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This e-Lecture was Recorded on:

November 12, 2014

Intermediate (IPC) Course Paper 3A: Cost Accounting


Chapter 12
CA. Dharmendra Gupta

The Institute of Chartered Accountants of India 1


This lecture has been delivered by faculty members to supplement the
Study Material, Practice Manual and other content
1

The views expressed in this lecture are of the Faculty Member.


2
The content of this video lecture has not been specifically discussed
by the Council of the Institute or any of its Committees and the views
expressed herein may not be taken to necessarily represent the views
3 of the Council or any of its committees

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This e-Lecture was Recorded on:
November 12, 2014

The e-Lectures, PPT, Podcasts


and Video lectures on ICAI The lecture recordings are made
Cloud Campus aim to according to the syllabus and
supplement the Study Material, laws existing/ applicable as on
Practice Manual and the date of recording.
Supplementary Study Material

Hence, students are advised to


refer to the Study Material
Due to changes in law, there is including Supplementary Study
likely to be some time gap Material, if any, and other
between these changes and the relevant legislation for latest
recording of updated lectures. provisions/ amendments
required for forthcoming
examination.

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Introduction & Cost Characteristics
Definitions Classification & Facts

Distinction
Assumptions CVP Analysis
MC & AC

Methods of CVP Imp. Limitations of


BEP Analysis Formulae MC

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Marginal Costing

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Marginal Marginal Direct
Costing Cost Costing

Differential Incremental
Contribution
Cost Cost

Key Factor

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The ascertainment of marginal cost and the effect on
profit of changes in volume or type of output by
differentiating between fixed costs and variable costs.

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The amount of any given volume of output by which
aggregate variable costs are changed if the volume of output
is increased by one unit.

In practice, it is measured by the Total Variable Cost


attributable to 1 unit.

Also, it can be called the sum of Prime Cost* and Variable


overhead.

*Prime cost = D. Material + D. Labour + D. Expenses

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Direct costing is the practice of charging all direct cost to
operations, processes or products, leaving all the indirect cost
to be written off against profit in the period in which they arise.

In this method, the stocks are valued at Direct cost, whether


fixed or variable.

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It can be defined as the increase or decrease in the total cost or the
changes in the specific element of cost that result from any
variations in operations.

It represents change in cost of

Producing or distributing different quantity of products.

Change in method of production or of distribution.

An addition or deletion of a product or territory.

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The additional costs of a change in the level or nature of
activity.

It is a part of Differential costing, where production(level


of activity) Increases.

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Contribution is the difference between sales and
marginal cost(variable cost).

It can also be defined as excess of sales revenue over


the variable cost.

For an easy understanding consider the following :

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Variable Cost = Rs. 50,000

Fixed Cost = Rs. 20,000

Selling Cost = Rs. 80,000

Contribution = Rs. 80,000 50,000 = Rs. 30,000

Profit = Rs. 30,000 20,000 = Rs. 10,000

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Key factor or Limiting In simple words, it is
factor is a factor a crucial element
which at a particular whose presence, (or
time or over a period absence) may affect
limits the activity of the activities of the
an undertaking. undertaking.

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Shortage of
Level of Shortage of
Raw
demand. labor.
Material.

Sales/Plant
Cash
capacity
availability.
available.

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Technique of Costing

For Managerial Decision Making

To Measure Profitability of Products

To study Cost Volume Profit Analysis

On the basis of nature of costs

Mainly Fixed and Variable costs

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An Intro.

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Costs

Semi
Fixed Variable
Variable

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Cost

Semi Variable
Fixed Cost Variable Costs
Costs :

Does not change Changes in exact Changes with level


with Level of proportion with of activity but not in
Activity level of Activity exact proportion

Example:
Example: Rent, Example: Material,
Maintenance costs
Salary etc. Labor etc
etc
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They are incurred
It does not
regardless of the
changes with
volume of
level of activity.
production.

Even at 0 level of For eg. Salary,


production, a firm Rent,
incurs this cost. Depreciation etc.

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It changes with level of activity at exact proportion, i.e.

If there is 10 % increase in level of activity there is 10 %


increase in Variable cost.

It is Nil at 0 level of production.

For eg : Material, Labor etc.

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It changes with level of activity but not in exact estimation.

Maintenance cost is a Semi-variable cost as it is not nil


at 0 level of production as no matter if there is production
or not some maintenance cost is maintained.

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Marginal Costing

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All elements are classified in fixed and variable costs.

Variable cost is treated as cost of product.

Value of Inventory and W.I.P comprises only of variable cost.

Fixed cost are charged for the period they are incurred for.

Profitability of deptts and products is determined with reference to


their contribution margin.

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Not a Distinct Method :
It is not a distinct method, but a special technique
used for managerial decision making.
Cost Ascertainment :
It tells us about how different cost is going to affect
the profitability of the firm.

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Decision Making :

Total Cost, Under this method is sum total of direct labor, direct
material, direct expenses manufacturing, selling and distribution
overheads.

If fixed cost would have been added it had been posed a threat
to the management in taking decisions.

Hence, it has given a wide recognition in the field of decision


making.

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Q. How adding Fixed cost would have affected
management decisions?

Ans:
Supposing Fixed cost = Rs. 15, Var. Cost = Rs. 3
of an item on a particular day, Total Cost = Rs. 18
And Next day, If 2 units are produced Fixed cost being the same,
Var. Cost = Rs. 6 ; Total Cost = Rs. 21
If Fixed cost is added: Increase in Cost = 16.67 %
While actual increase in cost( as per Mar. Costing is) = 200% .
As fixed cost has to be same in any production, we need to consider
variable cost for effective decision making.

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Distinction

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All costs of
production
Costs are
(Fixed or Variable)
classified on the
are included in
Basis of Functions
Inventory
Valuation

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Sales Value xxxx
less: Direct materials (xxxx)
less: Direct labour (xxxx)
less: Factory overheads (xxxx)
Gross profit xxxx
less: Administrative expense (xxxx)
less: Selling & Distribution expense (xxxx)
Net profit xxxx

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Sales xx

Less: Variable Costs xx


D. Material
D. Labour
D. Expenses
Var. Production Overheads
Var. Selling & Distribution Overheads

Contribution xx
Less: Fixed Costs xx
Fixed Production Overheads
Administrative Overheads
Fixed Selling & Distribution Overheads

Net Profit xx

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Marginal Costing Absorption Costing

Cost data Cost data


presented presented
highlights the highlights Gross
contribution of each Profit and Net
product. Profit.

Only variable costs Both fixed and


are considered for Variable cost are
product costing and considered for
inventory valuation. inventory valuation.

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Marginal Costing Absorption Costing

Sales Sales
- variable cost -Cost of goods sold
= Contribution = Gross Profit
- Fixed cost - Indirect expenses
= Profit = Net Profit

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An Intro.

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Break Even Margin of
PV Ratio
Point Safety

Cost Sales to
Shut Down
Indifference Earn Desired
Point
Point Profit

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Relation between Contribution and Sales

Also Known as Contribution to Sales Ratio

P V Ratio =
Total Contribution/Total Sales
Contribution per unit/Sales per unit
( Fixed Cost + Profit )/ Sales
( Sales- Variable costs)/ Sales
1- Variable Cost Ratio
Profit/ Margin of Safety
Fixed Costs / Break Even Point
Change in Contribution/Change in sales
Change in Profit /Change in Sales

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Sales Where Total Costs is equal to Total Sales
Total costs = Fixed Costs + Variable Costs

At BEP There is No Profit or No Loss

Total Contribution = Fixed Costs


Contribution =( Sales Variable costs) or Fixed costs + Profit)

BEP ( in units) =
Total Fixed Costs/Contribution per unit

BEP ( in amount) =
Total Fixed costs / Profit Volume Ratio

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Excess of Sales over Break Even Sales

MOS = Sales BEP

Alternatively MOS =
Profit / Contribution per unit ( in units)
Profit / P V Ratio ( in amount)
Profit = MOS x P V Ratio

P V Ratio = Profit / MOS

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Activity Level at which Two different Options result in
same Costs

Cost Indifference Point =


Change in Fixed Costs /Change in variable Costs per unit

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Sales below which Business can not be persued

Temporary Closure of Business To Avoid Off Season, Recession etc


Here Business must be able to generate Avoidable Fixed Costs
Avoidable Fixed Costs = Total Fixed Costs Minimum or unavoidable fixed
costs
Shut Down Point =
Avoidable Fixed Costs / Contribution p.u. (in units )
Avoidable Fixed Costs / P V Ratio ( in amount )

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Here Only Cash Fixed Costs are Considered

Non cash costs like Depreciation etc are not Considered

Cash Break Even Point =


Cash Fixed Costs / Contribution p u ( in units)
Cash Fixed Costs / P V Ratio (in amount)

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Here we calculate sales for given profit.

It can be calculated in units.

X = (Total fixed cost + Desired profit) / (Contribution per unit)

It can also be calculated in Rupees.

Sales = (Total fixed cost + Desired profit ) / (P.V. Ratio)

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Break Even Chart
Algebraic Method

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Break-Even Point refers to a situation in the
business where there is neither a loss nor any profit.
Here, Sales = Total Cost.

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Sales Where Total Costs is equal to Total Sales
Total costs = Fixed Costs + Variable Costs

At BEP There is No Profit or No Loss

Total Contribution = Fixed Costs


Contribution =( Sales Variable costs) or Fixed costs + Profit)

BEP ( in units) =
Total Fixed Costs/Contribution per unit

BEP ( in amount) =
Total Fixed costs / Profit Volume Ratio

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A mathematical or graphical representation,
showing approximate profit or loss of an enterprise
at different levels of activity within a limited range.

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Break Even Chart With Angle Of Incidence
25

20
Cost & Revenue

15
TC
TR
10

0
Break Even Point
1 2 Units 3 4

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An Intro.

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Simplifying Proper Shows
Pricing recovery of Realistic
Policy. Overheads. Profit.

Helps in More Control


How much
Decision- over
to Produce.
Making. Expenditure.

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Difficult to Classify fixed and variable elements.

Dependence on key factors.

Scope for Low Profitability.

Faulty valuation.

Unpredictable nature of cost.

Marginal Costing ignores time factor and Investment.

Understanding the W.I.P.

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Marginal Costing

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Change in levels of revenues and cost is only because of
number of units produced and sold.
Total cost can be separated in 2 components i.e. Fixed cost
and Variable Cost

Linear Relationship of cost and revenue.

Selling price, Variable cost per unit, and Total fixed cost
remains Constant.
Single product or proportion of sales is same for multi-
Product.

Time Value of Money is not considered.

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A brief Recap of all the formulas
we have learnt so far.

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Sales variable cost = Contribution = Fixed cost + Profit

P.V. Ratio = Contribution / Sales

Break-Even Point
A) BEP Units = (Fixed Cost) / (Contribution per unit)
B) BEP(Rs.) = (Fixed Cost) / P.V. Ratio

Margin of Safety (MOS) = Sales Break-Even Sales


A) MOS Units = Profit / (Contribution per unit)
B) MOS (Rs.) = Profit / P.V. Ratio

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Sales to Earn Desired Profit
A) In Units = (Total Fixed Cost + Desired Profit) /
(Contribution Per unit)
B) In Rs. = (Total Fixed Cost + Desired Profit) /
(P.V. Ratio)

Shut Down Point


A) In units = (Avoidable Fixed Cost) / (Contribution
per unit)
B) In Rs. = (Avoidable Fixed Cost) / (P.V. Ratio)

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Cost Indifference point
A) In units = (Change in Total Fixed Cost) / (Change in Variable cost per unit)
B) In Rs. = (Change in Total Fixed Cost) / (Change in variable cost ratio or P.V. ratio)

Contribution = Sales X P.V. Ratio

Profit = Margin of safety X P.V. Ratio

Fixed Cost = Break-Even Sales X P.V. Ratio

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Application of Marginal costing

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A Company produces a product whose Selling Price is Rs. 25 per
unit.

Variable Cost is Rs. 15 per unit and Total fixed Cost is Rs. 15000.

Company is producing and selling 20000 units

Find
Contribution per unit
P V Ratio
Break Even Point
Margin of safety
Shut Down Point if Minimum Fixed Cost is Rs. 10000

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Contribution per unit = Sales Variable cost

Hence Contribution per unit=Rs.25-15=Rs.10

P V Ratio=Contribution /Sales

So, P V Ratio=10/25=40%

Break Even Point = Total Fixed Cost /PV Ratio

So, Break Even Point= 15000/40%=Rs.37500

Note : Break even Point can also computed in terms of units.

In that case
BEP=Total fixed Costs /Contribution Per Unit
BEP =15000/10=1500 units

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Margin of Safety (MOS) = Sales BEP

MOS ( in units ) = 2000- 1500 =500 units

MOS (in amount) =2000 * 25 -37500


=Rs. 12500

Shut down point =


Avoidable fixed cost/contribution per unit (in units )
Avoidable Fixed cost / PV Ratio ( in amount)
Note : Avoidable Fixed Cost =
Total Fixed Cost Minimum Fixed Cost
Rs. 15000 10000 = Rs. 5000

Shut Down Point = Rs. 5000/10 = 500 units

Shut Down Point =Rs. 5000/ 40% =Rs 12500

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Machine A has a
A Company is to Fixed Cost of Rs.
select a machine out 20000 and Variable
of 2 machines A & B. Cost of Rs.20 per
unit

While Machine B
has a Fixed Cost Rs.
Find Cost
10000 and Variable
Indifference Point
Cost of Rs.25 per
unit

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Cost Indifference point =
Change in Total Fixed Cost /Change in Var. Cost per unit
Change in Total Fixed Cost =
Rs. 20000-10000=Rs.10000
Change in Var. Cost per unit = Rs. 25 -20 = Rs. 5
Cost Indifference Point = Rs. 10000/Rs. 5
2000 units

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We now have a better understanding of following aspects:

1 Cost classification
2 Profit Volume Ratio - PV Ratio
3 Break Even Point
4 Margin of Safety
5 Shut Down Point
6 Cost Indifference Point
7 Cash Break Even point
8 Break Even Charts & Angle of Incidence
9 Marginal Costing Vs. Absorption Costing

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