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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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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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http0FFaccountlearning.logspot.comF>1>F11Fresponsiilit!-centers-for.html
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