Paper 3A: Cost Accounting Chapter 9 CA. Dharmendra Gupta Introduction Cost classification Profit Volume Ratio ( P V ) ratio Break Even Point Margin of Safety Shut Down Point Cost Indifference Point Cash Break Even point Break even charts & Angle of Incidence Marginal Costing Vs. Absorption Costing Technique of Costing For Managerial Decision Making To Measure Profitability of Products To study Cost Volume Profit Analysis On the basis of nature of costs Mainly Fixed and Variable costs Costs Fixed Variable Semi Variable Cost Classification Fixed Cost Variable Costs Semi Variable Costs : Change with Level of Activity Changes in exact proportion with level of Activity Changes with level of activity but not in exact proportion Example: Rent, Salary etc. Example: Material, Labour etc Example: Maintenance costs etc Relation between Contribution and Sales Also Known as Contribution to Sales Ratio P V Ratio = • • • • • • • • • Total Contribution/Total Sales Contribution per unit/Sales per unit ( Fixed Cost + Profit )/ Sales ( Sales- Variable costs)/ Sales 1- Variable Cost Ratio Profit/ Margin of Safety Fixed Costs / Break Even Point Change in Contribution/Change in sales Change in Profit /Change in Sales Sales Where Total Costs is equal to Total Sales • Total costs = Fixed Costs + Variable Costs At BEP There is No Profit or No Loss Total Contribution = Fixed Costs • Contribution =( Sales – Variable costs) or Fixed costs + Profit) BEP ( in units) = • Total Fixed Costs/Contribution per unit BEP ( in amount) = • Total Fixed costs / Profit Volume Ratio Excess of Sales over Break Even Sales MOS = Sales – BEP Alternatively MOS = • Profit / Contribution per unit • Profit / P V Ratio Profit = MOS x P V Ratio P V Ratio = Profit / MOS ( in units) ( in amount) Sales below which Business can not be persued Temporary Closure of Business To Avoid Off Season, Recession etc Here Business must be able to generate Avoidable Fixed Costs • Avoidable Fixed Costs = Total Fixed Costs – Minimum or unavoidable fixed costs Shut Down Point = • Avoidable Fixed Costs / Contribution p.u. (in units ) • Avoidable Fixed Costs / P V Ratio ( in amount ) Activity Level at which Two different Options result in same Costs Cost Indifference Point = • Change in Fixed Costs /Change in variable Costs per unit Here Only Cash Fixed Costs are Considered Non cash costs like Depreciation etc are not Considered Cash Break Even Point = • Cash Fixed Costs / Contribution p u • Cash Fixed Costs / P V Ratio ( in units) (in amount) Break Even Chart With Angle Of Incidence 25 Cost & Revenue 20 15 TC TR 10 5 0 1 2 Units Break Even Point 3 4 Costs are classified on the Basis of Functions All costs of production (Fixed or Variable) are included in Inventory Valuation less: less: less: less: less: sales value Direct materials Direct labour Factory overheads Gross profit Administrative expense Selling & Distribution expense Net profit xxxx (xxxx) (xxxx) (xxxx) xxxx (xxxx) (xxxx) xxxx Sales Less: Variable Costs D. Material D. Labour D. Expenses Var. Production Overheads Var. Selling & Distribution Overheads Contribution Less: Fixed Costs Fixed Production Overheads Administrative Overheads Fixed Selling & Distribution Overheads Net Profit xx xx xx xx xx A Company produces a product whose Selling Price is Rs. 25 per unit. Variable Cost is Rs. 15 per unit and Total fixed Cost is Rs. 15000. Company is producing and selling 20000 units Find ◦ ◦ ◦ ◦ ◦ Contribution per unit P V Ratio Break Even Point Margin of safety Shut Down Point if Minimum Fixed Cost is Rs. 10000 Contribution per unit = Sales – Variable cost Hence Contribution per unit=Rs.25-15=Rs.10 P V Ratio=Contribution /Sales So, P V Ratio=10/25=40% Break Even Point = Total Fixed Cost /PV Ratio So, Break Even Point= 15000/40%=Rs.37500 Note : Break even Point can also computed in terms of units. In that case ◦ BEP=Total fixed Costs /Contribution Per Unit ◦ BEP =15000/10=1500 units Margin of Safety (MOS) = Sales – BEP MOS ( in units ) = 2000- 1500 =500 units MOS (in amount) =2000 * 25 -37500 Shut down point = ◦ =Rs. 12500 ◦ Avoidable fixed cost/contribution per unit (in units ) ◦ Avoidable Fixed cost / PV Ratio ( in amount) Note : Avoidable Fixed Cost = Total Fixed Cost – Minimum Fixed Cost Rs. 15000 – 10000 = Rs. 5000 Shut Down Point = Rs. 5000/10 = 500 units Shut Down Point =Rs. 5000/ 40% =Rs 12500 A Company is to select a machine out of 2 machines A & B. Machine A has a Fixed Cost of Rs. 20000 and Variable Cost of Rs.20 per unit While Machine B has a Fixed Cost Rs. 10000 and Variable Cost of Rs.25 per unit Find Cost Indifference Point Cost Indifference point = ◦ ◦ ◦ ◦ Change in Total Fixed Cost /Change in Var. Cost per unit Change in Total Fixed Cost = Rs. 20000-10000=Rs.10000 Change in Var. Cost per unit = Rs. 25 -20 = Rs. 5 Cost Indifference Point = Rs. 10000/Rs. 5 ◦ 2000 units ◦ We now have a better understanding of following aspects: 1 • Cost classification 2 • Profit Volume Ratio - PV Ratio 3 • Break Even Point 4 • Margin of Safety 5 • Shut Down Point 6 • Cost Indifference Point 7 • Cash Break Even point 8 • Break Even Charts & Angle of Incidence 9 • Marginal Costing Vs. Absorption Costing
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