1 Cost Accounting
May 06, 2015
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Cost Accounting
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Definition
Chartered Institute Of Management Accountants ( CIMA London )
“Costing is the technique and process of ascertaining cost”
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Cost Accounting
• Cost accounting measures and reports information relating to the cost of acquiring and utilizing resources
• Cost accounting provides information for management and financial accounting
• Cost management describes the approaches and activities of managers in short-run and long-run planning and control decisions
• These decisions increase value of customers and lower costs of products and services
• Cost management is an integral part of a company’s strategy
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Cost Accounting
It provides information for both management accounting and financial accounting.
It measures and reports from financial and non financial data.
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Financial Accounting
• Financial accounting measures and records business transactions and provides financial statements that are based on generally accepted accounting principles (GAAP)
• Managers are responsible for the financial statements issued to investors, government regulators, and other parties outside the organization
• Financial accounting focuses on external parties
• Financial accounting reports on what happened in the past
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An Introduction to Cost Terms
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Costs and Cost Objects
Cost• a resource sacrificed or foregone to achieve a specific
objective
Cost Object• any product, machine, service or process for which
cost information is accumulated• cost objects can vary in size from an entire company,
to a division or program within the company, or down to a single product or service
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Direct and Indirect Costs
Direct Cost• a cost which is related to a particular cost objective
and can be traced to it in an economically feasible way
Indirect Cost• a cost which is related a particular cost objective but
cannot be traced to it in an economically feasible way• indirect costs are allocated to cost objectives
Direct Cost
Indirect Cost
Cost
Object
Trace
Allocate
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Cost Drivers and Cost Management
Cost driver (cost generator or cost determinant)• a factor which causes the amount of cost incurred to
change• production costs are driven by the number of
products produced, labour costs, number of setups required, and the number of change orders
Cost Reduction Programs focus on two things:
1. Doing only value-added activities
2. Efficiently manage the use of cost drivers in those value-added activities
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Variable and Fixed Costs
Variable Cost• a cost which is constant per unit
but changes in total in proportion to changes in the output
• materials (parts), fuel costs for a trucking company
Rs
Volume
Rs
Volume
Fixed Cost• a cost which does not change in
total as volume changes but changes on a per-unit basis as the cost driver increases and decreases
• amortization, insurance
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Total Costs and Unit Costs
Unit Cost (or Average Cost)• Total cost / some number of units
Average cost= Total manufacturing costs / Number of units produced= Rs980,000 / 10,000= Rs98 per unit
• Unit or average costs must be interpreted with caution• As volume increases, the unit or average cost falls as
the fixed costs are spread over a larger number of units
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Types of Inventory
• Direct material inventory (stock awaiting use in the manufacturing process)
• Work-in process inventory (partially completed goods on the shop floor)
• Finished goods inventory (goods completed but not yet sold)
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Period and Product Costs
Period Costs• are expensed on the income statement as they are
incurred• also called operating costs (excluding cost of goods
sold)• examples: selling, general and administrative costs
Product Costs• are inventoried on the balance sheet and expensed
only when the product or service is sold• also called inventoriable costs• Examples: materials and labour (manufacturing)
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Costing System Terminology
Cost Object• anything for which a separate measurement of costs
is desired
Cost Pool• a grouping of individual cost items
Cost Allocation Base• a factor that is the common denominator for
systematically linking an indirect cost or group of indirect costs to a cost object
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Alternative Classifications of Costs
1. Business functiona. R&Db. Designc. Productiond. Marketinge. Distributionf. Customer service
2. Assignment to a cost objecta. Direct costsb. Indirect costs
3. Behaviour patterna. Variable costsb. Fixed costs
4. Aggregate or averagea. Total costsb. Unit costs
5. Assets or expensesa. Inventoriable costsb. Period costs
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Costs in a Manufacturing Company
Inventoriable
(Product)
Costs
DirectMaterial
Purchases
Work inProcess
InventoryCost of Goods Sold
Revenue
Gross Margin
Marketing andAdministrative Costs
Operating Income
Period
Costs
Income Statement
Balance Sheet
MaterialsInventory
DirectLabour
IndirectManufacturing
Costs
Finished
GoodsInventory
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Costing Systems
Job-CostingSystem
• Costs are assigned to a distinct unit or batch
• Resources are expended to bring a distinct product or service to market for a specific customer
• advertising campaign, audit, aircraft assembly
Process-CostingSystem
• Costs are assigned to a mass of similar units
• Resources are used to mass-produce a product or service and not for any specific customer
• Postal delivery, oil refining
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Job Costing Approach
1. Identify the cost object(s)
2. Identify the direct costs for the cost object(s)
3. Select cost-allocation bases to use in allocating the indirect costs to the cost object(s)
4. Identify the indirect costs associated with each cost-allocation base
5. Compute the rate per unit of each cost-allocation base to allocate indirect costs to the cost object(s)
6. Compute the indirect costs allocated to the cost object(s)
7. Determine the cost of the cost object(s) by adding the direct and indirect costs
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Job Costing Overview
IndirectCost Pool
Manufacturing OverheadRs1,215,000
Rs45 per directManufacturing Labour Hours
Cost Object:
Direct + Indirect CostsDirect Material
Direct Labour
Cost
Allocation Base27,000 Direct Manufacturing Labour-
Hours
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Job Costing System in Manufacturing
Cost of Goods Sold
Finished Goods
Inventory
Work-In-Process
Inventory
Materials
Inventory
Buy
Materials
Use
Materials
Incur Labour
Costs
Incur Overhead
Costs
Complete
Production
Sell
Goods
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Cost Sheet
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Cost SheetIt is a statement designed to show the output of a
particular accounting period along with breakup of cost.
• It is a memorandum statement
• It does not form part of double entry cost accounting records.
• It discloses the total cost and cost per unit.
• It helps
To fix Selling Price.
To submit quotation price.
To Control cost.
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• COST SHEET
Total Cost Cost Per unit
Direct Materials
Direct Labour
Prime Cost
Add: Works Overheads
Works Cost
Add: Administration overheads
Cost of Production
Add: Selling & Distribution Overheads
Total Cost or Cost of Sales
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Elements of Cost
Direct Material :-
Identify in the product
Easily measure & directly charge to the product
e.g. Timber in furniture making
Categories• raw material • Specifically purchased for specific job or process• Parts or components purchased.
e.g. tyres for cycles • Primary Packing material
to protect finished product
for easy handling inside the factory.
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Direct Labour :-
Labour engaged in • converting raw material into finished goods• Altering the construction• Actual Production• Composition of Product
i.e labour which can be attributed to a particular job,product or process
Exception :- Where the cost is not significant like
wages of trainees- their labour though directly
spent on product is not treated as direct Labour
Test:- • Easily Identify• Feasible to Identify
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Overheads :- It may be defined as the aggregate of the cost of indirect materials, indirect labour and such other expenses including services as can’t conveniently be charged direct to specific cost unit.
Categories:-• Manufacturing Overheads• Administration of machines• Selling & distribution of machines
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Standard Costing
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Why is Standard Costing Used?
A A standard standard is a preestablishedis a preestablishedbenchmark for desirable performance.benchmark for desirable performance.
A A standard cost systemstandard cost system is one in which a is one in which acompany sets cost standards and thencompany sets cost standards and then
uses them to evaluate actual performance.uses them to evaluate actual performance.
A A variance variance is the difference betweenis the difference betweenactual performance and the standard.actual performance and the standard.
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Favorable versus Unfavorable
An An unfavorableunfavorable variance occurs when actual variance occurs when actualperformance falls below the standard.performance falls below the standard.
A A standard standard is a preestablishedis a preestablishedbenchmark for desirable performance.benchmark for desirable performance.
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. . Standard cost is the Predetermined cost based on a technical estimate for material, labor and overhead for a selected period of time and for a specified set of working conditions.
•Standard costing is the preparation of standard cost and
applying them to measure the variations from actual
costs and analyzing the causes of variations with a view
to maintain maximum efficiency in production
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Quantity and Price Standards
Quantity usedQuantity used
Price paidPrice paid
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Ideal versus Practical Standards
A standard that allows for the normalA standard that allows for the normalinefficiencies of production isinefficiencies of production iscalled a practical standard.called a practical standard.
A standard that allows for no inefficienciesA standard that allows for no inefficienciesof any kind is an ideal standard.of any kind is an ideal standard.
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The Standard Costing Process
Gather informationGather informationand set standards.and set standards.
Compare actualCompare actualperformance toperformance to
standard and preparestandard and prepareperformance reports.performance reports.
Determine whichDetermine whichvariances to investigate.variances to investigate.
Investigate theInvestigate thecause of variances.cause of variances.
Take corrective action.Take corrective action.
Determine ifDetermine ifcorrective actioncorrective action
is needed.is needed.
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Problems With Standard Costing
Employees may try to set low standardsEmployees may try to set low standardsto make them easier to achieve.to make them easier to achieve.
Using historical data to set standardsUsing historical data to set standardsmay build in past inefficiencies.may build in past inefficiencies.
Managers might focus on theManagers might focus on the““numbers” to the exclusionnumbers” to the exclusionof other important factors.of other important factors.
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Problems With Standard Costing
Focus on unfavorable variancesFocus on unfavorable variancesmay result in ignoring themay result in ignoring the
favorable variances.favorable variances.
Managers may loseManagers may losesight of the big picture.sight of the big picture.
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Comparison of Cost Systems
CostCostClassificationClassification
ActualActualCostCost
SystemSystem
NormalNormalCostCost
SystemSystem
StandardStandardCostCost
SystemSystem
DirectDirectMaterialMaterial
DirectDirectLaborLabor
ManufacturingManufacturingOverheadOverhead
ActualActual
ActualActual
ActualActual
ActualActual
ActualActual
EstimatedEstimated
EstimatedEstimated
EstimatedEstimated
EstimatedEstimated
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Analysis of variance
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Analysis of Variance may be done in respect of each element of cost and sales:
1.Direct Material Variance
2.Direct Labor Variance
3.Overhead Variance
4.Sales Variance
Analysis of Variance
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Material Variances
(Standard Price x Standard Rate)(Standard Price x Standard Rate)- ( Actual quantity x Actual Rate )- ( Actual quantity x Actual Rate )
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Direct Materials Variances
There are two variances calculatedThere are two variances calculatedfor material cost variance.for material cost variance.
The The material quantity variance material quantity variance(also called the usage variance) is a(also called the usage variance) is a
measure of the amount of materials used.measure of the amount of materials used.
The The material price variance material price varianceis a measure of the cost to buy theis a measure of the cost to buy the
various materials that were purchased.various materials that were purchased.
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Material Variances
( Standard material price – ( Standard material price – Actual material price)Actual material price)
× Actual material quantity× Actual material quantity
( Standard material quantity –( Standard material quantity –Actual material quantity)Actual material quantity)
× Standard unit price× Standard unit price
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Direct Materials Variances
Again Material Qt variances can be Again Material Qt variances can be divided into two varaincesdivided into two varainces
The material mix varianceThe material mix variance..
The material Yield varianceThe material Yield variance
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Material Mix Variances
Standard Cost of Standard MixStandard Cost of Standard Mix – –Standard Cost of Actual MixStandard Cost of Actual Mix
Std. Unit cost (SQ – AQ)Std. Unit cost (SQ – AQ)
Actual weight do not differ
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Material Mix Variances
Actual weight differ
Total wt. Of actual mix X Std. Cost Total wt. Of actual mix X Std. Cost - - Std. CostStd. Cost
Total wt. Of standard of Std. Mix of actual mixTotal wt. Of standard of Std. Mix of actual mix mixmix
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Material Variances
Standard Rate (Actual Yield Standard Rate (Actual Yield ––Standard Yield )Standard Yield )
{If std. & actual mix are same}{If std. & actual mix are same}
Standard Rate = Std. Cost of Std. MixStandard Rate = Std. Cost of Std. Mix Net Std. OutputNet Std. Output (Gross output – Standard loss)(Gross output – Standard loss)
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Material yield Variances
{Standard Rate (Actual Yield {Standard Rate (Actual Yield ––Revised Standard Yield )Revised Standard Yield )
If std. & actual mix are not same}If std. & actual mix are not same}
Standard Rate = Std. Cost of Revised Std. MixStandard Rate = Std. Cost of Revised Std. Mix Net Std. OutputNet Std. Output (Gross output – Standard loss)(Gross output – Standard loss)
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Labor Variances
The labor cost variance is theThe labor cost variance is thedifference between actual cost of hourdifference between actual cost of hour worked and the standard cost allowed.worked and the standard cost allowed.
The labor rate variance is theThe labor rate variance is thedifference between the actual directdifference between the actual directlabor cost incurred and the standardlabor cost incurred and the standardcost for the actual hours worked.cost for the actual hours worked.
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St. Cost of labor – Actual cost of laborSt. Cost of labor – Actual cost of labor
Rate variance =Actual Time Rate variance =Actual Time Taken (Standard Rate Taken (Standard Rate ––Actual Rate)Actual Rate)
Labor Cost Variance
Labor Rate Variance
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Standard Rate (Standard time for actual Standard Rate (Standard time for actual Output - Actual time Paid for)Output - Actual time Paid for)
Total Labor Efficiency Variance
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Labor Variances
Total Labor efficiency variance are of two types
Labor Efficiency VarianceLabor Efficiency Variance
Labor Idle Time varianceLabor Idle Time variance
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Labor Variances
Labor Efficiency VarianceLabor Efficiency Variance
Labor Efficiency Variance = Standard rate(Standard time Labor Efficiency Variance = Standard rate(Standard time for actual output - Actual time worked)for actual output - Actual time worked)
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Labor Variances
Labor Idle Time variance = Abnormal Idle Time xLabor Idle Time variance = Abnormal Idle Time x Standard RateStandard Rate
Labor Idle Time varianceLabor Idle Time variance
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St. Cost of St CompositionSt. Cost of St Composition(Actual time taken)– Standard cost of actual (Actual time taken)– Standard cost of actual
Composition ( Actual time worked)Composition ( Actual time worked)
Labor Mix Variance
Labor Variances
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Standard Rate Standard Rate (Actual Yield –Revised (Actual Yield –Revised
Standard Yield)Standard Yield)
Labor Yield Variance
Labor Variances
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Overhead cost variance can be defined as the difference between the Standard cost allowed for the actual output achieved and the actual overhead cost incurred.
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Overhead :- According to terminology of cost Accountancy (ICWA London) Overhead is defined as “ The aggregate of indirect material cost, indirect wages (indirect Labor Cost) and indirect expenses.”
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Overhead Costs
• Overhead costs are significant for most organizations
Variable Overhead• Recall that variable overhead is allocated to
products and services using a budgeted variable overhead rate
Fixed Overhead• Recall that fixed overhead is allocated to products
and services using a budgeted fixed overhead rate
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Overhead Cost Variances
Variable Overhead Fixed Overhead
How theCost isPlanned
andControlled
How Costsare
Allocatedto
Products
Rs
Volume
Rs
Volume
Rs
Volume
Rs
Volume
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Overhead cost Variance:-
Overhead Cost Variance
Variable overhead variance Fixed overhead variance
Expenditure Efficiency Expenditure Volumevariance variance variance variance
Capacity Calendar Efficiencyvariance variance variance
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Overhead Cost Variance :-
Overhead Cost Variance
( Actual output x Standard overhead Rate per unit )
– Actual overhead cost
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Overhead Cost Variances
Overhead Cost variancesvariances can be can be divided into two varaincesdivided into two varainces
1. Variable Overhead variance
..
2. Fixed Overhead variance
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Variable Overhead Variance
1. Variable Overhead variance
(Actual output x Standard variable overhead rate)
– (Actual variable overheads)
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Variable Overhead Variances
Variable Overhead variancesvariances can be can be divided into two variancesdivided into two variances
1. Variable Overhead Expenditure variance
..2. Variable Overhead Efficiency variance
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(A) Variable overhead (spending) expenditure
variance
= (Actual hours worked x standard variable
overhead rate) – Actual variable overheads
(B) Variable overhead efficiency variance
= Standard variable overhead rate(standard
Hours for Actual output – Actual Hours)
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2. Fixed overhead variance
Fixed overhead variance
(Actual output x standard fixed overhead rate)
– Actual fixed overheads
Fixed overhead variance can be categorized into:-
a) Expenditure variance = Budgeted Fixed overheads – Actual fixed overheads
b) Volume variance = actual output x Standard rate – Budgeted fixed overheads
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b) Capacity variance= standard rate( Revised Budgeted units – Budgeted units)
c) Calendar variance
= (Decrease or increase in number of units produced due to the difference of budgeted and actual days x standard rate per unit)
e) Efficiency Variance = Standard Rate (Actual Production – Standard Production)
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Using Standard Cost Variances
A performance report should be preparedA performance report should be preparedon a periodic basis for the managerson a periodic basis for the managers
who are responsible for thewho are responsible for thestandard cost variances.standard cost variances.
The management by exception conceptThe management by exception conceptwould then be used by the managerswould then be used by the managersto focus their attention on the mostto focus their attention on the most
significant cost variances.significant cost variances.
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Marginal Costing
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Marginal Costing:-
Chartered Institute of Management Accountant, England-
“Marginal costing is the ascertainment of marginal cost and of the effect on profit of changes in volume or type of output by differentiating between fixed cost and variable costs”.
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Features of Marginal Costing:
Cost is classified into :
Fixed Cost
Variable Cost•Variable cost is only charged to production•Fixed cost is recovered from contribution•Valuation of stock of WIP and F.G. is done on the basis of marginal cost.•Selling price is based on marginal cost and contribution•It is technique used to ascertain the marginal cost & to know the impact of V.C. on volume of output•Profit is calculated by deducting marginal cost and fixed cost from sales•C-V-P analysis is one of integral part of marginal costing
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Costs
• Fixed (Indirect/Overheads) – are not influenced by the quantity produced but can change in the long run e.g., insurance costs, administration, rent, some types of labour costs (salaries), some types of energy costs, equipment and machinery, buildings, advertising and promotion costs.
• Variable (Direct) – vary directly with the quantity produced, e.g., raw material costs, some direct labour costs, some direct energy costs.
• Semi-fixed – Where costs not directly attributable to either of the above, for example some types of energy and labour costs.
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Costs
• Total Costs (TC) = Fixed Costs (FC)+ Variable Costs (VC)
• Average Costs = TC/Output (Q)AC (unit costs) show the amount it costs to produce
one unit of output on average
• Marginal Costs (MC) – the cost of producing one extra or one fewer units of production
MC = TCn – TCn-1
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Revenue
• Total Revenue – also known as turnover, sales revenue or ‘sales’ = Price x Quantity Sold
• TR = P x Q
• Price – may be a variety of different prices for different products in the portfolio
• Quantity – Units sold
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Profit
Profit = TR – TC
• Normal Profit – the minimum amount required to keep a business in a particular line of production
• Abnormal/Supernormal Profit – the amount over and above the amount needed to keep a business in its current line of production
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Marginal Cost Equation
•Sales = Variable Cost + Fixed Cost + Profit/Loss
•Sales - Variable Cost = Fixed Cost + Profit/Loss
•Sales - Variable Cost = Contribution
Therefore,
Contribution = S.P. – V.C. or
Contribution = Fixed Cost + Profit
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Cost-Volume-Profit(CVP) Analysis
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Cost volume Profit Analysis
Cost volume Profit Analysis is a logical extension of marginal costing
• C.V.P. analysis examines the relationship of cost & profit to the volume of business to maximize profits
• Indicates direct relationship between volume & profit
• Indicates Indirect relationship between volume & cost per unit (Inverse)
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Cost-Volume-Profit Assumptionsand Terminology
1. Changes in the level of revenues and costs arise only because of changes in the number of product (or service) units produced and sold.
2. Total costs can be divided into a fixed component and a component that is variable with respect to the level of output.
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Cost-Volume-Profit Assumptionsand Terminology
3. When graphed, the behavior of total revenues and total costs is linear (straight-line) in relation to output units within the relevant range (and time period).
4. The unit selling price, unit variable costs, and fixed costs are known and constant.
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Abbreviations
SP = Selling price
VCU = Variable cost per unit
CMU = Contribution margin per unit
CM% = Contribution margin percentage
FC = Fixed costs
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Abbreviations
Q = Quantity of output units sold(and manufactured)
OI = Operating income
TOI = Target operating income
TNI = Target net income
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Breakeven Point
SalesVariableexpenses
Fixedexpenses
– =
Total revenues = Total costs
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Break Even
• Point of No Profit and No Loss
• Occurs where Total Costs = Total Revenue
Fixed Costs• Break-Even Point = ---------------
Contribution
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• Break even point ( Rs ) =Fixed Cost / P/V ratio
• Break Even point (Units) = Fixed Cost (Total)
-----------------------------
(S.P per unit – M.C per unit)
or( Contribution per Unit)
Cost-Volume-Profit Assumptionsand Terminology
•P/V Ratio = Profit / Sales•P/V Ratio = Contribution / Sales
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• Value of sales to earn desired amount of
profit:-
(Fixed Cost + Desired Profit)
------------------------------------------
P/ V ratio
Cost-Volume-Profit Assumptionsand Terminology
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•Variable Cost = Sales – (sales x P/V ratio)
•Profit= (sales x P/V ratio) – Fixed Cost
•Fixed Cost= (sales x P/v ratio) – Profit
•Margin of safety =
(Rs) = Profit/ P/V ratio or
= Actual sales – Break Even Sales
(Units) = Profit / Contribution per unit
Cost-Volume-Profit Assumptionsand Terminology
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Essentials of Cost-Volume-Profit(CVP) Analysis Example
Assume that the Furniture Shop can purchase Chairs for Rs32 from a local factory; other variable costs amount to Rs10 per unit.
The local factory allows the Furniture Shop toreturn all unsold Chairs and receive a full Rs32
refund per pair of Chairs within one year.
The average selling price per pair of Chairs is Rs70and total fixed costs amount to Rs84,000.
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Essentials of Cost-Volume-Profit(CVP) Analysis Example
How much revenue will the business receive if2,500 units are sold?
2,500 × Rs70 = Rs175,000
How much variable costs will the business incur?
2,500 × Rs42 = Rs105,000
Rs175,000 – 105,000 – 84,000 = (Rs14,000)
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Essentials of Cost-Volume-Profit(CVP) Analysis Example
What is the contribution margin per unit?
Rs 70 – Rs 42 = Rs 28 contribution margin per unit
What is the total contribution margin when2,500 pairs of Chairs are sold?
2,500 × Rs 28 = Rs70,000
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Essentials of Cost-Volume-Profit(CVP) Analysis Example
Contribution margin percentage (contributionmargin ratio) is the contribution margin per
unit divided by the selling price.
What is the contribution margin percentage?
Rs28 ÷ Rs70 = 40%
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Essentials of Cost-Volume-Profit(CVP) Analysis Example
If the business sells 3,000 pairs of Chairs,revenues will be Rs 210,000 and contributionmargin would equal 40% × Rs 210,000 = Rs 84,000.
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Equation Method
Rs70Q – Rs42Q – Rs84,000 = 0Rs28Q = Rs 84,000
Q = Rs84,000 ÷ Rs28 = 3,000 units
Let Q = number of units to be sold to break even
(Selling price × Quantity sold) – (Variable unit cost× Quantity sold) – Fixed costs = Operating income
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Contribution Margin Method
Rs84,000 ÷ Rs28 = 3,000 units
Rs84,000 ÷ 40% = Rs210,000
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Graph Method
04284
126168210252294336378
0 1000 2000 3000 4000 5000
Units
$(00
0) Revenue
Total costs
Breakeven
Fixed costs
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Target Operating Income
(Fixed costs + Target operating income)divided either by Contribution margin
percentage or Contribution margin per unit
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Target Operating Income
Assume that management wants to have anoperating income of Rs 14,000.
How many pairs of Chairs must be sold?
(Rs84,000 + Rs14,000) ÷ Rs 28 = 3,500
What sales are needed to achieve this income?
(Rs84,000 + Rs14,000) ÷ 40% = Rs245,000
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Target Net Incomeand Income Taxes Example
Proof:Revenues: 4,822 × Rs70 Rs337,540Variable costs: 4,822 × Rs42 202,524Contribution margin Rs135,016Fixed costs 84,000Operating income 51,016Income taxes: Rs51,016 × 30% 15,305Net income Rs 35,711
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Alternative Fixed/Variable CostStructures Example
What is the new contribution margin?
Decrease the price they charge from Rs32 to Rs25 andcharge an annual administrative fee of Rs30,000.
Suppose that the factory the Chairs Shop is using toobtain the merchandise offers the following:
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Alternative Fixed/Variable Cost Structures Example
Rs70 – (Rs25 + Rs10) = Rs35
Contribution margin increases from Rs28 to Rs35.
What is the contribution margin percentage?
Rs35 ÷ Rs70 = 50%
What are the new fixed costs?
Rs84,000 + Rs30,000 = Rs114,000
100
Alternative Fixed/Variable Cost Structures Example
Management questions what sales volumewould yield an identical operating income
regardless of the arrangement.
28x – 84,000 = 35x – 114,000
114,000 – 84,000 = 35x – 28x
7x = 30,000
x = 4,286 pairs of Chairs
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Alternative Fixed/Variable Cost Structures Example
Cost with existing arrangement= Cost with new arrangement
.60x + 84,000 = .50x + 114,000
.10x = Rs30,000 x = Rs300,000
(Rs300,000 × .40) – Rs 84,000 = Rs36,000
(Rs300,000 × .50) – Rs114,000 = Rs36,000
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.
Financial accounting income statementemphasizes gross margin.
Contribution income statement emphasizescontribution margin.
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Application Of Marginal Costing
1. Cost Control
2. Profit planning
3. Evaluation of performance
4. Decision Making
• Fixation of selling Price
• Key or limiting factors
• Make or Buy Decision
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•Selection of suitable product mix•Effect of change in price•Maintained a desired level of Profit•Alternative methods of Production•Diversification of Products•Closing down of activities•Alternative course of action•Level of activity planning
Application Of Marginal Costing
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Typical Relevant Costing Decisions
• One-Time-Only Special Order (Pricing)
• Make or Buy Decisions (Outsourcing)
• Opportunity Costs
• Product Mix Decisions under Capacity Constraints
• Add or Drop a Product Line or Customer
• Equipment Replacement Decisions
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One-Time-Only Special Order
Without WithOrder Order Difference
Volume 30,000 35,000 5,000
Relevant revenues Rs600,000 Rs655,000 Rs55,000
Relevant costs:Variablemanufacturing (225,000) (262,500) (37,500)
Incremental income Rs17,500
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Outsourcing and Make/Buy Decisions
Make Buy Difference
Relevant costs:Outside cost of parts Rs160,000 Rs160,000Direct materials Rs80,000 (80,000)Direct labour 10,000 (10,000)Variable overhead 40,000 (40,000)Fixed purchasing, receiving and setup overhead 20,000 (20,000)
Incremental differenceIn favour of making Rs10,000
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Outsourcing and Opportunity Costs
Make Buy
Relevant cost to make Rs150,000
Relevant cost to buy Rs 160,000
Opportunity cost:Profit forgone becauseCapacity cannot be usedto make another product 25,000
Total relevant costs Rs175,000 Rs160,000
• Opportunity cost considers the profits lost by not following the next best alternative course of action
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Product Mix Decisions Under Constraint
Snowmobile BoatEngine
Engine
Contribution margin per unit Rs240 Rs375Machine hours required per unit 2 5Contribution margin per
machine hour Rs120 Rs75
• If machine hours are constrained, maximize income by first producing as many snowmobile engines as can be sold and then shift production to boat engines
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Customer Profitability Analysis
Keep DropAccount Account Difference
Relevant revenue Rs1,200,000 Rs800,000Rs(400,000)
Relevant costs:
Cost of goods sold 920,000 590,000 330,000
Material-handling labour 92,000 59,000 33,000
Marketing support 30,000 20,000 10,000
Order/delivery 32,000 20,000 12,000
Decline in operating incomeif drop account Rs(15,000)