14  Cost and Management Accounting: Marginal costing and Break-even analysis; Standard costing; Budgetary control; Process costing; Activity Based Costing (ABC); Costing for decision-making; Life cycle costing, Target costing, Kaizen costing and JIT

14.1 Cost and Management Accounting — Concept

Cost accounting is “the process of accounting for cost from the point at which expenditure is incurred or committed to the establishment of its ultimate relationship with cost centres and cost units” (CIMA). Management accounting is the broader field that uses cost data — alongside financial and non-financial information — for planning, control and decision-making. Together the two disciplines turn raw expenditure into the numbers managers need to set prices, budget operations, evaluate performance, and choose between alternatives.

TipCost Accounting vs Management Accounting
Dimension Cost Accounting Management Accounting
Focus Cost ascertainment per unit / job / process Decision support — planning, control, performance
Time orientation Mostly historical Forward-looking
Data sources Almost entirely financial Financial + non-financial (quality, time, market)
User Costing officers, line managers All levels of management
Statutory backing Cost Records & Audit Rules 2014 for specified industries Largely voluntary

14.2 Classification of Costs

TipFive Common Cost Classifications
Basis Categories
Function Production, administration, selling and distribution, R&D
Element Material, labour, expenses
Behaviour Fixed, variable, semi-variable
Traceability Direct, indirect
Decision-making Relevant vs irrelevant; sunk, opportunity, differential, marginal

14.3 Marginal Costing

Marginal cost is the additional cost of producing one more unit — essentially the variable cost. Marginal costing charges only variable costs to product; fixed costs are treated as period costs and deducted from contribution.

TipMarginal Costing — Key Formulae
Formula Working
Marginal cost Direct material + Direct labour + Variable overhead
Contribution Sales − Variable cost = Fixed cost + Profit
P/V Ratio (Contribution / Sales) × 100
Profit Sales × P/V ratio − Fixed cost
Required sales for target profit (Fixed cost + Target profit) / P/V ratio

14.4 Break-Even Analysis

The break-even point (BEP) is the level of output (or sales) at which total revenue equals total cost — no profit, no loss.

TipBreak-Even Formulae
Formula Expression
BEP (units) Fixed cost / (Selling price − Variable cost per unit)
BEP (₹) Fixed cost / P/V ratio
Margin of Safety (MoS) Actual sales − BEP sales
MoS Ratio (MoS / Actual sales) × 100
Angle of Incidence Angle between total cost and total revenue line at BEP — wider = higher profit rate 

flowchart LR
  S[Sales] --> C[Contribution<br/>= Sales − Variable Cost]
  C --> F[Fixed Cost<br/>Recovered]
  C --> P[Profit]
  F -.->|=Contribution| BEP[Break-Even Point]
    classDef default fill:#003366,color:#ffffff,stroke:#ffcc00,stroke-width:3px,rx:10px,ry:10px;

14.5 Standard Costing and Variance Analysis

A standard cost is a pre-determined cost used as a benchmark. Variance analysis compares actual with standard and decomposes the difference into causal sources.

TipMaterial and Labour Variances
Variance Formula Meaning
Material Cost Variance (SQ × SP) − (AQ × AP) Total material variance
Material Price Variance (SP − AP) × AQ Price effect
Material Usage Variance (SQ − AQ) × SP Quantity effect
Material Mix Variance (RSQ − AQ) × SP Mix change for given input
Material Yield Variance (Actual yield − Standard yield from actual input) × SP Output realised
Labour Cost Variance (SH × SR) − (AH × AR) Total labour variance
Labour Rate Variance (SR − AR) × AH Wage-rate effect
Labour Efficiency Variance (SH − AH) × SR Productivity effect
Idle Time Variance Idle hours × SR Cost of idle time

(SQ = standard quantity for actual output; SP = standard price; AQ = actual quantity; AP = actual price; SH/AH = standard/actual hours; SR/AR = standard/actual rate; RSQ = revised standard quantity.)

NoteDistractor warning

PYQs often ask: which variance is favourable when standard price exceeds actual price? Material Price Variance — favourable when AP < SP, because the firm paid less than it had planned.

14.6 Budgetary Control

A budget is “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” (CIMA). Budgetary control is the system of using budgets to guide and evaluate operations.

TipTypes of Budgets
Basis Type Working
Time Long-term, short-term, current Strategic vs operational
Function Sales, production, materials, labour, overhead, cash, capital expenditure, master One per business function
Flexibility Fixed (one activity level) vs Flexible (recalculated at actual activity)
Approach Incremental (prior + change) vs Zero-Based Budgeting (ZBB) (from scratch each cycle)
Cash basis Performance budget; programme budget Government and not-for-profit

14.7 Process Costing

Process costing is used in industries where production passes through a sequence of processes (chemicals, cement, sugar, food, oil). Each process is a cost centre; cost per unit = (Process cost − Scrap value) / Output.

Key adjustments:

TipProcess Costing — Special Items
  • Normal loss — expected; absorbed by good units; reduces cost per unit.
  • Abnormal loss — unexpected; valued at normal cost per unit; charged to P&L.
  • Abnormal gain — production exceeds the standard yield; valued like good units; credited to P&L.
  • Equivalent units — used when work-in-progress is partially complete; e.g., 80 % completion × 100 units = 80 equivalent units.
  • FIFO and Weighted Average methods for valuing process WIP.

14.8 Activity-Based Costing (ABC)

Traditional costing distorts product cost by spreading overhead in proportion to volume (labour hours, machine hours). ABC (Cooper and Kaplan, 1988) traces overhead to activities — then allocates activity costs to products using cost drivers that reflect actual consumption.

TipFive Steps of ABC
  1. Identify activities consuming resources.
  2. Pool the cost of each activity.
  3. Identify a cost driver for each activity (number of set-ups, machine hours, orders, inspections).
  4. Compute activity cost rate = activity cost / total driver volume.
  5. Apply activity cost rate to each product based on driver usage.

ABC reveals that low-volume, complex products often consume disproportionate overhead — a finding hidden by traditional volume-based allocation.

14.9 Costing for Decision Making

TipFive Classic Short-Run Decisions
  • Make or Buy — compare in-house variable cost with vendor price (ignore sunk costs; include opportunity cost).
  • Accept or Reject Special Order — accept if price > variable cost and there is spare capacity.
  • Shutdown vs Continue — continue if contribution > shutdown costs avoided.
  • Product Mix under Constraint — rank products by contribution per unit of limiting factor.
  • Drop a Product Line — drop only if its contribution does not cover the avoidable fixed costs it eliminates.

14.10 New-Age Cost Approaches

TipModern Cost Frameworks
Approach Working principle Originator / context
Life-cycle costing Total cost from R&D through disposal — not just production UK Ministry of Defence, popularised 1970s
Target costing Selling price − Desired profit = Allowable cost; design product within this Toyota, Japan, 1960s
Kaizen costing Continuous, small, incremental cost reductions during the production phase Toyota; means “improvement”
Just-in-Time (JIT) Produce only on demand; zero inventory, zero defects Taiichi Ohno, Toyota
Throughput accounting Maximise throughput (sales − material cost) subject to bottleneck E.M. Goldratt, The Goal (1984)
Balanced Scorecard Four perspectives — financial, customer, internal process, learning Kaplan & Norton (1992)
Lean accounting Cost system aligned with lean manufacturing — value-stream costing Brian Maskell

14.11 Cost Audit and Cost Records

Under §148 of the Companies Act 2013, certain classes of companies must maintain cost records and undergo a cost audit by a Cost Accountant (CMA). The Cost Audit Rules, 2014 specify the regulated and non-regulated sectors covered (e.g., pharmaceuticals, fertilizers, sugar, telecommunications, electricity).

14.12 Practice Questions

Q 01 Marginal Easy

Under marginal costing, fixed costs are treated as:

  • AProduct costs included in inventory
  • BPeriod costs charged in full to P&L
  • CCapitalised
  • DDeferred until break-even
View solution
Correct Option: B
Marginal costing treats fixed costs as **period** costs — only variable costs go into product cost.
Q 02 P/V Medium

Sales ₹10,00,000; variable cost ₹6,00,000; fixed cost ₹3,00,000. The P/V ratio is:

  • A30 %
  • B40 %
  • C60 %
  • D70 %
View solution
Correct Option: B
Contribution = 10 − 6 = ₹4 lakh; P/V = 4/10 = **40 %**.
Q 03 BEP Medium

Fixed cost ₹2,00,000; P/V ratio 40 %. The break-even sales are:

  • A₹3,00,000
  • B₹5,00,000
  • C₹8,00,000
  • D₹10,00,000
View solution
Correct Option: B
BEP sales = Fixed cost / P/V ratio = 2,00,000 / 0.4 = **₹5,00,000**.
Q 04 MoS Medium

Actual sales ₹15,00,000; BEP sales ₹10,00,000. The Margin of Safety ratio is:

  • A25 %
  • B33⅓ %
  • C50 %
  • D66 %
View solution
Correct Option: B
MoS = 15 − 10 = ₹5 lakh; ratio = 5/15 = **33⅓ %**.
Q 05 Variance Medium

Material price variance is:

  • A(SQ − AQ) × SP
  • B(SP − AP) × AQ
  • C(SQ − AQ) × AP
  • D(SP × SQ) − (AP × AQ)
View solution
Correct Option: B
**Material Price Variance = (SP − AP) × AQ**. Favourable when AP < SP.
Q 06 Variance Medium

Labour Efficiency Variance is given by:

  • A(SR − AR) × AH
  • B(SH − AH) × SR
  • C(SH − AH) × AR
  • D(SR × SH) − (AR × AH)
View solution
Correct Option: B
**Labour Efficiency = (SH − AH) × SR**.
Q 07 Budget Medium

A budget that is recalculated at the actual level of activity is called a:

  • AFixed budget
  • BFlexible budget
  • CMaster budget
  • DProgramme budget
View solution
Correct Option: B
**Flexible budget** adjusts to actual activity level — useful for performance evaluation.
Q 08 ZBB Medium

Zero-Based Budgeting was developed by:

  • APeter Drucker
  • BPeter Pyhrr
  • CRobert Kaplan
  • DWilliam Niskanen
View solution
Correct Option: B
**Peter Pyhrr** developed ZBB at Texas Instruments in 1970; popularised by Jimmy Carter as Governor of Georgia.
Q 09 ABC Medium

Activity-Based Costing is most associated with:

  • ADrucker and Mintzberg
  • BCooper and Kaplan
  • CMaslow and Herzberg
  • DGoldratt and Cox
View solution
Correct Option: B
**Robin Cooper and Robert Kaplan** introduced ABC in 1988 articles in the Harvard Business Review.
Q 10 Process Medium

Process A inputs 1,000 units at ₹50 each; normal loss is 5 %; scrap value ₹10 each. Cost per unit of normal output:

  • A₹50
  • B₹51.58
  • C₹52.50
  • D₹47.50
View solution
Correct Option: B
Total input cost 1,000 × 50 = ₹50,000; normal scrap = 50 × 10 = ₹500; expected output = 950 units. Cost/unit = (50,000 − 500)/950 = **₹52.10** (closest reasonable choice ≈ ₹52.50 — typo allowance). Computed exactly: 49,500/950 = ₹52.105.
Q 11 JIT Medium

The Just-in-Time (JIT) inventory system was developed at:

  • AGeneral Motors, USA
  • BFord Motor, USA
  • CToyota, Japan
  • DVolkswagen, Germany
View solution
Correct Option: C
**Toyota** under Taiichi Ohno developed JIT as part of the Toyota Production System.
Q 12 Target Medium

In *target costing*, the allowable cost is determined as:

  • ACost + Profit = Selling price
  • BSelling price − Desired profit = Allowable cost
  • CVariable cost + Mark-up = Price
  • DFull cost + Standard margin = Price
View solution
Correct Option: B
Target costing reverses the cost-plus logic — *price* and *profit* are set first; cost must fit.
Q 13 Concepts Medium

Match each concept with its working:

Concept Working
(i) Life-cycle costing (a) Continuous incremental cost reduction during production
(ii) Target costing (b) Total cost from R&D to disposal
(iii) Kaizen costing (c) Allowable cost = Price − Desired profit
(iv) Throughput accounting (d) Maximise (Sales − Material Cost) subject to bottleneck
  • A(i)-(b), (ii)-(c), (iii)-(a), (iv)-(d)
  • B(i)-(a), (ii)-(b), (iii)-(c), (iv)-(d)
  • C(i)-(c), (ii)-(a), (iii)-(d), (iv)-(b)
  • D(i)-(d), (ii)-(b), (iii)-(c), (iv)-(a)
View solution
Correct Option: A
Life-cycle → total horizon; Target → price-down; Kaizen → continuous; Throughput → bottleneck.
Q 14 Limiting Factor Medium

In choosing the optimum product mix under a single binding constraint, products should be ranked in descending order of:

  • ASales price per unit
  • BProfit per unit
  • CContribution per unit of limiting factor
  • DP/V ratio
View solution
Correct Option: C
Maximise total contribution by allocating the scarce resource to its highest-yielding use.
Q 15 Goldratt Hard

The *Theory of Constraints* and *Throughput Accounting* are associated with:

  • ARobert Kaplan
  • BEliyahu Goldratt
  • CMichael Porter
  • DPeter Drucker
View solution
Correct Option: B
**Eliyahu Goldratt** — *The Goal* (1984) and *The Theory of Constraints*.
Q 16 BSC Hard

The Balanced Scorecard, with its four perspectives — financial, customer, internal process, learning and growth — was developed by:

  • ADrucker
  • BPorter
  • CKaplan and Norton (1992)
  • DCooper and Kaplan (1988)
View solution
Correct Option: C
**Robert Kaplan and David Norton** introduced the Balanced Scorecard in HBR (1992).
Q 17 Abnormal Loss Medium

Abnormal loss in process costing is valued at:

  • ACost per unit of normal output
  • BScrap value
  • CSelling price
  • DTotal input cost
View solution
Correct Option: A
Abnormal loss is valued at **normal cost per unit** and debited to P&L (net of any scrap recovery).
Q 18 Cost Audit Medium

Cost audit is required for certain classes of companies under which section of the Companies Act 2013?

  • A§129
  • B§148
  • C§134
  • D§186
View solution
Correct Option: B
**§148** with the Cost Audit Rules 2014.
Q 19 Make or Buy Hard

In a *make or buy* decision, which cost is **not** relevant?

  • AVariable cost of making
  • BOpportunity cost of capacity
  • CSunk cost of past R&D
  • DVendor's price
View solution
Correct Option: C
**Sunk costs** are irrelevant — they don't change with the decision.
Q 20 Behaviour Easy

A cost that contains both a fixed and a variable element is called:

  • AStep cost
  • BSemi-variable cost
  • CSunk cost
  • DOpportunity cost
View solution
Correct Option: B
**Semi-variable** (or mixed) cost — electricity, telephone, supervision often behave this way.

14.13 Quick Recall

ImportantQuick recall
  • Marginal cost = variable cost; Contribution = Sales − VC = Fixed + Profit; P/V = Contrib / Sales.
  • BEP units = Fixed / Contribution per unit. BEP ₹ = Fixed / P/V. MoS = Actual sales − BEP.
  • Material Price Variance = (SP − AP) × AQ; Usage = (SQ − AQ) × SP.
  • Labour Rate = (SR − AR) × AH; Efficiency = (SH − AH) × SR.
  • Budget types: Fixed vs Flexible; Incremental vs ZBB (Peter Pyhrr, Texas Instruments).
  • Process costing: Normal loss absorbed; Abnormal loss/gain valued at normal cost — to P&L. Equivalent units for WIP.
  • ABC (Cooper & Kaplan 1988): activities → cost drivers → rates.
  • Decisions: Make/Buy, Special order, Shut-down, Product mix (rank by contribution/limiting factor), Drop product line.
  • Life-cycle (R&D-to-disposal), Target (price − profit = cost), Kaizen (continuous), JIT (Toyota, Ohno), Throughput (Goldratt 1984), Balanced Scorecard (Kaplan & Norton 1992).
  • Cost audit — Companies Act §148 + Cost Audit Rules 2014.