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ICAI, 2014 2
This e-Lecture was Recorded on:
November 12, 2014
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Introduction & Cost Characteristics
Definitions Classification & Facts
Distinction
Assumptions CVP Analysis
MC & AC
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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.
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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.
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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.
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The additional costs of a change in the level or nature of
activity.
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Contribution is the difference between sales and
marginal cost(variable cost).
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Variable Cost = Rs. 50,000
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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
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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 :
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.
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It changes with level of activity at exact proportion, i.e.
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It changes with level of activity but not in exact estimation.
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Marginal Costing
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All elements are classified in fixed and variable costs.
Fixed cost are charged for the period they are incurred for.
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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.
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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
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
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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
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
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
Alternatively MOS =
Profit / Contribution per unit ( in units)
Profit / P V Ratio ( in amount)
Profit = MOS x P V Ratio
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Activity Level at which Two different Options result in
same Costs
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Sales below which Business can not be persued
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Here Only Cash Fixed Costs are Considered
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Here we calculate sales for given profit.
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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
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.
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Difficult to Classify fixed and variable elements.
Faulty valuation.
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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
Selling price, Variable cost per unit, and Total fixed cost
remains Constant.
Single product or proportion of sales is same for multi-
Product.
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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
Break-Even Point
A) BEP Units = (Fixed Cost) / (Contribution per unit)
B) BEP(Rs.) = (Fixed Cost) / 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)
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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)
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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.
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
P V Ratio=Contribution /Sales
So, P V Ratio=10/25=40%
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
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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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