Management Accounting Unit 3 Absorption & Marginal Costing

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Management Accounting Unit 3 Absorption & Marginal Costing

Management Accounting Unit 3 Absorption & Marginal Costing Notes cover all the exercise questions in UGC Syllabus. Management Accounting Unit 3 Absorption & Marginal Costing provided here ensures a smooth and easy understanding of all the concepts. Understand the concepts behind every Unit and score well in the board exams.

Absorption & Marginal Costing

MANAGEMENT ACCOUNTING

VERY SHORT TYPES QUESTION & ANSWERS

1. Fill in the blanks:

(a) ___________ is the increase or decrease in total cost which results from producing or selling additional or fewer units of a product or from change in the method of production or distribution.

Ans: Marginal cost.

(b) Marginal costing is a technique which is concerned with the changes in __________ and ___________ resulting from changes in the volume of profit.

Ans: Costs, profit.

(c) Marginal costing is also known as ____________.

Ans: Variable costing.

(d) __________ refers to the study of relationship between costs, volume and profit at different levels of sales or production. 

Ans: Break-even analysis.

(e) Break-even point may be defined as the point at which ___________ is equal to ___________.

Ans: Total revenue, total cost.

(f) The angle of incidence is the angle between the _________ line and the _________ line formed at the break even point where the sales line and the total cost line intersect each other. 

Ans: Sales, total cost.

(g) Margin of safety is equal to ___________ by _________.

Ans: Profit, p/v ratio.

(h) ________ is the difference between sales and variable cost.

Ans: Contribution.

(i) In differential cost analysis decisions are taken by comparing the incremental revenue with __________.

Ans: Differential cost.

(j) In marginal costing all __________ are treated as product cost.

Ans: Variable Cost.

(k) P/V ratio is the ratio of __________ to sales.

Ans: Contribution.

(l) Total variable cost ___________ in proportion to output.

Ans: Increases.

(m) The break even point can be achieved when total sales revenue is _________ to total cost.

Ans: equal.

2. Write “true” or “false” against each of the following statements:

(a) In marginal costing, variable cost fluctuates per unit of output irrespective of the level of output.

Ans: False.

(b) Fixed cost is treated as period cost and is charged to profit and loss account for that period in marginal costing technique.

Ans: True.

(c) Managerial decisions are guided by contribution in marginal costing.

Ans: True.

(d) Contribution helps the management in the fixation of selling prices.

Ans: True.

(e) Fluctuation in the general price level is an important assumption in break-even analysis.

Ans: False.

(f) The study of cost-volume-profit analysis is often referred to as “break-even” analysis.

Ans: True.

(g) The margin of safety can be improved by lowering the level of production.

Ans: False.

(h) A limiting factor is a factor which limits production a sales and then prevents a concern from making unlimited profit.

Ans: True.

(i) Marginal costing is based on the distinction between Fixed and Variable Cost.

Ans: True.

(j) In marginal costing technique a portion of fixed overhead is carried over to the next period.

Ans: False.

(k) For decision making, absorption costing is more suitable than marginal costing.

Ans: False.

(l) In marginal costing, managerial decisions are guided by contribution margin than by profit.

Ans: True.

(m) Marginal costing is a technique of cost control.

Ans: True.

SHORT TYPE QUESTIONS & ANSWERS

1. Write a brief note on cost-volume profit analysis. 

Ans: Cost-volume-profit analysis is a technique for studying the relationship between cost, volume and profit. Profit of an undertaking depends upon a large number of factors. But the most important of these factors are the cost of manufacture, volume of sales and the selling prices of the products.

2. What is the key factor?

Ans: A key factor is that factor which puts a limit on production and profit of a business usually the limiting factor is sales. A concern may not be able to sale as much as it can produce. But sometimes a concern can sell it produces but production is limited due to the shortage of materials, labours, plant capacity or capital. In such a case, a decision has to be taken regarding the choice of the product whose production is to be increased, reduced or stopped.

3. What is meant by ‘make or buy decision’.

Ans: A concern can utilise its idle capacity by making component parts instead of buying them from the market. In arriving at such a make or buy decision, the price asked by the outside suppliers should be compared with the marginal cost of producing the component parts. If the marginal cost is lower than the price demanded by the outside suppliers, the component part should be manufactured in the factory itself to utilise unused capacity.

4. What is cost indifferent point?

Ans: Sometimes there are two alternatives one having low variable cost and high fixed cost and the other having high variable cost and low fixed cost. The cost indifferent point has to be determined by linking the incremental fixed overhead by the savings in variable costs. At an indifferent point the total cost of the two alternatives will be the same. And in which have the greatest contribution should be adopted.

5. Define ‘Break-even chart’.

Ans: A break even chart is a graphical representation of marginal costing. It is considered to be one of the most useful graphical presentation of accounting data. It is a readable reporting device that would otherwise require voluminous reports and tables to make the accounting data meaningful to the management. This chart shows the interrelationship between cost, volume and profit. It shows the break-even point and also indicates the estimated cost and profit or loss at various volume of activity.

6. Distinguish between contribution and profit.

Ans: The following are the main differences between contribution and profit:

Contribution	Profit
(i) Includes fixed cost and profit.	(i) Does not include fixed cost.
(ii) Based on marginal cost concept.	(ii) Based on absorption cost concept.
(iii) Contribution above break even contributes to profit.	(iii) Profit is expected only after covering variable and fixed cost.
(iv) Contribution analysis requires a knowledge of break even concept.	(iv) Profit does not require any such concept.

7. Distinguish between Absorption costing and marginal costing.

Ans: The following are the various point of difference between absorption and marginal costing:

Absorption costing	Marginal costing
(i) All cost fixed and variable are included for ascertaining of cost.	(i) Only variable cost are included.
(ii) Fixed expenses remaining same at different level.	(ii) Marginal cost per unit is same at any level.
(iii) Difference between sales and cost is profit.	(iii) Difference between cost is total contribution and fixed profit.
(iv) Cost are classified according to functional basis.	(iv) Cost are classified according to the behaviour of cost.
(v) Absorption cost fails to establish relationship of cost, volume and profit.	(v) Cost, volume and profit relationship is an integral part of marginal cost analysis.

8. Discuss the assumptions of marginal costing.

Ans: The technique of marginal costing is based upon the following assumptions:

(i) All elements of cost-production, administration and selling and distribution cost are divided into fixed and variable components.

(ii) Variable cost remains constant per unit of output irrespective of level.

(iii) The selling price per unit remains unchanged or constant at all levels of activity.

(iv) Fixed costs remain unchanged or constant for the entire volume of production.

(v) The volume of production or output is the only factor which influences the costs.

9. What is a profit-volume graph? Describe its uses?

Ans: Profit-volume graph is a pictorial representation of the profit-volume relationship. Profit-volume graph is a simplified form of break even chart and is an improvement over the break even chart as it clearly shows the relationship of profit to volume or sales.

Uses of P/v Graph:

(i) To determine break even point.

(ii) To show impact on profits of selling product at different prices.

(iii) To forecast costs and profits resulting from charges in sale volume.

(iv) To show the deviations of actual profit from anticipated profit relative profitability under conditions of high or low demand.

10. “The technique of marginal costing can be a valuable aid to management. Discuss.

Ans: Marginal costing technique is a valuable aid to management in taking many managerial decisions. It is a useful tool for making policy decisions, profit planning and cost control. The information supplied by the ‘total cost method’ is usually not sufficient to solve managerial problems.

Following are the some of the important managerial problem where marginal costing technique can be applied:

(i) Pricing Decisions.

(ii) Profit planning and maintaining a desired level of profit.

(iii) Make or buy decisions.

(iv) Problems of key or limiting factor.

(v) Selection of a suitable or profitable sales mix. 

(vi) Effect of changes in sales price.

(vii) Alternative methods of production.

(viii) Determination of optimum level of activity.

(ix) Evaluation of performance.

(x) Capital Investment Decisions.

11. What are the assumption of a Break-even Chart?

Ans: Following assumptions are required to be made in the construction of a break-even chart:

(i) Fixed cost will tend to remain constant.

(ii) The price of variable cost factor will remain unchanged.

(iii) Semi variable cost can be segregated into variable and fixed cost.

(iv) Operating efficiency will not increase or decrease.

(v) There will be no any change in price policy.

(vi) Product-mix will remain unchanged.

(vii) The number of units of sale and number of unit produced will be the same.

12. What is meant by Break Even chart?

Ans: Break even chart is a graphical representation of marginal costing showing inter relationship between cost-volume and profit. It shows break even point (i.e no profit no loss point) and also indicates the estimated cost and estimated profit or loss at various volumes of activity. 

The Break even chart has been defined by CIMA as “a chart which shows the profitability or otherwise of at various levels of activity and as a result indicates the point at which neither profit nor loss is made”. 

It shows the following information of various levels of activity.

(i) Variable cost.

ii) Sales volume.

(iii) Profit or loss.

(iv) Break even point.

(v) Margin of safety.

It is a chart which shows the interaction of volume, selling price, variable cost and fixed cost at different levels. It also shows the relevant variables and their impact upon profit simultaneously. This is why break even graph is also called a profit planning chart.

13. What is margin of safety in the break even sales?

Ans: It is basically the limit to which the actual or estimated sales exceed the break-even sales. You get margin of safety ratio after subtracting the actual sales from the break even sales, and the dividing the result by actual sales.

In simpler terms, the margin of safety measures the business risk. A company with a higher margin of safety is more likely to sustain the volatile conditions and maintain its sales. However, if the sales drop more than the margin of safety, it would result in a net loss for the period.

If the break-even sales are low and the angle of incidence is large, it reflects that the business is stable. This would also mean that the margin of safety would be high. If the break-even sales are slightly lower with a moderate angle of incidence, we can consider the business to be stable. However, the company is not making as much profit as in the first case. A third situation is where the break-even sales are higher, the angle of incidence would be narrow and the margin of safety sales would be low as well.

14. What Is Margin of Safety?

Ans: Margin of safety is a principle of investing in which an investor only purchases securities when their market price is significantly below their intrinsic value. In other words, when the market price of a security is significantly below your estimation of its intrinsic value, the difference is the margin of safety. Because investors may set a margin of safety in accordance with their own risk preferences, buying securities when this difference is present allows an investment to be made with minimal downside risk.

Alternatively, in accounting, the margin of safety, or safety margin, refers to the difference between actual sales and break-even sales. Managers can utilize the margin of safety to know how much sales can decrease before the company or a project becomes unprofitable.

15. Describe margin of safety.

Ans: The margin of safety principle was popularized by famed British- born American investor Benjamin Graham (known as the father of value investing) and his followers, most notably Warren Buffett. Investors utilize both qualitative and quantitative factors, including firm management, governance, industry performance, assets and earnings, to determine a security’s intrinsic value. The market price is then used as the point of comparison to calculate the margin of safety. Buffett, who is a staunch believer in the margin of safety and has declared it one of his “cornerstones of investing,” has been known to apply as much as a 50% discount to the intrinsic value of a stock as his price target.

Taking into account a margin of safety when investing provides a cushion against errors in analyst judgment or calculation. It does not, however, guarantee a successful investment, largely because determining a company’s “true” worth, or intrinsic value, is highly subjective. Investors and analysts may have a different method for calculating intrinsic value, and rarely are they exactly accurate and precise. In addition, it’s notoriously difficult to predict a company’s earnings or revenue.

16. Why margin of safety is important?

Ans: Importance of Margin of Safety: The size of margin of safety is a very important indicator of the soundness of a business. It shows how much sales may decrease before the firm will suffer a loss. If the size of margin of safety is high, chances of incurring loss by the business will be remote but if it is low, a small reduction  in sales may lead to loss. The common cause of lower margin of safety is higher fixed costs. In such a businesses a high level of activity is required. A low margin of safety is a matter of concern and so the following steps may be taken to improve an unsatisfactory margin of safety:

(a) Increase the selling price.

(b) Reduce the fixed or variable costs or the both.

(c) Increase the volume of output by utilising the unutilized production capacity.

(d) Stop production of unprofitable products and concentrate on only the profitable products.

17. How to Calculate a Margin of Safety Percentage?

Ans: The margin of safety measures how much extra sales you have over the minimum amount needed to break even. The break even point equals the amount of sales needed to cover all of your expenses. To calculate the margin of safety percentage, you must know the expected sales and the break even sales amount for your company. The larger the margin of safety percentage, the larger the buffer between your break even point and the anticipated sales. 

Subtract from the projected sales the amount of sales you need to break even. For example, if you anticipate sales of $500,000, but only need $460,000 to break even, subtract $460,000 from $500,000 to get a safety margin of $40,000.

Divide the safety margin by the projected sales to find the margin of safety ratio. In this example, divide $40,000 by $500,000 to get 0.08. Multiply the margin of safety ratio by 100 to find the margin of safety percentage. In this example, multiply 0.08 by 100 to get an 8 percent margin of safety.

18. How to calculate margin of safety?

Ans: The margin of safety is the difference between two figures, so it is a simple matter of subtraction. For example, if Company A made £200,000 in sales with a breakeven point of £100,000, they would have following margin of safety:

Sales	£200,000
Breakeven	£100,000
Margin of safety	£100,000

However, the margin of safety can also be represented as a percentage.

LONG TYPE QUESTIONS & ANSWERS

1. Write short notes on the following:

Ans: (a) Marginal Cost: The terminology of cost Accountancy of ICMA, London defines marginal cost as “Marginal Cost represents the amount of any given volume of output by which aggregate costs are changed if the volume of output is increased by one unit”. In practice, this is measured by the total variable costs attributable to one unit. In this context, a unit may be a single article, a batch of articles, an order, a stage of production capacity, a man-hour, a process or department. It relates to the change in output in the particular circumstances under consideration.

(b) Marginal costing: ICMA defines marginal costing as “The ascertainment of marginal cost and of the effect on profit of changes in volume or type of output by differentiating between fixed costs and variable costs.” “In this technique of costing only variable costs are charged to operations, processes or products, leaving all indirect costs to be written off against profits in the period in which they arise”.

(c) Absorption costing: Absorption costing is a conventional technique of ascertaining cost. All costs both variable and fixed are charged to an operation, process or product. Thus, the cost of a unit is made up of both direct costs and indirect or overhead costs. So, the cost per unit will change with the change in the level of output.

(d) Contribution: Contribution is the difference between sales and variable cost or marginal cost and sales. It may also be defined as the excess of selling price over variable cost per unit. It is also known as contribution or gross margin. It can be represented as:- Contribution = sales variable cost.

(e) Profit/volume ratio (p/v ratio): The profit / volume ratio, which is also called the ‘contribution ratio” or “margin ratio”, expresses the relation of contribution to sales and can be expressed as: 

p/v ratio = contribution/sales

The p/v ratio, which establishes the relation between contribution and sales is of vital importance for the studying the profitability of operations of a business.

(f) Break-even analysis: The term “break-even analysis” is used in two senses-narrow sense and broad sense. In its broad sense, break even analysis refers to the study of relationship between costs, volume and profit at different levels of sales or production. In its narrow sense, it refers to a technique of determining level of operations where total revenues equal to total expenses.

(g) Break-even point: The break-even point may be defined as that point of sales volume at which total revenue is equal to total cost. It is a point of no profit no loss.

It can be expressed in terms of:

(i) Break-even point (units) = Fixed cost/selling price per unit – variable cost per unit 

(ii) Break-even point (sales) = Fixed cost/Sales-variable cost×sales

Break-even point as a percentage of estimated capacity 

= Fixed cost/Total contribution 

(h) Margin of safety: The excess of actual or budgeted Sales over the break-even sales is known as the margin of safety. It is the difference between actual sales minus the sales at break-even point. It represents the amount by which sales revenue can fall before a loss is incurred.

It can be represented by :

Margin of safety = Total sales – Sales at break-even

Or

Margin of safety = Profit/P/V ratio

(i) Angle of incidence: The angle of incidence is the angle between the sales line and the total cost line formed at the break-even point where the sales line and the total cost line intersect each other. It indicates the profit earning capacity of a business. A large angle of incidence indicates a high rate of profit and on the other hand, a small angle of incidence indicates a lower rate of profit.

(j) Break even chart: A break-even chart is a graphical representation of marginal costing. It portrays a pictorial view of the relationship between costs, volume and profits. It shows the break-even point and also indicates the estimated profit or loss at various levels of output. The break-even point as indicated in the chart is the point at which the total cost line and total sales line intersect.

(k) Profit-volume graph: p/v graph is a pictorial representation of the profit-volume relationship. The graph shows profit and loss at different volumes of sales. It is said to be the simplified form of break-even chart as it clearly represents the relationship of profit to volume of sales. A profit- volume graph is also called the p/v graph.

2. Define marginal cost? Mention some advantages and limitations of marginal costing.

Ans: The terminology of cost Accountancy of ICMA, London defines marginal cost as “Marginal Cost represents the amount of any given volume of output by which aggregate costs are changed if the volume of output is increased by one unit”. In practice, this is measured by the total variable costs attributable to one unit. In this context, a unit may be a single article, a batch of articles, an order, a stage of production capacity, a man-hour, a process or department. It relates to the change in output in the particular circumstances under consideration.

The following are the important advantages of marginal costing:

(i) Easy to understand: The technique of marginal costing is very simple to operate and easy to understand. Since fixed costs are kept outside the unit cost, the cost statements prepared on the basis of marginal costs are much less complicated.

(ii) Removes the complexities of under absorption of overhead: It does away with the need for allocation, apportionment and absorption of fixed overhead and hence removes the complexities of under absorption of overheads.

(iii) Production planning: Marginal cost remains the same per unit of output irrespective of the level of activity. It is constant in nature and helps the management in production planning.

(iv) Facilitates the study of relative profitability: It facilitates the study of relative profitability of different product lines, departments, production facilities, sales division etc.

(v) Management reporting: It is very useful in management reporting. Marginal costing facilitates management by exception by focussing attention of the management towards more important areas than to waste time on problems which do not require urgent attention of the higher management.

The technique of marginal costing suffers from the following limitations:

(a) All costs are not divisible into fixed and variable: There are certain costs which are semi-variable in nature. It is very difficult and arbitrary to classify these costs into fixed and variable elements.

(b) Variable costs do not always remain constant: Variable costs do not always remain constant and do not always vary in direct proportion to the volume of output because of the law of diminishing and increasing returns.

(c) Fixed costs do not remain constant: Fixed costs do not remain constant after a certain level of activity. Further marginal costing ignores the fact that fixed costs are also controllable.

(d) Ignores the time factor: Marginal costing completely ignores the time factor. Thus, if two jobs give equal contribution but one takes a longer time to complete, the one which takes longer should be regarded as costlier than the other. But, the fact is ignored altogether under marginal costing.

(e) Difficulty in making pricing decisions: Fixation of selling prices in the long run cannot be done without considering fixed costs. The pricing decisions cannot be based on marginal cost alone.

3. “Marginal costing is a valuable aid to management.” Explain this statement. 

Ans: Marginal costing and Break even analysis are very useful to management. The important uses of marginal costing and Break Even analysis are the following:

(i) Cost Control: Marginal costing divides total cost into fixed and variable cost. Fixed Cost can be controlled by the Top management to a limited extent and Variable costs can be controlled by the lower level of management. Marginal costing by concentrating all efforts on the variable costs can control total cost.

(ii)  Make or Buy: Components and spare parts may be made in the factory instead of buying from the market. In such cases, the marginal cost of manufacturing the components or spare parts should be compared with market price while making the decision “to make or buy”. If the marginal cost is lower than the market price, it is more profitable to make than purchasing from the market.

(iii) Fixation of Selling Price: Generally prices are determined by demand and supply of products and services. But under special market conditions marginal costing is helpful in deciding the prices at which management should sell. When marginal cost is applied to fixation of selling price, it should be remembered that the price cannot be less than marginal cost. 

(iv)  Limiting Factor: when a limiting factor restricts the output, a contribution analysis based on the limiting factor can help maximise profit. For example, if machine availability is the limiting factor, then machine hour utilisation by each product shall be ascertained and contribution shall be expressed as so many rupees per machine hour utilised. Then, emphasis is given on the product which gives highest contribution.

(v) Evaluation of Performance: The different products and divisions have different profit earning potentialities. The Performance of each product and division can be brought out by means of Marginal cost analysis, and improvement can be made where necessary.

(vi) Profit Planning: It helps in short-term profit planning by making a study of the relationship between cost, volume and Profits, both in terms of quantity and graphs. An analysis of contribution made by each product provides a basis for profit-planning in an organisation with a wide range of products. 

4. Explain briefly the technique of Marginal Costing. In what ways is this technique useful in management accounting?

Or

Discuss the concept and characteristics of Marginal Costing as a technique of Management Accounting.

Ans: Characteristics of marginal cost:

(a) Fixed unit cost: The primary characteristic of marginal cost is that unit cost remains same in a given condition regardless of the level of output and the total variable cost changes directly with the changes in the level of output. Thus marginal cost consists of the variable cost only and as a result, the product cost will be a constant ratio regardless of changes in the level of output.

(b) Income Statement: Under this technique, difference between selling price and marginal cost is termed as profit or loss.

Usefulness to management accounting: Marginal costing technique is a valuable technique to the management in taking managerial decisions. It is a very useful in determining business policy, important decision profit planning and cost control.

Decision Making:

Marginal costing helps the management in various important decision making regarding the following matters:

(i) Introduction of a new product.

(ii) Whether to make or buy.

(iii) Selection of the most profitable production sales mix.

(iv) Utilisation of spare capacity.

(v) Selection of capital projects.

In formulating business policy, the management uses various tools offered by marginal costing such as contribution, BE chart, P.V. graph. C.V.P. analysis etc.

In Marginal costing technique, only the variable cost and not the fixed cost are considered as production cost and contribution being the difference between sales and variable cost is primary factor for taking decision on the above matters.

Profit Planning: Profit Planning is the planning of future operation to attain a defined profit goal i.e. the desired amount of profit or to maintain a specific level of profit. Marginal costing provides the necessary data for profit planning and decision making.

It helps the management in planning and evaluating profit from:

(a) a change in volume.

(b) a changes in sales mix.

(c) a change in pricing of products.

(d) A make or buy decision.

Evaluation of performance: Different products, department, markets and sales division have different earning potentialities. Marginal cost analysis is a very useful technique for evaluating the performance of each sector of a concern. The evaluation is possible because of the distinction made between fixed and variable expenses. The evaluation of performance is based on the respective contribution made by each sector and higher the contribution, better is the performance.

Thus, marginal costing is an effective tool for controlling variable cost. Again, it also facilitates the control of fixed cost by the management through the comparison of fixed cost with contribution. In income statement fixed cost is shown separately. Thus marginal costing helps the management in the control of fixed cost also.

5. What is meant by Break Even chart? 

Ans: Break even chart is a graphical representation of marginal costing showing inter relationship between cost-volume and profit. It shows break even point (i.e. no profit no loss point) and also indicates the estimated cost and estimated profit or loss at various volumes of activity. 

The Break even chart has been defined by CIMA as “a chart which shows the profitability or otherwise of at various levels of activity and as a result indicates the point at which neither profit nor loss is made”.

It shows the following information of various levels of activity.

(i) Variable cost.

(ii) Sales volume.

(iii) Profit or loss.

(iv) Break even point.

(v) Margin of safety.

It is a chart which shows the interaction of volume, selling price, variable cost and fixed cost at different levels. It also shows the relevant variables and their impact upon profit simultaneously. This is why break even graph is also called a profit planning chart.

6. What are the assumption of a Break-even Chart?

Ans: Following assumptions are required to be made in the construction of a break-even chart: 

(i) Fixed cost will tend to remain constant.

(ii) The price of variable cost factor will remain unchanged.

(ii) Semi variable cost can be segregated into variable and fixed cost.

(iv) Operating efficiency will not increase or decrease.

(v) There will be no any change in price policy.

(vi) Product-mix will remain unchanged.

(vii) The number of units of sale and number of unit produced will be the same.

Explain the utility of marginal costing.

7. Explain the utility of marginal costing.

Ans: Utility of marginal costing-

(i) Simple to understand: It is simple to compile and easy to understand for the management because it presents cost-volume-profit structure in a simpler way than profit and loss A/c, cost schedule, operating statement etc.

(ii) Guide to Management: It is useful tool to guide the management in studying the relationship between cost, volume and profit.

It shows the effect of profit of changes in:

(a) Selling price.

(b) Variable cost.

(c) Fixed cost.

(d) Volume of sales.

Thus the management can take important decisions.

(iii) Shows profit earning capacity: It shows profit earning capacity and strength of the business through margin of safety and angle of incidence.

Thus managers can take decision in respect of:

(a) activity level.

(b) price fixation.

(c) cost reduction. and 

(d) product substitution.

(iv) Price fixation: It helps the management in determining the sale price in order to attain a desired level of profit.

(v) A tool of cost control: It is a tool of cost control because it shows the relative importance of fixed cost and the variable cost.

List of formulas:

(i) Contribution = Sales – variable cost

Or

Fixed cost + profit 

(ii) Contribution per unit = Sales per unit – variable cost per unit

Fixed cost + profit

(iii) Profit-volume ratio (p/v ratio) = Sales – Variable Cost/Sales ×100

Or

Fixed cost + Profit/Sales x100

Or

Changes in Profit/Changes in Sales x100

(iv) Break even point (in Rs) 

Fixed cost/contribution per unit = x selling price

Or

Fixed Cost/p/v Ratio

(v) Break even point (in units) = Fixed cost/contribution per unit.

(vi) Desired sales to earn a profit (in units) = Fixed cost+desired profit\contribution per unit.

(vii) Desired Sales in Rs. = Fixed cost + desired profit/p/v ratio.

(viii) Margin of safety = Actual sales – break even sales.

Or

Profit/p/v ratio

7. Define Cost-Volume-Profit Analysis. Explain its assumptions.

Ans: A cost-volume-profit (CVP) analysis, also commonly known as the break-even analysis, is one of the common methods of cost accounting used to determine how variance in sales volume and costs impact a company’s profit. Finance professionals use this information to determine the relationship between cost and revenue to generate profit and better understand overall performance. Understanding the concept of CVP can help you make short-term strategies for your company.

The assumptions in CVP analysis are the same as that under marginal costing:

(a) Cost can be classified into fixed and variable components.

(b) Total fixed cost remain constant at all levels of output.

(c) The variable cost change in direct proportion with the volume of output.

(d) The product mix remains constant.

(e) The selling price per unit remains the same at all the levels of sales.

(f) There is synchronisation of output and sales, i.e, whatever output is produced , the same is sold during that period.

8. Write down the features of absorption costing. 

Ans: The features associated with absorption costing are as follows:

(a) In the absorption costing of a product, the cost is determined on the basis of full cost, i.e., variable and fixed manufacturing cost.

(b) The cost of inventory will be higher in absorption costing as product cost includes fixed factory overhead.

(c) Absorption costing net income changes with production.

(d) It is a conventional costing where gross profit is determined by subtracting the cost of goods sold from sales and net profit is determined by subtracting all commercial expenses from the gross profit.

(e) Under or over-allocation of fixed factory overhead is required to be adjusted in absorption costing as it is included in the cost of production.

9. Describe absorption costing?

Ans: Absorption costing is a costing method that includes all manufacturing costs — direct materials, direct labor and both variable and fixed manufacturing overhead in the cost of a unit of product. 

Absorption costing is also referred to as the full cost method. Because absorption costing includes all cost of production as product costs.

It is a conventional costing which is required for both external financial reporting and tax reporting. In the case of absorption costing, the cost production will be as follows:

Cost of production = Direct material + Direct labor + variable factory overhead + Fixed factory overhead.

Absorption costing treats all manufacturing costs as cost, regardless of whether they are variable or fixed.

The cost of a unit of product under the absorption costing method consists of direct materials, direct labor, and both variable and fixed manufacturing overhead. 

Thus, absorption costing allocates a portion of fixed manufacturing overhead cost to each unit of product, along with the variable manufacturing costs.

Because absorption costing includes all manufacturing costs in product costs, it is frequently referred to as the full cost method.

10. Define Absorption costing? Write down the advantages & disadvantages of absorption costing.

Ans: Absorption costing is a conventional technique of ascertaining cost. All costs both variable and fixed are charged to an operation, process or product. Thus, the cost of a unit is made up of both direct costs and indirect or overhead costs. So, the cost per unit will change with the change in the level of output.

Advantages of Absorption Costing, As a conventional technique, absorption costing has some advantages which are discussed below:

(a) Determining the actual cost of production: In absorption costing, fixed factory overhead is treated as product cost. As a result, it helps determine the actual cost of production.

(b) Acceptability: Absorption costing is followed for external reporting, various rules and regulations of GAAP and Tax authority are complied with by absorption costing, As a result, it is acceptable to a tax authority, investors, creditors, etc.

(c) Valuation of inventory: Inventories are valued based on actual production cost, As a result, a balance sheet represents a true and fair view.

Disadvantages of Absorption Costing, Absorption costing has some disadvantages which are discussed as follows:

(a) Cost allocation: In absorption costing fixed factory overhead is allowed on production based on pre-determined rate, But it is not easy to determined the accurate denominator volume to determine the rate, So, cost allocution becomes difficult.

(b) No useful for management decision making: Absorption costing does not produce information on contribution margin, As a result, it cannot assist in various.

(c) Cost control and cost comparison become difficult.

11. Describe the components, types & characteristics of absorption costing.

Ans: The components of absorption costing are:

(a) Direct costs: These expenses are directly related to the manufacturing process of a product and include raw material costs, wages of staff, and overhead expenses. 

(b) Fixed costs: These are overhead expenses that remain the same regardless of the fact how much more or less an organisation is selling, for instance lease of the building and salaries.

(c) Variable overhead costs: These are the indirect expenses that occur while operating an entity that can fluctuate because of manufacturing et activities; for example, the extra staff is hired to increase the output as there is an increase in demand. 

Types of Absorption Costing: 

There are three main types:

(a) Job order costing: The cost calculation is allocated to the product or services in LOTS and batches.

(b) Activity-based costing: The cost calculation is allocated to finished goods from cost items. It is important for small entities that do not have financial reserves and cannot bear the loss.

(c) Process costing: The cost calculation is assigned to a product due to the lack of LOTS or batches.

Characteristics of Absorption Costing:

The characteristics of absorption costing are explained in simple terms as follows:

(a) Direct and indirect costs: Absorption costing is popularly known as full cost method as it takes into consideration all the costs that are associated with a product or a service. It includes both direct and indirect costs, although the direct costs vary with production level, whereas the indirect cost does not change.

(b) Direct costs are allocated: One of the main characteristics of absorption costing is that the direct costs are allocated directly to the product.

(c) Indirect costs are absorbed: The costs that are incurred are added overhead costs, and then the overhead is charged go the products with the help of absorption rate. This is done because you cannot trace and allocate the indirect cost to a product; hence, ultimately it is absorbed.

(d) Absorption rate: Overhead or indirect costs are absorbed in absorption costing with the help of a fair absorption rate that is based on unit produced, labor hours, and machine hours.

(e) Administration expenses are not absorbed: The administrative cost is shown in the financial statement as operating expenditure. In absorption costing, you can add production expenses, and as administratio expenses are not a part of the production, it is dealt with separately.

12. Write down the features of Variable Costing.

Ans: Features of Variable Costing: Variable costing has the following features:

(a) In variable costing, product cost is determined only based on variable manufacturing cost.

(b) Here, fixed factory overhead is regarded as a period cost and is charged against revenue in the period it is incurred,

(c) Since fixed factory overhead is not included in the cost of production, the cost of inventory is less as compared with absorption costing.

(d) Variable costing operating income changes with sales, not with production.

(e) Contribution Approach is followed in determining net income. Here, the variable cast of goods sold is subtracted from the sales to determine C/M, and all fixed costs are subtracted from C/M to determine net income.

(f) There is no need to adjust under or over allocation of fixed factory overhead in variable costing as it is not included in the cost of production.

13. Write down the advantages & disadvantages of Variable Costing.

Ans: Advantages of Variable Costing: The advantages of costing can be summarized as follows:

(a) Operations planning: Variable costing can readily supply data on variable costs and contribution margin, which management needs each day to make decisions relating to special order, expansion of capacity, shut-down of production, etc.

(b) Cost-volume-profit analysis: Income statements under variable costing give data relating to “Gross contribution margin,” “Contribution margin,” and “Total fixed costs.” These data can easily be used in the c- v-p analysis.

(c) Product pricing: The variable cost of production is considered at the time of fixing the selling price for a special order. Variable costing can readily supply data relating to the variable cost of production.

(d) Management decisions: Variable costing income statements enables management to see and understand the effect that period costs have on profits and facilitates better decision-making.

(e) Management control: The reports based on variable costing are far more effective for management control than those based on absorption costing because;

(i) Variable costing reports are related to profit objectives,

(ii) It can pinpoint responsibility according to organizational lines.

(f) Cost control: Cost control becomes easier because only variable manufacturing costs are considered.

(g) Change in profit: Variable costing net income changes with sales. As a result, it becomes easily understandable as to how much additional profit will be earned from how much additional sales.

Disadvantages or Limitations of Variable Costing: Despite all the advantages, we cannot term variable costing flawlessly. It has some limitations/disadvantages which are stated below:

(a) Inaccurate cost: Directly identifiable fixed cost is specifically related to production. But all fixed costs are treated as a period cost. As a result, the cost of production may not be accurate. 

(b) Long-term pricing: Variable costing is not useful for long-term pricing policy simply because it does not consider fixed factory overhead as product cost.

(c) Undervaluation of inventory: Under variable costing, finished goods, and work-in-progress are undervalued. This is because inclusion of fixed factory overhead in product cost. As a result, the balance sheet does not represent a true and fair view. 

(d) External reporting and tax reporting: Variable costing is not acceptable for external reporting and tax reporting until today. It is only applicable to internal management. It does not conform to GAAP.

(e) Separation of costs into fixed and variable is a difficult task, especially when such costs are semi-variable.

(f) No cost is fixed in the long-run.

13. Difference Between Marginal Costing and Differential Costing.

Ans:

Marginal Costing	Differential Costing
Marginal cost is a unit concept and applies to output per unit basis.	Whereas Differential cost is a total concept and applies to a fixed additional quantity of output.
Marginal costing is presented by showing contribution per unit and fixed cost as a total amount.	Whereas Differential costs are presented in totals in both formats – i.e. under marginal cost as well as absorption cost techniques.
Product cost under differential cost analysis may contain fixed costs, which will not be so under marginal costing.	Product cost under differential cost analysis may contain fixed costs.
Marginal Cost can be incorporated in the accounting system.	Differential cost is determined separately from the analysis of accounting records.
In Marginal Costing Managerial Decisions are based mainly on Contribution.	But in Differential Costing Differential Costs are compared with incremental or decremental revenues for evaluating managerial decisions.

14. Explain with examples how income is determined under Marginal and Absorption Costing. 

Ans: The following points highlight the four cases of income determination under marginal costing and absorption costing.

The cases are:

When there is Production but no Sales: Under this case, the income under absorption costing may reflect profit though no sale has been made. This is due to the fact that fixed manufacturing overheads have been over absorbed above normal capacity production than its actual faked manufacturing overheads. But variable income statement will show loss as there are no sales.

Though no sales have been made but income statement will show gross profit equal to the amount of over absorption of fixed manufacturing overheads. Thus profit under absorption costing is influenced by various factors as quantity of production units, units sold, selling price, cost of production etc.

15. Explain some techniques which highlight the application of marginal costing in decision making.

Ans: Following are some techniques which highlight the application of marginal costing in decision making are:

(i) Make or Buy decision: Make or Buy Decision’ is a problem in respect of which management has to take decision continuously. In this context, the management has to decide whether a certain product or component should be made in the factory itself or bought from outside suppliers. The nature of decision regarding make or buy may be of the following types:

(a) Stopping the production of the part and buying it from the market: A business co. is already making a part or component which is used in the business. Now due to some decision has to be taken whether this part or component should be bought from the market additional requirement due to increase in production of main factory should be made in factory or should be bought from the market.

In the case of a decision like stopping the production of the part or component and buying it from market, it is to be remembered that there would not be additional fixed cost in case and only marginal cost is the relevant factor to be considered. If the marginal cost is less than buying price, additional requirement of the component should be met by making rather than buying.

Similarly, if buying price is less than marginal cost, it will be advantageous to purchase it from the market.

(b) Stopping the purchase of a component and to produce it in own factory: The second aspect of the problem of make or buy may be that a component or part thus far being purchased from the market should be produced or made in factory or not. In this case, normally some extra arrangement regarding space, labour, machine etc. will be required. This may involve capital investment too. Some special overheads may also be necessary. If the decision for making requires the setting up of a new and separate factory, separate supervisory staff may also be needed. All these arrangements will require additional costs. As such, the price being paid to outsiders should be compared with additional costs which have to be incurred in the form of raw materials, wages, salaries of additional supervisors, interest on capital investment, depreciation on new machine, rent of premises etc. If such additional cost are less than the buying price, the component should be manufactured and vice-versa.

(ii) Change in Product Mix:

(a) Introducing a new line or department: The problem of introducing a new product or line involves decision in two respect-whether a new product or line should be added to the existing production or not, and if it should be introduced, then what should be the model or design or shape of the new product. In other words, if new product can be produced in more than one model, which model should be introduced? The marginal cost of new product in all its possible models should be considered. It also possible that a portion of the cost of facilities relating to the original production may be used for the purpose of producing new product.

(b) Selecting optimum product mix: When a company is engaged in a number of lines or products, there arise a problem of selecting most optimum product mix which would maximize the earnings. This problem becomes complicated, when one of the factors happens to be limiting or key factors. Under such a situation, profitability will be improved only by economizing the scarce resources. As pointed out earlier, contribution per unit of key factor is the real index of profitability under such case. Thus, while deciding a profitable mix of products, contribution per unit of key factor should be considered. 

(iii) Shutting Down Decisions: Marginal costing technique may be used in deciding whether to discontinue a section of the business, provided the discontinuance will not change the total fixed costs of the firm. The decision will hinge on whether the particular section of the business is contributing towards fixed overheads.

Closure of an activity, which generates positive contribution, reduces the current operating profit, or increases the operating loss. In certain situations, a part of the fixed cost is avoided by temporary closure. In such a situation, if avoidable fixed cost is higher than expected contribution, the business segment should be closed.

Shut-down decisions may be of two types-closure of entire business and dropping a line or product or department. Closure of entire business: Sometimes, a business concern may not be in a position to carry out its trading activities in an adequate volume due to trade recession or cut throat competition. As such, the management of such business concern may be faced with a problem of suspending the trading activities.

Shut-down point = Net escapable fixed cost/contribution per unit

Or

Shut-down point = Avoidable expenses/contribution per unit of raw materials 

(iv) Pricing of products: This is one of the most important techniques in marginal costing and decision making. Generally, prices are determined by demand and supply of products and services. But under special market conditions, marginal costing is helpful in deciding the price at which the management should sell.

These special market conditions are following:

(a) Selling in the foreign market i.e. export prices may have to be decided. The export price may be lower than the price at which the product is selling in the domestic market.

(b) In times of cutthroat competition, the market price of products may fall below total cost. The management should be compelled to sell at a price which is below total cost. But the price should not be below the variable cost.

(v) Break-Even Analysis: The term ‘Break-even Analysis refers to a system of determination of that level of activity where total cost equals total selling price. However, in the broader sense, it refers to that system of analysis which determines the probable profit at any level of activity. The relationship between cost of production, volume of production, profit and sales value is established by break-even analysis. The analysis is also known as ‘Cost-Volume-Profit analysis. A break-even analysis is a financial tool which helps a company to determine the stage at which the company, or a new service or a product, will be profitable. In other words, it is a financial calculation for determining the number of products or services a company should sell or provide to cover its costs (particularly fixed costs).

(vi) Exploring new markets: Companies make a constant effort in exploring new markets to sell more and more so that they can fully utilize their plant capacity. The marginal costing technique helps in deciding the minimum price at which to sell in the foreign markets or home markets and widening their area of operation in various markets.

(vii) Profit planning: Profit planning is the planning of future operations to attain maximum profit. Under this technique, the contribution ratio indicates the relative profitability of the different products of the business wherever there is any change in the volume of sales, total fixed costs, selling price, etc.

(viii) Selection of a Profitable Product Mix: In a multiproduct concern, a problem is faced by the management as to which product mix or sales mix will give the maximum profit. The product mix which gives the maximum profit must be selected. Product mix is the ratio in which various products are produced and sold.

The marginal costing technique helps the management in taking decisions regarding changing the ratio of product mix which gives maximum contribution or in dropping unprofitable product line. The product which has comparatively less contribution may be reduced or discontinued.

(ix) Determining priority of products: In those businesses, which manufacture more than one product, there arises a problem of determining the priority of products to be manufactured. In such a situation the management is faced with the problem of which product should be manufacture in large quantities as compared to other products. This is because the cost-profit relation of various products differs and products should be produced in large quantities which makes a larger contribution per unit. Thus, the data required for determining the priority of products is that which is required for calculating contribution.

16. Discuss the Different types of Break-even charts.

Ans: The different types of break- even charts:

 (a) Contribution Breakeven Chart: This chart shows contribution earned by, the firm at different levels of activity.

(b) Cash Breakeven Chart: In this chart variable costs are assumed to be payable in cash.

(c) Control Breakeven Chart: Both budgeted and actual cost data are depicted in this chart. This chart is useful in comparing the actual performance of the firm with the budgeted performance for exercising control.

(d) Analytical break even chart: This chart shows the break-up of variable expenses into important elements of cost. Also the appropriations of profit such as ordinary dividends, preference dividend, reserves, etc. are depicted in this chart.

(e)  Product wise break even chart: Separate break-even charts for different products can also be prepared to compare the profitability of the products or their contribution.

PRACTICAL PROBLEMS

1. From the following particulars, find out the selling price per unit if break even point is to be brought down to 39,000 units.

Variable cost per unit Rs. 75.

Fixed expenses Rs. 2,88,000.

Selling price per unit Rs. 100.

Solution:

If desired BEP is brought down to 9,000 units, new BEP will be 9000, We know

BEP (units) = Fixed Cost/Contribution per unit.

9000 = Rs. 2,88000/New contribution per unit.

9000 = Rs. 2,88000/New selling price – variable cost i.e. Rs. 75

New selling price = Rs. 107 per unit.

2. Find out the Break even point from the following figures and also ascertain the sales required to earn a profit of Rs. 20,000.

Sales price per unit – Rs. 50.

Variable cost per unit Rs. 45.

Fixed cost – Rs. 80,000.

Solution:

Contribution = Selling price per unit – variable cost per unit Per unit = Rs. 50-Rs. 45 = Rs. 5

(i) Break even points

(in units) = Fixed cost/contribution per unit.

= Rs.80,000/Rs.5 -16000 units

Break even points (in Rs.)

Fixed cost/Contribution per unit × selling price. 

80,000/5 × Rs.50 = Rs. 8,00,000

(ii) Sales in units to earn a profit of Rs. 20,000

Desired Sales = Fixed cost+Profit/contribution per unit.

= Rs.80,000+ Rs.20,000/Rs.5

= 20,000 units 

Break even sales volume – 20,000×50 = Rs. 10,00,000 

3. From the following information, find out.

(i) Sales at Break even point.

(ii) p/v ratio.

(iii) margin of safety. 

Present sales (at Rs. 10 per unit) Rs. 100.000.

Fixed cost Rs. 30,000. 

Variable cost Rs. 6 per unit.

Solution:

We know, 

Contribution per unit = SP per unit – variable cost. per unit 

= Rs. 10 – Rs. 6 = Rs. 4

(i) Break even point (in units) = Fixed cost/contribution per unit

= Rs. 30,000 Rs. 4

= 7,500 units

Break even point in amount of sales = Break even units x selling price

= 7700 × Rs. 10

= Rs. 75,000

(ii) P/V ratio = Contribution per unit/Sales per unit

= Rs. 4/Rs.10 × 100 = 40%

(iIi) Margin of safety = Actual sales – BEP sales

= Rs. 100,000 – Rs.75000

= Rs. 25,000

4. Limca manufacturer sells its products at Rs. 5 each, variable costs are Rs. 2 per unit and the fixed cost amounted to Rs. 60,000.

(i) Calculate Rs. BEP.

(ii) What would be the profits if the firm sales only 30,000 units in a year.

(iii) How many units should be sold to make a profit of Rs. 30,000 in a year.

Solution:

We know,

Contribution per unit = Selling price per unit – variable cost

= Rs. 5 – Rs. 2

= Rs. 3.

(i) Break even point (in units) = Fixed cost/contribution per unit.

= Rs . 60,000/3

= 20,000 units

Break even point (in Rs.) = Fixed cost/contribution per unit xS.P. per unit

= (Rs.60,000/Rs.3×Rs.5 = Rs.1,00,000

(ii) Profit when sales are 3000 units.

Profit = Sales – variable cost – Fixed cost 

= (30000 units × Rs.5) – (30000 units × Rs. 2)

= Rs. 60,000

= Rs. 150,000 – Rs. 60,000 – Rs. 60,000

= Rs. 30,000

(iii) Sales when profit is Rs. 30,000.

Desired Sales = Fixed cost + Desired Profit/contribution per unit

= Rs.60,000+Rs.30,000/3 = 30,000 units

5. You are required to find Break even point from the following figures and also to find the sales required to earn profit of Rs. 20,000. 

Sales price per unit Rs. 50.

Variable cost per unit Rs. 45. 

Fixed cost Rs. 80,000.

Solution:

Contribution per unit = SP per unit – variable cost-per unit 

= Rs. 50 – Rs. 45 

= Rs. 5 

P/v Ratio = contribution per unit/Sales per unit ×100 

= Rs.5/Rs.50×100 = 10%

(i) Fixed even point = Fixed cost/P/v Ratio 

= Rs. 800,000/10% = Rs.800,000

(ii) Desired Sales to earn a profit of Rs. 20,000

Desired Sales = Fixed cost + Profit/P/v ratio

= Rs.80,000+Rs 20,000/10%

= Rs. 10,00,000

6. From the following information, calculate:

(i) P/v Ratio.

(ii) Break even point.

(iii) Margin of safety.

(iv) If the selling price is reduced to Rs. 90, by how much is M/s reduced?

Total sales – Rs. 3,60,000.

Selling price per unit – Rs. 100.

Variable lost per unit – Rs. 50.

Fixed cost – Rs. 1,00,000.

Solution:

Contribution per unit = S.P per unit-variable cost per unit

= Rs. 100 – Rs. 50 = Rs. 50

(i) P/V ratio = Contribution per unit/selling price per unit × 100

= Rs.50/Rs.100×100=50%

(ii) B.EP (in Rs) = Fixed Cost/P/v ratio

= Rs.100,000/50% = Rs. 2,00,000

(iii) Margin of safety = Actual sales – BEP sales 

= Rs. 3,60,000-Rs. 2,00,000 

= Rs. 1,60,000

(iv) If selling price is reduced to Rs. 90, then the new contribution will be: 

New contribution = New selling price – Variable cost per unit

= Rs. 90 – Rs. 50

= Rs. 40

… New Break even point (in Rs.)

= Fixed cost/New contribution per unit×New S.P.

= Rs.100,000/Rs.40×90 = Rs.2,25,000

New margin of safety = Actual sales – New BEP sales

= 3,60,000 – 2 ,25,000 = Rs. 25,000

… Reduced M/s = New 2,25,000-2,00,000

= Rs.25,000

7. The following information is available from the books of Asha Ltd.

Variable cost per unit – Rs.50.

Contribution per unit – Rs.200.

Monthly average fixed cost – Rs.60,000.

Tax rate – 40%.

You are required to calculate –

(i) Break even point in units and rupee value for the year 1999.

(ii) Number of units to be sold to earn a profit of Rs. 100,000 after tax for the year 1999.

Solution: Annual fixed cost = Rs. 60000 × 12 = Rs.720,000 

Contribution = Selling price per unit – variable cost per unit

… Selling price per unit = Contribution + variable cost

=Rs.20+Rs.50 = Rs.70

(i) Break even point = Fixed cost/Contribution per unit

= Rs.7,20,000/Rs.20= 36,000 units

Break even point= Fixed cost/Contribution per unit×selling price per unit

= 7,20,000/Rs.20×Rs.70 = Rs.25,20,000

(ii) Number of units to be sold to earn a profit of Rs. 100,000 after tax.

Let profit before tax = Rs. 100

Tax rate = 40%

= Rs. 60

Profit after tax = Rs.60

Desired profit after tax = Rs.100,000

(+) income tax (40/60×100000) = Rs. 66,667

Profit before tax = 166,667

Required sales (in units) = Fixed cost+Profit/contribution per unit 

= Rs.7,20,000+Rs.1,67,667/R.20

8. From the following information, you are required to calculate.

(i) P/v ratio.

(ii) Profit when sales are Rs.20,000.

(iii) New Break even point if selling price is reduced by 20%.

Fixed expenses – 4,000. 

Break even point – 10,000.

Solution: 

We know that,

(i) Break even point = Fixed cost/P/vratio

Rs. 10,000 = Rs. 4,000/P/v ratio

… P/V ratio = Rs.4000/Rs.10000×100 = 25%

(ii) Profit when sales are Rs. 20,000

Contribution (Rs. 20,000 × 40%) – Rs.8000

Less: Fixed cost – 4000

Profit – 4000

(iii) New Break even point when selling price reduced by 20% 

P/V ratio = C/S×100= 40%

P/V ratio 40% means contribution Ratio 40% 

… If SP per unit is Rs. 100 

Contribution per unit will be Rs. 40 

Variable cost per unit = Sales – contribution 

= Rs.100 – Rs.40 = Rs. 60 

If S.P. reduced by 20% the new S.P. will be Rs. 80 

New contribution per unit = 

New selling price per unit – variable cost per unit 

= Rs. 80 – Rs. 60 

= Rs. 20 

New P/V ratio = new contribution per unit/new selling price per unit ×100 

= Rs.20/Rs.80×100 = 25%

New Break even point = Fixed cost/P/V ratio = Rs.4000/25% = 16,000

9. Given the following revenue function, calculate –

(i) B.EP

(ii) Profit at output of 50 units 

Total Cost = 300 + 5x 

Total Revenue = 30 x 

Where, x is the quantity sold –

Solution:

Fixed Cost = Rs.300

Variable cost = Rs.5 per cent

Selling price = Rs.30 per unit

Contribution per unit = Rs.30 – Rs.5 = Rs.25

(i) BEP =Fixed cost/contribution per cent =Rs.300/Rs.25 = 12 units.

(ii) Profit at output of 50 units.

Sales = Rs.300+ Profit Rs. 25 50= Profit (50x Rs.25)-300 = Rs. 950

Profit at output of 50 units = Rs. 950

Sales = Fixed cost+Profit/contribution per unit 

50 = Rs.300+Profit/Rs.25

Profit = (50×Rs.25) – 300 = Rs.950

… Profit at output of 50 units = Rs.950

10.

Year	Sales	Net Profit
1991	100,000	6,000
1990	80,000	2,000

Fund

(i) P/v ratio.

(ii) Fixed overhead.

(iii) B.EP.

(iv) New profit for sale of Rs. 9,00,000 and sales required for net profit of Rs. 10,000.

Solution:

Changes in sales = Rs. 100000 – Rs. 80,000 = Rs. 20,000

Changes in profit = Rs. 6000 – Rs. 2000 = Rs. 4000

(i) P/v ratio = Changes in profit/Changes in sales × 100 = 4000/20,000×100 = 20%

(ii) P/v ratio = Fixed cost+profit/sales

= 20/100 = Fixed cost+2000/80,000

= Fixed cost = Rs.14,000

(iii) Break even point = Fixed cost/P/V ratio = 14000/20% = Rs. 70,000

(iv) Net profit when sales are Rs. 9,00,000. 

Contribution (900,000×20%) = Rs. 1,80,000

Less: Fixed cost = 14,000

Profit = Rs. 166,000

(v) Sales required for net profit of Rs. 10,000. 

Sales = Fixed cost + profit/P/V ratio

= Rs. 14000+ Rs. 10,000/20% = 24000/20% = Rs.1,20,000

11. There are two plants manufacturing the same products under the corporate management which decides to merge them, following particulars are available regarding the two plants.

Capacity operation	Plant I 100%	Plant II 60%
Sales	Rs.60,000	Rs.24,000
Variable cost	Rs.44,000	Rs.18,000
Fixed cost	Rs.8000	4000

You are required to calculate for the consideration of Board of Directors:

(a) What would be the capacity of the merged plant to be operated for the purpose of Break even.

(b) What would be the profitability on working at 75% of the merged capacity.

(c) What turnover will give an overall profit of Rs. 12,000?

Solution:

Plant II: For 60% capacity sales are = Rs. 24,000

For 100% capacity sales would be = 24000/60×100

= 40,000 

Plant II: For 60% capacity variable cost – Rs. 18,000

For 100% capacity variable cost would be = 18000×100/60

= Rs.30,000

	Plant I	Plant II	Merged plant
Capacity Generation	100%	100%	100%
Sales	Rs.60,000	Rs.40,000	Rs.100,000
Less: variable cost	Rs.44,000	Rs.30,000	Rs.74,000
Contribution	Rs.16000	Rs.10,000	Rs.26,000
Fixed cost	Rs.8,000	Rs.4000	Rs.12000
	Rs.8,000	Rs.6000	Rs.14000

P/v ratio of merged plant:

Contribution/Sales×100 = 26000/1000,000×100 = 20%

BEP of merged plant = Fixed cost/P/vratio = 12000/26%

Rs. = 46,154

(a) Capacity of merged plant at Break even.

= Sales at BEP/Total sales of merged plantx100

= Rs.46154/Rs.100,000×100=46.15% 

(b) Profitability on working at 75% merged capacity Sales (75% of Rs. 1,00,000) – Rs.75000.

Less: Variable cost (75% of Rs.74,000) – Rs.55500

Contribution – 19500

Less: Fixed cost – 12000

Profit – 7,5000

(c) Turnover for an overall profit of Rs. 12,000

Sales = Fixed Cost+profit/P/vratio = Rs.12000+ Rs. 12000/26% = Rs.92,308

12. A firm manufactures 1000 small cycle the contents per unit of which is given below:

	Unit cost
Material	60
Labour	20
Variable overhead	20
Fixed overhead	50
Total cost	150
Selling price	200

In view of the keen competition in the market, if the management decides to reduce the selling price by 10%, other factor remains the same, what quantity of the product must be manufactured and sold to get the same quantum of profit.

Solution:

Variable cost = Material + Labour + Variable overhead

= Rs. (60 + 20 + 20) per cycle

= Rs.100 per cycle

Fixed overhead = Rs.50 per cycle

Present profit = Rs.50 per cycle

Total no. of cycles= 1000

Total Fixed Cost = Rs. 50×1000 = Rs. 50,000

Total Present profit = Rs 0.5×1000

= Rs.50,000

If the selling price is reduced by 10%, new 

selling price will be = Rs.200 

= Rs.20

= Rs.180 

new contribution per cycle = Rs.180 – Rs. 100 (sp – vc)

= Rs. 80

Desired sales = Fixed cost + Profit/Contribution per cycle

= Rs.50,000 + Rs.50,000/Rs.80

= 1,250 cycles

13. The following figures relate to 100% capacity level of a manufacturing concern. 

(i) Fixed overhead = Rs.1,20,000

(ii) Variable overhead = Rs.200,000

(iii) Direct wages = Rs.150,000

(iv) Direct Material = Rs.410,000

(v) Sales = Rs.10,00,000

Represent the above figures on a break even chart and determine the BEP and verify your results. 

Solution: Statement of Cost and Revenue.                (Rs.)

Capacity (%)	Fixed overhead	Variable overhead	Total cost	Sales (Rs.)
–	120,000	–	120,000	–
20	120,000	152,000	272,000	200,000
40	120,000	304,000	4,24,000	400,000
60	120,000	456,000	576,000	600,000
80	120,000	6,08,000	728,000	800,000
100	120,000	7,60,000	880,000	10,00,000

14. From the following information, find out.

(a) P/v ratio.

(b) Break-even sales.

(c) Sales required to earn a profit of Rs.450000

Variable cost per unit:

Direct material = Rs.5

Direct labour = Rs.2

Direct expenses = 100% of labour

Selling price per unit = Rs.12

Solution:

Selling price per unit = Rs.12

(-) Variable cost per unit

Material = Rs.5

Labour = Rs.2

Overhead = Rs.2

= Rs.9

… Contribution per unit Rs.3

(a) P/v ratio = contribution/sales×100 = 3/12×100 = 25%

(b) Break-even sales = Fixed expenses P/v ratio

= 90000 x 100/25 = Rs.360000

(c) Desired sale to earn a profit of Rs. 45000

= Fixed expenses + Profit/P/v ratio

90000+45000/25%

= 540000 x 100/25 = Rs. 2160000

15. The fixed costs amount to Rs.50000 and the percentage of variable costs to sales is 66/2/3% If 100% capacity sales are Rs.300000, find out the break even point and the percentage sales when it occurred. Determine profit at 80% capacity.

Solution: Percentage of V.C to sales is 66/1/2% i .e 200\3

Percentage of contribution = 100 – 200/3 = 100/3

P/v ratio = contribution/sales×100 = 100/3×1/100×100

= 100/3 = 33\1/3%

Break-even sales = Fixed cost/P/v ratio 

=50000/331/3% 

=50000×300/100 = Rs.150000% 

100% capacity sales = Rs. 300000

… B.E.P occurs at = 150000/300000×100 = 50% capacity

Profit at 80% capacity 

At 100% capacity sales are = 300000

… At 80% capacity sales = Rs.300000×80/100

Contribution at 80% capacity ( 240000×33\1/3 \%) = Rs. 80000

(-) Fixed expenses = Rs.50000

Profit at 80% capacity = Rs.30000

16. Star Ltd. manufactures and sells a standard product at fixed selling price. The budgeted figures are as under:

Sales 200000 units

Variable cost Rs.56 per unit 

Fixed cost Rs. 4800000 per annum

Profit margin 33/1/3% of selling price.

You are required to determine selling price per unit and sales at break-even point in terms of quantity and value at the above selling price for the year.

Solution:

we know,

Sales (Fixed cost + variable cost) = profit

= (200000× X)-(4800000+56×200000) = 33/1/3% (200000× X)

= 200000x-6666> x = 16000000

= X = 1600000/1333333

133333x = 16000000

= X = 120

… Selling price per unit = Rs.120

… Contribution per unit = Rs.(120 – 56) = Rs.64

… (i) Break-even point (Qty) = Fixed cost/Contribution = Rs.4800000/Rs.64

= 75000 units.

(ii) Break even point (value) = 75000×Rs.120

= Rs.9000000

17. From the following data, calculate.

(i) Break-even point.

(ii) Number of units that must be sold to earn a profit of Rs.120000 per year.

(iii) How many units are to be sold to earn a net income of 15% of sales.

Selling price per unit – Rs.40

Variable cost per unit – Rs.25

Fixed overhead – Rs.180000

Solution:

(i) BEP (in units) = Fixed Expenses/Selling price – Variable cost

= Rs.180000/Rs.40-Rs.25 = Rs.180000/Rs.15 = 12000 

BEP (in Rs.) = Break even units×selling price per unit

= 12000×Rs.40 = Rs.480000

(ii) Output to earn a profit of Rs.120000

= Fixed cost + Profit/Selling price per unit – Variable cost per unit.

= Rs.180000+Rs.120000/Rs.40 – Rs.25

= Rs.300000/Rs.15 = 20000 units.

(iii) Suppose number of units to be sold = N

… N = =Fixed cost + Profit\Contribution per unit

= N = Rs.180000N + 15/100 (N×Rs.40))/(Rs.15

= 15N = 180000 + 6N 

= 15N – 6N = 180000 

= 9N = 180000 = N = 180000/9 = N = 20000

… 20000 units must be sold.