Process Costing:

Process costing is a method used to determine the cost of production in stages, typically applied in industries with
continuous production.

Method of costing used to find out the cost of the product in each process.

For eg. - if a product passes through 3 processes at that time we have a find out the cost

of each process.

Application of process costing:

Process costing method is adopted in the following types of Industries:

 Soap making

 Oil refining

 Biscuit manufactories

 Milk Dairies

 Textile Mils

Costing procedure in process costing:

1. Separate Process Account:

• Each stage of production gets its own account. So, if there are different steps in making a product,
each step has its own account.

2. Debit Side of Process Account:

• For each process:

• Material costs are recorded. This includes the cost of all materials used in that specific
process.

• Labor costs, like wages paid to workers for that process, are also recorded.

• Overhead expenses, such as utilities or rent for the space used in that process, are noted.

3. Credit Side of Process Account:

• If any scrap or waste is sold from a particular process, the money received from that sale is recorded
as a credit in the process account.
4. Cost of Process:

• To find out how much it costs to complete a process, you subtract the credits (like scrap sales) from
the debits (total expenses).

• The net cost gives you the total cost of that particular process.
Abnormal gain in process costing occurs when the actual output surpasses the expected output in a production
process due to unforeseen factors. This unexpected increase in output can have several implications for the
manufacturing process and the company as a whole.

Abnormal gain refers to the unexpected increase in the quantity or quality of output during a production process. It's
a positive deviation from the anticipated output level.

Abnormal gain can occur due to factors like improved efficiency, optimized processes, or better utilization of
resources, leading to higher-than-expected production.
Abnormal gain can have positive implications for the company, such as higher revenue, reduced production costs per
unit, and improved competitiveness in the market

Managers should analyze the reasons behind the abnormal gain to identify best practices, streamline processes
further, and capitalize on the favorable conditions to enhance overall performance and profitability.
Some Emerging concepts of cost accounting:

Traditional costing, while simple, often leads to mistakes in calculating product costs.

To fix this, new methods like target costing set a cost goal first and then work backward, adjusting expenses to meet
it.

Life Cycle Costing looks at all costs a product incurs from start to finish, helping to manage expenses better.

Benchmarking compares a company's costs with competitors to find areas needing improvement.

Activity Based Costing (ABC) links costs to specific activities, giving a clearer picture of what things really cost. These
new ways make it easier to understand costs and make smarter decisions.

Target costing

Target costing is like setting a goal for making a product or service.

Target costs are derived from target selling price is follows: Target cost or a product (or service) = Target Selling Price
Less Target Profits.

This method helps companies create products that customers want, at prices they can afford, while still making the
money the company needs. Basically, it's like working backward from the selling price to decide how much you can
afford to spend on making the product.

Designers and production teams use this target cost as a guide to make sure they stay within budget while creating
something people will buy. The main idea is that target costs are based on what the market wants, making them
more realistic and practical for businesses.

Steps involved

The following steps / stages are involved under target costing -

• Design and develop a product that customer desire.

• Determine the target price of the product based on customers’
• perceived value for it and competitive market price.
• Determine the desired profit margin.
• Derive target costs by detecting desired margin from target selling
• price.
• Perform value engineering to advice target cost.

Life Cycle Costing:

Meaning:

• Life Cycle costing is a method used to calculate the total cost of producing or owning a physical asset
throughout its economic life.

• It considers all costs associated with the product or asset from development to disposal.

• It's a crucial technique for sales forecasting, planning, and control, recognizing that products have
finite market lifespans.

Concept of Life Cycle Costing: a) Identifying Product Life Cycle and Estimating Production Units:

• Recognize the different phases a product goes through: Development, Introduction, Growth,
Maturity, and Decline.

• Estimate the number of units expected to be produced in each phase over the product's lifespan. b)
Estimating Costs:
 • Determine the costs associated with each phase of the product life cycle, including development,
production, marketing, and disposal.

• Consider both direct and indirect costs incurred during each phase. c) Determining Overage Cost of
Production:

• Calculate the average cost of production over the entire life cycle by dividing total costs by the
number of units produced.

Phases of Product Life Cycle:

Development: This initial phase involves significant investment in product development without any revenue
generation.

Introduction: The product is launched into the market, and efforts are focused on creating awareness among
potential consumers. Heavy expenditure on advertising and promotional activities to establish market presence.

Growth: Customers become more aware of the product, leading to increased sales and profitability. Production
scales up to meet rising demand, and revenue generation peaks.

Maturity: Demand stabilizes, resulting in consistent but possibly reduced profitability. Market saturation may prompt
product modifications or improvements to sustain demand.

Decline: Sales volume begins to decrease as market saturation is reached. Demand falls, leading to a decrease in
revenue and profitability, ultimately marking the end of the product's life cycle.

Benchmarking:

Meaning:

• Benchmarking is the process of setting targets based on best practices, whether financial or non-
financial.

• It involves continuously measuring products, services, or activities against the best levels of
performance both inside and outside the organization.

• Essentially, it's about comparing a company's activities with the best practices in the industry to
identify areas for improvement.

Steps: i) Collect Data and Establish Benchmarks:

• Gather relevant data from various departments or units.

• Establish benchmarks based on the best practices and communicate them to the relevant
departments. ii) Measure Actual Performance:

• Measure the actual performance of the company against the benchmarks set. iii) Analyse Variations
and Report:

• Analyse the reasons for variations between actual performance and benchmarks.

• Report findings to management for preventive and corrective actions. iv) Review and Set New
Targets:

• Review existing benchmarks and set new targets for continuous improvement.

Types of Benchmarking:

Strategic Benchmarking: Focuses on high-level aspects such as core competencies, new product development, and
adapting to changes in the external environment.
Performance or Competitive Benchmarking: Compares the company's products, processes, and results with those of
competitors, often through trade associations or third parties.

Process Benchmarking: Compares critical business processes and operations with best practices in the same field,
aiming to improve specific processes.

Functional or Generic Benchmarking: Involves benchmarking with partners from different sectors to improve similar
functions or work processes.

Internal Benchmarking: Seeks partners from within the same organization, such as different business units or
branches in different countries.

Global or International Benchmarking: Bridges differences in international culture, business processes, and trade
practices across companies to understand and utilize their implications for improvement.

External Benchmarking: Seeks assistance from outside organizations known for their best practices, providing
learning opportunities from industry leaders.

Activity-based costing (ABC)

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.

Imagine a company makes two products: A and B. Product A is complex and requires a lot of setup time for machines,
while Product B is simpler and requires less setup. Traditional costing methods might allocate the same overhead
cost (e.g., machine setup costs) to both products equally.

ABC is a more precise method that assigns overhead costs based on the activities required to produce each product.
So, Product A would be charged more for machine setup costs because it uses that activity more.

Key ABC Terms:

• Activity: A specific task or event that consumes resources (e.g., ordering materials, setting up machines,
inspecting products).

• Resource: Anything used to perform an activity (e.g., labor, machines, materials).

• Cost: The amount spent on resources used in an activity.

• Cost Object: The product or service for which you want to calculate the cost (e.g., Product A, Product B).

• Cost Pool: A group of similar costs associated with a particular activity (e.g., all costs related to machine
setup).

• Cost Driver: A factor that causes the cost of an activity to change (e.g., number of machine setups, number
of purchase orders).

Steps in ABC:

1. Identify Activities: List all the important activities involved in making your products or services.

2. Find Cost Drivers: Determine what factors influence the cost of each activity (e.g., number of setups for
machine setup activity).

3. Create Cost Pools: Group all the costs associated with each activity.

4. Calculate Overhead Rate: Divide the total cost in a cost pool by the cost driver to get a rate per unit of the
cost driver (e.g., total machine setup cost divided by number of setups).
 5. Assign Costs to Products: Multiply the overhead rate for each activity by the amount of that activity used by
each product (e.g., number of setups required for Product A x machine setup overhead rate). This gives you
the total overhead cost for each product.

Benefits of ABC:

• More accurate product costing.

• Better decision-making on pricing and product mix.

• Helps identify areas to improve efficiency and reduce costs.

Overall, ABC provides a more realistic picture of how much each product or service actually costs to produce.
Standard Costing:

Standard costing

Predetermined Costs: Standard costing involves setting predetermined costs for materials (quantity and price), labor
(hours and wage rate), and overhead (allocated cost per unit). These standards are based on historical data,
engineering estimates, and expected efficiency levels.

Comparison: Actual production costs are compared to these predetermined standard costs.

Variance Analysis: The core of standard costing is comparing actual costs to standard costs. This analysis identifies
variances (positive or negative differences) for material price and quantity, labor rate and efficiency, and overhead
spending.

Cost Control: Variances help pinpoint areas where production deviates from the plan. Positive material price
variances might indicate good purchasing deals, while negative variances could suggest higher material costs or
waste. Similarly, labor variances can reveal issues like worker inefficiency or changes in production methods.

Performance Evaluation: Measures how well production aligns with planned costs.

Inventory Valuation: Values inventory based on standard costs, simplifying accounting.

Decision Making: Provides a basis for pricing and product mix decisions.

Material Cost Variance (MCV)

Explanation in 6-7 points:

1. Overall Difference: MCV shows the total difference between the expected cost of materials for actual
production and the actual cost incurred. It reflects a gain or loss due to combined effects of price and
quantity variations.

2. Formula: MCV = (Standard Price x Actual Quantity) - (Actual Price x Actual Quantity)

3. Interpretation:

o Positive MCV indicates a gain, meaning material costs were lower than expected.

o Negative MCV indicates a loss, meaning material costs were higher than expected.

4. Causes: MCV can be caused by changes in both material price and usage. It doesn't pinpoint the specific
reason for the variance.

5. Further Analysis: MCV requires further breakdown into material price variance (MPV) and material usage
variance (MUV) to understand the root causes of the cost difference.
 6. Management Tool: MCV is a starting point for investigating material cost efficiency. It helps identify potential
areas for cost savings.

7. Decision Making: By understanding MCV, managers can make informed decisions about material purchasing
strategies, production processes, and pricing.

Material Price Variance (MPV)

Explanation in 6-7 points:

1. Price Impact: MPV isolates the difference in cost due to changes in the actual purchase price of materials
compared to the standard price.

2. Formula: MPV = (Actual Quantity x (Standard Price - Actual Price))

3. Interpretation:

o Positive MPV indicates a gain, meaning materials were purchased at a lower price than expected.

o Negative MPV indicates a loss, meaning materials were purchased at a higher price than expected.

4. Causes: MPV is influenced by factors like negotiation with suppliers, market fluctuations, and unexpected
price changes.

5. Responsibility: Purchasing department typically holds responsibility for managing MPV.

6. Cost Control: Analyzing MPV helps identify opportunities to improve material purchasing strategies and
negotiate better prices.

7. Performance Evaluation: By monitoring MPV, management can assess the effectiveness of the purchasing
department in securing favorable material prices.

Material Usage Variance (MUV)

Explanation in 6-7 points:

1. Quantity Impact: MUV isolates the difference in cost due to the variation between the actual quantity of
materials used and the standard quantity allowed for production.

2. Formula: MUV = (Standard Price x (Standard Quantity - Actual Quantity))

3. Interpretation:

o Positive MUV indicates a gain, meaning less material was used than expected (favorable variance).

o Negative MUV indicates a loss, meaning more material was used than expected (unfavorable
variance).

4. Causes: MUV can be caused by factors like production inefficiencies, material waste, spoilage, or inaccurate
estimates during standard setting.

5. Responsibility: Production department typically holds responsibility for managing MUV.

6. Cost Reduction: Analyzing MUV helps identify areas for improvement in production processes to minimize
material waste and optimize usage.

7. Process Improvement: By monitoring MUV, management can evaluate production efficiency and take
corrective actions to reduce material usage.

Material Mix Variance and Material Yield Variance

These variances help understand the reasons behind the total material usage variance. Let's break them down:

Material Mix Variance:

 • Concept: Explains the difference in cost due to changes in the proportion of different materials used
compared to the standard mix, even if the total quantity remains the same.

• Calculation:

1. Take the total actual quantity of materials used.

2. Apply the standard mix ratio to the actual quantity to get the expected quantity based on the
standard mix.

3. Compare the actual mix quantity with the expected mix quantity for each material.

4. Multiply the difference in quantity for each material by the standard price of that material.

5. Sum the product of price and quantity difference for all materials to get the material mix variance.

• Interpretation:

o Positive variance: Using a cheaper material mix than standard (favorable).

o Negative variance: Using a more expensive material mix than standard (unfavorable).

• Responsibility: Purchasing or production planning departments might be responsible for managing material
mix.

Material Yield Variance:

• Concept: Explains the difference in cost due to changes in the total quantity of materials used compared to
the standard quantity, even if the mix remains the same.

• Calculation: There are four methods for calculating yield variance:

1. Based on Input: Compare the total standard input quantity with the total actual input quantity.
Multiply the difference by the standard average cost per unit.

2. Based on Process Loss: Calculate the difference between standard process loss and actual process
loss based on the actual input quantity. Multiply this difference by the standard average cost per
unit of output.

3. Based on Yield/Output: Compare the standard output based on actual input quantity with
the actual output. Multiply the difference in output by the standard average cost per unit of output.

4. Based on Mix: Compare the standard mix based on actual input (developed for mix variance) with
the standard mix of standard input. Multiply the difference in quantity for each material by
the standard price and sum them for all materials.

• Interpretation:

o Positive variance: Less material used than expected for the output achieved (favorable).

o Negative variance: More material used than expected for the output achieved (unfavorable).

• Responsibility: Production department is typically responsible for managing material yield variance.
Labor Cost Variances Explained

Here's a breakdown of labor cost variances in 6-7 points each:

1. Total Labor Cost Variance (LVC):

• Concept: Shows the overall difference between the expected cost of labor for actual production and the
actual cost incurred.

• Formula: LCV = (Standard Labor Cost for Actual Output) - (Actual Labor Cost)

• Interpretation:

o Positive LCV: Favorable, meaning labor costs were lower than expected.

o Negative LCV: Unfavorable, meaning labor costs were higher than expected.

• Further Analysis: LCV needs to be broken down further to understand the specific reasons for the difference.

2. Labor Rate Variance (LRV):

• Concept: Isolates the difference in cost due to changes in the actual wage rate paid to workers compared to
the standard wage rate.

• Formula: LRV = (Actual Hours Worked x (Standard Rate - Actual Rate))

• Interpretation:

o Positive LRV: Favorable, meaning workers were paid a lower wage than expected.

o Negative LRV: Unfavorable, meaning workers were paid a higher wage than expected.

• Causes: Negotiations with unions, employee raises, or errors in setting standard rates.

• Responsibility: Human resources or payroll department might be responsible for managing LRV.

3. Labor Efficiency Variance (LEV):

• Concept: Isolates the difference in cost due to variations between the actual hours worked and the standard
hours allowed for production.

• Formula: LEV = (Standard Wage Rate x (Standard Hours - Actual Hours (excluding idle time)))

• Interpretation:

o Positive LEV: Favorable, meaning less labor was used than expected (fewer hours worked).

o Negative LEV: Unfavorable, meaning more labor was used than expected (more hours worked).

• Causes: Inefficiencies in production processes, worker training issues, or inaccurate standard setting.

• Responsibility: Production department is typically responsible for managing LEV.

Marginal Costing:

1. Marginal Cost Definition: Marginal costing focuses on the cost of producing one additional unit of a product
or service. It tells us how much more it costs to make one more item. Imagine you're baking cookies, and you
want to know how much extra it costs to bake just one more cookie – that's your marginal cost.

2. Variable Costs: In marginal costing, we only consider variable costs. Variable costs are expenses that change
in direct proportion to the level of production. These include things like raw materials, direct labor, and
variable overheads. For example, if you're making more cookies, you'll need more flour and sugar – those are
variable costs.

3. Fixed Costs: Unlike variable costs, fixed costs don't change with production levels in the short run. Examples
include rent, salaries of permanent staff, and insurance premiums. However, in marginal costing, fixed costs
are treated differently. They are considered as period costs and are not allocated to products. Instead, they
are deducted from the contribution earned in the period.

4. Contribution Margin: In marginal costing, we calculate something called the contribution margin. It's the
difference between the sales revenue generated by a product and its variable costs. Think of it as the money
left over to cover fixed costs and provide profit after variable costs are covered.

5. Treatment of Fixed Costs: Under marginal costing, fixed costs are not directly assigned to products. Instead,
they are treated as costs of the period and are subtracted from the total contribution to find the profit. This
approach helps in decision-making by showing how much each product contributes to covering fixed costs
and making a profit.

6. Flexibility in Decision Making: Marginal costing provides managers with useful information for decision-
making. By focusing on the marginal costs of producing additional units, managers can make decisions about
pricing, production levels, and product mix more effectively. It helps them understand the impact of their
decisions on profitability.

In summary, marginal costing simplifies cost analysis by focusing on variable costs and contribution margin, which
helps in making better decisions regarding pricing, production, and profitability.

Absorption cost:

1. Total Cost Approach: Absorption costing considers both variable and fixed costs in calculating the total cost
of producing a product.

2. Fixed Costs as Product Costs: Unlike marginal costing, absorption costing treats fixed costs as part of the
product cost, allocating them to each unit produced.

3. Inventory Valuation: The cost of a finished unit in inventory includes direct materials, direct labor, and both
variable and fixed manufacturing overhead.

4. Alternative Names: Absorption costing is also known as full costing or full absorption method.
Advantages of marginal costing:

1. Simple Pricing Decisions: Marginal costing provides a clear picture of the variable cost per unit, making it
easier for companies to set prices. Since this cost remains consistent over short periods, pricing decisions can
be made swiftly.

2. Effective Overhead Recovery: Unlike traditional costing methods, marginal costing doesn't allocate fixed
overhead costs to products. This eliminates the problem of under or over-recovery of overheads, ensuring
more accurate cost allocation.

3. Accurate Profit Calculation: Marginal costing considers only variable costs when valuing inventory, while
fixed expenses are treated as period costs. This approach provides a more realistic view of the profit earned
in a given period.

4. Production Planning: Marginal costing facilitates break-even analysis, which helps companies determine the
level of production needed to cover costs and generate profit. This assists in making informed decisions
about production levels.

5. Decision Making Support: Marginal costing aids management in various business decisions such as whether
to manufacture a product internally or outsource it, discontinuing unprofitable products, or upgrading
machinery. By focusing on variable costs, it provides insights into the financial implications of these decisions.
Profit-volume ratio:

1. Understanding Marginal Costing: Marginal costing helps businesses understand how changes in the volume
and type of output affect both costs and profits. It focuses on identifying the impact of these changes on the
bottom line.

2. What is Profit-Volume Ratio?: Profit-volume ratio, also known as contribution margin ratio, measures the
relationship between the contribution margin (the difference between sales revenue and variable costs) and
sales volume. In simpler terms, it shows how changes in sales volume affect profits.

3. Impact of Output Changes: The profit-volume ratio helps in understanding how changes in the quantity of
goods or services sold impact profits. For example, if sales increase, the profit volume ratio helps predict how
much the profit will increase.

4. Calculating Profit-Volume Ratio: The profit-volume ratio is calculated by dividing the contribution margin by
the total sales revenue. This ratio indicates the portion of each sale that contributes to covering fixed costs
and generating profit.

5. Interpreting Profit-Volume Ratio: A higher profit-volume ratio means that a larger proportion of each sale
contributes to covering fixed costs and generating profit. Conversely, a lower ratio indicates that less of each
sale contributes to profitability.

6. Decision Making: Understanding the profit-volume ratio helps businesses make informed decisions about
pricing strategies, production levels, and sales targets. It allows them to predict how changes in sales volume
will impact their overall profitability.

Break-even point:

1. Definition of Break-Even Point (BEP): The break-even point is the point at which a business neither makes a
profit nor incurs a loss. It's the stage where total revenue equals total costs, including both fixed and variable
costs.

2. Balancing Income and Costs: At the break-even point, the total sales revenue generated by selling a certain
quantity of products or services exactly covers all the costs incurred in producing and selling those products
or services. This includes both the fixed costs (like rent, salaries) and variable costs (like raw materials, labor).

3. No Profit, No Loss Situation: Since total revenue equals total costs at the break-even point, there is neither a
profit nor a loss. In other words, the business is just covering its costs without making any additional income.

4. Importance in Decision Making: Calculating the break-even point helps businesses understand the minimum
level of sales required to cover their costs. It provides valuable insights into pricing strategies, production
levels, and sales targets.

5. Break-Even Analysis: Businesses often conduct break-even analysis to determine how changes in sales
volume, pricing, or costs affect their profitability. By identifying the break-even point, they can make
informed decisions to achieve profitability and manage risks.

6. Visual Representation: The break-even point is often depicted graphically on a break-even chart. This chart
shows the relationship between sales volume, costs, and profits, making it easier for businesses to visualize
their financial position and plan accordingly.