concepts in practical decision-making
situations.
Unit Costing, Job Costing, Cost Sheet and Tender and Process Costing and their Variants:
Unit Costing, Job Costing, Process Costing, and their variants are methods used in cost
accounting to allocate and track costs for different types of production processes, products, or
services. Each method is suited to specific industries or situations. Here's an overview of
these costing methods and their variants:
1. Unit Costing:
• Definition: Unit costing, also known as single or output costing, is used when
identical or similar units of a product are manufactured in a continuous process. The total
production cost is divided by the number of units produced to determine the cost per unit.
• Variants:
• Simple Unit Costing: Used for products with uniform characteristics and production
processes.
• Composite Unit Costing: Applied when different products are produced using the
same facilities and share common costs.
2. Job Costing:
• Definition: Job costing is used when products or services are unique, custom-made, or
produced in distinct batches or jobs. Costs are allocated to each job individually based on the
specific resources and materials used.
• Variants:
• Batch Costing: Similar to job costing but used for a group or batch of similar products
produced simultaneously.
• Contract Costing: Applied to large projects or contracts, such as construction, where
costs are accumulated for specific contracts rather than individual jobs.
3. Process Costing:
• Definition: Process costing is used in industries where products or services undergo a
continuous, uniform production process. Costs are averaged over all units produced during a
specific time period, resulting in a cost per unit.
• Variants:

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• Weighted Average Costing: The total cost of beginning work-in-progress inventory
and current period costs are combined and divided by the total equivalent units produced.
• FIFO (First-In, First-Out) Costing: This method assigns the cost of beginning work-
in-progress inventory to units completed and the cost of current period production to units in
process at the end of the period.
4. Cost Sheet:
• Definition: A cost sheet is a document or record used to accumulate and analyze the
various costs associated with a specific product, project, or job. It provides a detailed
breakdown of costs, including direct costs, indirect costs, and overhead.
• Variants:
• Job Cost Sheet: Used in job costing to track the costs associated with a specific job or
project.
• Process Cost Sheet: Used in process costing to record costs for a particular production
process or department.
• Batch Cost Sheet: Applied in batch costing to track costs for a group or batch of
similar products.
• Contract Cost Sheet: Used in contract costing to record costs for specific contracts or
projects.
5. Tender Costing:
• Definition: Tender costing, often referred to as bidding or quotation costing, is the
process of estimating costs accurately to prepare competitive bids or quotations for potential
projects or contracts. It involves assessing all costs, including direct and indirect costs, and
considering profit margins.
• Variants:
• Fixed Price Tender: A bid or quotation that specifies a fixed price for the project or
contract.
• Cost-Plus Tender: A bid that includes costs plus an agreed-upon percentage or fee for
profit.
• Target Cost Tender: A bid that aims to achieve a specific target cost while sharing cost
savings or overruns with the client.
These costing methods and their variants are essential tools in cost accounting, helping
organizations allocate costs accurately, make informed pricing decisions, and evaluate the
profitability of various products, projects, or contracts. The choice of costing method depends
on the nature of the business, the type of products or services offered, and the specific cost
allocation requirements.
Treatment of Normal Losses and Abnormal Losses, Inter- process Profits:

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In process costing, which is commonly used in industries like manufacturing, chemical, and
food processing, the treatment of normal losses, abnormal losses, and inter-process profits is
a crucial aspect of cost accounting. Here's how each of these is typically treated:
1. Normal Losses:
• Definition: Normal losses refer to the expected and unavoidable losses that occur
during the production process due to factors like evaporation, shrinkage, spoilage, or waste.
These losses are inherent to the production process and are considered normal.
• Treatment:
• Normal losses are typically included in the cost of production for the current period.
• The cost of normal losses is spread across the good units produced during the period,
increasing their cost slightly to account for the losses.
• The objective is to ensure that the cost of normal losses is absorbed by the production
process and does not distort the cost of good units.
2. Abnormal Losses:
• Definition: Abnormal losses are unexpected and non-routine losses that occur due to
unforeseen events, accidents, or errors. These losses are not part of the normal production
process and are considered abnormal.
• Treatment:
• Abnormal losses are treated as a separate cost and are not absorbed by the good units
produced during the period.
• They are typically expensed immediately in the accounting records.
• The cost of abnormal losses is not spread to other units or processes.
• Management may investigate the causes of abnormal losses and take corrective
actions to prevent their recurrence.
3. Inter-Process Profits:
• Definition: In some production processes, multiple departments or processes may be
involved in transforming raw materials into finished products. At the end of each process,
there may be inter-process transfers of partially completed units. Inter-process profits refer to
the profit earned when one process sells its output to another process within the same
organization.
• Treatment:
• Inter-process profits are considered unrealized until the final product is completed and
sold to external customers.
• They are not recognized as revenue in the financial statements until the final product
is finished.

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• The profit generated during one process becomes a part of the cost basis for the
receiving process.
• When the final product is completed and sold externally, the accumulated inter-
process profits are realized as part of the total revenue.
It's important to note that the specific treatment of normal losses, abnormal losses, and inter-
process profits may vary depending on the organization's accounting policies and industry
practices. These treatments ensure that the cost and revenue recognition accurately reflect the
actual production process and help in determining the true cost of goods sold and
profitability. Additionally, they assist in identifying areas where process improvements can be
made to minimize losses and maximize profits.

Costing for By-products and Equivalent Production:

Costing for by-products and equivalent production are accounting methods used in industries
where multiple products are produced simultaneously from a common set of inputs or
materials. These methods are particularly relevant in industries like manufacturing, chemical
processing, and agriculture where by-products are generated alongside the main products.
Here's an explanation of these concepts:
1. Costing for By-Products:
• Definition: By-products are secondary products that are produced incidentally or as a
result of the main production process. By-products often have value and can be sold, but they
are not the primary focus of production.
• Treatment:
• By-products are typically assigned a value based on their market price or realizable
value.
• The cost of producing the by-products is subtracted from their market value to
determine the net realizable value.
• Any net realizable value attributed to by-products is then deducted from the cost of
the main product, reducing the overall cost of production for the primary product.
Here's a simplified formula: Cost of Primary Product = Total Production Cost - Net
Realizable Value of By-Products
• Example: In a sawmill, lumber is the primary product, and sawdust is a by-product.
The cost of producing lumber is reduced by the value of the sawdust generated during the
process.
2. Equivalent Production:
• Definition: Equivalent production is a concept used in process costing to account for
the partially completed units in a production process. It's especially applicable when there are
units in progress at the end of an accounting period.
• Treatment:

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• Equivalent production represents the number of units that could have been completed
from the materials and effort expended during the period, considering units in progress.
• Equivalent production accounts for both completed and partially completed units by
converting them into equivalent units of production.
• This concept helps in allocating costs more accurately between completed and in-
progress units.
• Example: In a chocolate manufacturing process, if 90% of the chocolate bars are fully
completed during the month, and the remaining 10% are in progress (partially completed),
equivalent production calculations would consider the partially completed bars in terms of
their equivalent fully completed units.
Calculations for equivalent production may vary based on the specific industry and
circumstances, but they generally involve assessing the percentage of completion of units in
process and then using that percentage to determine equivalent fully completed units for cost
allocation purposes.
Both costing for by-products and equivalent production are important in ensuring that the
cost accounting accurately reflects the cost of the primary products and the value of any by-
products or in-progress units. These methods help organizations in cost allocation, pricing
decisions, and inventory valuation, ultimately contributing to better financial reporting and
decision-making.
Application of Managerial Costing for Control, Profit Planning, Closing down of a
Plant, Dropping a Product line:
Managerial costing plays a pivotal role in various aspects of business management, including
control, profit planning, and strategic decision-making. Here's how managerial costing is
applied in scenarios such as control, profit planning, closing down of a plant, and dropping a
product line:
1. Control:
• Application: Managerial costing provides real-time insights into cost variances,
helping management control costs effectively. By comparing actual costs to budgeted or
standard costs, managers can identify discrepancies and take corrective actions.
• Example: If the actual manufacturing cost for a product exceeds the budgeted cost,
cost control measures may be implemented. This could involve investigating the causes of the
cost overrun, optimizing production processes, or renegotiating supplier contracts to reduce
material costs.
2. Profit Planning:
• Application: Managerial costing is crucial for profit planning and budgeting. It helps
in setting realistic revenue and cost targets, which are essential for achieving profit goals.
• Example: When preparing an annual budget, managers use cost data to estimate the
cost of goods sold (COGS), operating expenses, and capital expenditures. These projections
help in determining the expected profit for the year and guide decision-making to ensure
profitability.
3. Closing down of a Plant:
• Application: Managerial costing provides the necessary information for evaluating the
financial viability of a plant or facility. It helps in assessing whether the costs of operating the
plant exceed the benefits, which is essential in deciding whether to close it down.

Strategic Cost and Management Accounting MBA I Year IISem (R22)

• Example: If the operating costs of a manufacturing plant significantly outweigh the
revenue generated by its products, managerial costing data can highlight the plant's financial
underperformance. Management can then make an informed decision about closing the plant
to reduce losses.
4. Dropping a Product Line:
• Application: Managerial costing assists in evaluating the profitability of individual
product lines. When deciding whether to drop a product line, managers assess whether the
contribution margin generated by the product covers its fixed and variable costs.
• Example: If a product line consistently reports negative contribution margins, it may
be a candidate for discontinuation. Managerial costing helps identify unprofitable product
lines and supports the decision to allocate resources to more profitable areas.
In each of these scenarios, managerial costing provides valuable insights into the financial
aspects of decision-making. It allows management to make informed choices that align with
the organization's objectives, whether that involves controlling costs, planning for
profitability, optimizing resource allocation, or streamlining operations. By applying
managerial costing effectively, organizations can enhance their financial performance and
competitiveness in the market.

Charging General and Specific Fixed Costs, Fixation of Selling Price, Make or Buy
Decisions, Key or Limiting Factor:

Charging General and Specific Fixed Costs, Fixation of Selling Price, Make or Buy
Decisions, and Key or Limiting Factor are important aspects of managerial accounting and
decision-making in various business situations. Let's explore each of these concepts:
1. Charging General and Specific Fixed Costs:
• General Fixed Costs: These are fixed costs that cannot be directly traced to a specific
product, department, or project. Examples include rent for a shared office space and salaries
of top management.
• Charging: General fixed costs are typically allocated to various cost centers or
products based on a suitable allocation method, such as square footage, headcount, or
revenue.
• Specific Fixed Costs: These are fixed costs that can be attributed to a particular
product, department, or project. Examples include depreciation of machinery used
exclusively for a specific product.
• Charging: Specific fixed costs are directly allocated to the product or department that
incurs them.
2. Fixation of Selling Price:
• Determining the selling price of a product or service involves considering various
factors, including production costs, market demand, competition, and profit margin goals.
• Common methods for fixing selling prices include cost-plus pricing (adding a markup
to the cost), target costing (setting a selling price based on a desired profit margin), and
market-based pricing (aligning prices with market conditions).
3. Make or Buy Decisions:
• Make or buy decisions involve evaluating whether to produce a component or product
in-house (make) or purchase it from an external supplier (buy).
• Factors to consider include the cost of in-house production, quality control, capacity,
lead times, and the availability of external suppliers.
4. Key or Limiting Factor:

Strategic Cost and Management Accounting MBA I Year IISem (R22)

• A key or limiting factor is a resource or constraint that limits the production or
profitability of a business. Common limiting factors include machine hours, labor availability,
raw material shortages, or storage capacity.
• Decision-making involving limiting factors focuses on optimizing the use of the
constrained resource to maximize profit.
Here's how these concepts may be applied in various scenarios:
• Scenario 1: Pricing a New Product: To determine the selling price of a new product, a
company considers its production costs (including both variable and specific fixed costs),
desired profit margin, and market demand. They ensure that the selling price covers all
relevant costs and generates the desired profit.
• Scenario 2: Make or Buy Decision: A manufacturing company is considering whether
to make a critical component in-house or buy it from a supplier. They compare the cost of in-
house production (including specific fixed costs) with the cost of purchasing from the
supplier. If in-house production is more cost-effective, they opt to make the component.
• Scenario 3: Allocating General Fixed Costs: An organization has shared
administrative staff and office space. General fixed costs, such as salaries and rent, are
allocated to different cost centers based on a suitable allocation base, such as headcount or
square footage.
• Scenario 4: Key Factor in Production: A bakery has limited oven capacity. To
maximize profitability, they use the available oven hours efficiently by producing the most
profitable products during peak demand times, taking the oven capacity as the key factor into
account.
Effective application of these concepts helps businesses optimize resource allocation, control
costs, set appropriate selling prices, and make informed decisions that contribute to
profitability and competitiveness in the market.

Selection of Suitable Product Mix, Desired level of Profits, Diversification of

Products, Closing down or Suspending activities:

The selection of a suitable product mix, desired level of profits, diversification of

products, and the decision to close down or suspend activities are important strategic
decisions that businesses make based on their goals, market conditions, and available
resources. Here's how these decisions are typically approached:
1. Selection of Suitable Product Mix:
• Definition: The product mix refers to the combination of products or services that a
company offers to its customers. It involves deciding which products to produce, how
much of each product to produce, and the pricing strategy for each product.
• Factors to Consider: When selecting a suitable product mix, companies consider
factors such as market demand, production capacity, profitability, competition, and
alignment with the company's core competencies.
2. Desired Level of Profits:
• Definition: Setting a desired level of profits involves establishing specific financial
targets, such as net income, return on investment (ROI), or profit margin, that the
company aims to achieve.
• Factors to Consider: Companies consider their financial goals, growth aspirations,
risk tolerance, and market conditions when determining the desired level of profits.
3. Diversification of Products:
• Definition: Product diversification involves expanding the range of products or
services offered by a company. It can include introducing new products, entering new

Strategic Cost and Management Accounting MBA I Year IISem (R22)

 markets, or targeting different customer segments.
• Factors to Consider: Companies diversify to reduce risk, tap into new revenue
streams, and leverage existing capabilities. They assess the potential market demand,
competitive landscape, and the cost and feasibility of diversification.
4. Closing Down or Suspending Activities:
• Definition: The decision to close down or suspend activities involves discontinuing
a business unit, product line, or project that is no longer viable or aligned with the
company's objectives.
• Factors to Consider: Companies evaluate factors such as profitability, market
demand, cost structures, resource allocation, and the potential for recovery before making
decisions to close or suspend activities.

Here's how these decisions may be approached in different scenarios:

• Scenario 1: Selection of Suitable Product Mix: A clothing retailer assesses
customer preferences, sales data, and production capacity to decide which clothing lines
to feature in the upcoming season. They consider factors like trends, profit margins, and
inventory management to determine the ideal product mix.
• Scenario 2: Desired Level of Profits: A tech startup sets a desired level of profits to
attract investors and fund expansion. They calculate the expected costs, revenue
projections, and investment requirements to determine the profit target necessary to
achieve their growth objectives.
• Scenario 3: Diversification of Products: An established food manufacturer explores
diversification by introducing a new line of organic, health-conscious snacks to appeal to
a different market segment. They conduct market research to assess demand and
competition in the healthy snack industry.
• Scenario 4: Closing Down or Suspending Activities: A retail chain evaluates the
performance of underperforming stores in less profitable locations. Based on financial
analysis and market trends, they decide to close down a few of these stores to reallocate
resources and improve overall profitability.
In all these scenarios, data analysis, financial modeling, market research, and strategic
planning play critical roles in making informed decisions that align with the company's
goals and objectives. Additionally, risk assessment and contingency planning are essential
when considering diversification or discontinuation of activities.

Strategic Cost and Management Accounting MBA I Year IISem (R22)