ASSIGNMENT SOLUTIONS GUIDE (2020-2021)

MCO-05: ACCOUNTING FOR MANAGERIAL DECISIONS

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Q1. (a) The elements of cost can be presented in the form of a statement called ‘Cost Sheet’. Comment.
Prepare a proforma of cost sheet showing the important components.
Ans. A cost sheet is a statement that shows the various components of total cost for a product and shows
previous data for comparison. You can deduce the ideal selling price of a product based on the cost sheet.
A cost sheet document can be prepared either by using historical cost or by referring to estimated costs. A
historical cost sheet is prepared based on the actual cost incurred for a product. An estimated cost sheet,
on the other hand, is prepared based on estimated cost just before the production begins.
Importance of cost sheet: Cost sheets help with a number of essential business processes:
• Determining cost: The main objective of the cost sheet is to obtain an accurate product cost. It
gives you both the total cost and cost per unit of a product.
• Fixing selling price: In order to fix the selling price of a product, you need to create a cost sheet
so you can see the details of its production cost.
• Cost comparison: It helps the management compare the current cost of a product with a previous
per unit cost for the same product. Comparing the costs helps management take corrective
measures if costs have increased.
• Cost control: The cost sheet is an important document for a manufacturing unit, as it helps in
controlling production costs. Using an estimated cost sheet aids in monitoring labour, material
and overhead costs at each step of production.
• Decision-making: Some of the most important decisions management makes are based on the
cost sheet. Whenever a business needs to produce or buy a component, or quote prices for its
goods on a tender, managers refer to the cost sheet.
Types of cost: Costs are broadly classified into four types: fixed cost, variable cost, direct cost, and
indirect cost.
• Fixed cost: These are costs that do not change based on the number of items produced. For
example, the depreciating value of a building or the price of a piece of equipment.
• Variable cost: These costs are tied to a company’s level of production. For example, a
bakery spends $10 on labor and $5 on raw materials to produce each cake. The variable cost
changes based on the number of cakes the company bakes.
 •Operating costs: These are those expenses incurred by an organisation to maintain the product
on a day to day basis. Traveling cost, telephone expenses, office supplies are some of things that
come under operating costs.
• Direct costs: These costs can be directly associated with production. For example, if a furniture
manufacturing company takes five days to produce a couch, then the direct cost of the finished
product includes the raw material cost and labor charges for five days.
Components of total cost: Components of total cost are constituted mainly of prime cost, factory cost,
office cost and cost of sales. Let us take a detailed look at each of these elements:
1. Prime cost: This comprises direct material, direct wages, and direct expenses. It is also called basic cost,
first cost, or flat cost. It can be defined as an aggregate of the price of the material consumed, the wages
involved in production, and the direct expenses.
Prime cost = Direct material + Direct wages + Direct expenses: Direct material cost usually refers to the
cost of raw materials used or consumed during a given period. To calculate the amount of raw
material actually consumed during a given period, you add the opening stock and the amount of material
purchased, and deduct the closing stock. Here is the formula for material consumed:
Material consumed = Material purchased + Opening stock of material – Closing stock of material
2. Factory cost: This is made up of prime cost plus factory overhead, which includes indirect wages,
indirect material and indirect expenses. Factory cost is also known as works cost, production cost, or
manufacturing cost.
Factory cost = Prime cost + Factory overhead
3. Office cost: This is also called administration cost or total cost of production. Office cost is equal
to factory cost plus office and administration overhead.
4. Total cost or cost of sales: This is the sum of the total cost of production and the total of selling and
distribution overhead.
Total cost = Cost of goods sold + Selling and distribution overhead: In the production process, some
units of a product are scheduled to be finished at the end of a period. Such incomplete units are called
work-in-progress. In such situations, while calculating the factory cost of a product unit, it is necessary to
make adjustment for opening and closing stock to arrive at net factory cost of the product. Generally, the
cost of these unfinished units include direct material, direct expenses, and factory overheads.
Besides this, the adjustments for inventories need to be made in the following manner
1. Direct material consumed = Opening stock of direct material + Purchases of direct material – Closing
stock of direct
2. Works cost = Gross works cost + Opening work in progress – Closing work in progress
3. Cost of production of goods sold = Cost of production + Opening stock of finished goods – closing
stock of finished goods
(b) Briefly explain the issues addressed under Strategic Cost Management.
Ans. Strategic Cost Management or otherwise called as SCM is the cost management technique that aims
at reducing costs while strengthening the position of the business. It is a process of combining the
decision-making structure with the cost information, in order to reinforce the business strategy as a
whole. It measures and manages costs to align the same with the company’s business strategy.
Stages of Strategic Cost Management

 Formulating Strategies
 Communication of Strategies in the entire organization.
 Planning and Carrying out tactics, to execute those strategies.
 Developing and implementing controls to track the success.
In Strategic Cost Management (SCM), primary importance is given to constant improvement in the
product to provide better quality to its target customers. It is an essential part of the value chain that
covers every facet such as purchase, design, production, sales and service.
Need for SCM
1. It is an updated form of cost analysis, in which the strategic elements are more clear and formal
and improves the overall position of the company.
2. It is used to analyse cost information, and use it to develop various measures to achieve a
sustainable competitive advantage.
3. It provides a better understanding of the overall cost structure in the quest of gaining a
sustainable competitive advantage.
4. It uses cost information specifically to govern the strategic management process – formulation,
communication, implementation and control.
5. It helps in identifying the cost relationship between value chain activities and its process of
management to gain competitive advantage.
The strategic cost management must be implemented at the initial stages of production, so as to reduce
heavy cost failure.
Components of Strategic Cost Management: There are three important components of strategic cost
management:
 1. Strategic Positioning Analysis: It determines the company’s comparative position in the
industry in terms of performance.
2. Cost Driver Analysis: Cost is driven by different interrelated factors. In strategic cost
management, the cost driver is divided into two categories, i.e. structural cost drivers and
executional cost drivers. It examines, measures and explains the financial effect of the cost driver
concerned with the activity.
3. Value Chain Analysis: The process in which a firm recognizes and analyses, all the activities and
functions that contribute to the final product. It was propounded by Michael Porter (1985), to
show the way a customer value assembles along the activity chain that results in the final product
or service.
In a nutshell, strategic cost management is not just about controlling the costs but also uses the
information for managerial decision making. The fundamental objective of strategic cost management
(SCM) is to gain a sustainable competitive advantage by way of product differentiation and cost
leadership.

Q2. (a) Differentiate between fixed and flexible budgeting.

Ans. Difference between Fixed Budget and Flexible Budget
Fixed Budget Flexible Budget
Fixed budget is inflexible and Flexible budget can be suitably
does not change with the actual recasted quickly according to level of
volume of output achieved. activity attained.
Fixed budget assumes that Flexible budget is design to change according to changed
conditions would remain static. conditions.
Costs are not classified Coasts are classified according to the nature of their variability.
according to their variability
i.e. fixed, variable and semi
variable.
Comparison of actual and Comparisons are realistic as the changed plan figures are placed
budgeted performance cannot against actual ones.
be done correctly if the volume
of output differs.
It is difficult o forecast Flexible budget clearly shows the impact of various expenses on
accurately the results in it. the operational aspects of the business.
Only one budget at a fixed Series of budgets are prepared at different level of activities.
level of activity is prepared due
to an unrealistic expectation on
the part of the management
Fixed budget has a limited Flexible budget has more application and can be used as a tool
application and is inefficient as for cost control.
a tool for cost control.
If the budgeted and actual Flexible budget helps in fixation of prices and submission of
activity levels vary, the correct tenders due to correct ascertainment of coasts.
ascertainment os coasts and
fixation of prices becomes
difficult.
(b) Define budgeting and budgetary control. What are the essentials of establishment of Budgeting
system?
Ans. A budget is an instrument of management used as an aid in the planning, programming and control
of business activity. A budget may be defined as a financial and/or quantitative statement, prepared and
approved prior to a defined period of time, of the policy to be pursued during that period for the purpose
of attaining a given objective. It may include income, expenditure and employment of capital.
Based upon this definition, a recreation budget of a person for one fine evening may look as:

The budget is a statement showing the way the person plans to spend Rs. 121.50.
Thus budget is a written plan of action. A budget is used for cost control purposes and it is one of the
most important overall control devices employed by management. A budget represents the financial
requirements of different sections of the business during a given period to achieve an estimated profit
based upon a given volume of sales.
A budget is based upon past statistical data and it predicts the estimated labour, sales, production and
other management requirements for future, i.e., for a definite budgetary period (of time). A budget can be
thought of as an overall plan for the operation of the business in terms of sales, production and
expenditures. Thus budget acts as a coordinating device among the various functions of the business.
Definition and Concept of Budgetary Control: Budgetary control makes use of budgets for planning and
controlling all aspects of producing and/ or selling products or services. Budgetary control attempts to
show the plans in financial terms. Budgetary control is the planning in advance of the various functions
of a business so that the business can be controlled. Budgetary control relates expenditure to a section or
department who incurs the expenditure, so that the actual expenses can be compared with the budgeted
ones, thus providing a convenient method of control.
Q3. Prepare a Cash Flow statement from the following balance sheet of ABC Sugars Ltd.

Total interest paid during the year amounted to Rs. 37,800

Q4. (a) What do you understand by Standard Costing? Explain the advantages and limitations of
Standard Costing.
Ans. Standard costing is the practice of estimating the expense of a production process. It's a branch of
cost accounting that's used by a manufacturer, for example, to plan their costs for the coming year on
various expenses such as direct material, direct labor or overhead. These manufacturers will also be able
to compare the standard cost to the actual costs.
The difference between the standard cost and actual cost is known as a variance. The presence of a
variance indicates a deviation from what was recorded in the profit plan. If actual costs are greater than
standard costs, it's likely that management can anticipate a lower profit than expected. If actual costs are
less than standard costs, however, management might anticipate a higher profit than they originally
planned for.
Five of the benefits that result from a business using a standard cost system are:
• Improved cost control.
• More useful information for managerial planning and decision making.
• More reasonable and easier inventory measurements.
• Cost savings in record-keeping.
• Possible reductions in production costs.
Improved cost control: Companies can gain greater cost control by setting standards for each type of cost
incurred and then highlighting exceptions or variances—instances where things did not go as planned.
Variances provide a starting point for judging the effectiveness of managers in controlling the costs for
which they are held responsible.
Assume, for example, that in a production center, actual direct materials costs of $ 52,015 exceeded
standard costs by $ 6,015. Knowing that actual direct materials costs exceeded standard costs by $ 6,015 is
more useful than merely knowing the actual direct materials costs amounted to $ 52,015. Now the firm
can investigate the cause of the excess of actual costs over standard costs and take action.
Further investigation should reveal whether the exception or variance was caused by the inefficient use of
materials or resulted from higher prices due to inflation or inefficient purchasing. In either case, the
standard cost system acts as an early warning system by highlighting a potential hazard for management.
More useful information for managerial planning and decision making: When management develops
appropriate cost standards and succeeds in controlling production costs, future actual costs should be
close to the standard. As a result, management can use standard costs in preparing more accurate
budgets and in estimating costs for bidding on jobs. A standard cost system can be valuable for top
management in planning and decision making.
More reasonable and easier inventory measurements: A standard cost system provides easier inventory
valuation than an actual cost system. Under an actual cost system, unit costs for batches of identical
products may differ widely. For example, this variation can occur because of a machine malfunction
during the production of a given batch that increases the labor and overhead charged to that batch.
Under a standard cost system, the company would not include such unusual costs in inventory. Rather, it
would charge these excess costs to variance accounts after comparing actual costs to standard costs.
Thus, in a standard cost system, a company assumes that all units of a given product produced during a
particular time period have the same unit cost. Logically, identical physical units produced in a given
time period should be recorded at the same cost.
Cost savings in record-keeping: Although a standard cost system may seem to require more detailed
record-keeping during the accounting period than an actual cost system, the reverse is true. For example,
a system that accumulates only actual costs shows cost flows between inventory accounts and eventually
into cost of goods sold. It records these varying amounts of actual unit costs that must be calculated
during the period. In a standard cost system, a company shows the cost flows between inventory
accounts and into cost of goods sold at consistent standard amounts during the period. It needs no special
calculations to determine actual unit costs during the period. Instead, companies may print standard cost
sheets in advance showing standard quantities and standard unit costs for the materials, labor, and
overhead needed to produce a certain product.
Possible reductions in production costs: A standard cost system may lead to cost savings. The use of
standard costs may cause employees to become more cost conscious and to seek improved methods of
completing their tasks. Only when employees become active in reducing costs can companies really
become successful in cost control.
Three of the disadvantages that result from a business using standard costs are:
 • Controversial materiality limits for variances.
• Nonreporting of certain variances.
• Low morale for some workers.
Controversial materiality limits for variances: Determining the materiality limits of the variances may be
controversial. The management of each business has the responsibility for determining what constitutes a
material or unusual variance. Because materiality involves individual judgment, many problems or
conflicts may arise in setting materiality limits.
Nonreporting of certain variances: Workers do not always report all exceptions or variances. If
management only investigates unusual variances, workers may not report negative exceptions to the
budget or may try to minimize these exceptions to conceal inefficiency. Workers who succeed in hiding
variances diminish the effectiveness of budgeting.
Low morale for some workers: The management by exception approach focuses on the unusual
variances. Management often focuses on unfavorable variances while ignoring favorable variances.
Workers might believe that poor performance gets attention while good performance is ignored. As a
result, the morale of these workers may suffer.
Meaning of Budget: The word Budget is derived from a French term `Bougette’ which denotes a leather
pouch in which funds are appropriated for meeting anticipated expenses. The same meaning applies to
the business management. A ‘budget’ is a quantitative expression of plan of action.
In another words, a budget is a numerical statement expressing the plans, policies and goals of the
enterprise for a definite period in the future. It is a plan, laying down the targets to be achieved within a
specified period. When a forecast a reduced into black and white and approved by the management as a
sort of commitment, it becomes a budget. The essentials of an effective budget is given below:
Essentials of Effective Budgeting System:
(1) Support of Top Management: The whole system should enjoy the support and co-operation of top
management.
(2) Efficient Organization: There should be well-planned organizational set-up with responsibility and
authority clearly demarcated.
(3) Accurate Accounting System: There should be a good accounting system which provides accurate
and timely information.
(4) Well defined Policies: The business policies of the firm should be well conceived, explained and
implemented.
(5) Constant Vigilance: Variations should be reported promptly and clearly to the appropriate levels of
management
(6) Motivation: Staff should be strongly and properly motivated towards the system.
(7) Proper Feedback: Budgets have no meaning unless they lead to control action as a consequence of
feedback provided.
(8) Logical Sequence: The budgetary control system should have a logical sequence. Having regard to the
main objectives of the company, targets agreed upon have to be given a proper shape and linked up to
form the master budget.
(9) Budget Education: Every functionary in budgetary control system should be taught basic principles of
budgetary control system. All line executives should accept the philosophy of budgetary control and
should be emotionally involved in achieving the company’s objectives and progress.

(b) What is Break Even analysis? Explain the different methods of computing break-even point?
Ans. A break-even analysis is a useful tool for determining at what point your company, or a new
product or service, will be profitable. Put another way, it’s a financial calculation used to determine the
number of products or services you need to sell to at least cover your costs. When you’ve broken even,
you are neither losing money nor making money, but all your costs have been covered.
For example, a break-even analysis could help you determine how many cell phone cases you need to sell
to cover your warehousing costs. Or how many hours of service you need to sell to pay for your office
space. Anything you sell beyond your break-even point will add profit.
There are a few definitions you need to know in order to understand break-even analysis.
• Fixed Costs: Expenses that stay the same no matter how much you sell.
• Variable Costs: Expenses that fluctuate up and down with sales.
So the Minnesota Kayak Company has these awesome new kayaks they are going to introduce to the
market. They are a new company and need help in determining pricing, costs and how many kayaks they
will need to sell in a month to break even. They are looking to you to help them determine if the selling
price and costs will help them to reach their goals. They give you the following information to work with:
Q5. Calculate the following ratios from the details given below:
a) Current ratio
b) Quick ratio
c) Operating ratio
d) Gross profit ratio
Details:
Current assets: Rs.70,000
Net working capital: Rs. 30,000
Inventories: Rs. 30,000
Sales: Rs. 1,40,000
Cost of goods sold: Rs. 68,000
Ans. Same as question with answer: