Q.1 Describe the marginal costing with its assumptions.

The Institute of Cost and Management Accountants, London, has defined Marginal 
Costing as “the ascertainment of marginal costs and of the effect on profit of 
changes in volume or type of output by differentiating between fixed costs and 
variable costs”. 

Assumptions of Marginal Costing: 

The technique of marginal costing is based upon the following assumptions: 

a. All elements of cost—production, administration, and selling and distribution—can 

be segregated into fixed and variable components. 
In this technique of costing only variable costs are charged to operations, processes, 
or products, leaving all indirect costs to be written off against profits in the period in 
which they arise. 

b. All elements of cost—production, administration, and selling and distribution are 

classified into variable and fixed components. Even semi-variable costs are analyzed 
into fixed and variable. 

c. The variable costs (marginal costs) are regarded as the costs of the products. 

d. Fixed costs are treated as period costs and are charged to profit and loss account 
for the period for which they are incurred. 

e. The stocks of finished goods and work-in-process are valued at marginal costs 
only. 

f. Prices are determined on the basis of marginal cost by adding ‘contribution’ which 
is the excess of sales or selling price over marginal cost of sales. 

Q.2 Explain the following terms in relation to marginal costing? 

a) Contribution:- contribution is the difference between sales and variable cost or 
marginal cost of sales. It may also be defined as the excess of selling price over 
variable cost per unit. The contribution is also known as Contribution Margin or 
Gross Margin. Contribution being the excess of sales over variable cost is the 
amount that is contributed towards fixed expenses and profit. 
for example 
If the selling price of a product is Rs. 20/- per unit and its variable cost is Rs. 15/- per 
unit, contribution per unit is Rs. 5/- (i.e. Rs. 20-15). Further, let us say that the fixed 
expenses are 50,000 and the total number of units sold is 8,000. This means that the 
total contribution is 8000 × 5 or Rs. 40,000 which is not sufficient even to meet the 
fixed expenses and the result is a loss of Rs. 10,000 (50,000 – 40,000). 

In case, the output is 10,000 units, then the total contribution of Rs. 50,000 equals 
the fixed cost, and no amount is left for profit. The profit can be earned only when 
the amount of contribution exceeds the fixed costs. 

b) The margin of safety:- reak-even point (BEP) is the level of sales where a total of 
fixed and variable cost equals total revenues. In other words, the breakeven point is a 
level where the company neither makes profit nor loss. 

A margin of safety (MoS) is a difference between actual/budgeted sales and the 

level of breakeven sales. Although the breakeven point (level) and margin of safety 
fall under the broad domain of cost-volume-profit analysis (CVP Analysis), they differ 
in various aspects. Main points of difference between the breakeven point and 
margin of safety areas listed below: 

The breakeven point means a number of sales that covers entire fixed and variable 
cost. Sales lower than the BEP will result in losses, while, the sales above the BEP 
will generate profit after considering all the costs. 

As the name suggests, the Margin of Safety is the margin between the 
actual/budgeted sales and breakeven point. It denotes the level of safety that the 
company enjoys before incurring losses (i.e. falling below the breakeven level). 
c) P/V ratio:- Meaning of P/V Ratio: 
The ratio that shows the relationship between ‘he value of sales and contribution is 
called P/V Ratio. A more appropriate term might be the Contribution/Sales Ratio. 
This is often expressed as a percentage and calculated as follows: 
When total sales and total costs [without break up for fixed and variable 
components] are given for two periods of activity, the following formula may be used 
to calculate the P/V Ratio: 
Where, Sales – Total Costs = Profits 

d) BEP :- Break-even Point: 

Break-Even Point is the level of sales required to reach a position of no profit, no 
loss. At Break-Even Point, the contribution is just sufficient to cover the fixed cost. 
The organization starts earning a profit when the sales cross the Break-Even Point. 
Break-Even Point can be calculated either in terms of units or in terms of cash or in 
terms of capacity utilization. It can be calculated as follows: 
BEP in units = Fixed Cost / Contribution per unit 
BEP in cash = Fixed Cost / P.V. Ratio 
BEP in terms of capacity utilization = (BEP in units / Total capacity) x 100 

Q.3 What do you mean by CVP analysis? Draw a break-even chart with imaginary 
figures and show all the important components. 

Cost-volume-profit (CVP) analysis is a method of cost accounting that looks at the 

impact that varying levels of costs and volume have on operating profit. The 
cost-volume-profit analysis, also commonly known as a break-even analysis, looks to 
determine the break-even point for different sales volumes and cost structures, 
which can be useful for managers making short-term economic decisions. 
The cost-volume-profit analysis makes several assumptions, including that the sales 
price, fixed costs, and variable cost per unit are constant. Running this analysis 
involves using several equations for the price, cost, and other variables, then plotting 
them out on an economic graph. 

Q.4 Stale briefly the effect of the following on break-even point and profit- volume 
ratio. 

i) reduction in variable cost ratio:- 

If there is a reduction in price per unit, it will decrease the P/V ratio, increase the 
breakeven point, and shorten the margin of safety. (ii) There is an increase in variable 
cost per unit, it will decrease the P/V ratio, increase the breakeven point, and shorten 
the margin of safety. 

ii) increase in total fixed cost:- As the total number of units of the good produced 
increases, the average fixed cost decreases because the same amount of fixed 
costs is being spread over a larger number of units of output. Cost of production that 
does not change with changes in the quantity of output produced by a firm in the 
short run. 

i) increase in the price of the product:- Increasing pricing on products is a result of 
various things – such as increased costs, additional services, improved quality, etc. 
When a company decides to hike their prices, we found that it stemmed from either 
two things: costs increased or they had their economics wrong in the first place 

Q.5 CVP analysis can be used as a tool to profit planning'. Explain 

Cost-Volume-Profit Analysis is a method used for analyzing how various operating 

decisions and marketing decisions will affect profit. This planning tool analyzes the 
effects of changes in volume, sales mix, selling price, a variable expense, fixed 
expense, and profit. The CVP analysis is often referred to as the break-even analysis. 
It is a simple model that assumes sales volume is the primary cost driver. The CVP 
analysis can be used to find the desired profit in revenue and planning. 
Revenue planning is used to determine the level of revenue required to achieve the 
desired profit level. If a company wants to know the sales volume needed to achieve 
$65000 a year in profits, they can use the CVP analysis. The formula used to obtain 
the answer is, units sold= fixed costs + profit/ unit selling price — unit variable cost. 
This will give the company the number of units they must sell in order to achieve the 
profit they desire. 

Q.6 Define budget, budgeting & budgetary control. Give the advantages & limitations 
of budgetary control 

Budgeting is a process of looking at a business's estimated incomes (the money that 

comes into the business from selling products and services) and expenditures (the 
money that goes out form paying expenses and bills) over a specific period in the 
future. 

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. 

Advantages of Budgetary Control 

Budgetary control has become an important tool for an organization to control costs 
and to maximize profits. Some of the advantages of budgetary control are: 

1. It defines the goals, plans, and policies of the enterprise. If there is no definite aim 
then the efforts will be wasted in achieving some other aims. 
2. 2. Budgetary control fixes targets. Each and every department is forced to work 
efficiently to reach the target. Thus, it is an effective method of controlling the 
activities of various departments of a business unit. 

3. It secures better co-ordination among various departments. 

4. In case the performance is below expectations, budgetary control helps the 

management in finding up the responsibility. 

5. It helps in reducing the cost of production by eliminating the wasteful expenditure. 

6. By promoting cost consciousness among the employees, budgetary control brings 

in efficiency and economy. 

7. Budgetary control facilitates centralized control with decentralized activity. 

8. As everything is planned and provided in advance, it helps in the smooth running 
of business enterprises. 

9. It tells the management as to where the action is required for solving problems 
without delay 

Disadvantages or Limitations of Budgetary Control 

The following are the limitations of budgetary control: 

1. It is really difficult to prepare the budgets accurately under inflationary conditions. 

2. The budget involves a heavy expenditure which small business concerns cannot 
afford. 

3. Budgets are prepared for the future period which is always uncertain. In the future, 
conditions may change which will upset the budgets. Thus, future uncertainties 
minimize the utility of a budgetary control system. 

4. Budgetary control is only a management tool. It cannot replace management in 

decision-making because it is not a substitute for management. 

5. The success of budgetary control depends upon the support of the top 
management. If there is a lack of support from top management, then this will fail. 

07 Give the differences between fixed and flexible budgets. Which is better and why? 

A fixed budget is a budget that doesn't change due to any change in activity level or 
output level. The flexible budget is a budget that changes as per the activity level or 
production of units. The fixed budget is static and doesn't change at all. ... Flexible 
budget, on the other hand, is semi-variable. 

The flexible budget is good for comparison because it is helpful to show the change 
which affects the organization's performance. The fixed budget is not able to 
forecast accurately because some factors do not remain the same. The fixed budget 
is able to forecast accurately because the budget adapts the changes frequently. 

Q.8 Classify the various types of budgets and explain any four of them 
. 
1. Master Budget 
A master budget is an aggregate of a company's individual budgets designed to 
present a complete picture of its financial activity and health. The master budget 
combines factors like sales, operating expenses, assets, and income streams to 
allow companies to establish goals and evaluate their overall performance, as well 
as that of individual cost centers within the organization. Master budgets are often 
used in larger companies to keep all individual managers aligned. 

2. Operating Budget 
An operating budget is a forecast and analysis of projected income and expenses 
over the course of a specified time period. 

To create an accurate picture, operating budgets must account for factors such as 
sales, production, labor costs, materials costs, overhead, manufacturing costs, and 
administrative expenses. Operating budgets are generally created on a weekly, 
monthly, or yearly basis. A manager might compare these reports month after month 
to see if a company is overspending on supplies. 

3. Cash Flow Budget 

A cash flow budget is a means of projecting how and when cash comes in and flows 
out of a business within a specified time period. It can be useful in helping a 
company determine whether it's managing its cash wisely. 

Cash flow budgets consider factors such as accounts payable and accounts 
receivable to assess whether a company has ample cash on hand to continue 
operating, the extent to which it is using its cash productively, and its likelihood of 
generating cash in the near future. A construction company, for example, might use 
its cash flow budget to determine whether it can start a new building project before 
getting paid for the work it has in progress. 

4. Financial Budget 
A financial budget presents a company's strategy for managing its assets, cash flow, 
income, and expenses. A financial budget is used to establish a picture of a 
company's financial health and present a comprehensive overview of its spending 
relative to revenues from core operations. 

A software company, for instance, might use its financial budget to determine its 
value in the context of a public stock offering or merger. 

5. Static Budget 
A static budget, unlike a flexible budget, is a fixed budget that remains unaltered 
regardless of changes in factors such as sales volume or revenue. A plumbing 
supply company, for example, might have a static budget in place each year for 
warehousing and storage, regardless of how much inventory it moves in and out due 
to increased or decreased sales. 

Q9 Write a short note on "Cash Budget" along with its methods of preparation 
the cash budget is the finance budget? 

: A cash budget is a budget or plan of expected cash receipts and disbursements 

during the period. These cash inflows and outflows include revenues collected, 
expenses paid, and loan receipts and payments. In other words, a cash budget is an 
estimated projection of the company's cash position in the future. 

METHODS OF PREPARING CASH BUDGET 

There are three methods of preparing a cash budget. They are briefly explained 
below: 

1. Receipts and Payments Method 

Under this method, the cash budget is prepared on a columnar basis. There are two 
parts. The first part is receipts and the second part is payments. The total receipts 
are added with an opening balance of cash and deducted the payments to get the 
closing balance of cash. If receipts are more than payments, there is a surplus of 
cash at the end of the month and vice versa. 

Adjusted Profit and Loss Method 

This method is also called the cash flow statement. This type of budget is prepared 
for a long period. It gives more details of incomes and expenses in connection with 
long term planning. 

The profit is considered to be equivalent to cash. Even though, cash receipts and 
payments are not into consideration but consider only non-cash transactions to 
prepare the cash budget under this method. The profit is adjusted by adding back 
depreciation, provisions, stock, work in progress, capital receipts, decrease in 
debtors, increase in creditors, and by deducting dividends, capital payments, 
increase in debtors, increase in stock and decrease in creditors. The adjusted profit 
is the closing balance of cash. 

The following information is necessary to prepare the cash budget under the 
adjusted profit and loss method. 

Expected opening balance. 

Net profit for the period. 
Changes in current assets and current liabilities. 
Capital receipts and capital expenditure. 
Payment of dividends. 
3. Balance Sheet Method 
This method is very similar to the adjusted profit and loss method. Under this 
method, all the items of the balance sheet are recorded in respective sides except 
cash. Then, the balance sheet is balanced. If the liabilities side is heavier than the 
assets side, the balancing figure is cash at the bank. Likewise, if the assets side is 
heavier than the liabilities side, the balancing figure is an overdraft. 

Q.10 What is Zero-Based Budgeting? What are its advantages and limitations? 

zero-based budgeting deviates from traditional budgeting in that the budget for each 
new period is created starting from a "zero base." They must justify each expense 
before adding it to the new budget—even old and recurring expenses. 

Benefits of Zero-Based Budgeting 

The benefits of this budgeting method include: 

Managers Must Justify All Operating Expenses 

Zero-based budgeting ensures that managers think about how every dollar is spent, 
every budgeting period. This process also forces them to justify all operating 
expenses and consider which areas of the company are generating revenue. 

Keeps Legacy Expenses in Check 

In traditional budgeting, legacy costs may not be examined for years until there is 
some sort of economic shock that forces the company to take extreme actions. 
Expenses have a tendency to grow over time, with each department protecting its 
budget from cuts. This approach can be myopic and, over time, it can lead to 
significant misallocation of resources. If done correctly, zero-based budgeting can 
prevent this from happening. 

The major advantages are flexible budgets, focused operations, lower costs, and 
more disciplined execution. The disadvantages include the possibilities of resource 
intensiveness, being manipulated by savvy managers, and bias toward short-term 
planning. 

Drawbacks of Zero-Based Budgeting 

There are also several drawbacks to zero-based budgeting: 

Can Reward Short-Term Thinking 

One of the major shortcomings of zero-based budgeting is that it can reward 
short-term thinking by shifting resources toward areas of companies that will 
generate revenue over the next calendar year or budgeting period. As a result, some 
areas of companies that are typically viewed as long-term investments that aren't 
directly tied to revenue, such as research and development or worker training, may 
be left with smaller budgets than they actually need. This could possibly hurt a 
company because, although these areas won't be generating revenue in the near 
term, they're often the keys to remaining competitive over the long term. 

Resource Intensive 
Zero-based budgeting is also resource-intensive. It takes a lot more time and effort 
to closely review and justify every budget element rather than modify an existing 
budget and review only new elements. Because of this, some critics argue that the 
benefits of zero-based budgeting do not justify its time cost. 

Manipulation by Savvy Managers 

In addition, the process can be gamed by savvy managers to get more resources into 
their departments. If this happens, it can lead to a change in culture where there is a 
decreased spirit of cooperation in the company, as workers feel expendable.