Escolar Documentos
Profissional Documentos
Cultura Documentos
CONTRACT COSTIN
Contract costing is L+ form of specific order costing; attribution of costs to
indi&idual contractsM#
+ contract cost is L+ggregated costs of a single contract; usually applies to maJor
long term contracts rather than short term JobsM#
1eatures of long term contracts:
8y contract costing situations! "e tend to mean long term and large contracts:
such as ci&il engineering contracts for building houses! roads! bridges and so
on# We could also include contracts for building ships! and for pro&iding
goods and ser&ices under a long term contractual agreement#
With contract costing! e&ery contract and each de&elopment "ill be
accounted for separately; and does! in many respects! contain the features of a
Job costing situation#
Wor( is fre0uently site based#
We might ha&e problems "ith contract costing in the follo"ing areas
'dentifying direct costs
Lo" le&els of indirect costs
%ifficulties of cost control
Profit and multi period proJects
9
$he source of the follo"ing has eluded me: my sincere gratitude for "hoe&er the
author might be#
XContract Costing such Jobs ta(e a long time to complete O may spread o&er t"o or
more of the contractor)s accounting yearsM#
F#atur#$ %f a C%ntract
$he end product
$he period of the contract
$he specification
$he location of the "or(
$he price
Completion by a stipulated date
$he performance of the product
C%&&#cti%n %f C%$t$ :
%esirable to open up one or more internal Job accounts for the collection of
costs# 'f the contract not obtained! preliminary costs be "ritten off as aborti&e
contract costs in POL 'n some cases a series of Job accounts for the contract "ill be
necessary:
to collect the cost of different aspects
to identify different stages in the contract
S'#cia& f#atur#$
Materials deli&ered direct to site#
%irect expenses
,tores transactions#
2se of plant on site
T(% '%$$i)&# acc%unting *#t+%,$:
Where a plant is purchased for a particular contract O has little further &alue to the
business at the end of the contract
Where a plant is bought for or used on a contract! but on completion of the contract it
has further useful life to the business
+lternati&ely the plant may be capitalised "ith Maintenance and running costs
charged to the contract#X
1ormat:6
;
Particulars 4s# Particulars 4s#
$o Materials
a# Purchased directly
b# 'ssue from site
c# ,upplied by contractee
55
55
55
8y materials returned 55
8y Material sold *cost
price) 55
$o Wages and salaries 55 8y W'P
Wor( certified
Wor( 2ncertified
55
55
$o .ther direct Expenses 55
$o ,ub6contractor fees 55
$o Plant O Machinery *purchase
price-8oo( &alue) 55
8y Materials at site 55
$o 'ndirect expenditure *apportioned share
of o&erheads)
55 8y Plant and
machinery*W%K) 55
$o 3otional profit *,urplus) 55
$otal $otal 55
Profit of 'ncomplete contract :6
1) When D of completion is less than or e0ual to :D then full 3otional profit is
transferred to reser&e#
) When D of completion is abo&e :D but less than :HD follo"ing amount should
be credited to profit O loss a-c < 1-9 5 3otional Profit 5 YCash recei&ed - Wor(
certifiedZ
9) When D of completion is more than or e0ual to :HD then the amount transferred
to profit is < -9 5 3otional Profit 5 YCash recei&ed - Wor( certifiedZ
V8alance is transferred to reser&e a-cW
[ D of completion < YWor( certified-Contract priceZ 5 1HH
;) When the contract is almost complete the amount credited to profit O loss a-c is
a) Estimated total profit 5 YWor( certified - Contract priceZ
b) Estimated total profit 5 YCash recei&ed - Contract priceZ
c) Estimated total profit 5 YCost of "or( done - Estimated total profitZ
d) Estimated total profit5YCost of "or( done5Cash recei&ed
Estimated total cost 5 Wor( certifiedZ
:) Wor(6'n6Progress is sho"n in 8alance ,heet as follo"s:6
,(eleton 8alance sheet
:
Liabilities *4,
)
+sset *4s
)
Profit O loss a-c *"ill
include)
Profit on contract
*,pecify
the contract
number)
Less : Loss on contract
*,pecify the contract
number)
,undry creditors *"ill
include)
Wages accrued
%irect expenses
accrued
+ny other expenses
*,pecify)
Wor(6in6progress
Kalue or "or( certified
Cost of "or( uncertified
Less :6 4eser&e for unrealiIed
profit
Less :6 +mount recei&ed from
contractee
@) Escalation Clause < $his is to safeguard against li(ely change in price of cost
elements rise by and certain D o&er the prices pre&ailing at the time tendering the
contractee has to bear the cost#
@
MARINAL COSTIN
,tatement of profit:6
Particulars +mount
,ales 555
Less:6Kariable cost 555
Contribution 555
Less:6 1ixed cost 555
Profit 555
1) ,ales < $otal cost = Profit < Kariable cost = 1ixed cost = Profit
) $otal Cost < Kariable cost = 1ixed cost
9) Kariable cost < 't changes directly in proportion "ith &olume
;) Kariable cost 4atio < YKariable cost - ,alesZ 5 1HH
:) ,ales > Kariable cost < 1ixed cost = Profit
@) Contribution < ,ales 5 P-K 4atio
E) Profit Kolume 4atio VP-K 4atioW:6
YContribution - ,alesZ 5 1HH
YContribution per unit - ,ales per unitZ 5 1HH
YChange in profit - Change in salesZ 5 1HH
YChange in contribution - Change in salesZ 5 1HH
F) 8rea( E&en Point V8EPW:6
1ixed cost - Contribution per unit Vin unitsW
1ixed cost - P-K 4atio Vin &alueW *or) 1ixed Cost 5 ,ales &alue per unit
*,ales > Kariable cost per unit)
G) Margin of safety VM.PW
+ctual sales > 8rea( e&en sales
3et profit - P-K 4atio
Profit - Contribution per unit V'n unitsW
1H) ,ales unit at %esired profit < Y1ixed cost = %esired profitZ - Cont# per unit
11) ,ales &alue for %esired Profit < Y1ixed cost = %esired profitZ - P-K 4atio
E
1) +t 8EP Contribution < 1ixed cost
19) Kariable cost 4atio < Change in total cost 5 1HH
Change in total sales
1;) 'ndifference Point < Point at "hich t"o Product sales result in same amount of
profit
< Change in fixed cost *in units)
Change in &ariable cost per unit
< Change in fixed cost *in units)
Change in contribution per unit
< Change in 1ixed cost *in 4s#)
Change in P-4atio
< Change in 1ixed cost *in 4s#)
Change in Kariable cost ratio
1:) ,hut do"n point < Point at "hich each of di&ision or product can be closed
< Maximum *or) ,pecific *or) +&ailable fixed cost
P-K 4atio *or) Contribution per unit
'f sales are less than shut do"n point then that product is to shut do"n#
3ote :6
1) When comparison of profitability of t"o products if P-K 4atio of one product is
greater than P-K 4atio of other Product then it is more profitable#
) 'n case of 'ndifference point if
,ales \ 'ndifference point 666 ,elect option "ith higher fixed cost *or) select
option "ith lo"er fixed cost#
F
STANDARD COSTIN
Method one of reading:6
Material:6
,P 5 ,A ,P 5 +A ,P 5 4,A +P 5 +A
*1) *) *9) *;)
a) Material cost &ariance < *1) > *;)
b) Material price &ariance < *)*;)
c) Material usage &ariance < *1) > *)
d) Material mix &ariance < *9) > *)
e) Material yield &ariance < *1) >*9)
Labour :6
,45,$ ,45+$ *paid) ,454,$ +45+$ ,45+$*"or(ed)
*1) *) *9) *;) *:)
a) Labour Cost &ariance < *1) > *;)
b) Labour 4ate &ariance < *) > *;)
c) Labour Efficiency &ariance < *1) > *)
d) Labour mix &ariance < *9) > *:)
e) Labour 'dle time &ariance < *:) > *)
Kariable .&erheads cost &ariance :6
,4 5 ,$ ,4 5 +$ +4 5 +$
*1) *) *9)
a) Kariable .&erheads Cost Kariance < *1) > *9)
b) Kariable .&erheads Expenditure Kariance < *) > *9)
c) Kariable .&erheads Efficiency Kariance < *1) > *)
VWhere: ,4 <,tandard rate-hour < 8udgeted &ariable ./
8udgeted /ours W
1ixed .&erheads Cost Kariance:6
,45,$ ,45+$*"or(ed) ,4548$ ,458$ +45+$*paid)
*1) *) *9) *;) *:)
a) 1ixed .&erheads Cost Kariance < *1) > *:)
b) 1ixed .&erheads 8udgeted Kariance < *;) > *:)
c) 1ixed .&erheads Efficiency Kariance < *1) > *)
d) 1ixed .&erheads Kolume Kariance < *1) > *;)
e) 1ixed .&erheads Capacity Kariance < *) > *9)
G
f) 1ixed .&erheads Calendar Kariance < *9) > *;)
,ales &alue &ariance:6
8udgeted Price58A 8P5+A 8P58udgeted mix +P5+A
*1) *) *9) *;)
a) ,ales &alue &ariance < *;)*1)
b) ,ales price &ariance < *;) > *)
c) ,ales &olume &ariance < *) > *1)
d) ,ales mix &ariance < *) > *9)
e) ,ales 0uantity &ariance < *9) > *1)
3ote :6
i) +ctual margin per unit *+MP2) < +ctual sale price > selling cost per unit
ii) 8udgeted margin per unit *8MP2) < 8udgeted sale price > selling price per unit
,ales margin &ariance :6
8MP258A 8MP25+A 8MP258udgeted mix +MP25+A
*1) *) *9) *;)
a) ,ales margin &ariance < *;) > *1)
b) ,ales margin price &ariance < *;) > *)
c) ,ales margin &olume &ariance < *) > *1)
d) ,ales margin mix &ariance < *) > *9)
e) ,ales margin 0uantity &ariance < *9) > *1)
Control 4atio :6
1) Efficiency 4atio < ,tandard hours for actual output 5 1HH
+ctual hours "or(ed
) Capacity 4atio < +ctual /ours Wor(ed 5 1HH
8udgeted /ours
9) +cti&ity 4atio < +ctual hours "or(ed 5 1HH
8udgeted /ours
Kerification: +cti&ity 4atio < Efficiency 5 Capacity 4atio
9H
STANDARD COSTIN
Method t"o of reading:6
Material:6
a) Material cost &ariance < ,C > +C < *,A5+A) > *+A5+P)
b) Material price &ariance < +A *,P > +P)
c) Material usage &ariance < ,P *,A > +A)
d) Material mix &ariance < ,P *4,A > +A)
e) Material yield &ariance < *+] > ,] for actual input) ,tandard material cost per
unit of output
f) Material re&ised usage &ariance *calculated instead of material yield &ariance)
< Vstandard 0uantity > 4e&ised standard
for actual output 0uantity W 5 ,tandard price
Labour :6
a) Labour Cost &ariance < ,C > +C < *,/5,4) > *+/5+4)
b) Labour 4ate &ariance < +/ *,4 6 +4)
c) Labour Efficiency or time &ariance < ,4 *,/ >+/)
d) Labour Mix or gang composition Kariance < ,4*4,/6+/)
e) Labour 'dle $ime Kariance < 'dle hours 5 ,4
f) Labour ]ield Kariance < V+ctual .utput > ,tandard output for actual inputW
5 ,tandard labour cost-unit of output
g) Labour 4e&ised Efficiency Kariance *instead of L]K) <
V,tandard hours for actual output > 4e&ised standard hoursW 5 ,tandard rate
3otes :6 i) LCK < L4K = LMK = '$K = L]K
ii) LCK < L4K = LEK = '$K
iii) LEK < LMK! L]K *or) L4EK
91
.&erhead &ariance :6 *general for both &ariable and fixed)
a) ,tandard o&erhead rate *per hour) < 8udgeted .&erheads
8udgeted /ours
b) ,tandard hours for actual output < 8udgeted hours 5 +ctual .utput
8udgeted output
c) ,tandard ./ < ,tandard hrs for actual output 5 ,tandard ./ rate per hour
d) +bsorbed ./ < +ctual hrs 5 ,tandard ./ rate per hour
e) 8udgeted ./ < 8udgeted hrs 5 ,tandard ./ rate per hour
f) +ctual ./ < +ctual hrs 5 +ctual ./ rate per hour
g) ./ cost &ariance < +bsorbed ./ > +ctual ./
Kariable .&erheads &ariance :6
a) Kariable ./ Cost Kariance < ,tandard ./ > +ctual ./
b) Kariable ./ Exp# Kariance < +bsorbed ./ > +ctual Kariable ./
c) Kariable ./ Efficiency Kariance < ,tandard ./ > +bsorbed ./
< V,tandard hours for > +ctual 5 ,tandard rate
actual output hoursW for &ariable ./
1ixed .&erheads &ariance :6
a) 1ixed ./ Cost Kariance < ,tandard ./ > +ctual ./
b) 1ixed ./ expenditure &ariance < 8udgeted ./ > +ctual ./
c) 1ixed ./ Efficiency Kariance < ,tandard ./ *units based) > +bsorbed ./
*/ours based)
d) 1ixed ./ Kolume Kariance < ,tandard ./ > 8udgeted ./
< V,tandard hrs for > 8udgeted 5 standard rate
actual output hours W
e) 1ixed ./ capacity &ariance < +bsorbed ./>8udgeted ./
9
f) 1ixed ./ Calendar Kariance < V4e&ised budgeted hrs > 8udgeted hrsW
5 ,tandard rate-hrs
3ote:6 When there is calendar &ariance capacity &ariance is calculated as follo"s :6
Capacity &ariance < V+ctual hours > 4e&ised 5 ,tandard
*4e&ised) 8udgeted hrsW rate-hour
Kerification :6
i) &ariable ./ cost &ariance < Kariable ./ Expenditure &ariance
= Kariable ./ Efficiency &ariance
ii) 1ixed ./ cost &ariance < 1ixed ./ Expenditure &ariance = 1ixed ./ &olume
&ariance
iii) 1ixed ./ &olume &ariance < 1ixed ./ Efficiency &ariance = Capacity &ariance
= Calander &ariance
,ales &ariances :6
$urno&er method *or) sales &alue method :6
a) ,ales &alue &ariance < +ctual ,ales > 8udgeted ,ales
b) ,ales price &ariance < V+ctual Price > ,tandard priceW 5 +ctual 0uantity
< +ctual sales > standard sales
c) ,ales &olume &ariance < V+ctual68udgeted 0uantityW 5,tandard price
< ,tandard sales > 8udgeted sales
d) ,ales mix &ariance < V+ctual 0uantity > 4e&ised standard 0uantityW 5 ,tandard
price
< ,tandard sales > 4e&ised sales
e) ,ales 0uantity &ariance < V4e&ised standard &ariance > 8udgeted 0uantityW
5 ,tandard price
< 4e&ised ,tandard sales > 8udgeted sales
Profit method:6
a) $otal sales margin &ariance < *+ctual Profit>8udgeted price)
< Y+ctual 0uantity 5 +ctual profit per unitZ6
99
Y8udgeted 0uantity 5 ,tandard profit per unitZ
b) ,ales margin price &ariance<+ctual profit>,tandard profit
< Y+ctual Profit per unit > ,tandard profit per unitZ 5 +ctual 0uantity of sales
c) ,ales margin &olume &ariance < ,tandard profit > 8udgeted Profit
< Y+ctual 0uantity > 8udgeted 0uantityZ 5 ,tandard profit per unit
d) ,ales margin mix &ariance < ,tandard profit > 4e&ised ,tandard profit
< Y+ctual 0uantity > 4e&ised standard 0uantityZ 5 ,tandard profit per unit
e) ,ales margin 0uantity &ariance < 4e&ised standard profit 6 8udgeted profit
< Y4e&ised standard 0uantity > 8udgeted 0uantityZ 5 ,tandard profit per unit
9;
STANDARD COSTIN
%iagrammatic 4epresentation: 6
Material Kariance: 6
Material cost &ariance < ,C > +C < *,A5+A) > *+A5+P)
Labour Kariances:6
Labour Cost &ariance < ,C > +C < *,/5,4) > *+/5+4)
1ixed .&erhead Kariance : 6
a) ,tandard ./ < ,tandard hrs for actual output 5 ,tandard ./ rate per hour
b) +bsorbed ./ < +ctual hrs 5 ,tandard ./ rate per hour
c) 8udgeted ./ < 8udgeted hrs 5 ,tandard ./ rate per hour
d) +ctual ./ < +ctual hrs 5 +ctual ./ rate per hour
e) 4e&ised 8udgeted /our < +ctual %ays 5 8udgeted /ours per day
*Expected hours for actual days "or(ed)
9:
When Calendar &ariance is as(ed then for capacity &ariance 8udgeted
.&erhead is *8udgeted days 5 ,tandard ./ rate per day)
4e&ised 8udgeted /our *8udgeted hours for actual days) < +ctual days 5 8udgeted
hours per day
Kariable .&erhead Kariance : 6
9@
,ales Kalue Kariances : 6
,ales &alue &ariance < +ctual ,ales > 8udgeted ,ales
,ales Margin Kariances : 6
$otal sales margin &ariance < *+ctual Profit>8udgeted price)
< Y+ctual 0uantity 5 +ctual profit per unitZ6
Y8udgeted 0uantity 5 ,tandard profit per unitZ
VWhere :6
,C < ,tandard Cost! +C < +ctual Cost
,P < ,tandard Price! ,A < ,tandard Auantity
+P < +ctual Price! +A < +ctual Auantity
+] < +ctual ]ield! ,] < ,tandard ]ield
4,A < 4e&ised ,tandard Auantity! ,4 < ,tandard 4ate!
,$ < ,tandard $ime +4 < +ctual 4ate!
+$ < +ctual $ime 4,$ < 4e&ised ,tandard $ime!
8P < 8udgeted Price! 8A < 8udgeted Auantity
48$ < 4e&ised 8udgeted $ime
8MP2 < 8udgeted Margin per 2nit
9E
+MP2 < +ctual Margin per 2nit
4econciliation:6
4econciliation statement is prepared to reconcile the actual profit "ith the
budgeted profit
Particulars 1a&orable 2nfa&orable *4s)
8udgeted Profit :
+dd 1a&orable &ariances
Less 2nfa&orable &ariances
,ales Kariances :
,ales price &ariance
,ales mix &ariance
,ales 0uantity &ariance
C%$t -arianc# :.
Material :
Cost &ariance
2sage &ariance
Mix &ariance
Labour :
4ate &ariance
Mix &ariance
Efficiency &ariance
'dle time &ariance
1ixed o&erhead &ariance :
Expenditure &ariance
Efficiency &ariance
1ixed o&erhead &ariance :
Expenditure &ariance
Efficiency &ariance
Capacity &ariance
Calendar &ariance
9F
NON.INTERATED ACCOUNTS
,cheme of Journal entries:6
Material:
a) 1or material purchases *cash or credit)
i) Material control a-c %r
$o Cost ledger control a-c
ii) ,tores ledger control a-c %r
$o Material control a-c
b) Purchases for a special Job
Wor(6in6progress ledger control a-c %r
$o Cost ledger control a-c
c) Material returned to &ender
Cost ledger control a-c %r
$o ,tores ledger control a-c
d) Material *direct) issued to production
Wor(6in6progress control a-c %r
$o ,tores ledger control a-c
e) Material *indirect) issued to production
Manufacturing o&erheads a-c %r
$o ,tores ledger control a-c
f) Material returned from shop to stores
,tores ledger control a-c %r
$o Wor(6in6progress control a-c
g) Material transferred from Rob 1 to Rob
Rob a-c %r
$o Rob 1 a-c
i) Material issued from stores for repairs
Manufacturing o&erhead a-c %r
$o ,tores ledger control a-c
9G
Labour:
a) %irect "ages paid
i) Wage control a-c %r
$o Cost ledger control a-c
ii) Wor(6in6progress a-c %r
$o Wage control a-c
b) 'ndirect "ages paid to "or(ers in Production!
+dministration! ,elling and %istribution departments
i) Wage control a-c %r
$o Cost ledger control a-c
ii) Production .&erhead a-c %r
+dministrati&e .&erhead a-c %r
,elling O %istribution .&erhead a-c %r
$o Wage control a-c
c) %irect Expenses on a particular Job
Rob a-c %r
$o Cost ledger control a-c
.&erheads:6
a) .&erhead expenses incurred
Production o&erhead a-c %r
+dministrati&e .&erhead a-c %r
,elling O %istribution .&erhead a-c %r
$o cost ledger control a-c
b) Carriage in"ard
Manufacturing .&erhead a-c %r
$o Cost ledger control a-c
c) Production .&erheads reco&ered
Wor(6in6progress control a-c %r
$o Production .&erhead a-c
d) +dministrati&e .&erhead reco&ered from finished goods
1inished goods ledger control a-c %r
;H
$o +dministrati&e .&erhead a-c
e) ,elling and %istribution .&erhead reco&ered from sales
Cost of sales a-c %r
$o ,elling O %istribution a-c
f) 'f o&er-under absorbed amounts are carried for"ard to subse0uent year! the
balance of each .&erhead account "ill ha&e to be transferred to respecti&e
.&erhead suspense *or reser&e) +ccounts as follo"s:
i) 1or o&er reco&ery : Production .&erhead a-c %r
$o Production o&erhead suspense a-c
ii) 1or under reco&ery : +dministrati&e .&erhead ,uspense a-c %r
$o +dministrati&e .&erhead a-c
,elling O %istribution .&erhead ,uspense a-c %r
$o ,elling O %istribution .&erhead a-c
g) 'n case the 2nder-.&er absorbed o&erheads are transferred to costing profit O loss
a-c then the rele&ant entries are:
i) 1or .&er reco&ery: Production .&erhead a-c %r
$o Costing Profit O Loss a-c
ii) 1or 2nder reco&ery: Costing Profit O Loss a-c %r
$o +dministration .&erhead a-c
,ales:6
1or sales effected: Cost ledger control a-c %r
$o Costing Profit O Loss a-c
Profit - Loss:
a) 'n case of profit the entry is as follo"s
Costing Profit O Loss a-c %r
$o Cost ledger control a-c
b) 4e&erse the entry in case of loss
;1
$he main accounts "hich are usually prepared "hen a separate cost ledger is
maintained is as follo"s:6
i) Cost ledger control a-c
ii) ,tores ledger control a-c
iii) Wor(6in6progress control a-c
i&) 1inished goods control a-c
&) Wage control a-c
&i) Manufacturing-Production-Wor(s .&erheads a-c
&ii) +dministrati&e .&erhead a-c
Kiii) ,elling O %istribution .&erhead a-c
ix) Cost of sales a-c
x) Costing profit O loss a-c
;
Tran$f#r !ricing
+ transfer price is the amount of money that one unit of an organisation
charges for goods and ser&ices to another unit of an organisation#
.ne of the (ey aspects here is that a transfer price is e0ui&alent to an ordinary
selling price and that any department or di&ision that sets a transfer price is
effecti&ely selling its goods and ser&ices at a profit or a loss to another department or
di&ision "ithin its organisation# +ny part of an organisation using transfer pricing
"ill be classed as a profit centre: since it is operating "ith a &ie" to ma(ing a profit
*"hether positi&e! profit! or negati&e! loss)# 'f goods and ser&ices are transferred
bet"een departments and di&isions at cost! then no profit or loss arises and the issue
of transfer pricing does not! or should not! arise#
.rganisations ha&e a system of transfer pricing! therefore! in order to assess
the efficiency and effecti&eness of its department and di&isional managers# $his
maybe in spite of the fact that transfer prices may be artificial in the sense that it is
felt that there is no rationale for LsellingM bet"een departments and di&isions#
Criteria for fixing $ransfer Pricing:6
i) External Capacity not fully utiliIed < Kariable Cost
ii) Capacity fully 2tiliIed
a) 'f single product :6
,elling Price *>) ,elling Expenses
b) 'f multiple product
Kariable cost = .pportunity cost *measured on the basis of Product
actually sacrificed)
iii) 'f no mar(et for 'ntermediate product
Cost of supplying di&ision of optimum le&el
*6) Cost of the supplying di&ision at pre&ious output le&el#
%ifference in .utput
*$his "ould be e0ual to Kariable cost "hen 1ixed Cost is same at all le&els)
3ote:6
i) 'gnore Kariable ,elling expenses on 'nter %epartment $ransfer
ii) 'n case of *ii) abo&e 'f selling expenses is not gi&en "e ha&e to assume some
D as selling Expenses but it should not exceed :D #
;9
Bu,g#tar/ C%ntr%&
8udget 4atios:6
1) Capacity usage 4atio
< # 8udgeted /ours # 5 1HH
Maximum possible "or(ing hours in budget period
) ,tandard Capacity Employed 4atio
< +ctual /ours Wor(ed 5 1HH
8udgeted hours
9) Le&el of +cti&ity 4atio
< ,tandard /ours for +ctual Production 5 1HH
,tandard /ours for 8udgeted Production
;) Efficiency 4atio
< ,tandard /ours for +ctual Production 5 1HH
+ctual /ours
:) Calendar 4atio
< +ctual Wor(ing days 5 1HH
8udgeted "or(ing days
^ero 8ase 8udgeting:
$he name Iero base budgeting deri&es from the idea that such budgets are
de&eloped from a Iero base: that is! at the beginning of the budget de&elopment
process! all budget headings ha&e a &alue of ^E4.# $his is in sharp contrast to the
incremental budgeting system in "hich in general a ne" budget tends to start "ith a
balance at least e0ual to last year)s total balance! or an estimate of it#
%efinition of ^ero 8ase 8udgeting *^88)
L+ method of budgeting "hereby all acti&ities are ree&aluated each time a
budget is set# %iscrete le&els of each acti&ity are &alued and a combination chosen to
match funds a&ailableM#
.bJecti&es and 8enefits of ^88
;;
What Iero base budgeting tries to achie&e is an optimal allocation of
resources that incremental and other budgeting systems probably cannot achie&e#
^88 starts by as(ing managers to identify and Justify their area*s) of "or( in terms
of decision pac(ages *0&)#
+n effecti&e Iero base budgeting system benefits organisations in se&eral
"ays# 't "ill
1ocus the budget process on a comprehensi&e analysis of obJecti&es and
needs
Combine planning and budgeting into a single process
Cause managers to e&aluate in detail the cost effecti&eness of their operations
Expand management participation in planning and budgeting at all le&els of
the organisation
Acti-it/ Ba$#, c%$ting
;:
'n $raditional Method "e split the .&er /ead incurred in production! based
on machine hours "hich are not acceptable for many reasons#
'n +8C method .&er /ead are splited according to the related acti&ity! for
each type of .&er /ead# .&erhead are apportioned among &arious Production cost
centers on the basis of +cti&ity cost dri&ers#
R#&#-ant C%$ting . $%*# t+#%r/
'ntroduction: 6
+ management decision in&ol&es predictions of costs O re&enues# .nly the
costs and re&enues that "ill differ among alternati&e actions are rele&ant to the
decision# $he role of historical data is to aid the prediction of future data# 8ut
historical data may not be rele&ant to the management decision itself# Aualitati&e
factors may be decisi&e in many cases! but to reduce the number of such factors to be
Judged! accountants usually try to express many decision factors as possible in
0uantitati&e terms#
Meaning of 4ele&ant Costs: 6
4ele&ant costs represent those future costs that "ill be changed by a
particular decision# While irrele&ant costs are those costs that "ill not be affected by
a decision# 'n the short run! if the rele&ant re&enues exceed the rele&ant costs then it
"ill be "orth"hile accepting the decision# $herefore rele&ant costs playa maJor role
in the decision6ma(ing process of an organiIation# + particular cost can be rele&ant
in one situation but irrele&ant in another! the important point to note is that rele&ant
costs represent those future costs that "ill be changed by a particular decision! "hile
irrele&ant costs are those costs that "ill not be affected by that decision# We shall
no" see "hat are rele&ant costs and re&enues for decision6ma(ing process# 'n
summary rele&ant information concerns:
.ther 'mportant $erminologies : 6
4ele&ant costs are costs appropriate to aiding the ma(ing of specific
management decisions# +ctually! to affect a decision a cost must be:
1uture: Past costs are irrele&ant as they are not affected them by future decisions O
decisions should be made as to "hat is best no"#
'ncremental: $his refers to additional re&enue or expenditure! "hich may appear as a
;@
result of our decision6ma(ing#
*+ cash flo" 6 ,uch charges as depreciation may be future but do not represent cash
flo"s and! as such! are not rele&ant#)
,un( costs: Past costs! not rele&ant for decision ma(ing
Committed costs: $his is future in nature but "hich arise from past decisions!
perhaps as the result of a contract#
4ele&ant Costs: Problem areas:
1 Problems in determining the rele&ant costs of materials:
When considering &arious decisions! if the any materials re0uired is not ta(en
from existing stoc(s but "ould be purchased on a later date! then the estimated
purchase price "ould be the rele&ant material cost# + more difficult problem arises
"hen materials are ta(en from existing stoc(# 'n this situation the rele&ant cost of
materials for a particular Job *say Job _) depends on
Material is in regular use of the company
Material is not in regular use of the company
Material is in short supply#
'f the material is in regular use of the company then the material ta(en from
existing stoc( re0uires replacement for the purpose of regular use therefore the
rele&ant cost of material "ill be the 4eplacement cost#
'f the material is not in regular use of the company the rele&ant cost of the
materials depends on their alternati&e use# $he alternati&e use of the materials "ill be
either to sell them or to use them on other Jobs# /ence the cost of using the materials
results in an opportunity cost consisting of either
$he net sales re&enue if the materials "ere sold *or) $he expense that "ould be
a&oided if the materials "ere used on some other Job Whiche&er is greater#
'f the material is in short supply the only "ay material for the Job under
consideration can be obtained is by reducing production of some other product - Job#
This would release material for the order. but the reduced production "ill result in
loss of contribution "hich should be ta(en in to account "hen ascertaining the
rele&ant costs for the specific order# $herefore the rele&ant cost "ill be Contribution
lost *before the material cost since the material cost "ill be incurred in any case) "ill
be the rele&ant cost#
labour:
;E
%etermining the direct labour that are rele&ant to short 6 term decision depends on
the circumstances#
Where a company has temporary sparse capacity and the labour force is to be
maintained in the short 6 term! the direct labour cost incurred "ill remain same for all
alternati&e decisions# $he direct labour cost "ill therefore be irrele&ant for short 6
term decision 6 ma(ing purposes#
/o"e&er "here casual labour is used and "here "or(ers can be hired on a
daily basis; a company may then adJust the employment of labour to exactly the
amount re0uired to meet the production re0uirements# $he labour cost "ill increase
if the company accepts additional "or(! and "ill decrease if production is reduced#
'n this situation the labour cost be a rele&ant cost for decision 6 ma(ing purposes#
'n a situation "here full capacity exists and additional labour supplies are
una&ailable in the short 6 term! and "here no further o&ertime "or(ing is possible!
the only "ay that labour resources could then be obtained for a specific order "ould
be to reduce existing production# This would release labour for the order. but the
reduced production "ill result in loss of contribution! "hich should be ta(en in to
account "hen ascertaining the rele&ant costs for the specific) order# $herefore the
rele&ant cost "ill be Contribution lost *before the labour cost) "ill be the rele&ant
cost#
P4.8LEM,
1# 'n a firm! material + has no alternati&e uses and HH units of "hich lie in stoc(#
$he information belo" has been collected# ]ou are re0uired to find the rele&ant price
of 1H units and :H units respecti&ely#
8oo( &alue
Current price
,ale price obtainable
4s# per (g 4s#9 per (g 4s##FH per (g
# +ssume in the abo&e problem the material is in regular use of the company
9# +ssume in the abo&e problem the material is in short `supply and it is not possible
to obtain the stoc( of material for some more time# +t present the material is used in
another product on "hich a contribution at the rate of 4s#1 .-unit is earned *after
meeting the material cost)# Each unit of the product re0uires 1 P7 of 4a" material
+#
;F
Ca$+ an, fun, f&%( $tat#*#nt
4ules for preparing schedule of changes in "or(ing capital :6
'ncrease in a current asset! results in increase in "or(ing capital > so +dd
%ecrease in current asset! results in decrease in "or(ing capital > so %ecrease
'ncrease in current liability! results in decrease in "or(ing capital > so %ecrease
%ecrease in current liability results in increase in "or(ing capital > so +dd
1unds from operations > 1ormat
Particulars 4s# 4s#
3et profit 555
+dd : %epreciation
7ood"ill "ritten off
Preliminary Exp# Written off
%iscount on share "ritten off
$ransfer to 7eneral 4eser&e
Pro&ision for $axation
Pro&ision for %i&idend
Loss on sale of asset
Loss on re&aluation of asset
555
555
555
555
555
555
555
555
555 555
555
Less : Profit on sale of asset
Profit on 4e&aluation of asset
555
555 555
1und flo" statement 555
1und flo" statement
Particulars 4s#
,ources of funds : 6
'ssue of shares
'ssue of %ebentures
Long term borro"ings
,ale of fixed assets
.perating profit
555
555
555
555
555
555
$otal ,ources 555
+pplication of funds : 6
4edumption of 4edeemable preference shares
4edumption of %ebentures
Payment of other long term loans
Purchase of 1ixed assets
.perating Loss
555
555
555
555
555
555
;G
Payment of di&idends! tax etc 555
$otal 2ses 555
3et 'ncrease - %ecrease in "or(ing capital
*$otal sources > $otal uses) 555
Cash flo" statement
Cash 1rom .peration : 6
< 3et profit = %ecrease in Current +sset
= 'ncrease in Current Liability
6 'ncrease in Current +sset
6 %ecrease in Current Liability
Cash flo" statement
,ources 4s# +pplication 4s#
.pening cash and ban(
balance
'ssue of shares
4aising of long term loans
,ales of fixed assets
,hort term 8orro"ings
Cash 'nflo"
Closing 8an( .-%
55
55
55
55
55
55
55
.pening 8an( .-%
4edumption of Preference ,hares
4edumption of Long term loans
Purchase of fixed assets
%ecrease in %eferred payment Liability
Cash .utflo"
$ax paid
%i&idend paid
%ecrease in 2nsecured loans! %eposits
Closing cash and ban( balance
55
55
55
55
55
55
55
55
55
55
55 55
:H
Rati% Ana&/$i$
+) Cash Position 4atio : 6
1) +bsolute Cash 4atio < Cash 4eser&oir
Current Liabilities
) Cash Position to $otal asset 4atio < Cash 4eser&oir 5 1HH
*Measure li0uid layer of assets) $otal +ssets
9) 'nter&al measure < Cash 4eser&oir
*ability of cash reser&oir to meet cash expenses) +&erage daily cash expenses
* +ns"er in days)
3otes : 6
Cash 4eser&oir < Cash in hand = 8an( = Mar(etable 3on trade in&estment at
mar(et &alue#
Current liabilities < Creditors = 8ills Payable = .utstanding Expenses =
Pro&ision for tax *3et of ad&ance tax) = Proposed di&idend = .ther
pro&isions#
$otal assets < $otal in asset side > Miscellaneous expenses > Preliminary
expenses = +ny increase in &alue of mar(etable non trading 'n&estments#
+&erage cash expenses <$otal expenses in debit side of P O L a-c > 3on cash
item such as depreciation! good"ill! preliminary expenses "ritten off! loss on
sale of in&estments! fixed assets "ritten off = ad&ance tax *'gnore pro&ision
for tax) # $he net amount is di&ided by 9@: to arri&e a&erage expenses#
4emar(s : 6 'n Comparison
When absolute cash ratio is lo"er then current liability is higher
When cash position to $otal +sset ratio is lo"er then the total asset is
relati&ely higher#
When cash inter&al is lo"er the company maintain lo" cash position# 't is not
good to maintain too lo" cash position or too high cash position#
8) Li0uidity 4atio : 6
1) Current ratio < Current asset
Current Liability
) Auic( ratio or +cid $est ratio < Auic( +sset
Auic( liability
:1
3otes : 6
Auic( +sset < Current +sset > ,toc(
Auic( Liability < Current liability > Cash credit! 8an( borro"ings! .% and
other ,hort term 8orro"ings#
,ecured loan is a current liability and also come under cash credit
,undry debtors considered doubtful should not be ta(en as 0uic( asset#
Creditors for capital W'P is to be excluded from current liability#
Current asset can include only mar(etable securities#
Loans to employees in asset side are long term in nature and are not part of
current assets#
Pro&ision for gratuity is not a current liability#
7ratuity fund in&estment is not a part of mar(etable securities#
$rade in&estments are not part of mar(etable securities#
4emar(s : 6
/igher the current ratios better the li0uidity position#
C) Capital structure ratios : 6
1) %ebt e0uity ratio < %ebt < External E0uity
*or) Le&erage ratio E0uity 'nternal E0uity
< Long term debt < ,hare holders fund
Long term fund Long term fund
) Proprietary ratio < Proprietary fund
$otal +ssets
9) $otal Liability to 3et "orth ratio < $otal Liabilities
3et "orth
;) Capital gearing ratio < Preference share capital = %ebt
E0uity > Preference share capital
3otes : 6
,hare holders fund *or) E0uity *or) Proprietary fund *or) ."ners fund *or)
3et "orth < E0uity share = Preference share = 4eser&es and surplus > P O L
a-c > Preliminary Expenses#
%ebt *or) Long term liability *or) Long term loan fund < ,ecured loan
*excluding cash credit) = unsecured loan = %ebentures#
$otal asset < $otal assets as per 8alance sheet > Preliminary expenses#
:
$otal liability < Long term liability = Current liability *or) short term liability
Long term fund < $otal asset > Current liability < ,hare holders fund = long
term loan fund#
4emar(s : 6
'n debt e0uity ratio higher the debt fund used in capital structure! greater is
the ris(#
'n debt e0uity ratio! operates fa&orable "hen if rate of interest is lo"er than
the return on capital employed#
'n total liability to 3et "orth 4atio < Lo"er the ratio! better is sol&ency
position of business! /igher the ratio lo"er is its sol&ency position#
'f debt e0uity ratio is comparati&ely higher then the financial strength is
better#
%) Profitability 4atio : 6
1) 7ross Profit 4atio < 7ross Profit 5 1HH
,ales
) 3et Profit 4atio < 3et Profit 5 1HH
,ales
9) .perating Profit ratio < .perating profit 5 1HH
,ales
;) 4eturn to shareholders < 3et profit after interest and tax
,hare holders fund
:) 4eturn on 3et Worth < 4eturn on 3et "orth 5 1HH
3et "orth
@) 4eturn on capital employed *or) 4eturn on in&estment < 4eturn *E8'$)
Capital Employed
E) Expenses 4atios :6
a) %irect expenses 4atios : 6
i) 4a" material consumed 5 1HH
,ales
ii) Wages 5 1HH
,ales
iii) Production Expenses 5 1HH
,ales
:9
b) 'ndirect expenses 4atios : 6
i) +dministrati&e Expenses 5 1HH
,ales
ii) ,elling Expenses 5 1HH
,ales
iii) %istribution Expenses 5 1HH
,ales
i&) 1inance Charge 5 1HH
,ales
3otes : 6
'n the abo&e the term LtermM is used for business engaged in sale of goods!
for other enterprises the "ord Lre&enueM can be used#
7ross profit < ,ales > Cost of goods sold
.perating profit < ,ales > Cost of sales
< Profit after operating expenses but before 'nterest and tax#
.perating Expenses < +dministration Expenses = ,elling and distribution
expenses! 'nterest on short term loans etc#
4eturn < Earning before 'nterest and $ax
< .perating profit
< 3et profit = 3on operating expenses > 3on operating 'ncome
Capital employed < ,hare holders fund = Long term borro"ings
< 1ixed assets = Wor(ing capital
'f opening and closing balance is gi&en then a&erage capital employed can be
substituted in case of capital employed "hich is
.pening capital employed = Closing capital employed
E) %ebt ser&ice co&erage ratios < Profit a&ailable for debt ser&icing
Loan 'nstallments = 'nterest
3otes : 6
Profit a&ailable for debt ser&icing < 3et profit after tax pro&ision =
%epreciation = .ther non cash charges = 'nterest on debt#
4emar(s : 6
/igher the debt ser&icing ratio is an indicator of better credit rating of the
company#
't is an indicator of the ability of a business enterprise to pay off current
installments and interest out of profits#
:;
1) $urno&er 4atios: 6
i) +ssets turno&er < ,ales
$otal assets
) 1ixed assets turno&er < ,ales V3umber of times fixed assets has
1ixed assets turned into salesW
9) Wor(ing capital turno&er < ,ales
Wor(ing capital
;) 'n&entory turno&er < Cost of goods sold
*for finished goods) +&erage in&entory
:) %ebtors turno&er *or) +&erage collection period < Credit sales *in ratio)
+&erage accounts recei&able
*or) < +&erage accounts recei&able 5 9@: *in days)
Credit sales
@) Creditors turno&er *or) +&erage payment period Credit purchases *in ratio)
+&erage accounts payable
*or) < +&erage accounts Payable 5 9@: *in days)
Credit Purchases
E) 'n&entory $urno&er *for W'P) < Cost of production
+&erage 'n&entory *for W'P)
F) 'n&entory $urno&er *for 4a" material) < 4a" material consumed
+&erage in&entory *for ra" material)
1H) 'n&entory /olding Period < 9@: #
'n&entory turno&er ratio
11) Capital $urno&er ratio < Cost of sales
Capital employed
3ote : 6
Wor(ing capital < Current asset > Current liability
< H#: 5 Proprietary ratio
+ccounts 4ecei&able < %ebtors = 8ills recei&able
::
+ccounts payable < Creditors = 8ills Payable
4emar(s : 6
'f assets turno&er ratio is more than 1! then profitability based on capital
employed is profitability based on sales#
/igher in&entory turno&er is an indicator of efficient in&entory mo&ement# 't
is an indicator of in&entory management policies#
Lo" in&entory holding period lo"er "or(ing capital loc(ing! but too lo" is
not safe#
/igher the debtors turno&er! lo"er the credit period offered to customers# 't is
an indicator of credit management policies#
/igher the creditors turno&er! lo"er the credit period offered by suppliers#
7) .ther 4atios: 6
1) .perating profit ratio < 3et profit ratio = 3on operating loss - ,ales ratio
) 7ross profit ratio < .perating profit ratio = 'ndirect expenses ratio
9) Cost of goods sold - ,ales ratio < 1HHD 6 7ross profit ratio
;) Earnings per share < 3et profit after interest and tax
3umber of e0uity shares
:) Price earning ratio < Mar(et price per e0uity share
Earning per share
@) Pay out ratio < %i&idend per e0uity share 5 1HH
Earning per e0uity shares
E) %i&idend yield ratio < %i&idend per share 5 1HH
Mar(et price per share
F) 1ixed charges co&erage ratio < 3et profit before interest and tax
'nterest charges
G) 'nterest co&erage ratio < Earning before interest and tax
'nterest charges
1H) 1ixed di&idend co&erage ratio < 3et profit #
+nnual Preference di&idend
:@
11) .&er all profitability ratio < .perating profit 5 1HH
Capital employed
1) Producti&ity of assets employed < 3et profit #
$otal tangible asset
19) 4etained earning ratio < 4etained earnings 5 1HH
$otal earnings
/) 7eneral 4emar(s: 6
1all in 0uic( ratio "hen compared "ith last year or other company is due to
huge stoc( pilling up#
'f current ratio and li0uidity ratio increases then the li0uidity position of the
company has been increased#
'f debt e0uity ratio increases o&er a period of time or is greater "hen
comparing t"o ratios! then the dependence of the company in borro"ed
funds has increased#
%irect expenses ratio increases in comparison then the profitability decreases#
'f there is "ages - ,ales ratio increases! then this is to &erified
a) Wage rate
b) .utput - Labour rate
'ncrement in "age rate may be due to increased rate or fall in labour
efficiency#
+gain there are many reasons for fall in labour producti&ity namely abnormal
idle time due to machine failure! po"er cut etc#
4eduction in 4a" material consumed - sales ratio may be due to reduction in
"astage or fall in material price#
'ncrease in production expenses ratio may also be due to price raise#
,toc( turno&er ratio denotes ho" many days "e are holding stoc(#
'n stoc( turno&er ratio greater the number of days! the mo&ement of goods
"ill be on the lo"er side#
1inancial ratios are Current ratio! Auic( ratio! %ebt e0uity ratio! Proprietary
ratio! 1ixed asset ratio#
,hort term sol&ency ratios are current ratio! Li0uidity ratio
Long term sol&ency or testing sol&ency of the company ratios are %ebt e0uity
ratio! fixed asset ratio! fixed charges co&erage ratio *or) 'nterest co&erage
ratio#
$o compute financial position of the business ratios to be calculated are >
current ratio! %ebt e0uity ratio! Proprietary ratio! fixed asset ratio#
1ictitious asset are Preliminary expenses! %iscount on issue of shares and
debentures! Profit and loss account debit balance#
:E
A$$ign*#nt
1) 8asis of $echni0ue used is minimiIation $echni0ue
) 't can also be done in maximation $echni0ue
9) Karious steps in +ssignment Problem are
,tep 1: Chec( "hether the problem is balanced or unbalanced by chec(ing
"hether ro" is e0ual to column! if unbalanced add dummy column or
ro" to balance the problem
,tep : 'dentify Least 3umber in each ro" and subtract "ith all number in that
4o"#
,tep 9: 'dentify least number of each column and subtract "ith all number in that
column#
,tep ;: Chec( "hether solution is reached "ith Iero selection in one ro" and
column! ie# Co&er all the Iero "ith minimum number of lines! solution is
reached only "hen selected Ieros is e0ual to number of ro"s or columns
or number of lines is e0ual to order of matrix#
,tep :: 'f solution is not reached so maximum stic(ing
,tep @: ,elect the least element in "ithin the unstri(ed Element
,tep E: $he element selected abo&e is
i) ,ubtracted "ith all the unstri(ed element
ii) +dded to all the double stri(ed element *'ntersection of t"o
lines)
,tep F: Chec( the solution
,tep G: 'f solution is not reached continue "ith the process from step :#
:F
Lin#ar !r%gra**ing
,implex Method:6
,teps:6
1# %etermine the obJecti&e function ^# .bJecti&e may be maximiIation or
minimiIation#
# 1or maximation problem the constraints "ould be < sign#
1or minimiIation problem the constraints "ould be \ sign#
9# 'ntroduce slac( &ariable
1or a sign > add the slac( &ariable ie# +dd ,1
1or \ sign > subtract the slac( &ariable and add artificial &ariable
ie# ,ubtract ,1! add +1#
;# Change the .bJecti&e function
1or ,1 > +dd `H,1B
1or +1 > +dd `M+1B
:# ,implex table format:6
@# ^J is arri&ed by summation of constant column "ith _!]!^ columns
E# Criteria for selecting the (ey column :6
1or Maxima ion Problem > /ighest &alue of CJ > ^J
1or MinimiIation Problem > Lo"est Kalue of CJ > ^J
F# %i&ide the Auantity Column "ith Pey column to arri&e at 44
G# Criteria for ,electing the Pey ro" :6
1or Maximation O MinimiIation Problem > Lo"est Positi&e 44 is selected
CJ
Auantity Kariable Const# _ ] ^ ,1 , 44
,1
,
^J
CJ 6
^J
:G
1H# $he Meeting Point is (ey Element
11# Criteria for deciding the optimal solution
1or Maximation Problem > +ll elements in CJ > ^J ro" is negati&e or Iero#
1or MinimiIation Problem > +ll elements in CJ > ^J ro" is positi&e or Iero
3ote > 1or finding "hether all the elements in CJ > ^J ro" is positi&e or Iero
for minimiIation problem substitute all the `MB "ith highest &alue#
1# 'f solution is not reached next table is formed#
19# 'nput for next table is
1irst (ey ro" in the next table is filled by di&iding all the numbers in the (ey
ro" of the pre&ious table "ith the (ey element#
4emaining all the ro"s is arri&ed as follo"s: 6
Corresponding pre&ious b *Kalue relating to that 5 Corresponding
$able ro" element ro" in the (ey column element in (ey ro"
in the
nd
table as
filled in pre&ious
step)
1;# Chec( the optimal solution! if not reached form the third table#
1:# 'f solution is reached then ans"er is amount in 0uantity column
corresponding to the &ariable#
.ther Points : 6
We can con&ert the MinimiIation Problem into Maximation Problem# $his is
(no"n as duality#
We can change the \ sign to a sign to match the problem
E#g# _ = ] a 1HH
is con&erted into 6_ 6 ] \ 61HH
@H
Tran$'%rtati%n
$he procedure follo"ed is MinimiIation Procedure
Problem is generally sol&ed in KogelBs +pproximation Method*K+M)
,teps for the problem is : 6
1# Con&ert profit matrix into loss matrix#
# 8alance the problem#
9# +rri&e at 4o" penalty and column penalty
4o" penalty and column penalty is calculated at *
nd
least > 1
st
least) in the
corresponding ro" or column#
;# ,elect from the entire 4o" penalty and column penalty maximum number#
:# 1rom the entire 4o" or Column minimum is selected#
@# ,tri(e the ro" or column "hich gets eliminated#
E# Continue until the entire item in the table is stri(e#
F# Write separately 'nitial solution table#
G# Chec( for %egeneracy# %egeneracy occurs "hen all the elements in the initial
solution is e0ual to *4o" = column > 1)
1H# 'f degeneracy occurs introduce efcilon > `eB# `eB is introduced in least
independent cell#
11# 1orm 2K Matrix# 't is formed by the element in the original solution
corresponding to the element in the 'nitial solution#
1# 1ind unalloted elements in the 2K Matrix
19# 1ind 'J i#e#*.riginal Matrix element > 2nalloted element found abo&e)
@1
1;# Chec( for optimal solution ie# +ll items must be Iero or positi&e#
1:# 'f not reached select the maximum negati&e in 'J matrix#
1@# 1orm a loop and reallocate the solution#
1E# 4epeat from step G#
3otes: 6
1# 'f there is Iero in 'J matrix "hile arri&ing at optimal solution then there is
another solution for the problem#
# %ummy column can be introduced in profit or loss matrix#
9# 'f there is penalty-redundancy payment for unsatisfying demand etc# is gi&en
then fills the dummy ro" or column "ith that amount or fill it "ith Ieros#
;# 'f there is constraint in the problem first satisfy the constraint and then sol&e#
:# &arious other methods for sol&ing the problem is
Least cost method
3orth "est corner rule
@# 7enerally K+M method is used
@
N#t(%r0 Ana&/$i$ 1C!M/!ERT2
C!M
$otal float < L, > E, *or) L1 > E1
1ree float < $otal float > /ead e&ent slac(
'ndependent float < 1ree float > $ail e&ent slac(
'n the diagram Es < Lf in the critical path
Critical path is the longest duration
$o find the minimum time associated cost *i#e# +dditional cost incurred per
unit of time sa&ed) follo"ing formula is used :6
Crash cost per day *or) +cti&ity cost supply
< Crash cost > 3ormal cost
3ormal time > Crash time
'nterfacing float < 't is the part of the total float "hich causes reduction in the
float of the succession acti&ities# 'n other "ords it is the portion of acti&ity
float "hich cannot be continued "ithout affecting ad&ersely the float of the
subse0uent acti&ity or acti&ities#
,teps in proceeding the problem : 6
# 1irst find and fill the E, and L1 column from the diagram#
9# $hen find L, and E1 as follo"s :6
Ls < Lf > %uration
Ef < Es = %uration
;# 1ind total float
:# 1ind free float# Where&er total float column has Iero free float column is also
ta(en has Iero and remaining elements is filled as said abo&e
@9
@# 1ind 'ndependent float# Where&er free float column has Iero 'ndependent
float column is also ta(en has Iero and remaining elements is filled as said
abo&e
3otes: 6
1# E, < Earliest ,tart# 'ndicates earliest time that the gi&en acti&ity can be
scheduled
# E1 < Earliest 1inish# $ime by "hich the acti&ity can be completed at the
earliest#
9# L1 < Latest 1inish# Latest allo"able occurrence time of the head e&ent of the
acti&ity#
;# L, < Latest ,tart#
:# $otal duration of the critical path is the maximum time-amount consumed for
the acti&ity# $his should be crashed "ith respect to crashing days and
crashing cost# $his crashing should not change the critical path#
!ERT : 6
Expected *or) +&erage time is found by assigning "eights as follo"s : 6
1 for optimistic
; for Most li(ely
1 for pessimistic
+&erage time < 1 optimistic = ; most li(ely = 1 pessimistic
@
,tandard %e&iation < *Pessimistic time > .ptimistic time)
@
Kariance < *,tandard %e&iation)
< *1=r)
6i
5
i
*2sed to find the present &alue of &ariance)
i<H
Where mi <Mean of cash flo" in the i
th
period > expected cash flo" for year i
i
< Kariance in the i
th
period#
r < %iscounting 1actor
M < $otal of Present &alue of mean
< $otal of present &alue of &ariance
8ench mar( < ProJect "ith lo"er ,% "ill be preferred#
1) 4eal Cash flo"s restated in terms of nominal cash flo"s as follo"s:6
*1 = inflation rate) 5 4eal cash flo"s
+fter this discounting cash flo" is applied to find 3PK#
) Con&erting nominal discounting rate into real terms
4eal discount rate < 1 = 3ominal discount rate 6 1
1 = inflation rate
With this real discount rate the Cash 'nflo"s are discounted to find 3PK#
9) Pay bac( reciprocal
< +&erage annual cash inflo"s *'t is used for reasonable approximation of
'nitial 'n&estment '44)
;) $he formula for deflation is
'ndex 3umber at the beginning 5 Cash 'nflo"s
'ndex 3umber at the end
*or) Cash 'nflo"s - *1='nflation 4ate)
n
3ote: 'f in a problem 4eal cash flo"s are gi&en and 'nflation 4ate and Cost of
Capital is gi&en then
i) Con&ert 4eal Cash 1lo"s into 3ormal Cash 1lo"s by using formulae said in *1)
abo&e#
ii) +dJust for %epreciation and tax and find Cash 1lo" after $ax before %epreciation#
iii) %eflate the amount arri&ed abo&e by using formulae said in *;)#
i&) With the amount arri&ed abo&e find 3PK using C.C#
E1
,ummary:6
i) 4is( +dJusted %iscount rate approach
< 3PK for C1+$ at 4is( adJusted %iscount 4ate#
ii) Certainty E0ui&alent +pproach
< 3PK for *Certainty E0ui&alent Coefficient 5 C1+$) at 4is( less 'nterest rate#
iii) Probality %iscount approach
< 3PK for *C1) at ris( less 'nterest rate#
E
Ana&/$i$ %f Ri$0 an, Unc#rtaint/
1) ,ensiti&ity +nalysis: 6 't pro&ides different cash flo" estimates under 9
assumptions a# "orst
b# $he expected *Most li(ely)
c# $he best#
3PK is found under these three assumptions and decision is ta(en#
) Precise measure of ris(:6
a) ,tandard de&iation: 6 +bsolute measure of ris(#
n
< C e P
i
* C1 > C1 )
i<1
C1 < Cash flo" i < ]ear
C1 < Mean cash flo" *C1 of particular proJects total di&ided by number of C1)
< e C1 5 P
P < Probability
n
b) Kariance < * )
<
e P
i
* C1 > C1 )
i<1
c) Co > Kariance *a!b) < P
i
* C1
a
> C1
a
) * C1
b
> C1
b
)
d) Coefficient of correlation of t"o &ariable factor < Co > Kariance *a!b)
a b
e) 4eturn of portfolio < W
a
5 4
a
= W
b
5 4
b
Where W > Proportion in&ested
4 > 4eturn
f) 4is( of portfolio < C P
a
5
a
= P
b
5
b
= P
a
5 P
b
5
a
5
b
5 Cor*a!b)
g) Co > Efficient of &ariation < + relati&e measure of ris(#
,tandard %e&iation
K< Expected cash flo"
*or)
mean *or) C1
*.r) Expected 3PK *3PK
)
3PK < 3PK 5 Probability
E9
h) 4is( adJusted discount rate approach: 6 'n this ris( adJusted discount rate is ta(en
as PK factor and calculated as 3PK method#
<e *C1+$)
t
6 C. Where P
r
< 4is( adJusted discount rate
*1 = P
r
)
t
i) Certainty E0ui&alent *CE) approach < 4is( less Cash 1lo"
4is(y Cash 1lo"
J) 'f Correlation Coefficient VCor*a!b)W is
Cor*a!b)
p #
=1 *P
a
5
a
) = *P
b
5
b
) Vie# 'f it is perfectly positi&ely correlatedW
61 *P
a
5
a
) > *P
b
5
b
) Vie# 'f it is perfectly negati&ely correlatedW
H +bo&e
p
formula "ill apply
() Probability %istribution approach: 6
t
*,% of C1) < C e p *C1 > C1)
< e
C1 6 C. < 3PK
*1=i)
t
Where
C1 < Cash 1lo"
C1 < Mean i#e# $otal of cash flo" multiplied by probability
for the period *or) expected &alue for C1+$ in period t)
i < 4is( less rate of interest#
t
< ,% for period t *,% for particular period)
l) ,% for the probability distribution of 3PK is *ie# ,% of C1)
*3PK) < C e *
t
) - *1 = i)
t
*this is used for uncorrelated C1)
*3PK) < e *
t
) - *1 = i)
t
*used for perfectly correlated C1)
Where ' < 4ate of 4eturn#
m) .ptimum proportion at "hich ris( is minimum < _
a
<
b
- *
a
=
b
)
*or)
a
_ 6
b
*16_) < H
3PK for the period is calculated by ta(ing C1 as C1 for respecti&e period and
calculated normally
3ote:6
i) 'n certainty E0ui&alent approach rate of discount is the ris( less rate of
'nterest as the ris( is adJusted "ith C1+$#
ii) 'n this case C1+$ is multiplied "ith certainty e0ui&alent and PK is
calculated by ris( less rate of interest#
iii) 'f proJects are ran(ed "ith respect of ris( and return# ProJect "ith respect
to ris( re0uires e 3PK *i#e# e*3PK 5 Probability)) and the proJect "ith respect to
E;
return find co6efficient
of &ariation < - e
3PK
i&) Probability that 3PK "ould be ^ero or less
^ < H > 3PK $he ^ Kalue is con&erted "ith the `^ $ableB
&alues and the probability of the 3PK being
Iero or less "ould be < H#: > *^ Kalue)#
&) Probability that 3PK being greater than ^ero "ould be
1 > *Probability less than ^ero)
&i) Probability that 3PK "ithin the range _ and ]
^
1
< _ > 3PK ^
))W
Where d
1
< l
n
*s-x) = *r
f
= Y
- Z) 5 t
Ct
l
n
< 3atural log
d
< d
1
6 Ct
s < Present spot rate
x < 1uture stri(e *excise) price
r
f
< 4is( free rate
,e&en step to sol&e the problem:6
i) 1ind log *s-x)
ii) 1ind d
1
iii) 1ind d
i&) 1ind 3 *d
1
)
&) 1ind 3 *d
)
i&) 1ind 3 *d
1
) 3ormal $able Kalue
= H#: &) 1ind 3 *d
)
&i) 1ind `eB &alue
&ii) +pply 8lac( ,chools Model#
,ub step to step 1:6
a) Log *s-x) < Log s > Log x
H#;9;9
b) 'f x and s are digit figure the &alue shall be *1 = Log table &alue)#
c) 'f x and s are 9 digit then the &alue shall be * = Log table &alue)#
,ub step to step @:6
a) 't is to find the po"er &alue of `eB#
b) e
6t5r
f
< 1 *or) 1 #
1 = r-9@: 5 3o# of days *t) 1 = r-9@: 5 3o# of Months *t)
E@
Kalue of Put option: 6
< V*x) 5 *e
6t5r
f
) 5 *3 *6d
))W 6 V, 5 3 *6d
1
)W
Excise price:6
't is the price at "hich the person "rites the prices on a share to buy after a
period#
Expected Kalue of the share:6
't is the total of estimate mar(et price of the share multiplied "ith the
respecti&e probability#
Expiration &alue: 6 Excise price > Expected Kalue
Expected *or) $heoretical &alue of the call option price at expiration *Pay off of Call
option) :6
< e *Estimated mar(et price > Excise Price) 5 Probability *or)
< VMax *s > x)! HW 5 Probability
Pay off of call option
Expected *or) $heoretical &alue of the put option price at expiration *Pay of put
option):6
< e *Excise Price 6 Estimated mar(et price) 5 Probability *or)
< VMax *x > s)! HW 5 Probability
Pay off of Put option
Where *Estimated mar(et price > Excise Price) is called pay off# 'f it is negati&e it is
ta(en as Iero#
s < Estimated Mar(et Price#
Put call parity < Put call parity e0uation is
*Kalue of call option = Present &alue of excise price) < *&alue of put option =
,pot rate)
3ote:6
i) Changes to be made in computation of 8lac( ,choles model for di&idend stoc(s:6
,ubstitute in all the places of LsM "ith Ls > PK of di&idendM
ii)'n the abo&e all PK is found at 4is( free rate#
EE
B#ta
8eta means! it measures the &olatility of securities to the changes in the
mar(et#
f *le&el of ris() <
s
5 Cor *s!m) "here
s
< ,% of return on securities
m
m
< ,% of return on mar(et portfolio
*or) Co&ariance*s!m) -
m
f should al"ays be applied on ris( premium and not to the entire return#
r
s
< r
f
= *r
m
> r
f
) 5 f Where r
f
< 4is( free rate
r
s
< Expected return on securities *or) VCapital
+ppreciation = %i&idend of the
companyW
r
m
< Expected return on mar(et portfolio *or)
VMar(et index YMar(et rateZ appreciation = Mar(et di&idend yield
DW
Portfolio $heory *P$):6
r
p
*expected return under CML) < r
f
= *r
m
> r
f
) 5 *
p
-
m
)
$he abo&e formula is based on total ris(#
Where
p
< ,% of efficient portfolio#
When expected return under efficient portfolio is as(ed then
r
p
*expected return under efficient portfolio) < Capital mar(et line*CML) >
Express e0uilibrium price relationship bet"een expected return and %,
Capital +sset Pricing Model *C+PM):6
r
s
*expected return portfolio in C+PM) < r
f
= *r
m
> r
f
) 5 V*
s
-
m
) 5
cor*s!m)W
*or) r
f
= V*r
m
> r
f
)W 5 f
Where r
m
< r
f
= Mar(et premium
8eta of the portfolio < * f
a
5 P
a
) = * f
b
5 P
b
)
Where P
a
! P
b
< Proportion of in&estment in Company + and Company 8#
EF
3ote:6
i) *r
m
> r
f
) < Mar(et ris( premium *or) Compensation per unit of ris(#
ii) Cor*s!m) is =1 under CML
iii) r
f
= *r
m
> r
f
) 5 V*
s
-
m
) 5 cor*s!m)W < $his portion in C+PM formula is
ris( premium
i&) *r
m
> r
f
) -
m
< Mar(et ris( return trade off *slope)#
3otes:6
$o find the in&estment to be made in ris( free in&estments to get a certain f is
f of expected portfolio < *W
1
5 f
1
) =*W
5 f
)
*or) < *W
1
5 f
1
) = *16W
1
) f
is f of r
f
securities *ie#H)
$his can also be use to find in&estment in other then r
f
securities# 'n that case
that f is substituted in f
#
$he "eitage *W
1
!W