A to Z Costing Knowledge Glossary — Letter N
Investopedia-style costing concepts explained with formulas, practical examples, comparisons, and exam-focused teaching tips.
1 Net Present Value (NPV)
| Category | Capital Budgeting |
|---|---|
| Best Used In | Evaluating long-term investment projects |
| Key Formula | NPV = Σ Cash inflows/(1+r)^t − Initial Investment |
| Exam Importance | Very High |
Net Present Value (NPV) is a capital budgeting technique that calculates the present value of all expected future cash flows from a project, discounted at the cost of capital, minus the initial investment.
A positive NPV indicates that the project is expected to generate value above the required return and should be accepted; negative NPV means value destruction.
- Evaluating long-term investment projects
- Comparing mutually exclusive projects
- Determining whether to accept or reject capital proposals
A company considers investing ₹10,00,000 in a project expected to yield cash inflows of ₹3,00,000 annually for 5 years. At a discount rate of 10%, NPV is calculated; if positive, the project is undertaken.
Initial investment ₹10,00,000; cash inflows Year 1 ₹2,00,000, Year 2 ₹3,00,000, Year 3 ₹4,00,000, Year 4 ₹5,00,000, Year 5 ₹6,00,000; discount rate 10%. NPV = 2,00,000/1.1 + 3,00,000/1.1² + 4,00,000/1.1³ + 5,00,000/1.1⁴ + 6,00,000/1.1⁵ − 10,00,000 ≈ ₹3,87,000 (positive).
- Identify initial investment cost.
- Estimate future cash inflows for each period.
- Determine discount rate (cost of capital).
- Discount each cash inflow to present value.
- Sum present values and subtract initial investment. If NPV > 0, accept; else reject.
| NPV vs. IRR | NPV gives absolute value; IRR gives percentage return. NPV is generally preferred for ranking projects. |
|---|---|
| NPV vs. Payback Period | Payback ignores time value of money and cash flows after payback; NPV considers all. |
2 Net Realizable Value (NRV)
| Category | Inventory Valuation / Joint Cost Allocation |
|---|---|
| Best Used In | Valuing inventory, allocating joint costs, accounting for by-products |
| Key Formula | NRV = Estimated Selling Price − Estimated Costs to Complete and Sell |
| Exam Importance | High |
Net Realizable Value (NRV) is the estimated selling price of an asset minus the estimated costs of completion and the estimated costs necessary to make the sale.
NRV represents the net amount a company expects to realize from the sale of inventory, used to ensure inventory is not valued above its recoverable amount.
- Inventory valuation at lower of cost or NRV
- Allocating joint costs using NRV method
- Accounting for by-products (crediting NRV to main product)
A company has inventory with cost ₹100 and estimated selling price ₹120, but further processing cost ₹10 and selling cost ₹5. NRV = 120 − 10 − 5 = ₹105. Since NRV > cost, inventory is valued at ₹100.
Joint products A and B are produced. A: selling price at split-off ₹80, further processing ₹20, selling expenses ₹5; NRV = ₹55. B: selling price at split-off ₹50, no further processing, selling expenses ₹2; NRV = ₹48. Joint costs allocated based on NRV.
- Determine the estimated selling price of the asset.
- Estimate any costs still required to complete the asset.
- Estimate costs required to make the sale (commissions, delivery).
- Subtract completion and selling costs from selling price.
- Use resulting NRV for valuation or allocation.
| NRV vs. Fair Value | Fair value is market price; NRV is net of selling costs and completion. |
|---|---|
| NRV vs. Market Value | Market value is current price; NRV is adjusted for costs to sell. |
3 Non-Controllable Cost
| Category | Responsibility Accounting |
|---|---|
| Best Used In | Performance evaluation, cost control |
| Key Formula | No formula; classification based on manager’s authority |
| Exam Importance | Medium |
A Non-Controllable Cost is a cost that a specific manager cannot influence or change within a given time period, such as allocated overheads, depreciation, or senior management salaries.
These costs are excluded from the performance report of a responsibility centre because the manager cannot control them, ensuring fair evaluation.
- Responsibility accounting and performance reports
- Management by exception
- Budgeting and cost control
A production manager cannot control factory rent or head office salaries allocated to the department. These are non-controllable costs and are not included in the manager’s performance evaluation.
Department manager’s performance report shows direct material cost (controllable) and allocated head office expenses (non-controllable). Only controllable costs are used to assess manager’s efficiency.
- Identify the responsibility centre and its manager.
- List all costs incurred in that centre.
- Determine which costs the manager cannot influence.
- Classify as non-controllable.
- Exclude from manager’s performance report or report separately.
| Non-Controllable vs. Controllable Cost | Controllable costs can be influenced by manager’s decisions; non-controllable cannot. |
|---|---|
| Non-Controllable vs. Unavoidable Cost | Non-controllable may be avoidable at a higher level (e.g., closing department); unavoidable cannot be avoided at all. |
4 Non-Value-Added Cost
| Category | Activity-Based Management / Lean |
|---|---|
| Best Used In | Identifying waste and inefficiency |
| Key Formula | Non-Value-Added Cost = Cost of activities that do not add value from customer’s perspective |
| Exam Importance | Medium |
Non-Value-Added Cost is the cost of activities that consume resources but do not increase the value of a product or service as perceived by the customer, such as rework, inspection, storage, or waiting.
In lean accounting, these costs are targets for elimination because they represent waste. Reducing them improves efficiency and profitability without reducing product quality.
- Identifying and eliminating waste
- Activity-based management
- Lean process improvement
A factory identifies rework cost, waiting time, and excess inventory storage as non-value-added costs. By reducing rework through better quality control, these costs decrease, increasing overall profitability.
Total production cost ₹10,00,000. Non-value-added activities: rework ₹50,000, inspection ₹30,000, storage ₹20,000. Non-value-added cost = ₹1,00,000. Eliminating or reducing these can save up to ₹1,00,000.
- List all activities in the production process.
- Classify each as value-added or non-value-added from customer’s perspective.
- Determine the cost of non-value-added activities.
- Sum to get total non-value-added cost.
- Prioritize and implement waste reduction initiatives.
| Value-Added vs. Non-Value-Added Cost | Value-added cost is necessary and customer perceives as beneficial; non-value-added is waste. |
|---|---|
| Non-Value-Added vs. Unnecessary Cost | Unnecessary cost may be value-added but excessive; non-value-added is waste regardless of level. |
5 Normal Capacity
| Category | Capacity Planning / Overhead Absorption |
|---|---|
| Best Used In | Determining overhead absorption rates |
| Key Formula | Normal Capacity = Average activity level over a period covering seasonal/cyclical fluctuations |
| Exam Importance | Medium |
Normal Capacity is the average level of activity that a company expects to achieve over a long period (e.g., 3-5 years), considering seasonal and cyclical fluctuations, used as a basis for fixed overhead absorption.
It represents a realistic, sustainable level of production, not peak or idle capacity, ensuring that overhead rates are stable and not distorted by short-term variations.
- Setting predetermined overhead absorption rates
- Budgeting and planning for moderate term
- Inventory valuation using absorption costing
A factory has a maximum capacity of 20,000 machine hours per year but normal capacity is 15,000 hours based on average demand over the past five years. Fixed overheads are budgeted at ₹3,00,000; absorption rate = ₹20/hour (3,00,000/15,000).
Normal capacity 12,000 units/year; budgeted fixed overhead ₹2,40,000. Overhead rate = ₹20/unit. If actual production is 11,000 units, absorbed overhead = 11,000 × 20 = ₹2,20,000, under-absorbed by ₹20,000.
- Analyze historical activity levels over several years.
- Adjust for expected future trends and normal fluctuations.
- Determine average annual activity as normal capacity.
- Use as denominator in fixed overhead absorption rate.
- Review periodically to reflect changing business conditions.
| Normal Capacity vs. Maximum Capacity | Maximum is theoretical 100% utilization; normal is realistic average. |
|---|---|
| Normal Capacity vs. Budgeted Capacity | Budgeted capacity is planned for a specific period; normal is long-term average. |
6 Normal Loss
| Category | Process Costing |
|---|---|
| Best Used In | Accounting for expected losses in production |
| Key Formula | Normal Loss = Expected Loss based on predetermined percentage of input |
| Exam Importance | High |
Normal Loss is the expected and unavoidable loss of materials or units in a production process, arising due to inherent characteristics like evaporation, shrinkage, or handling.
Normal loss is anticipated and is absorbed into the cost of good units. It may have a scrap value, which reduces the total process cost before allocation to remaining units.
- Process industries like chemicals, food processing, oil refining
- Calculating cost per unit after excluding normal loss
- Valuing finished goods and work-in-process
In a chemical process, input 1,000 kg. Normal loss is 5% = 50 kg. If actual output is 930 kg, total loss = 70 kg, of which 50 kg is normal, 20 kg abnormal. Normal loss cost is spread over the 950 kg expected good output; abnormal loss is separately recorded.
Input 1,000 kg at ₹10/kg = ₹10,000. Normal loss 10% = 100 kg with scrap value ₹2/kg = ₹200. Net process cost = 10,000 − 200 = ₹9,800. Expected good output = 900 kg. Cost per kg = 9,800/900 ≈ ₹10.89.
Cost per Unit of Good Output = (Total Process Cost − Scrap Value of Normal Loss) / (Input Units − Normal Loss Units)
- Determine input quantity and total process cost.
- Apply normal loss percentage to compute normal loss units.
- Determine scrap value of normal loss, if any.
- Subtract scrap value from total process cost.
- Divide by expected good output (input − normal loss) to get cost per unit.
| Normal Loss vs. Abnormal Loss | Normal is expected and absorbed into cost; abnormal is unexpected and charged separately to P&L. |
|---|---|
| Normal Loss vs. Scrap | Normal loss may result in scrap; scrap is the residue that may have value. |
7 Notional Cost
| Category | Cost Concept |
|---|---|
| Best Used In | Imputed costs for decision making |
| Key Formula | Notional Cost = Imputed value of a resource even though no cash outlay occurs |
| Exam Importance | Low |
Notional Cost (also called Imputed Cost) is a cost that does not involve actual cash payment but is considered for decision-making, such as interest on owner’s own capital or rent on owned premises.
These costs represent the opportunity cost of using internal resources, ensuring that economic profit, not just accounting profit, is considered.
- Make-or-buy decisions where owned resources have alternative uses
- Economic value added (EVA) calculations
- Evaluating true profitability of projects
A business uses its own building for production, paying no rent. But for accurate costing and pricing, it imputes a notional rent (market rate) to reflect the opportunity cost of not renting it out.
Owner uses ₹10,00,000 of own capital. Notional interest at 10% = ₹1,00,000, included in cost to show true economic cost. This reduces accounting profit but shows economic loss if revenue is insufficient.
- Identify internal resources used without explicit payment.
- Determine their market value or opportunity cost.
- Impute a cost for decision-making.
- Include in cost statements or economic profit calculations.
- Analyze impact on profitability.
| Notional vs. Explicit Cost | Explicit cost involves cash payment; notional does not. |
|---|---|
| Notional vs. Opportunity Cost | Opportunity cost is the benefit foregone; notional cost is the imputed cost of using owned resources. |
8 Net Profit
| Category | Financial Performance |
|---|---|
| Best Used In | Income statement, profitability analysis |
| Key Formula | Net Profit = Total Revenue − Total Expenses (including tax and interest) |
| Exam Importance | High |
Net Profit is the excess of total revenues over total expenses, including all operating, non-operating, financing, and tax expenses, representing the final profit available to shareholders.
It is the bottom-line profit after all costs have been deducted, indicating the overall financial performance of a business.
- Income statement reporting
- Return on investment and profitability ratios
- Dividend and reinvestment decisions
A company has revenue of ₹10,00,000, cost of goods sold ₹6,00,000, operating expenses ₹2,00,000, interest ₹50,000, tax ₹50,000. Net profit = 10,00,000 − 8,50,000 = ₹1,50,000.
Sales ₹20,00,000; COGS ₹12,00,000; administrative and selling expenses ₹3,00,000; interest ₹1,00,000; tax ₹1,00,000. Net profit = 20,00,000 − 17,00,000 = ₹3,00,000.
- Determine total revenue for the period.
- Identify all expenses including cost of goods sold, operating, interest, and taxes.
- Sum expenses.
- Subtract total expenses from total revenue.
- Result is net profit (or net loss if negative).
| Net Profit vs. Gross Profit | Gross profit = sales − COGS only; net profit deducts all expenses. |
|---|---|
| Net Profit vs. Operating Profit | Operating profit excludes interest and taxes; net profit includes all. |
9 Normal Costing
| Category | Costing Methodology |
|---|---|
| Best Used In | Assigning overhead using predetermined rates |
| Key Formula | Normal Cost = Actual Direct Materials + Actual Direct Labour + Applied Overhead |
| Exam Importance | Medium |
Normal Costing is a costing method that uses actual direct costs (materials and labour) but applies manufacturing overhead using predetermined overhead rates, rather than actual overhead.
It provides timely cost information because overhead is applied based on estimated rates and actual activity, avoiding delays in waiting for actual overhead figures. Variances arise due to estimation differences.
- Job order costing for timely pricing
- Interim financial reporting
- Standard costing environments
A company uses actual materials ₹50 and actual labour ₹30 for a job, but applies overhead at a predetermined rate of ₹10 per labour hour (job used 5 hours, so ₹50 overhead). Normal cost = 50+30+50 = ₹130.
Actual direct material ₹20,000, actual direct labour ₹15,000, predetermined overhead rate ₹8/machine hour, machine hours used 1,000 → applied overhead ₹8,000. Normal cost = ₹43,000.
- Record actual direct materials and labour costs.
- Determine predetermined overhead rate (budgeted overhead / budgeted activity).
- Multiply rate by actual activity to get applied overhead.
- Sum with actual direct costs to get normal cost.
- Compare with actual overhead at period end to compute over/under-absorption.
| Normal Costing vs. Actual Costing | Actual costing uses actual overhead; normal costing uses predetermined rate. |
|---|---|
| Normal Costing vs. Standard Costing | Standard costing sets standards for all costs; normal costing uses actual for direct costs, predetermined for overhead. |
10 Net Margin
| Category | Profitability Ratio |
|---|---|
| Best Used In | Measuring overall profitability of sales |
| Key Formula | Net Margin = (Net Profit / Sales) × 100 |
| Exam Importance | Medium |
Net Margin is a profitability ratio that measures how much net profit a company earns for every rupee of sales, expressed as a percentage.
It indicates the overall efficiency of the company in controlling all costs and generating profit from sales, after deducting all expenses, interest, and taxes.
- Comparing profitability across companies or periods
- Identifying cost control effectiveness
- Benchmarking against industry standards
A company has net profit ₹50,000 and sales ₹5,00,000. Net margin = (50,000/5,00,000)×100 = 10%. This indicates 10 paise of profit per rupee of sales.
Sales ₹20,00,000; net profit ₹2,40,000. Net margin = (2,40,000/20,00,000)×100 = 12%. This shows a healthy profit margin.
- Obtain net profit from income statement.
- Obtain total sales revenue.
- Divide net profit by sales.
- Multiply by 100 to express as percentage.
- Compare with previous periods and industry average.
| Net Margin vs. Gross Margin | Gross margin = (sales − COGS)/sales; net margin uses final net profit. |
|---|---|
| Net Margin vs. Operating Margin | Operating margin excludes interest and taxes; net margin includes all. |
11 Net Assets
| Category | Financial Position |
|---|---|
| Best Used In | Measuring net worth, capital employed |
| Key Formula | Net Assets = Total Assets − Total Liabilities |
| Exam Importance | Low |
Net Assets represent the residual value of a company after deducting all liabilities from total assets, equivalent to shareholders’ equity or net worth.
It is the amount that would be left for shareholders if all assets were sold and all liabilities paid. It is a measure of a company’s financial strength.
- Balance sheet analysis
- Return on net assets (RONA) calculation
- Valuation and credit analysis
A company has total assets ₹50,00,000 and total liabilities ₹30,00,000. Net assets = ₹20,00,000, which equals shareholders’ equity. This is used to assess solvency and return on capital.
Total assets ₹10,00,000; total liabilities ₹4,00,000. Net assets = ₹6,00,000. If net profit ₹60,000, Return on Net Assets = 10%.
- Identify total assets from balance sheet.
- Identify total liabilities.
- Subtract liabilities from assets.
- Result is net assets, equivalent to equity.
- Use for financial analysis and ratio computation.
| Net Assets vs. Total Assets | Total assets include all resources; net assets subtract liabilities. |
|---|---|
| Net Assets vs. Net Worth | Net worth is another term for net assets or equity. |
12 Non-Production Overheads
| Category | Overhead Classification |
|---|---|
| Best Used In | Full cost per unit, pricing |
| Key Formula | Non-Production Overheads = Administrative + Selling + Distribution Overheads |
| Exam Importance | Medium |
Non-Production Overheads are indirect costs that are not related to the manufacturing process, including administrative, selling, and distribution overheads.
These costs are incurred after the production stage, supporting the overall business operations and sales functions, and are typically treated as period costs but are often included in full cost for pricing.
- Full cost per unit for pricing decisions
- Cost sheet preparation (bottom section)
- Profitability analysis by product
A company calculates production cost ₹100/unit, administrative overhead ₹10/unit, selling overhead ₹5/unit, distribution overhead ₹3/unit. Total cost including non-production overheads = ₹118/unit for pricing.
Total production cost ₹2,00,000; admin overhead ₹40,000; selling overhead ₹30,000; distribution overhead ₹20,000. Total non-production = ₹90,000. For 10,000 units, non-production overhead per unit = ₹9. Full cost = ₹29/unit (if production ₹20/unit).
- Identify all non-manufacturing overhead categories.
- Sum administrative, selling, and distribution overheads.
- Allocate to products using appropriate bases (e.g., sales value, units).
- Add to production cost to get full cost.
- Use for pricing and profitability analysis.
| Non-Production vs. Production Overheads | Production overheads are incurred in factory; non-production are outside factory. |
|---|---|
| Non-Production vs. Period Costs | Non-production overheads are typically treated as period costs, expensed as incurred, but may be included in full cost for pricing. |
13 Negative Variance
| Category | Variance Analysis |
|---|---|
| Best Used In | Identifying underperformance |
| Key Formula | Negative Variance = Actual Result is Worse than Standard (e.g., higher cost, lower revenue) |
| Exam Importance | Medium |
Negative Variance (or Adverse/Unfavorable Variance) occurs when actual results are worse than the standard or budgeted amounts, such as higher costs or lower revenues than expected.
It indicates that performance did not meet expectations, requiring investigation and corrective action. In cost variance, negative means actual cost exceeded standard; in revenue variance, negative means actual revenue fell short.
- Budgetary control and standard costing
- Performance evaluation
- Identifying problem areas
Standard material cost ₹50/unit, actual ₹55/unit. Variance = ₹5 adverse per unit. This negative variance triggers investigation into supplier price increases or inefficient usage.
Budgeted sales ₹10,00,000; actual sales ₹9,00,000. Variance = ₹1,00,000 adverse (negative). Management investigates lower demand or pricing issues.
For revenue: Negative Variance = Actual Revenue − Budgeted Revenue (if negative)
- Determine standard/budgeted amount.
- Determine actual amount.
- Compute difference (actual − standard for costs; actual − budget for revenue).
- If cost variance positive or revenue variance negative, it is adverse/negative.
- Analyze causes and take corrective action.
| Negative Variance vs. Positive Variance | Positive is favorable; negative is adverse. |
|---|---|
| Negative Variance vs. Exception Reporting | Negative variances often trigger exception reporting for management attention. |
14 Normal Waste
| Category | Process Costing / Waste Management |
|---|---|
| Best Used In | Accounting for expected waste in production |
| Key Formula | Normal Waste = Expected waste based on standard input-output ratio |
| Exam Importance | Low |
Normal Waste is the expected and unavoidable residue or loss of material during the production process, such as shavings, offcuts, or evaporation, which is anticipated and absorbed into product cost.
Normal waste is similar to normal loss but specifically refers to the physical residue or scrap. It may have a small salvage value, which reduces the overall process cost.
- Manufacturing with material cutting, machining
- Process industries with evaporation or shrinkage
- Inventory valuation and cost per unit
In a woodworking shop, sawdust and offcuts are normal waste. The cost of wood includes the waste, and any sale of sawdust (scrap) reduces the material cost.
Input 1,000 kg of steel; normal waste 5% (50 kg) with scrap value ₹5/kg = ₹250. Net material cost = (1,000 × ₹50) − 250 = ₹49,750 spread over 950 kg good output.
Net Cost = Total Input Cost − Salvage Value of Normal Waste
- Determine input quantity and cost.
- Apply normal waste percentage.
- Determine salvage value of waste, if any.
- Subtract salvage value from total cost.
- Allocate net cost to good output.
| Normal Waste vs. Abnormal Waste | Normal waste is expected; abnormal waste is unexpected and charged to P&L. |
|---|---|
| Normal Waste vs. Scrap | Normal waste may be scrap; scrap is the residual material with possible value. |
