Costing and BEP Analysis
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Transcript of Costing and BEP Analysis
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2/4/13
S Ravi Shankar
COSTING
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Aims and Objectives
(i) Understand meaning and definition ofmarginal costing
(ii) Analyse break even point analysis
(iii) Discuss applications of marginalcosting and selecting a suitable productmix.
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Marginal Costing
Introduction
Tool to aid Management Decision
Fix price of Product/Service
Assess profitability of Product/Service
Tool that analyses relationship between the cost,volume of sales and profitability
Definition
"Marginal cost is the amount at any givenvolume of output, by which aggregate costs arecharged, if the volume of output is increased ordecreased by one unit."
Meaning
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The firm XYZ Ltd. incurs Rs 1000/- for the production of100 units at one level of operation. By increasing only oneunit of product i.e. 101 units, the firm's total cost of
production amounted Rs 1010.Total cost of production at first instance (C')=Rs. 1000/
Total cost of production at second instance (C")=Rs.1010/-
Total number of units during the first instance (U')=100
Total number of units during the second instance(U")=101
Increase in the level of production and Cost of production:
Change in the level of production in units= U"-U'= U
Change in the total cost of production = C"- C
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Marginal Cost
From the above table -11.1 the marginal costis equivalent to the variable cost per unit ofthe various levels of production. The fixedcost of Rs.500, a cost that remains the sameirrespective levels of production and isalready absorbed at the initial level ofproduction.
The initial absorption of fixed overhead led
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Fixed Cost
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Variable Cost
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Components of variable cost
Direct Materials: Materials costconsumed for the production of goods
Direct Labour: Wages paid to thelabourers, who are directly involved in theproduction of goods.
Direct Expenses: other expenses directlyinvolved in the production stream.
Variable portion of Overheads:Generally the overheads can be classifiedinto two categories. Viz- Variable overheadsand Fixed overheads.
Variable overheads are the cost involved in
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Absorption costing
It is costingsystem which treatsall manufacturingcosts including boththefixed and variablecosts as productcosts
Marginal costingIt is a costing
system which treatsonly thevariable
manufacturing costsas product costs.
The fixedmanufacturing
overheads areregarded as periodcost
Marginal Vs AbsorptionCosting
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CostManufacturing
costNon-manufacturingcost
DirectMaterials
DirectLabour
Overheads
Finishedgoods
Cost of goodssold
Periodcost
Profit and lossaccount
AbsorptionCosting
CostManufacturing
costNon-manufacturingcost
DirectMaterials
DirectLabour
VariableOverheads
Finishedgoods Cost of goodssold
Periodcost
Profit and lossaccount
MarginalCosting
Fixedoverhead
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Semi-Variable Cost
Marginal Costing is defined as "theascertainment of marginal cost and of theeffect on profit of changes in volume or typeof output by differentiating between fixed and
variable costs.
Importance of Marginal costing:
The costs are classified into two categories viz
fixed and variable cost.
Variable cost per unit is considered as marginalcost of the product.
Fixed costs are charged against contribution of
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Marginal costing profitabilitystatement
Sales xxxxVariable Cost xxxxContribution xxxxFixed Cost xxxx
Profit xxxx
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Sales Rs.100,000/-, variable cost Rs.50,000/- andfixed cost Rs.20,000/- find-out the contribution andprofit.
`
Sales 1,00,000
Variable Cost 50,000Contribution 50,000
Fixed Cost 20,000
Profit 30,000Method of Difference
Contribution= Sales Variable Cost= ` 1,00,000 `50,000= `50,000
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Break Even Point Analysis
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Break Even Point is the point at which the Total
Cost is equivalent to Total Revenue. At the breakeven point the business neither earns profit norincurs a loss. It means that the firm's cost isrecovered at the minimum level of production.
Break Even Point Analysis
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BEP Analysis aids ManagerialDecision
Fixation of Selling price
Acceptance of Special / Foreign order
Incremental Analysis- On cost as well as
revenueMake or Buy Decision
Key factor analysis
Selection of production mix
Maintaining the specified level of profit andso on
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BEP Analysis
BEP can be classified into two categories
Break Even Point in Units
Break Even Point in Sales
Assume the selling price of product Rs.20/-per unit and
variable cost per unit Rs.10/- and the fixed cost Rs.1000/- Findout the break even point.
Sales Rs.20/-
Variable Cost Rs.10/-
Contribution Rs 10/-
Fixed Cost Rs.1000/-
Profit (-) Rs. 990/-
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PV Ratio
What is PV ratio?
PV ratio is Profit Volume ratio which establishes therelationship in between the profit and volume of sales.It is a ratio normally expressed in terms ofcontribution towards volume of sales. It is expressed interms of percentage.
Utility of PV ratio:
To find out the Break Even Point in sales volume
To identify the desired level of profit at any salesvolume
To determine the sales volume to earn required levelof profit
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Calculate Break Even Point from the followingparticulars
Fixed Cost Rs.3,00,000
Variable Cost Per Unit Rs.20/-
Selling Price Per Unit Rs.30/-
PracticeProblem
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Contribution Margin Per Unit = Selling Price Per Unit VariableCost Per Unit
= Rs.30 Rs.20 = Rs. 10
Break Even (Rupees) can be found out in two ways
Method I:
= B.E.P (Units) Selling Price
= 30,000 units Rs.30= Rs.9,00,000/-
Method II:
Under this method PV ratio component has to be found out
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BEP Problem
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Practice Problem
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Margin of Safety
Margin of safety is the excess volume ofsales over the break even sales. It ishighlighted in the form of absolute sales orin percentage. It is the difference in
between the actual sales and break evensales. It elucidates the extent to whichsales can be reduced without incurring aloss.
a es o ume at es re
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a es o ume at es reLevel of Profit
Re-Design existing formula
The above formula is in accordance with themethod of coverage i-e covering the fixed cost andprofit.
Desired level of profit should be combined with the
fixed cost, to find out the contribution level to the tuneof unchanged selling price and variable cost per unit.
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Problem
From the following information relating to quickstandards ltd., you are required to find out
i) PV ratio
ii) Break even point
iii) Margin of safety
iv) Calculate the volume of sales to earn a Profitof Rs.6,000/
Given:
Total Fixed Costs Rs.4,500/
Total Variable Cost Rs.7,500/
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Problem
Break even sales Rs.1,60,000
Sales for the year 1987 Rs.2,00,000
Profit for the year 1987 Rs.12,000
Calculate
(a) Profit or loss on a sale value ofRs.3,00,000
(b) During 1988, it is expected that sellingprice will be reduced by 10%. What shouldbe the sale if the company desires to earnthe same amount of profit as in 1987 ?
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Problem
Break even sales Rs.1,80,000
Sales for the year 2003 Rs.2,40,000
Profit for the year 2003 Rs.20,000
Calculate
(a) Profit or loss on a sale value ofRs.3,60,000
(b) During 2004, it is expected that sellingprice will be increased by 10%. What shouldbe the sale if the company desires to earnthe same amount of profit as in 2003 ?
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Practice Problem
Th fi t t i t fi d t th PV ti
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The first step is to find out the PV ratio
To identify the change in profit, the profits of the twodifferent periods should be known
Profit= Sales-Total cost
Profit of the first half of the year = Rs.45,000Rs.40,000 = Rs.5,000
Profit of the second half of the year= Rs.50,000
Rs.43,000 = Rs.7,000
Change in profit= Rs.7,000Rs.5,000= Rs.2,000
Change in sales= Rs.50,000Rs.45,000=Rs.5,000
Fi d t fi d t th t ib ti h ld
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Fixed expenses, to find out the contribution shouldbe initially found out
Contribution = Sales PV ratio
= Rs.50,000 40% = Rs.20,000
The fixed expenses to be found out through thefollowing equation
Contribution-Fixed expenses= Profit
Rs.20,000Rs.7,000= Rs.13,000= Fixed expenses
The fixed expenses found only for six months ; for
the entire year
= Rs.13,000 2=Rs. 26,000
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Margin of safety
= Total sales- BE sales
The next component to be found out is total salesTotal sales = Sale of the first half of the year +Sale of the second half of the year
= Rs.45,000 + Rs.50,000 = Rs.95,000Margin of safety= Rs.95,000 Rs.65,000=Rs.30,000
Margin of safety in percentage of sales = 100= 31.578%
APPLICATIONS OF
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APPLICATIONS OFMARGINAL COSTING
Make or Buy Decision
The management of a company finds that while thecost of making a component part is Rs. 20, thesame is available in the market at Rs. 18 with anassurance of continuous supply.
Give a suggestion whether to make or buy this part.Give also your views in case the supplier reducesthe price from Rs. 18 to Rs. 16.
The cost information is as follows
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Cost of Manufacturing
Note: Only variable cost is considered (NOT theFixed Cost)
Production Worthy
Cost of the production < Price of the productavailable in the market
Purchase Worthy
Cost of the production > Price of the product
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Make or Buy Decision
A refrigerator manufacturer purchases a certain
component @ Rs.50 per unit. If he manufacturesthe same product he has to incur a fixed cost ofRs.20,000 and variable cost per unit is Rs. 40/-when should the manufacturer make on his own
or when should he buy from outside ?
When the requirements is 5,000 units, willyou advise to make or buy?
Calculate Break even point in units where
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Calculate Break even point in units where
Cost of Buying = Cost of manufacturing
Cost of Buying = Rs 50/Unit
Total Cost of manufacturing = Fixed Cost + Variable Cost
Saving per Unit = Contribution = Rs 50 Rs 40 = Rs 10
Before finding out the Break even point in units, the
contribution of the product should be found out.
Contribution margin per unit= Selling price in the market Cost of manufacture
Contribution margin per unit is the amount of savings tothe manufacture
Amount of savings out of the manufacture = Purchase price Variable cost
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The next step is to identify the worth of eithermanufacturing the units or buying at 5,000 Units
If the manufacturer buys from the outsider= 5,000 X Rs.50= Rs.2,50,000
If the same manufacturer produces the
component instead of buying=Rs.20,000+ Rs.2,00,000= Rs.2,20,000
From the above, the company is advised tomanufacture the component due to low cost ofmanufacture.
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OFFER
The above figures are for an output of 50,000 units. Thecapacity for the firm is 65,000 units A foreign customeris desirous of buying 15,000 units a price of Rs.20 perunit. Advise the manufacturer whether the order shouldbe accepted, what will be your advise if the orderwere from the local merchant?
Order Acceptance should be based on the two factors
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Order Acceptance should be based on the two factors
Additional cost and Additional revenue.
If the additional demand of the foreign buyer is able to
generate the additional revenue more than theadditional cost of the operations, the firm should haveto accept the foreign order.
Decision criteria
Marginal/Additional cost for the additional order of15,000 units
K F t A l i
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Key Factor Analysis
A limiting factor or deterring factor on sales
volume, production, labour, materials and so on.Volume of sales- the limiting factor is the
production of required number of articles
Volume of production- the limiting factors are asfollows
Inadequate supply of raw materials,
Labor,
Inability to sell the produced articles etc
The limiting factor is studied in the context of thecontribution. The limiting factor is bears an
inverse relationship with the volume of
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Key Factor Analysis - Problem
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Problem
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Comment on the profitability of each productduring the following conditions:
(a) In adequate supply of raw material
(b) Production capacity is limited
(c) Sales quantity is limited
(d) Sales value limited
Problem
According to the constraints given in the problem
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According to the constraints given in the problem,contribution of two products should be compared.
Calculate Contribution per unit, next, Contribution
margin per unit1. The first constraint is in adequate supply ofthe raw material:
2 D h f h l b h fi h ld
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2. Due to shortage of the labour, the firm shouldidentify the product which requires lesser labour hoursas well as able to generate more contribution margin
per labour hour.In the next step, Contribution margin per hour shouldbe calculated
The contribution per hour is greater in the case of the
product B, considered to be as a better product among
The next one is that sale of the quantities is the major
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The next one is that sale of the quantities is the majorlimiting factor. It means that the vendor finds somedifficulties in selling the articles. While considering thedifficulties in selling the quantities, the firm should
identify the product which is able to generate greatercontribution.
From the earlier calculation, it is clearly understood that,the product B is bearing greater value of contribution
margin per unit than product A.
(d) If the sales value is considered to be a limiting factor,to choose one among the given products PV ratio is beingapplied as a measure. It means that the sales value of the
products are ignored for comparison in between them. Toidentify the better product, irrespective of the price, PVratio should be applied. The PV ratio of the Product A & Bare calculated as follows
SELECTING A SUITABLE
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SELECTING A SUITABLEPRODUCT MIX
To Analyze profitability of variousproduct out combinations
To Optimize/Maximize profitability
Greater the profitability Greater theVolume produced and Vice Versa
From the following information has been extracted
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From the following information has been extractedof EXCEL rubber products ltd
The directors want to be acquainted with thedesirability of adopting any one of the
Determine the contribution margin per unit of A and
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Determine the contribution margin per unit of A andB
Prepare the Marginal costing statement
Determine the profit level of every mix, bydetermining Total
Contribution and then deducting fixed overheads toarrive at profit.
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