Paper 3A: Cost Accounting Chapter 9CA. 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
Change with Level of Activity
Example: Rent, Salary etc.
Variable Costs
Changes in exact proportion with level
of Activity
Example: Material, Labour etc
Semi Variable Costs :
Changes with level of activity but not in
exact proportion
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 ( in units)• Profit / P V Ratio ( in amount)
Profit = MOS x P V Ratio
P V Ratio = Profit / MOS
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 ( in units)• Cash Fixed Costs / P V Ratio (in amount)
0
5
10
15
20
25
1 2 3 4
Cos
t & R
even
ue
Break Even Chart With Angle Of Incidence
TC
TR
Break Even PointUnits
Costs are classified on the
Basis of Functions
All costs of production
(Fixed or Variable) are included in
Inventory Valuation
sales value xxxxless: Direct materials (xxxx)less: Direct labour (xxxx)less: Factory overheads (xxxx)
Gross profit xxxxless: Administrative expense (xxxx)less: Selling & Distribution expense (xxxx)
Net profit xxxx
Sales xxLess: Variable CostsD. MaterialD. LabourD. ExpensesVar. Production OverheadsVar. Selling & Distribution Overheads
xx
Contribution xxLess: Fixed CostsFixed Production OverheadsAdministrative OverheadsFixed Selling & Distribution Overheads
xx
Net Profit 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 ◦ =Rs. 12500
Shut down point = ◦ 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
33 • Break Even Point
4 • Margin of Safety
55 • Shut Down Point
6 • Cost Indifference Point
7 • Cash Break Even point
88 • Break Even Charts & Angle of Incidence
9 • Marginal Costing Vs. Absorption Costing