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Amity CampusUttar PradeshIndia 201303

ASSIGNMENTSPROGRAM M!C

SEMESTER"IISu#$e%t Name Study COUNTR& R'(( Num#er )Re*+N'+, Student Name

INSTRUCTIONSa,Students are re-uired t' su#mit a(( three assi*nment sets+

ASSIGNMENT .ETAI/S MAR S

Assi*nment A !ie Su#$e%tie uesti'ns 10Assi*nment Three Su#$e%tie uesti'ns 4

Case Study

10

Assi*nment C O#$e%tie 'r 'ne (ineuesti'ns

10

#,T'ta( 5ei*hta*e *ien t' these assi*nments is 306+ OR 30Mar7s

%, A(( assi*nments are t' #e %'mp(eted as typed in 5'rd8pd9+d,A(( -uesti'ns are re-uired t' #e attempted+e,A(( the three assi*nments are t' #e %'mp(eted #y due

dates and need t' #e su#mitted 9'r ea(uati'n #y AmityUniersity+9, The students hae t' atta%hed a s%an si*nature in the

9'rm+

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Si*nature :::::::::::::::::::::::::::::::::.ate :::::::::::::::::::::::::::::::::

) ; , Ti%7 mar7 in 9r'nt '9 the assi*nments su#mitted

Assi*nment

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managers make aout how their organi%ations should do things.

&ome cost information, is provided to external users, such as

shareholders and creditors as part of the nancial statements'.

Thus, cost accounting involves the accumulation, recording and

reporting of costs and other (uantitative data. The information

generated ! the Cost Accounting s!stem is used ! an

organi%ation for internal purposes and for external purposes.

)roviding cost information to managers *internal purposes' to

assist them in decision-making is called +anagement Accounting.

O#$e%ties '9 %'st a%%'untin*

As%ertainment '9 C'stThe primar! o#ective of the cost

accounting is to ascertain cost of each product, process, #o,operation or service rendered.

As%ertainment '9 Pr'>ta#i(ity Cost accounting

determines the protailit! of each product, process, #o,

operation or service rendered. The statement of prot or losses

and alance &heet also sumitted to the management

periodicall!. C(assi>%ati'n '9 C'st Cost accounting classies cost in to

dierent elements such as materials, laorer and expenses. It has

further een divided as direct cost and indirect cost for cost

control and recording.

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C'ntr'( '9 C'st Cost accounting aims at controlling cost !

setting standards and compared with the actual, the deviation or

variation etween two is identied and necessar! steps are taken

to control them.

!i?ati'n 'r Se((in* Pri%es Cost accounting guides

management in regard to xation of selling prices of the products.

It is also helpful for preparing tender and (uotations.

'

C/SSI!ICATION O! COST

Cost classication is the process of grouping costs according to

their common characteristics. A suitale classication of costs is

ver! helpful in identif!ing a given cost with cost centers or cost

units. Costs ma! e classied according to their nature, i.e.,

material, laor and expenses and a numer of other

characteristics. /epending upon the purpose to e achieved and

re(uirements of a particular concern the same cost gures ma!

e classied into dierent categories. The classication of costs

can e done in the following wa!s0

1. ! 2ature of 3lement

. ! 4unctions

5. ! Traceailit!

6. ! 7ariailit!

8. ! Controllailit!

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9. ! 2ormalit!

:. ! Capital or ;evenue

. According to )lanning and Control

11. 4or +anagerial /ecisions

1. ?thers.

3ach classication will e discussed in detail in the following

paragraphs0

1+ y Nature '9 E(ement

The costs are divided into three categories i.e. +aterials, @aor

and ?verheads. 4urther su-classication of each element is

possile for example, material can e classied into raw materialcomponents, spare parts, consumale stores, packing material,

etc.

Materia(s0 +aterials are the principal sustances that go into the

production process and are transformed into nished goods.

+aterials are further classied as direct materials and indirect

materials. /irect materials are that materials that can e directl!

identied with and easil! traced to nished goods. In

manufacturing organi%ations, the cost of direct materials

constitutes a ma#or proportion of the nished product cost. All the

other materials that go into the production of the nished goods

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are called indirect material costs. Indirect materials generall!

form a part of the manufacturing overheads. 4or example.a

furniture manufacturer, teak wood is a direct material as it can e

traced easil! to the furniture made, and the nails, adhesives and

other sundr! materials can e treated as indirect materials.

/a#'r @aor refers to the human eort to produce goods and

services. It is a factor of production the talents, training, and

skills of people which contriute to the production of goods and

services. It involves the ph!sical and mental eort. It can e

further classied into direct and indirect laor. /irect laor is theeort of emplo!ees who transforms direct materials into a

nished product and it is ph!sicall! traceale to the nished good

or service. In some industries laor cost forms a signicant

portion of total costs. The laor which cannot e traced to a

product is considered to e the indirect laor. The indirect laor

forms part of factor! overhead. In the aove example, the cost of

the workers who directl! expend their energ! on making the

furniture with the help of tools and machines is considered to e

the direct laor. The salar! paid to a supervisor, who oversees the

activities of a team of workers is considered as indirect laor.

OerheadsThose elements of costs necessar! in the production

of an article or the performance of a service which are of such a

nature that the amount applicale to the product or service

cannot e determined accuratel! or readil!. Bsuall! the! relate to

those o#ects of expenditures which do not ecome an integral

part of the nished product or service such as rent, heat, light,

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supplies, management, supervision, etc. In other words,

overheads consist of indirect materials, indirect laor and other

indirect expenses. The overheads can e classied into factor!

overheads, oce and administration overheads and selling and

distriution overheads. Continuing with the aove example, cost

of factor! lighting, rent of the factor!, rent of administrative

uilding, salar! of administrative sta and managers,

depreciation of machiner! etc. constitute overheads.

2+ y !un%ti'ns

It leads to grouping of costs according to the road divisions offunctions of a usiness undertaking or asic managerial activities,

i.e. production, administration, selling and distriution. According

to this classication costs are divided as follows0

Manu9a%turin* and Pr'du%ti'n C'sts

This categor! includes the total of costs incurred in manufacture,

construction and farication of units of production. The

manufacturing and production costs comprise of direct materials,

direct laor and factor! overheads.

Administratie C'sts

This categor! includes costs incurred on account of planning,

directing, controlling and operating a compan!. 4or example,

salaries paid to managers and other administrative sta.

Se((in* and .istri#uti'n C'sts

&elling costs and distriution costs are most often confused to e

one and the same. Dowever, there is a distinction etween the

two. &elling costs are dened as "the cost of seeking to create

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and stimulate demand and of securing orders$. 3xample of selling

costs are advertisement, salesman salaries, etc. Ehereas,

distriution costs are dened as "the cost of se(uence of

operations which egin with making the packed product availale

for dispatch and ends with making the reconditioned, returned

empt! packages, if an! availale for re-use. 4or example,

insurance on goods in transit, warehousing etc. are distriution

costs.

3+ y Tra%ea#i(ity

According to this classication, total cost is divided into dire%t%'sts and indire%t %'sts

/irect costs are those costs which are incurred for and ma! e

convenientl! identied with or easil! traced to a particular cost

center or cost unit. The common examples of direct costs are

materials used and laor emplo!ed in manufacturing an article or

in a particular process of production.

Indirect costs are those costs which are incurred for the enet of

a numer of cost centers or cost units and cannot e convenientl!

identied with a particular cost center or cost unit. 3xamples of

indirect costs include rent of uilding, management salaries,

machiner! depreciation, etc. The nature of the usiness and the

cost unit chosen will determine the costs as direct and indirect.

4or example, the hire charges of a moile crane used onsite ! a

contractor would e regarded as a direct cost since it is

identiale with the pro#ectFsite on which it is emplo!ed, ut if the

crane is used as a part of the services of a factor!, the hire

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charges would e regarded as indirect cost ecause it will

proal! enet more than one cost center or department. The

distinction etween direct and indirect cost is essential ecause

the direct costs of a product or activit! can e accuratel!

identied with the cost o#ect while the indirect costs have to e

apportioned on the asis of certain assumptions aout their

incidence.

@+ y aria#i(ity

The asis for this classication is the ehavior of costs in relation

to changes in the level of activit! or volume of production. ?n thisasis, costs are classied into three groups vi%. xed, variale and

semi-variale.

!i?ed C'sts

4ixed costs are those which remain xed in total with increase or

decrease in the volume of output or activit! for a given period of

time or for a given range of output. 4ixed costs per unit var!

inversel! with the volume of production, i.e. xed cost per unit

decreases as production increases and increases as production

decreases. 3xamples of xed costs are rent, insurance of factor!

uilding, factor! managerGs salar!, etc. These costs are constant

in total amount ut Huctuate per unit as production level changes.

These costs are also termed as capacit! costs.

aria#(e C'sts

7ariale costs are those which var! in total directl! in proportion

to the volume of output. These costs per unit remain relativel!

constant with changes in volume of production or activit!. Thus,

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variale costs Huctuate in total amount ut tend to remain

constant per unit as production level changes. 3xamples0 direct

material costs, direct laor costs, power, repairs, etc.

Semi"aria#(e C'sts&emi-variale costs are those which are partl! xed and partl!

variale. 4or example, telephone expenses include a xed portion

of monthl! charge plus variale charge according to the numer

of calls made thus total telephone expenses are semi-variale.

?ther examples of such costs are depreciation, repairs and

maintenance of uilding and plant, etc. These are also calledsemi-xed costs or mixed costs.

B+ y C'ntr'((a#i(ity

?n this asis costs are classied into two categories0

C'ntr'((a#(e C'sts

If the costs are inHuenced ! the action of a specied memer of

an undertaking, that is to sa!, costs which are at least partl!

within the control of management the! are called controllale

costs. An organi%ation is divided into a numer of responsiilit!

centers and controllale costs incurred in a particular cost center

can e inHuenced ! the action of the manager responsile for

the center. enerall! speaking, all direct costs including direct

material, direct laor and some of the overhead expenses are

controllale ! lower level of management.

Un%'ntr'((a#(e C'sts

If the costs cannot e inHuenced ! the action of a specied

memer of an undertaking, that is to sa!, which are not within the

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control of management the! are called uncontrollale costs. +ost

of the xed costs are uncontrollale. 4or example, rent of the

uilding is not controllale and so is managerial salaries.

?verhead cost, which is incurred ! one service section or

department and is apportioned to another which receives the

service is also not controllale ! the latter.

Controllailit! of costs depends on the level of management *top,

middle or lower' and the period of time *long-term or short-term'.

+ y N'rma(ity

?n this asis, is the costs are classied into two categories.N'rma( C'st

It is the cost which is normall! incurred at a given level of output

in the conditions in which that level of output is normall! attained.

It forms a part of production cost.

A#n'rma( C'st

It is the cost which is not normall! incurred at a given level of

output in the conditions in which that level of output is normall!

attained. It is not considered as a part of production cost, hence it

is charged to Costing )rot and @oss Account.

D+ y Capita( and Reenue 'r !inan%ia( A%%'untin*

C(assi>%ati'n

If the cost is incurred in purchasing assets either to earn income

or increasing the earning capacit! of the usiness it is called

capital cost, for example, the cost of a rolling machine in case of

steel plant. Though the cost is incurred at one point of time the

enets accruing from it are spread over a numer of accounting

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!ears. ;evenue expenditure is an! expenditure done in order to

maintain the earning capacit! of the concern such as cost of

maintaining an asset or running a usiness. 3xample, cost of

materials used in production, laor charges paid to convert the

material into production, salaries, depreciation, repairs and

maintenance charges, selling and distriution charges, etc. Ehile

calculating cost, revenue items are considered whereas capital

items are completel! ignored.

+ y Time

Costs can e classied as *i' Distorical costs and *ii')redetermined costs.

Fist'ri%a( C'sts

The costs which are ascertained after eing incurred are called

historical costs. &uch costs are availale onl! when the production

of a particular thing has alread! een done. &uch costs are onl! of

historical value and not at all helpful for cost control purposes.

Predetermined C'sts

&uch costs are estimated costs, i.e. computed in advance of

production taking into consideration the previous periodsG costs

and the factors aecting such costs. If the! are determined on

scientic asis the! ecome standard cost. &uch costs when

compared with actual costs will give the variances and reasons of

variance and will help the management to x the responsiilit!

and to take remedial action to avoid its recurrence in future.

Distorical costs and predetermined costs are not mutuall!

exclusive. 3ven in a s!stem when historical costs are used,

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predetermined costs have a ver! important role to pla! ecause a

gure of historical cost ! itself has no meaning unless it is

related to some other standard gure to give meaningful

information to the management.

+ y Ass'%iati'n 5ith Pr'du%t

Costs on this asis are classied as )roduct Costs and )eriod

Costs. This distinction is re(uired for the purpose of prot

determination. This is ecause product costs are carried forward

to the next accounting period in the form of unsold nished stock.

Ehereas period costs are written o in the accounting period inwhich it is incurred.

Pr'du%t C'st

)roduct costs are associated with unit of output. )roduct costs are

the costs Jasored !G or Jattached toG the units produced.

These costs go into the determination of inventor! valuation

*nished goods and partl! completed goods' hence are called

Inventoriale costs. This consists of direct materials, direct laor

and factor! overheads *partl! or full!'. The extent of inclusion of

factor! costs depends on the t!pe of costing s!stem in force

asorption or direct costing. If asorption costing method is

adopted, oth the xed and variale factor! overheads are

included as part of product costs. If direct costing method is

adopted onl! variale factor! overheads are included as part of

inventoriale cost.

Peri'd C'sts )eriod costs are costs associated with period for

which the! are incurred, rather than the unit of output or

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manufacturing activit!. These costs are not treated as part of

inventor! and hence the! are treated as expenses of the period

for which the! are incurred. Administrative, &elling and

/istriution costs are treated as period costs and are deducted as

an expense for the determination of income and are not regarded

as a part of inventor!.

10 A%%'rdin* t' P(annin* and C'ntr'(

Cost accounting furnishes information to the management which

is helpful in discharging the two important functions of

management i.e. planning and control. 4or the purpose ofplanning and control, costs are classied as udgeted costs and

standard costs.

ud*eted C'sts

udgeted costs represent an estimate of expenditure for dierent

phases or segments of usiness operations, such as

manufacturing, administration, sales, research and development,

for a period of time in future which suse(uentl! ecomes the

written expression of managerial targets to e achieved. 7arious

udgets are prepared for dierent phasesFsegments of usiness,

such as sales udget, raw material cost udget, laor cost

udget, cost of production udget, manufacturing overhead

udget, oce and administration overhead udget. Continuous

comparison of actual performance *i.e., actual cost' with that of

the udgeted cost is made so as to report the variations from the

udgeted cost to the management for corrective action.

Standard C'st

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The Institute of Cost and +anagement Accountants, @ondon

denes standard cost as "the predetermined cost ased on a

technical estimate for materials, laor and overhead for a

selected period of time and for a prescried set of working

conditions$. Thus, standard cost is a determination, in advance of

production, of what should e its cost under a set of conditions.

udgeted costs and standard costs are similar to each other to

the extent that oth of them represent estimates of cost for a

period of time in future. In spite of this, the! dier in the following

respects0&tandard costs are scienticall! predetermined costs of ever!

aspect of usiness activit! whereas udgeted costs are mere

estimates made on the asis of past actual nancial accounting

data ad#usted to future trends. Thus, udgeted costs are

pro#ection of nancial accounts whereas standard costs are

pro#ection of cost accounts.

The primar! emphasis of udgeted costs is on the planning

function of management whereas the main thrust of standard

costs is on control.

udgeted costs are extensive whereas standard costs are

intensive in their application. udgeted costs represent a macro

approach of usiness operations ecause the! are estimated inrespect of the operations of a department. Contrar! to this,

standard costs are concerned with each and ever! aspect of

usiness operation carried in a department, udgeted costs are

calculated for dierent functions of the usiness, i.e. production,

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sales, purchases, etc. whereas standard costs are compiled for

various elements of costs, i.e. materials, laor and overhead.

11+ !'r Mana*eria( .e%isi'ns?n this asis, costs ma! e classied into the following

categories0

Mar*ina( C'st

+arginal cost is the additional cost to e incurred if an additional

unit is produced. In other words, marginal cost is the total of

variale costs, i.e. prime cost plus variale overheads. It is asedon the distinction etween xed and variale costs.

Out '9 P'%7et C'sts

This is that portion of the cost which involves pa!ment, i.e. gives

rise to cash expenditure as opposed to such costs as depreciation,

which do not involve an! cash expenditure. &uch costs are

relevant for price xation during recession or when make or u!

decision is to e made.

.iHerentia( C'sts

If there is a change in costs due to change in the level of activit!

or pattern or method of production the! are known as dierential

costs. If the change increases the cost, it will e called

incremental cost and if the change results in the decrease in cost

it is known as decremental cost.

Sun7 C'sts

&unk cost is another name for historical cost. It is a cost that has

alread! een incurred and is irrelevant to the decision making

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process. A good example is depreciation on a xed asset.

/epreciation on a given asset is a sunk cost ecause the cost *of

purchasing the asset' has alread! een incurred *when it was

purchased' and it cannot e aected ! an! future action, though

we allocate the depreciation cost to future periods the original

cost of the asset is unavoidale. Ehat is relevant in this context is

the salvage value of the asset not the depreciation. Thus, sunk

costs are not relevant for decision making and are not aected !

increase or decrease in volume.

Imputed )'r n'ti'na(, C'stsThese costs appear in cost accounts onl!. 4or example notional

rent charged on usiness premises owned ! the proprietor,

interest on capital for which no interest has een paid. Ehen

alternative capital investment pro#ects are eing evaluated it is

necessar! to consider the imputed interest on capital efore a

decision is arrived as to which is the most protale pro#ect.

Opp'rtunity C'st

It is the maximum possile alternative earnings that will e

foregone if the productive capacit! or services are put to some

alternative use. 4or example, if an owned uilding is proposed to

e used for a pro#ect, the likel! rent of the uilding is the

opportunit! cost which should e taken into consideration while

evaluating the protailit! of the pro#ect. &ince opportunit! costs

are not actuall! costs incurred ut onl! are enets foregone,

the! are not as a matter of fact recorded in the accounting ooks.

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Dowever, the! are relevant costs for decision making purposes

and are considered while evaluating dierent alternatives.

Rep(a%ement C'st

It is the cost at which there could e purchase of an asset or

material identical to that which is eing replaced or revalued. It is

the cost of replacement at current market price.

A'ida#(e and una'ida#(e C'st

Avoidale costs are those which can e eliminated if a particular

product or department with which the! are directl! related to, is

discontinued. 4or example, salar! of the clerks emplo!ed in aparticular department can e eliminated, if the department is

discontinued. Bnavoidale cost is that cost which will not e

eliminated with the discontinuation of a product or department.

4or example, salar! of factor! manager or factor! rent cannot e

eliminated even if a product is eliminated.

12+ Other Types '9 C'sts

!uture C'sts

Are those costs that are expected to e incurred at a later date.

Pr'*rammed C'st

Certain decisions reHect the policies of the top management

which results in periodic appropriations and these costs are

referred to as programmed cost. 4or example, the expenditure

incurred ! the compan! under the Kawahar;o#garLo#ana program

initiated ! the prime minister is a programmed cost which

reHects the polic! of the top management.

'int C'st

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Koint cost is the cost of manufacturing #oint products up to or prior

to the split-o point. Cost incurred after the split-o point is called

separale cost. Koint cost is common to the processing of #oint

products and !-products till the point of separation and cannot

e traced to a particular product efore the point of split-o.

C'nersi'n C'st

Conversion cost is the cost incurred in converting the raw

material into nished product. It can e calculated ! deducting

the cost of direct materials from the production cost.

.is%reti'nary C'sts/iscretionar! costs are those costs which do not have ovious

relationship to levels of capacit! or output activit! and are

determined as part of the periodic planning process. In each

planning period the management decides on how much to spend

on certain discretionar! items such as advertising, research and

development, emplo!ee

C'mmitted C'st

Committed cost is a xed cost which results from the decisions of

the management in the prior period and is not su#ect to the

management control in the present on a short run asis. The!

arise from the possession of production facilities, e(uipment, an

organi%ation setup, etc.

&ome examples of committed costs are0 plant and e(uipment

depreciation, taxes, insurance premium and rent charges.

5'

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AC anal!sis is an inent'ry %ate*'riJati'n meth'dwhich

consists in dividing items into three categories, A, and C0 A

eing the most valuale items, C eing the least valuale ones.

This method aims to draw managersM attention on the %riti%a(

9e5*A-items' and not on the triia( many*C-items'.

The AC approach states that, when reviewing inventor!, a

compan! should rate items 9r'm A t' C, asing its ratings on

the following rules0

A"itemsare goods which annua( %'nsumpti'n

a(ueis the hi*hest. The top :>-N of the annual consumption

value of the compan! t!picall! accounts for onl! 1>->N of total

inventor! items.

C"itemsare, on the contrar!, items with the ('5est

%'nsumpti'n a(ue. The lower 8N of the annual consumption

value t!picall! accounts for 8>N of total inventor! items.

"itemsare the interclass items, with a medium

%'nsumpti'n a(ue. Those 18-8N of annual consumption value

t!picall! accounts for 5>N of total inventor! items.

The annual consumption value is calculated with the

formula0 *Annual demand' x *item cost per unit'.

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Through this categori%ation, the suppl! manager can identi9y

inent'ry h't sp'ts, and separate them from the rest of the

items, especiall! those that are numerous ut not that protale.

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3-Commerce example 0

The graph aove illustrates the !earl! sales distriution of a B&

eCommerce in >11 for all products that have een sold at least

one. )roducts are ranked starting with the highest sales volumes.

?ut of 1:>>> references0

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Top 8>> products *Top 18N'

represent :>N of the sales.

2ext 6>>> products *2ext 8N'

represent >N of the sales.

ottom 1>8>> products *ottom

9>N' represents 1>N of the sales.

Adanta*es '9 AC Ana(ysis

1. Close and strict control is facilitated on the most important

items which help in overall inventor! valuation or overall material

consumption.

. )roper regulation of investment in inventor! which will ensure

optimum utili%ation of availale funds.

5. Delps in maintaining a high inventor! turnover rates.

6'

enerall! idle time means that time for which the emplo!er

pa!s, ut from which he otains no production. ?therwise it is

the dierence etween the time for which workers are paid

ut the workers do not work. &o it is a loss to theorganisation. It can e minimi%ed ut, cannot e controlled

during idle time, the workers remain due and contriute

nothing towards production. It is the dierence etween

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actual hour and actual hour worked. There are two t!pes of

idle times0

1. N'rma( id(e timeThe normal idle time is that idle timewhich cannot e full! avoided ut eective eort should e

made to reduce it.

. A#n'rma( id(e time Anormal idle time arises due to

various causes which can e avoided. Anormal idle time can

e avoided if proper precautions are taken. Thus the factors

which are responsile for controlling and avoiding idle timemust e taken care of.

2ormal idle time is permitted ut anormal idle time should

e avoided.

The %auses 9'r id(e time

Idle time indicates that time for which wages are paid to the

workers ut no production is otained during that time. 4ollowing

are the causes of idle time0

- /ue to machine reak down

- )ower failures

- Eaiting for instructions

- Eaiting for tools or raw materials to start the production

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- 3conomic Causes includes0 &easonal, c!clical or industrial

nature

this is unproductive time spent ! emplo!ees due to factors

e!ond their control

B,

C'st"'(ume"pr'>t ana(ysis (''7s primari(y at the eHe%ts

'9 diHerin* (ee(s '9 a%tiity 'n the >nan%ia( resu(ts '9 a

#usiness

In an! usiness, or, indeed, in life in general, hindsight is a

eautiful thing. If onl! we could look into a cr!stal all and nd

out exactl! how man! customers were going to u! our product,

we would e ale to make perfect usiness decisions and

maximise prots.

Take a restaurant, for example. If the owners knew exactl! how

man! customers would come in each evening and the numer

and t!pe of meals that the! would order, the! could ensure that

stang levels were exactl! accurate and no waste occurred in the

kitchen. The realit! is, of course, that decisions such as stang

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and food purchases have to e made on the asis of estimates,

with these estimates eing ased on past experience.

Ehile management accounting information canMt reall! help much

with the cr!stal all, it can e of use in providing the answers to

(uestions aout the conse(uences of dierent courses of action.

?ne of the most important decisions that needs to e made

efore an! usiness even starts is Ghow much do we need to sell

in order to reak-evenOM ! Greak-evenM we mean simpl! covering

all our costs without making a prot.

This t!pe of anal!sis is known as Gcost-volume-prot anal!sisM

*C7) anal!sis' and the purpose of this article is to cover some of

the straight forward calculations and graphs re(uired for this part

of the )aper 48 s!llaus, while also considering the assumptions

which underlie an! such anal!sis.

THE OBJECTIVE OF CVP ANALYSIS

C7) anal!sis looks primaril! at the eects of diering levels of

activit! on the nancial results of a usiness. The reason for the

particular focus on sales volume is ecause, in the short-run,

sales price, and the cost of materials and laour, are usuall!

known with a degree of accurac!. &ales volume, however, is not

usuall! so predictale and therefore, in the short-run, protailit!

often hinges upon it. 4or example, Compan! A ma! know that the

sales price for product x in a particular !ear is going to e in the

region of P8> and its variale costs are approximatel! P5>.

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It can, therefore, sa! with some degree of certaint! that the

contriution per unit *sales price less variale costs' is P>.

Compan! A ma! also have xed costs of P>>,>>> per annum,

which again, are fairl! eas! to predict. Dowever, when we ask the

(uestion0 GEill the compan! make a prot in that !earOM, the

answer is GEe donMt knowM. Ee donMt know ecause we donMt know

the sales volume for the !ear. Dowever, we can work out how

man! sales the usiness needs to make in order to make a prot

and this is where C7) anal!sis egins.

Meth'ds 9'r %a(%u(atin* the #rea7"een p'int

The reak-even point is when total revenues and total costs are

e(ual, that is, there is no prot ut also no loss made. There are

three methods for ascertaining this reak-even point0

1 The e-uati'n meth'd

A little it of simple maths can help us answer numerous dierentcost-volume-prot (uestions.

Ee know that total revenues are found ! multipl!ing unit selling

price *B&)' ! (uantit! sold *Q'. Also, total costs are made up

rstl! of total xed costs *4C' and secondl! ! variale costs *7C'.

Total variale costs are found ! multipl!ing unit variale cost

*B7C' ! total (uantit! *Q'. An! excess of total revenue over total

costs will give rise to prot *)'. ! putting this information into a

simple e(uation, we come up with a method of answering C7)

t!pe (uestions. This is done elow continuing with the example

of Compan! A aove.

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Total revenue total variale costs total xed costs R )rot

*B&) x Q' *B7C x Q' 4C R ) *8>Q' *5>Q' >>,>>> R )

2ote0 total xed costs are used rather than unit xed costs since

unit xed costs will var! depending on the level of output.

It would, therefore, e inappropriate to use a unit xed cost since

this would var! depending on output. &ales price and variale

costs, on the other hand, are assumed to remain constant for all

levels of output in the short-run, and, therefore, unit costs are

appropriate.

Continuing with our e(uation, we now set ) to %ero in order to nd

out how man! items we need to sell in order to make no prot, ie

to reak even0

*8>Q' *5>Q' >>,>>> R >

>Q >>,>>> R >>Q R >>,>>>

Q R 1>,>>> units.

The e(uation has given us our answer. If Compan! A sells less

than 1>,>>> units, it will make a loss if it sells exactl! 1>,>>>

units, it will reak-even, and if it sells more than 1>,>>> units, it

will make a prot.

2 The %'ntri#uti'n mar*in meth'd

This second approach uses a little it of algera to rewrite our

e(uation aove, concentrating on the use of the Gcontriution

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marginM. The contriution margin is e(ual to total revenue less

total variale costs. Alternativel!, the unit contriution margin

*BC+' is the unit selling price *B&)' less the unit variale cost

*B7C'. Dence, the formula from our mathematical method aove

is manipulated in the following wa!0

*B&) x Q' *B7C x Q' 4C R )

*B&) B7C' x Q R 4C S )

BC+ x Q R 4C S )

Q R 4C S )

BC+

&o, if )R> *ecause we want to nd the reak-even point', then

we would simpl! take our xed costs and divide them ! our unit

contriution margin. Ee often see the unit contriution margin

referred to as the Gcontriution per unitM.

Appl!ing this approach to Compan! A again0

BC+ R >, 4C R >>,>>> and ) R >.

Q R 4C

BC+

Q R >>,>>>

>

Therefore Q R 1>,>>> units

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The contriution margin method uses a little it of algera to

rewrite our e(uation aove, concentrating on the use of the

Gcontriution marginM.

3 The *raphi%a( meth'd

Eith the graphical method, the total costs and total revenue lines

are plotted on a graph P is shown on the ! axis and units are

shown on the x axis. The point where the total cost and revenue

lines intersect is the reak-even point. The amount of prot or

loss at dierent output levels is represented ! the distance

etween the total cost and total revenue lines. !i*ure 1shows a

t!pical reak-even chart for Compan! A. The gap etween the

xed costs and the total costs line represents variale costs.

Alternativel!, a contriution graph could e drawn. Ehile this is

not specicall! covered ! the )aper 48 s!llaus, it is still useful

to see it. This is ver! similar to a reak-even chart, the onl!dierence eing that instead of showing a xed cost line, a

variale cost line is shown instead.

Dence, it is the dierence etween the variale cost line and the

total cost line that represents xed costs.The advantage of this is

that it emphasises contriution as it is represented ! the gap

etween the total revenue and the variale cost lines. This is

shown for Compan! A in !i*ure 2.

4inall!, a protvolume graph could e drawn, which emphasises

the impact of volume changes on prot *!i*ure 3'. This is ke! to

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the )aper 48 s!llaus and is discussed in more detail later in this

article.

ASCERTAINING THE SALES VOLUME REQUIRED TO ACHIEVE

A TARGET PROFIT

As well as ascertaining the reak-even point, there are other

routine calculations that it is #ust as important to understand. 4or

example, a usiness ma! want to know how man! items it must

sell in order to attain a target prot.

E?amp(e 1

Compan! A wants to achieve a target prot of P5>>,>>>. The

sales volume necessar! in order to achieve this prot can e

ascertained using an! of the three methods outlined aove. If the

e(uation method is used, the prot of P5>>,>>> is put into thee(uation rather than the prot of P>0

*8>Q' *5>Q' >>,>>> R 5>>,>>>

>Q >>,>>> R 5>>,>>>

>Q R 8>>,>>>

Q R 8,>>> units.

Alternativel!, the contriution method can e used0

BC+ R >, 4C R >>,>>> and ) R 5>>,>>>.

Q R 4C S )

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BC+

Q R >>,>>> S 5>>,>>>

>

Therefore Q R 8,>>> units.

4inall!, the answer can e read from the graph, although this

method ecomes clumsier than the previous two. The prot will

e P5>>,>>> where the gap etween the total revenue and total

cost line is P5>>,>>>, since the gap represents prot *after the

reak-even point' or loss *efore the reak-even point.'

A contriution graph shows the dierence etween the variale

cost line and the total cost line that represents xed costs. An

advantage of this is that it emphasises contriution as it is

represented ! the gap etween the total revenue and variale

cost lines.

This is not a (uick enough method to use in an exam so it is not

recommended.

Mar*in '9 sa9ety

The margin of safet! indicates ! how much sales can decrease

efore a loss occurs, ie it is the excess of udgeted revenues over

reak-even revenues. Bsing Compan! A as an example, letMs

assume that udgeted sales are >,>>> units. The margin of

safet! can e found, in units, as follows0

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udgeted sales reak-even sales R >,>>> 1>,>>> R 1>,>>>

units.

Alternativel!, as is often the case, it ma! e calculated as a

percentage0

udgeted sales reak-even salesFudgeted sales.

In Compan! AMs case, it will e 1>,>>>F>,>>> x 1>> R 8>N.

4inall!, it could e calculated in terms of P sales revenue as

follows0

udgeted sales reak-even sales x selling price R 1>,>>> x P8>

R P8>>,>>>.

C'ntri#uti'n t' sa(es rati'

It is often useful in single product situations, and essential in

multi-product situations, to ascertain how much each P sold

actuall! contriutes towards the xed costs. This calculation is

known as the contriution to sales or CF& ratio. It is found in single

product situations ! either simpl! dividing the total contriution

! the total sales revenue, or ! dividing the unit contriution

margin *otherwise known as contriution per unit' ! the selling

price0

4or Compan! A0 P>FP8> R >.6

In multi-product situations, a weighted average CF& ratio is

calculated ! using the formula0

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Total contriutionFtotal sales revenue

This weighted average CF& ratio can then e used to nd C7)

information such as reak-even point, margin of safet! etc.

E?amp(e 2

As well as producing product x descried aove, Compan! A also

egins producing product !. The following information is availale

for oth products0

)roduct x )roduct !

&ales price P8> P9>

7ariale cost P5> P68

Contriuion per unit P> P18

udgeted sales

*units' >,>>> 1>,>>>

The weighted average CF& ratio can e once again calculated !

dividing the total expected contriution ! the total expected

sales0

*>,>>> x P>' S *1>,>>> x P18' F*>,>>> x P8>' S *1>,>>> x P9>'

R 56.5:8N

The CF& ratio is useful in its own right as it tells us what

percentage each P of sales revenue contriutes towards xed

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costs it is also invaluale in helping us to (uickl! calculate the

reak-even point in P sales revenue, or the sales revenue re(uired

to generate a target prot. The reak-even point can now e

calculated this wa! for Compan! A0

4ixed costs F contriution to sales ratio R P>>,>>>F>.565:8 R

P8,>>>0

4ixed costs S re(uired prot Fcontriution to sales ratio R

P>>,>>> S P5>>,>>>F>.565:8 R P1,686,869.

?f course, such calculations provide onl! estimated information

ecause the! assume that products x and ! are sold in a constant

mix of x to 1!. In realit!, this constant mix is unlikel! to exist

and, at times, more ! ma! e sold than x. &uch changes in the

mix throughout a period, even if the overall mix for the period is01, will lead to the actual reak-even point eing dierent than

anticipated. This point is touched upon again later in this article.

Contriution to sales ratio is often useful in single product

situations, and essential in multi-product situations, to ascertain

how much each P sold actuall! contriutes towards the xed

costs.

Ta#(e 3 !i*ure 3 %'ntinued

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)rodu

ct x

)rodu

ct !

&ales price P8> P9>

7ariale cosr P5> P68

Contriution per unit P> P18

udgeted sales *units' >,>>> 1>,>>>

CF& ratios >.6 >.8

Eeighted average CF&ratio

>.565:8

)roduct ranking *most

protale rst' 1

)rod

uct

Contriu

tion

P>>>

Cumulative

protFlo

ss

P>>>

;even

ue

P>>>

Cumulat

ive

revenue

P>>>

*4ixed

costs' > *>>' > >

U 6>> >>

1,>>>,>

>>

1,>>>,>>

>

L 18> 58> 9>>,>> 1,9>>,>>

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)rod

uct

Contriu

tion

P>>>

Cumulat

ive

protFlo

ss

P>>>

;even

ue

P>>>

Cumulat

ive

revenue

P>>>

> >

In order to draw a multi-productFvolume graph it is necessar! to

work out the CF& ratio of each product eing sold.

MULTI-PRODUCT PROFITVOLUME CHARTS

Ehen discussing graphical methods for estalishing the reak-

even point, we considered reak-even charts and contriution

graphs. These could also e drawn for a compan! selling multiple

products, such as Compan! A in our example. The one t!pe ofgraph that hasnMt !et een discussed is a protvolume graph.

This is slightl! dierent from the others in that it focuses purel!

on showing a protFloss line and doesnMt separatel! show the cost

and revenue lines. In a multi-product environment, it is common

to actuall! show two lines on the graph0 one straight line, where a

constant mix etween the products is assumed and one ow-

shaped line, where it is assumed that the compan! sells its most

protale product rst and then its next most protale product,

and so on. In order to draw the graph, it is therefore necessar! to

work out the CF& ratio of each product eing sold efore ranking

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the products in order of protailit!. It is eas! here for Compan!

A, since onl! two products are eing produced, and so it is useful

to draw a (uick tale *prevents mistakes in the exam hall' in

order to ascertain each of the points that need to e plotted on

the graph in order to show the protFloss lines.

&ee Ta#(e 3.

The graph can then e drawn *!i*ure 3', showing cumulative

sales on the x axis and cumulative protFloss on the ! axis. It can

e oserved from the graph that, when the compan! sells itsmost protale product rst *x' it reaks even earlier than when it

sells products in a constant mix. The reak-even point is the point

where each line cuts the x axis.

LIMITATIONS OF COST-VOLUME-PROFIT ANALYSIS

Cost-volume-prot anal!sis is invaluale in demonstrating

the eect on an organisation that changes in volume *in

particular', costs and selling prices, have on prot. Dowever,

its use is limited ecause it is ased on the following

assumptions0 3ither a single product is eing sold or, if there

are multiple products, these are sold in a constant mix. Ee

have considered this aove in 4igure 5 and seen that if the

constance mix assumption changes, so does the reak-even

point.

All other variales, apart from volume, remain constant, ie

volume is the onl! factor that causes revenues and costs to

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change. In realit!, this assumption ma! not hold true as, for

example, economies of scale ma! e achieved as volumes

increase. &imilarl!, if there is a change in sales mix, revenues

will change. 4urthermore, it is often found that if sales volumes

are to increase, sales price must fall. These are onl! a few

reasons wh! the assumption ma! not hold true there are

man! others.

The total cost and total revenue functions are linear. This is

onl! likel! to hold a short-run, restricted level of activit!.

Costs can e divided into a component that is xed and a

component that is variale. In realit!, some costs ma! e

semi-xed, such as telephone charges, where! there ma! e

a xed monthl! rental charge and a variale charge for calls

made.

4ixed costs remain constant over the relevant range - levels

in activit! in which the usiness has experience and can

therefore perform a degree of accurate anal!sis. It will either

have operated at those activit! levels efore or studied them

carefull! so that it can, for example, make accurate predictions

of xed costs in that range.

)rots are calculated on a variale cost asis or, if

asorption costing is used, it is assumed that production

volumes are e(ual to sales volumes.

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SECTION

1'

Standard C'stin* &tandard costing is the practice of

sustituting an expected cost for an actual costin the accountingrecords, and then periodicall! recording variances showing the

dierence etween the expected and actual costs. This approach

represents a simplied alternative to cost la!ering s!stems, such

as the 4I4?and @I4?methods, where large amounts of historical

cost information must e maintained for items held in stock.

&tandard costing involves the creation of estimated *i.e.,

standard' costs for some or all activities within a compan!. The

core reason for using standard costs is that there are a numer of

applications where it is too time-consuming to collect actual costs,

so standard costs are used as a close approximation to actual

costs.

&ince standard costs are usuall! slightl! dierent from actual

costs, the cost accountantperiodicall! calculates variances that

reak out dierences caused ! such factors as laor rate

changes and the cost of materials. The cost accountant ma! also

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periodicall! change the standard costs to ring them into closer

alignment with actual costs.

Distorical cost

Historical costis a term used instead of the term cost. Cost and

historical cost usuall! mean the original cost at the time of a

transaction. The term historical cost helps to distinguish an

assets original cost from its replacement cost, current cost, or

inHation-ad#usted cost. 4or example, land purchased in 1== at

cost of P,>>> and still owned ! the u!er will e reported on

the u!ers alance sheetat its cost or historical cost of P,>>>

even though its current cost, replacement cost, and inHation-

ad#usted cost is much higher toda!.

The cost principleor historical cost principle states that an asset

should e reported at its cost *cash or cash e(uivalentamount' atthe time of the exchange transaction and should include all costs

necessar! to get the asset in place and read! for use.

'

4lexile udget

A Hexile udget includes formulas that ad#ust expenses ased on

changes in actual revenue or other activities. The result is a

udget that is fairl! closel! aligned with actual results. This

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approach varies from the more common static udget, which

contains nothing ut xed expense amounts that do not var! with

actual revenue levels.

In its simplest form, the Hex udget uses percentages of revenue

for certain expenses, rather than the usual xed numers. This

allows for an innite series of changes in udgeted expenses that

are directl! tied to actual revenue incurred. Dowever, this

approach ignores changes to other costs that do not change in

accordance with small revenue variations. Conse(uentl!, a more

sophisticated format will also incorporate changes to man!

additional expenses when certain larger revenue changes occur,

there! accounting for step costs. ! incorporating these

changes into the udget, a compan! will have a tool for

comparing actual to udgeted performance at man! levels of

activit!.

Adanta*es '9 !(e?i#(e ud*etin*

&ince the Hexile udget restructures itself ased on activit!

levels, it is a good tool for evaluating the performance of

managers - the udget should closel! align to expectations at an!

numer of activit! levels. It is also a useful planning tool for

managers, who can use it to model the likel! nancial results at a

variet! of dierent activit! levels.

.isadanta*es '9 !(e?i#(e ud*etin*

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Though the Hex udget is a good tool, it can e dicult to

formulate and administer. &everal issues are0

+an! costs are not full! variale, instead having a xed cost

component that must e derived and then included in the Hex

udget formula.

A great deal of time can e spent developing step costs,

which is more time than the t!pical accounting sta has availale,

especiall! when in the midst of creating the more traditional static

udget. Conse(uentl!, the Hex udget tends to include onl! a

small numer of step costs, as well as variale costs whose xed

cost components are not full! recogni%ed.

The Hexile udget model usuall! onl! works within a

relativel! limited revenue range the udget anal!st is unlikel! to

spend the time developing a more wide-ranging model if it is

considered unlikel! that outlier revenue amounts will e

encountered.

There ma! also e a time dela! etween when there is a change

in revenue and when a supposedl! variale cost changes. Dere

are several examples0

&ales increase, ut factor! overhead costs do not increase at

a similar rate, since the sales are from inventor! that was

produced in a prior period.

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&ales increase, ut commissions do not increase at a similar

rate, since the commissions are ased on cash received, which

has a 5>-da! time lag.

&ales decline, ut direct laor costs do not decline at the

same rate, ecause management elected to retain the production

sta.

iven the considerale amount of time re(uired to maintain a

Hexile udget, some organi%ations ma! instead opt to eliminate

their udgets entirel!, in favor of using short-range forecasting

without the use of an! t!pes of standards *Hexile or otherwise'.

An alternative is to run a high-level Hex udget as a pilot test to

see how useful the concept is, and then expand the model as

necessar!.

E?amp(e '9 a !(e?i#(e ud*et

AC Compan! has a udget of P1> million in revenues and a P6

million cost of goods sold. ?f the P6 million in udgeted cost of

goods sold, P1 million is xed, and P5 million varies directl! with

revenue. Thus, the variale portion of the cost of goods sold is

5>N of revenues. ?nce the udget period has een completed,

AC nds that sales were actuall! P= million. If it used a Hexile

udget, the xed portion of the cost of goods sold would still e

P1 million, ut the variale portion would drop to P.: million,

since it is alwa!s 5>N of revenues. The result is that a Hexile

udget !ields a udgeted cost of goods sold of P5.: million at a

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P= million revenue level, rather than the P6 million that would e

listed in a static udget.

5'

A responsiilit! center is a functional entit! within a usiness that

has its own goals and o#ectives, dedicated sta, policies and

procedures, and nancial reports. &uch a center is used to tie

specic responsiilit! for revenues generated, expenses incurred,

andFor funds invested to individuals.This allows the senior

managers of a compan! to trace all nancial activities and resultsof a usiness ack to specic emplo!ees. /oing so preserves

accountailit!, and ma! also e used to calculate onus

pa!ments for emplo!ees.

A responsiilit! center ma! e one of four t!pes,

1. Cost Cete!

A cost center is an organi%ational su-unit such as department or

division, whose manager is held accountale for the costs

incurred in that division. 4or example, a )ower

and Airco /epartment can can e dened as a cost center within

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the ?peration and +aintenance /epartment in Bnited

Telecommunication Compan!. +anager of a cost center is

responsile for controllale costs incurred in the department, ut

is not responsile for revenue, prot or investment in that center.

A cost center is a responsiilit! center in which inputs, ut not

outputs are measured in monetar! value.

". Re#e$e Cete!

A manager of a revenue center is held accountale for the

revenue attriuted to the su-unit. ;evenue centers areresponsiilit! centers where managers are accountale onl! for

nancial outputs in the form of generating sales revenue. A

revenue centers manger ma! also e held accountale for selling

expenses such as sales persons salaries, commissions, and order

receiving costs.

%. P!o&t Cete!

)rots are the excess of revenue over the total expenses.

Therefore, the manager of a prot center is held accountale for

the revenues, costs, and prots of the center. A prot center is

aresponsiilit! center in which inputs are measured in terms of

expenses and outputs are measured in terms of revenues.

'. I#est(et Cete!

The manger of investment center is held accountale for the

divisions prot and the invested capital used ! the center

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to generate its prots. Investment centers consider not onl! costs

and revenues ut also the assets used in the division.

)erformance of an investment center are measured in terms of

assets turnover and return on the capital emplo!ed.

CASE STU.&

A retail dealer in garments is currentl! selling 6>>> shirts

annuall!. De supplies the following details for the !ear ended

51st /ecemer, >>:.

;s

&elling )rice per shirt 6>

7ariale Cost per shirt 8

4ixed cost0

&ta salaries for the !ear 1>>>>

eneral oce cost for the !ear >>>

Advertising costs for the !ear 6>>>>

As a cost accountant of the rm, !ou are re(uired to answer the

following each part independentl!0-

*i' Calculate the reak-even point and margin of safet! in sales

revenue and no of shirts sold.

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*ii' Assume that >>>> shirts were sold in a !ear. 4ind out the net

prot of the rm.

*iii' If it is decided to introduce selling commission of ;s 5 per

shirt, how man! shirts would re(uire to e sold in a !ear

to earn a net income of ;s 18>>>.

Ans5er

)i,;3AV-3732 )?I2T, +A;I2 ?4 &A43TL I2 &A@3& ;3732B3,

2B+3; ?4 &DI;T& &?@/.

reakeven point of revenue R 4ixed Costs W CF&where

CR selling price per unit variale cost per unit R ;s. *6>-8' R

;s. 18

&R selling price per unit R ;s. 6>

4ixed costsR ;s. *1>,>>>S,>>>S6>,>>>' R ;s. 6>,>>>

reak 3ven )oint revenue R 6>,>>>W18F 6> R;s. 96>,>>>

2umer of shirts at reak 3ven R ;s. 96> >>> W ;s. 6> R 19 >>>

shirts

+argin of &afet! in &ales ;evenue

R Annual &ales- reak 3ven point revenue

R ;s. 6>X6,>>> ;s. 96>,>>>

R ;s. =9>,>>> - ;s. 96>,>>>

R ;s. 5>, >>>

2umer of &hirts associated with +argin of &afet! in &ales

;evenue

R ;s. 5> >>> W ;s. 6>

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R < >>> shirts

Therefore0

reak even point revenue R ;s. 96>,>>> *19 >>> shirts'

+argin of safet! in sales revenue R Rs+ 320K000*>> shirts'

)ii,23T );?4IT ?4 TD3 4I;+ A&&B+I2 >>>> &DI;T& E3;3

&?@/ I2 A L3A;

Total &ales R >, >>> x ;s. 6> R ;s. >, >>>

7ariale Cost per unit R ;s.8

Total 7ariale Cost R >, >>> x ;s. 8 R ;s. 8>>, >>>2et )rotR Total &ales- *4ixedS variale Costs'

2et )rot R ;s. >, >>>- ;s. *6>, >>>S 8>>, >>>'

2et prot R ;s. *>, >>>- :6>, >>>'

2et )rot RRs+ 0K 000

)iii,&DI;T& ;3QBI;3/ T? 3 &?@/ I2 A L3A; T? 3A;2 A 23T

I2C?+3 ?4 ;& 18, >>>, I4 A &3@@I2

C?++I&&I?2 ?4 ;& 5 )3; &DI;T I& I2T;?/BC3/

2et Income )rot R ;s. 18, >>>

7ariale cost R ;s. 8Funit

&ales Commission R ;s. 5Funit

Total 7ariale costs R ;s. >> R 6>x - 6>,>>> - >> R 1x - 6>,>>>

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1xR 6>, >>>S 18, >>>

1xR 88, >>>

xR 18>

Thus, at a prot of ;s. 18,>>> and selling commission of ;s. 5 per

shirt,

the numer of shirts to e sold R 21K 2B0

SECTION C

1 . 11 .

C 1 .

5 . 15 A

6 . 16 C

8 18

9 E 19 C

: . 1: C

< . 1< A

= C 1= E1> > A

1 . 51 .

E 5 C

5 55

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51/51

6 C 56 E

8 A 58 A

9 E 59

: . 5: C

< 5< C= E 5=

5> A 6>

;eference

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