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