Synetic College Logo
Unit 2 of 4 · M.Com Sem 2

Unit 2: Marginal, standard costing and budgeting

Management and Cost Accounting notes · PTU syllabus (MCOP202-18)

3 min read6 topics10 exam questions
On this page
  1. Unit summary
  2. Marginal costing and CVP analysis
  3. Standard costing and variance analysis
  4. Budgetary control: concept
  5. Cash budget and flexible budget
  6. Zero-base budgeting (ZBB)
  7. Performance budgeting
  8. Key terms
  9. Quick revision
  10. Important questions

Unit summary

Marginal costing, standard costing and budgets are the main tools of cost control. This unit covers marginal costing, its advantages, limitations and applications, cost-volume-profit analysis, standard costing with material, labour and overhead variances, budgetary control, zero-base budgeting and performance budgeting.

After this unit you can

  • Apply marginal costing and CVP analysis to decisions
  • Compute material, labour and overhead variances
  • Explain budgetary control and prepare budgets
  • Explain zero-base and performance budgeting

PTU syllabus topics

  • Marginal costing meaning
  • advantages
  • limitations and applications
  • cost-volume-profit analysis
  • standard costing — material/labour/overhead variance computation
  • budgetary control advantages/limitations/preparation
  • zero-base budgeting
  • performance budgeting
Key formulasCVP and variances

  • P/V ratio

    Contribution / sales × 100

  • Break-even point (units)

    Fixed cost / contribution per unit

  • Margin of safety

    Profit / P/V ratio

  • Material price variance

    AQ × (SP − AP)

  • Labour efficiency variance

    SR × (SH − AH)

1

Topic 1

Marginal costing and CVP analysis

Marginal costing is the ascertainment of marginal costs and the effect on profit of changes in volume or type of output by differentiating between fixed and variable costs (CIMA). Only variable costs are charged to products; fixed costs are written off against contribution.

Key formulasMarginal costing formulas

  • Contribution

    Sales − Variable cost = Fixed cost + Profit

  • P/V ratio

    Contribution ÷ Sales × 100

  • Break-even point (units)

    Fixed cost ÷ Contribution per unit

  • Break-even point (sales)

    Fixed cost ÷ P/V ratio

  • Margin of safety

    Actual sales − BEP sales = Profit ÷ P/V ratio

  • Sales for desired profit

    (Fixed cost + Desired profit) ÷ P/V ratio

Example

Selling price ₹50, variable cost ₹30, fixed cost ₹40,000, sales 3,000 units. Contribution = ₹20 per unit; P/V ratio = 40%. BEP = 40,000 ÷ 20 = 2,000 units (₹1,00,000). Margin of safety = ₹1,50,000 − ₹1,00,000 = ₹50,000. Profit = 50,000 × 40% = ₹20,000.

ComparisonMarginal costing vs absorption costing
Marginal costing
Absorption costing

Fixed costs

Period costs, charged against contribution

Included in product cost

Stock valuation

At variable cost

At full cost

Profit when production > sales

Lower

Higher

Use

Short-term decisions

External reporting

  • Break-even chart shows total cost, total sales and the BEP; the angle of incidence between sales and total cost lines indicates profitability.
  • Decisions using marginal costing: make or buy, accept a special order, key (limiting) factor, shut down, product mix, pricing in recession.

Applications of marginal costing

  • Make or buy: buy if the purchase price is below the marginal cost of making (and capacity has other uses).
  • Accept a special order below normal price if it covers marginal cost and there is spare capacity.
  • Key factor: rank products by contribution per unit of the limiting factor (e.g., per machine hour).
  • Shut down or continue: continue in the short run if contribution covers avoidable fixed costs.
  • Product mix and pricing in recession.

Example

Products A and B: contribution ₹40 and ₹60 per unit; machine hours per unit 2 and 4. Contribution per hour: A ₹20, B ₹15 — with limited machine hours, produce A first.

2

Topic 2

Standard costing and variance analysis

Standard costing sets predetermined costs for each element, compares actual costs with standards, and analyses variances to control performance.

Key formulasMaterial and labour variances

  • Material cost variance

    (SQ × SP) − (AQ × AP)

  • Material price variance

    AQ × (SP − AP)

  • Material usage variance

    SP × (SQ − AQ)

  • Labour cost variance

    (SH × SR) − (AH × AR)

  • Labour rate variance

    AH × (SR − AR)

  • Labour efficiency variance

    SR × (SH − AH)

  • Idle time variance

    Idle hours × SR

Key formulasOverhead variances

  • Variable overhead cost variance

    Standard VOH for actual output − Actual VOH

  • Fixed overhead cost variance

    Absorbed FOH (actual output × standard rate) − Actual FOH

  • Fixed overhead expenditure variance

    Budgeted FOH − Actual FOH

  • Fixed overhead volume variance

    Absorbed FOH − Budgeted FOH

Example

Standard: 2 kg per unit at ₹10. Output 500 units; actual 1,050 kg at ₹9.50. SQ = 1,000 kg. MCV = 10,000 − 9,975 = ₹25 (F). MPV = 1,050 × 0.50 = ₹525 (F). MUV = 10 × (1,000 − 1,050) = ₹500 (A). Check: 525 F − 500 A = 25 F.

  • Favourable (F) when actual cost is below standard; adverse (A) when above.
  • Advantages: cost control, management by exception, pricing, performance evaluation; limitations: setting standards is difficult, standards become outdated, may demotivate.
3

Topic 3

Budgetary control: concept

  • Budget: a quantitative statement, for a defined period, of the policies, plans, objectives and goals established by management (CIMA).
  • Budgetary control: establishment of budgets relating to responsibilities of executives and continuous comparison of actual with budgeted results to secure objectives or revise them.
ProcessSteps in budgetary control
  1. 1

    Define objectives

  2. 2

    Set up budget centres and committee

  3. 3

    Prepare budget manual

  4. 4

    Fix budget period

  5. 5

    Identify key (limiting) factor

  6. 6

    Prepare functional and master budgets

  7. 7

    Compare actual with budget

  8. 8

    Analyse variances and take corrective action

  • Key (principal budget) factor: the factor that limits activity — usually sales; can be materials, labour or plant capacity.
  • Advantages: planning, coordination, control, motivation, cost consciousness. Limitations: based on estimates, rigidity, time and cost, may cause conflict.
4

Topic 4

Cash budget and flexible budget

Cash budget

Estimates cash receipts and payments to show expected cash surplus or deficit each month.

Example

Opening cash ₹20,000. July: receipts from debtors ₹60,000; payments — creditors ₹45,000, wages ₹12,000, overheads ₹8,000. Closing cash = 20,000 + 60,000 − 65,000 = ₹15,000 (becomes opening balance for August).

  • Uses: plan borrowing and investment of surplus, ensure liquidity, time capital expenditure.

Flexible budget

A budget designed to change with the level of activity attained — fixed costs remain constant, variable costs change in proportion, semi-variable costs are split.

Item60% capacity80% capacity100% capacity
Units6,0008,00010,000
Variable cost @ ₹201,20,0001,60,0002,00,000
Semi-variable (₹20,000 fixed + ₹5/unit)50,00060,00070,000
Fixed cost80,00080,00080,000
Total cost2,50,0003,00,0003,50,000
Cost per unit41.6737.5035.00
ComparisonFixed vs flexible budget
Fixed budget
Flexible budget

Activity

One level only

Several levels

Comparison

Misleading if actual activity differs

Meaningful at actual activity

Suitable

Stable conditions

Changing conditions

5

Topic 5

Zero-base budgeting (ZBB)

ZBB requires every activity to be justified from scratch (zero base) each budget period, rather than adjusting last year's figures. Introduced by Peter Pyhrr at Texas Instruments (1970s).

ProcessZBB process
  1. 1Identify decision units
  2. 2Prepare decision packages

    Purpose, costs, benefits, alternatives

  3. 3Rank decision packages by priority
  4. 4Allocate resources to top-ranked packages
  • Advantages: removes inefficient activities, better resource allocation, questions every expense.
  • Limitations: time-consuming, needs skilled managers, difficult to rank intangible activities.
6

Topic 6

Performance budgeting

Performance budgeting relates inputs (expenditure) to outputs and outcomes of programmes and activities, rather than just listing items of expenditure.

  • Introduced in the USA (Hoover Commission, 1949); in India, the Outcome Budget (from 2005–06) presents financial outlays with physical outputs and outcomes of ministries.
ComparisonTraditional vs performance budget
Traditional (line-item) budget
Performance budget

Focus

What is bought — salaries, materials

What is achieved — outputs and outcomes

Classification

By object of expenditure

By functions, programmes and activities

Control

Financial compliance

Efficiency and effectiveness

Example

₹10 crore for teachers' salaries

₹10 crore to enrol 50,000 students with 95% retention

Key terms

Contribution
Sales minus variable cost
Key factor
Limiting factor restricting output
Standard cost
Predetermined cost under efficient conditions
Variance
Difference between standard and actual cost
Performance budgeting
Budgeting that links expenditure to outputs and outcomes

Quick revision

  • Marginal costing: contribution, P/V ratio, BEP, margin of safety; decisions.
  • Material variances: price + usage = cost; labour: rate + efficiency (+ idle time).
  • Overhead variances: expenditure and volume.
  • Budgetary control; fixed vs flexible; cash budget.
  • ZBB (decision packages) and performance budgeting (outcome budget).

Important exam questions

Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).

Short-answer questions

  1. Q1.What is the key factor?
  2. Q2.Define standard costing.
  3. Q3.Write the formula for material price variance.
  4. Q4.What is labour efficiency variance?
  5. Q5.What is zero-base budgeting?
  6. Q6.What is performance budgeting?

Long-answer questions

  1. Q1.Explain the applications of marginal costing in managerial decisions.
  2. Q2.Explain material and labour variances with an illustration.
  3. Q3.Explain budgetary control and the preparation of flexible budgets.
  4. Q4.Explain zero-base budgeting and performance budgeting.

Stuck on this unit?

Message SBS on WhatsApp for help with Management and Cost Accounting, or to ask about studying M.Com at Synetic.

WhatsApp us