2. Features of Marginal Costing
3. Limitations of Marginal Costing
4. Two Underlying Principles in Marginal Costing
5. Basic Terms used in Marginal Costing
6. Important Formulae used in Marginal Costing
After reading this chapter, you should be able to understand:
Marginal costing is basically concerned with the determination of product cost, which consists of total costs minus fixed costs, for example, direct material, direct labour, direct expenses and variable overheads. In marginal costing, costs are separated into fixed and variable components and only variable costs are included. Marginal costing is not a system of costing but a technique used by managements for decision making. Thus, marginal costing is the same as variable costing. The other names for marginal costing are direct costing, variable costing, differential costing and incremental costing.
The meaning of marginal costing is explained as follows: Marginal costing may be defined as the technique of presenting cost data in which variable costs and fixed costs are shown separately for managerial decision making. Marginal costing is a technique of cost accounting that pays special attention to the behaviour of costs with changes in the volume of output. Marginal costing is a technique of determining the amount of change in aggregate costs due to an increase of one unit over the existing level of production. Thus,
Marginal cost = prime cost + total variable overheads
Marginal cost = total cost − fixed cost
The features of marginal costing are as follows:
The limitations of marginal costing are as follows:
The concept of marginal costing can be understood by the following principles:
The basic terms used in marginal costing are as follows:
C = S – V or C = FC + P or C – FC = P or C = S × P/V ratio
where
S = sales
V = variable cost
FC = fixed cost
P = profit
C = contribution
The margin of safety can be increased by the following steps:
Some important formulae used in marginal costing are as follows:
= Fixed costs + Profit (C = F + P)
= sales × P/V ratio (C = S × P/V ratio)
Illustration 1
From the following information, find the amount of profit earned during the year using marginal cost technique:
Fixed cost = Rs 5,20,000
Variable costs = Rs 12 per unit
Selling price = Rs 16 per unit
Output level = 1,50,000 units
(B.Com., Calicut)
Solution:
Contribution = Selling price − Marginal cost
= Rs 24,00,000 − Rs 18,00,000
= Rs (1,50,000 × 16) − Rs (1,50,000 × 12)
= Rs 6,00
Contribution = fixed cost + profit
= Rs 6,00,000 = Rs 5,20,000 + profit
= Rs 6,00,000 − Rs 5,20,000 = profit
Profit = Rs 80,000
This equation is known as ‘marginal cost equation’. If three factors of the equation are known, it is easy to find the fourth factor. This equation is useful for ascertaining the BEP, P/V ratio and margin of safety.
Illustration 2
From the following particulars, calculate the BEP:
Variable cost per unit = Rs 14
Fixed expenses = Rs 75,000
Selling price per unit = Rs 20
(B.Com., Calicut)
Solution:
BEP (in units) =
(Selling price − variable costs = contribution)
(Rs 20 − Rs 14 = Rs 6)
Rs 75,000 ÷ Rs 6 = 12,500 units
BEP (sales) = 12,500 × Rs 20 = Rs 2,50,000
Calculate BEP from the following particulars:
Rs | |
---|---|
Fixed expenses | 1,50,000 |
Variable cost per unit | 10 |
Selling price per unit | 15 |
(Madras, 1997)
[Ans: BEP = 30,000 units or Rs 4,50,000]
Illustration 3:
You are required to calculate the BEP in the following case: The fixed cost for the year is Rs 90,000; variable cost per unit for the single product being made is Rs 6. Estimated sales for the period are valued at Rs 2,00,000. The number of units involved coincides with the expected volume of output. Each unit sells at Rs 22. Calculate BEP by applying relevant formulae.
(C.A. Final)
Solution:
Per unit (Rs) | Total (Rs) | |
---|---|---|
Sales | 22 | 2,00,000 |
Variable costs | 6 | 40,000 |
Contribution | 16 | 1,60,000 |
Fixed costs | 80,000 | |
Profit | 80,000 |
Illustration 4
A company estimates that in the coming year it will earn a profit of Rs 50,000. The budgeted fixed costs and sales are Rs 2,75,000 and Rs 10,25,000, respectively. Find the BEP for
Solution:
Illustration 5
From the following data, calculate BEP expressed in terms of units and also the new BEP if selling price is reduced by 10%.
Fixed expenses:
Rs | |
---|---|
Depreciation | 1,20,000 |
Salaries | 1,30,000 |
Variable expenses: | |
Materials | Rs 6 per unit |
Labour | Rs 4 per unit |
Selling price | Rs 20 per unit |
(B.Com., [Pass] Delhi)
Solution:
When the selling price is reduced by 10%, it becomes Rs 20 − Rs 2 = Rs 18 per unit. So, contribution = Rs 18 − Rs 10 = Rs 8.
Illustration 6
Calculate BEP from the following:
Sales = 1,000 units at Rs 20 each = Rs 20,000
Variable costs = Rs 12 per unit
Fixed costs = Rs 16,000
If the selling price is reduced to Rs 18, what is the new BEP?
(Madras, 1987)
Solution:
Contribution per unit = selling price per unit − variable cost per unit
= Rs 20 − Rs 12 = Rs 8
Illustration 7
A company is considering expansion. Fixed costs amount to Rs 4,50,000 and are expected to increase by Rs 1,25,000 when plant expansion is completed. The present plant capacity is 80,000 units a year. Capacity will increase by 50% with the expansion. Variable costs, currently Rs 6.80 per unit, are expected to go down by Re 0.40 per unit with the expansion. The current selling price is Rs 20 per unit and it is expected to remain the same under each alternative. What are the BEPs under each alternative? Which alternative is better and why?
(Madras, 1989)
Solution:
Current BEP
Present capacity = 80,000 units a year
Contribution = selling price per unit − variable cost per unit
= Rs 20 − Rs 6.8 = Rs 13.2
Expanded capacity = 1,20,000 units
New variable cost = Rs 6.80 − Rs 0.40 = Rs 6.40
New fixed cost = Rs 4,50,000 + Rs 1,25,000 = Rs 5,75,000
Contribution = 20.0 − 6.40 = 13.6
Conclusion:
Current position | Position after expansion | |
---|---|---|
Total contribution | 80,000 × 13.2 | 1,20,000 × 13.6 |
Installed capacity | Rs 10,56,000 | Rs 16,32,000 |
Less: fixed cost | Rs 4,50,000 | Rs 5,75,000 |
Profit at full capacity | Rs 6,06,000 | Rs 10,57,000 |
After expansion, the P/V ratio has improved from 66% to 68%. If selling is not a problem, profit can be almost doubled as a result of the increased capacity. The alternative to expand is definitely better due to the improved P/V ratio and scope for higher profits.
Illustration 8
Raviraj Ltd manufactures and sells four types of products under the brand names of A, B, C and D. The sales mix in value comprises 33⅓% , 41⅔%, 16⅔% and 8⅓% of products A, B, C and D, respectively. The total budgeted sales (100%) are Rs 60,000 per month.
Operating costs are
Variable costs:
Product A: | 60% of selling price |
B: | 68% of selling price |
C: | 80% of selling price |
D: | 40% of selling price |
Fixed cost: Rs 17,500 per month
Calculate BEP for the products on an overall basis and also the break-even sales of individual products. Provide proof for your answer.
(Madras, 1989)
Solution:
P/V ratio for individual products = 100 − percentage of variable cost to sales
A = 40% (100 − 60)
B = 32% (100 − 68)
C =20% (100 − 80)
D = 60% (100 − 40)
Calculation of composite P/V ratio:
(After adjusting fractions)
Composite BEP in rupees =
Proof of validity of composite BEP:
Break-even sales | Contribution | |
---|---|---|
A: Rs 50,000 × 33⅓% = Rs 16,665 | 16,665 × 40% | = Rs 6,666 |
B: Rs 50,000 × 41⅔% = Rs 20,830 | 20,830 × 32% | = Rs 6,666 |
C: Rs 50,000 × 16⅔% = Rs 8,385 | 8,385 × 20% | = Rs 1,668 |
D: Rs 50,000 × 8⅓% = Rs 4,165 | 4,165 × 60% | = Rs 2,500 |
Total contribution | = Rs 17,500 | |
Total fixed cost | = Rs 17,500 | |
Profit/loss | = nil |
Illustration 9
The sales turnover and profits during two periods are as follows:
Period I: Sales = Rs 20,00,000 and profit = Rs 2,00,000
Period II: Sales = Rs 35,00,000 and profit = Rs 5,00,000
(B.Com., Osmania)
Solution:
Illustration 10
Calculate the P/V ratio from the following information:
Sales (Rs) | Profits (Rs) | |
---|---|---|
1997 | 1,50,000 | 20,000 |
1998 | 1,80,000 | 30,000 |
Solution:
P/V ratio =
= 40%
Contribution = SP – VC, that is, Rs 10 – Rs 6 = Rs 4
P/V ratio =
= 33.33%
Illustration 11
Determine the amount of fixed expenses from the following particulars:
Sales = Rs 2,60,000
Direct materials = Rs 82,000
Direct labour = Rs 53,000
Variable overheads = Rs 20,000
Profit = Rs 50,000
Solution: The marginal cost equation is
S – V = F + P
S or sales = Rs 2,60,000
V or variable costs = Rs 82,000 + Rs 53,000 + Rs 20,000 = Rs 1,55,000
(V = direct materials + direct labour + variable overheads)
P or profit = Rs 50,000
F or fixed expenses =? (not given)
Applying the figures in the equation S –V = F + P, we get
Rs 2,60,000 – Rs 1,55,000 = F + Rs 50,000
or
Rs 2,60,000 – Rs 1,55,000 – Rs 55,000 = F
or
Rs 55,000 = F
∴ Fixed expenses = Rs 55,000
Illustration 12
From the following details, find out (a) P/V ratio, (b) BEP and (c) margin of safety:
Rs | |
---|---|
Sales | 1,20,000 |
Total costs | 70,000 |
Fixed costs | 20,000 |
Net profit | 30,000 |
Solution:
or
or
margin of safety = actual sales -sales at BEP
= Rs 1,20,000 – Rs 48,000 = Rs 72,000
Illustration 13
From the following information, calculate
BEP
Number of units that must be sold to earn a profit of Rs 66,000 per year
Number of units that must be sold to earn a net income of 10% on sales
Sales price = Rs 20 per unit
Variable costs = Rs 14 per unit
Fixed costs = Rs 81,000
(Madras, 1989)
Solution:
Contribution per unit = sales price per unit – variable cost per unit
= 20 – 14 = 6
If x is the number of units,
20x = Fixed costs + variable costs + profit
20x = 81,000 + 14x + 2x
20x – 16x = 81,000
= 20,250 units
Proof: Sales = 20,250 × 20 = Rs 4,05,000
Less: variable costs = 20,250 × 14 = Rs 2,83,500
Contribution = Rs 1,21,500
Less: fixed costs = Rs 81,000
Profit = Rs 40,500
Profit as a percentage of sales =
Illustration 14
From the following information relating to Palani Bros. Ltd, you are required to find out (a) P/V ratio, (b) BEP, (c) profit, (d) margin of safety and (e) volume of sales to earn a profit of Rs 12,000
Rs | |
---|---|
Total fixed costs | 4,500 |
Total variable cost | 7,500 |
Total sales | 20,000 |
(Madras, 1995)
Solution: Marginal cost and contribution statemen
Particulars | Amount (Rs) |
---|---|
Sales | 20,000 |
Less: variable cost | 7,500 |
Contribution | 12,500 |
Less: fixed cost | 4,500 |
Profit | 8,000 |
Profit = Rs 8,000
Margin of safety = sales – break-even sales
= Rs 20,000 – Rs 7,200 = Rs 12,800
Sales to earn a profit of Rs 12,000:
Illustration 15
From the following data, calculate (a) P/V ratio, (b) variable cost and (c) profit
Rs | |
---|---|
Sales | 1,00,000 |
Fixed expenses | 20,000 |
BEP | 50,000 |
Solution:
Calculation of P/V ratio:
Calculation of variable cost:
Contribution = sales × P/V
Variable cost = sales − contribution
= Rs 1,00,000 – Rs 40,000 = Rs 60,000
Calculation of profit:
Profit = contribution fixed cost
= Rs 40,000 – Rs 20,000 = Rs 20,000
Illustration 16
Assuming that cost structure and selling prices remain the same in periods I and II, calculate the following: (a) profit volume ratio; (b) fixed cost; (c) BEP for sales; (d) profit when sales are of Rs 1,00,000; (e) sales required to earn a profit of Rs 20,000; (f) margin of safety at a profit of Rs 15,000; and (g) variable cost in period II.
Solution:
Illustration 17
The P/V ratio of a firm dealing in precision instruments is 50% and margin of safety is 35%. You are required to work out BEP and the net profit if the sales volume is Rs 52,00,000. If 25% of variable cost is labour cost, what will be the effect on BEP and profit when labour efficiency decreases by 5%.
(Madras, 1989)
Solution:
Calculation of BEP:
Break-even sales = sales – margin of safety
= Rs 52,00,000 – Rs 18,20,000
= Rs 33,80,000
Calculation of fixed cost:
Fixed cost = break-even sales × P/V ratio
Calculation of profit:
Contribution = sales × P/V ratio
=
Net profit = contribution – fixed cost
= Rs 26,00,000 – Rs 16,90,000
= Rs 9,10,000
Effect of decrease in labour efficiency by 5%:
Variable cost = sales – contribution
= Rs 52,00,000 – Rs 26,00,000 = Rs 26,00,000
New labour cost when labour efficiency decreases by 5%
Increase in labour cost = Rs 6,84,210 – Rs 6,50,000
= Rs 34,210
∴ New variable cost = Rs 26,00,000 + Rs 34,210
= Rs 26,34,210
Contribution = Rs 52,00,000 – Rs 26,72,222
= Rs 25,65,790
Profit = contribution – fixed cost
= Rs 25,65,790 – Rs 16,90,000 = Rs 8,75,790
Note: If for 100 units labour cost is Rs 100, 5% decrease in efficiency results in labour producing only 95 units in the same time.
∴ Cost of 95 units = Rs 100
∴ Original labour cost has to be multiplied with to get the new labour cost.
Illustration 18
Sales turnover and profit during two years are as follows:
Year | Sales (Rs) | Profit (Rs) |
---|---|---|
1991 | 1,40,000 | 15,000 |
1992 | 1,60,000 | 25,000 |
Calculate the following:
(Madras, B.Com., April 2001 (old); Madras, B.Com., C & M, March 1997; March 1996)
Solution: When sales and profit or sales and cost of two periods are given, P/V ratio is obtained by using the ‘change formula’. Fixed cost can be found by ascertaining the contribution of one of the periods given by multiplying sales with the P/V ratio. Then, contribution − profit gives the fixed cost. Ascertaining the P/V ratio using the change formula and finding the fixed cost are the essential requirements in these types of problems.
Change in profit = Rs 25,000 – Rs 15,000 = Rs 10,000
Change in sales = Rs 1,60,000 – Rs 1,40,000 = Rs 20,000
Fixed expenses = contribution – profit
Contribution = sales × P/V ratio
Using the 1991 sales figure contribution =
Fixed expenses = Rs 70,000 − Rs 15,000 = Rs 55,000
Note: The same fixed cost can be obtained using the 1992 sales figure also.
Contribution = sales × P/V ratio
=
Profit = contribution – fixed cost
= Rs 60,000 – Rs 55,000
= Rs 5,000
Illustration 19
A.G. Ltd furnishes the following data related to the year 1996:
First half of the year (Rs) | Second half of the year(Rs) | |
---|---|---|
Sales | 50,000 | 60,000 |
Total cost | 40,000 | 43,000 |
Assuming that there is no change in prices and variable cost and that fixed expenses are incurred equally in the two half-year periods, calculate the following for the year 1996:
(Madras, 1997)
Solution:
Contribution = sales × P/V ratio
During the first half year = Rs 50,000 × 70%
= Rs 35,000
Fixed cost = contribution − profit
For the first half year = Rs 35,000 − Rs 10,000 = Rs 25,000
Fixed cost for the full year = Rs 25,000 × 2 = Rs 50,000
Margin of safety for the year 1996:
Margin of safety = Sales − break-even sales
= Rs 1,10,180 − Rs 71,430 = Rs 38,570
Note:
Illustration 20
The following information is obtained from Gopu & Co. for the year ending on 31 March 1998: Sales = Rs 2,80,000; variable costs = Rs 2,10,000; and fixed costs = Rs 30,000. You are required to calculate the following:
25% increase in selling price
10% decrease in selling price
20% increase in fixed costs
10% decrease in fixed costs
10% increase in variable costs
10% decrease in variable costs
10% increase in selling price accompanied by 10% decrease in variable costs
10% decrease in selling price accompanied by 10% increase in variable costs
Solution: Marginal cost and contribution statemen
Particulars | Amount(Rs) |
---|---|
Sales | 2,80,000 |
Less: variable costs | 2,10,000 |
Contribution | 70,000 |
Less: fixed costs | 30,000 |
Profit | 40,000 |
Margin of safety = sales − break-even sales
= Rs 2,80,000 − Rs 1,20,000 = Rs 1,60,000
Sales showing revised P/V, BEP and margin of safety
Note:
Revised P/V is calculated by making adjustments to the original P/V of 25%, that is, for sales of Rs 100 variable costs is Rs 75 and contribution is Rs 25.
It is assumed that the different changes mentioned do not affect sales volume, that is, number of units of sale, because there is no such indication.
Illustration 21
You are given the following data for the year 1986 for a factory:
Output: 60,000 units
Fixed expenses: Rs 2,00,000
Variable cost per unit: Rs 15
Selling price per unit: Rs 30
How many units must be produced and sold in 1987 if it is anticipated that selling price will reduce by 10%, variable cost will be Rs 12 per unit and fixed cost will increase by 10%? The factory wants to make a profit in 1987 that is equal to the profit made in 1986.
(Madras, 1987)
Solution: Marginal cost and contribution statement for the year 1986
Particulars | Rs |
---|---|
Sales = 60,000 × 30 | 18,00,000 |
Less: variable cost = 60,000 × 15 | 9,00,000 |
Contribution | 9,00,000 |
Less: fixed cost | 2,00,000 |
Profit | 7,00,000 |
Calculation of units to be produced and sold in 1987 to make the same profit as in 1986:
New selling price = 30 − (30 × 10%) = 30 − 3 = Rs 27
New variable cost = Rs 12 (given)
New fixed cost = 2,00,000 + (2,00,000 × 10%)
= 2,00,000 + 20,000 = Rs 2,20,000
Illustration 22
Rs | |
---|---|
Present sales | 1,50,000 |
Variable costs | 60,000 |
Fixed costs | 30,000 |
Ascertain the effect of 10% reduction of selling price on P/V ratio and BEP. Also, calculate the sales required to maintain the profit at the present level.
Solution:
If selling price is reduced by 10% (without any change in sales volume)
New sales = Rs 1,50,000 − Rs 15,000 = Rs 1,35,000
Variable costs = Rs 60,000
Present profit = sales − variable costs − fixed costs
= Rs 1,50,000 − Rs 60,000 − Rs 30,000 = Rs 60,000
Illustration 23
From the following information relating to Quick Standard Ltd, you are required to find out
Total fixed costs = Rs 4,500
Total variable costs = Rs 7,500
Total sales = Rs 15,000
Units sold = 5,000
(B.Com., ACS)
Solution:
Sales − variable cost = contribution
Rs 15,500 − Rs 7,500 = Rs 7,500
Margin of safety = total sales − BEP sales
= Rs 15,000 − Rs 9,000 = Rs 6,000
Profit = total sales − total cost
= Rs 15,000 − (Rs 7,500 + Rs 4,500) = Rs 15,000 − Rs 12,000 = Rs 3,000
Sales to earn a profit of Rs 6,000:
Illustration 24
A multipurpose company furnishes the following data for a year:
First half year (Rs) | Second half year (Rs) | |
---|---|---|
Sales | 45,000 | 50,000 |
Total cost | 40,000 | 43,000 |
Assuming that there is no change in prices and variable costs and that fixed expenses are incurred equally in two half years, calculate the following:
(C.A. Inter)
Solution:
Total sales = Rs 95,000
Contribution = 40% of Rs 95,000
= Rs 38,000
Less: profit = Rs 12,000
Fixed cost = Rs 26,000
Margin of safety = Rs 95,000 − Rs 65,000 = Rs 30,000
Illustration 25
You are given the following information regarding a company:
Rs | |
---|---|
Fixed cost | 13,000 |
Variable cost | 14,000 |
Total cost | 27,000 |
Net profit | 3,000 |
Net sales | 30,000 |
(A.C.S. Final)
Solution: Contribution = Rs 30,000 − Rs 14,000 = Rs 16,000
Illustration 26
In 1994, the position of Y Ltd was as follows:
Rs | |
---|---|
Sales | 1,44,000 |
Variable overheads | 96,000 |
Gross profit | 48,000 |
Fixed overhead | 32,000 |
Net profit | 16,000 |
Find out the following:
Solution:
Marginal costing helps in profit planning, that is, planning for future operations in such a manner as to maximize profits or to maintain a specified level of profit. Absorption costing fails to bring out the correct effect of change in sales price, variable costs or product mix on the profits of a concern; but this is possible with the help of marginal costing. Profits are increased or decreased as a consequence of fluctuations in selling prices, variable costs and sales quantities in case there is a fixed capacity to produce and sell.
The different products, departments, markets and sales divisions have different profit-earning potentialities. Marginal cost analysis is very useful for evaluating the performance of the different sectors of a concern. Performance can be evaluated better if distinction is made between fixed and variable expenses. A product, department, market or sales division contributing highly should be preferred over divisions whose contributions are less if fixed expenses remain constant.
Although prices are controlled more by market conditions and other economic factors than by decisions of management, fixation of selling prices is one of the most important functions of management.
When a factory manufactures more than one product, a problem is faced by management as to which product mix gives the maximum profits. The best product mix is the one that yields the maximum contribution. The products that give the maximum contribution are to be retained and their production must be increased.
The production of products that give comparatively less contribution over others should be reduced or closed down altogether. The effect of sales mix can also be seen by comparing the P/V ratio and BEP. A new sales mix is favourable if it increases the P/V ratio and reduces the BEP.
Management may be interested in maintaining a desired level of profits. The volume of sales needed to attain a desired level of profit can be ascertained by the marginal costing technique.
Marginal costing is helpful in comparing alternative methods of production, that is, machine work and hand work. The method that gives the greatest contribution (assuming fixed expenses remaining same) is to be adopted keeping, of course, the limiting factor in view. However, where fixed expenses change, decision is taken on the basis of the profit contributed by each method.
When deciding between alternative courses of action, it shall be kept in mind that whatever the course of action adopted certain fixed expenses remains unaffected. Therefore, the criterion that carries weight is the effect of an alternative course of action upon the marginal (that is, variable) costs in relation to the revenue obtained. The course of action that yields the greatest contribution is the most profitable one to be followed by a management.
Illustration 27
The following information is given regarding products A and B of a firm:
Product A | Product B | |
---|---|---|
Sales price | Rs 80 | Rs 55 |
Direct material | Rs 35 | Rs 35 |
Direct labour hours (Re 0.50 per hour) | 15 hours | 2 hours |
Variable overheads: 100% of direct wages | ||
Fixed overhead: Rs 3,000 |
Present this information to show the profitability of products during labour shortage.
Solution: Contribution statement
Therefore, production of product B is more profitable than that of A during labour shortage.
Illustration 28
In a factory producing two different kinds of articles, the limiting factor is the availability of labour. From the following information for the factory for 1994, show which product is more profitable
Product A, cost per unit (Rs) | Product B, cost per unit (Rs) | |
---|---|---|
Materials | 5.00 | 5.00 |
Labour: | ||
6 hours at 0.50 | 3.00 | 1.50 |
3 hours at 0.50 | ||
Overheads: | ||
Fixed (50% of labour) | 1.50 | 0.75 |
Variable | 1.50 | 1.50 |
Total cost | 11.00 | 8.75 |
Selling price | 14.00 | 11.00 |
Profit | 3.00 | 2.25 |
Total production for the month | 700 units | 800 units |
Maximum capacity per month = 4,800 hours. Also, give proof in support of your answer.
(B.Com., Madurai)
Solution: Marginal cost statement
Contribution per unit of limiting factor:
On the basis of contribution, product A is more profitable. On the basis of net profit also product A is more profitable. On the basis of limiting factor product B is more profitable, as contribution is greater.
Illustration 29
The following particulars are obtained from the records of a company manufacturing two products P and R:
Per unit | ||
---|---|---|
Product P (Rs) | Product R (Rs) | |
Selling price | 250 | 500 |
Material cost (Rs 20 per kilogram) | 40 | 100 |
Direct wages (Rs 6 per hour) | 60 | 120 |
Variable overheads | 20 | 40 |
Total fixed overhead = Rs 10,000 |
Comment on the profitability of each product when production capacity in hours is the limiting factor.
(Madras, 1999)
Solution: Statement showing key factor contribution
Note: Hours required to produce the products: hours hours
Comment: When production capacity in hours is the limiting factor, the product that gives higher contribution per hour of output is more profitable over others. Product P whose contribution per hour is Rs 8 is better than product R whose contribution per hour is Rs 7. Product P is recommended for production.
In a factory producing two different products, limiting factor is the availability of materials. From the following particulars, which product would you recommend for priority?
Illustration 30
Raman & Co. produces two products X and Y. The technical labour needed to produce the products is in short supply. The following data is available for the year ending on 31 March 2000
Product X per unit (Rs) | Product Y per unit (Rs) | |
---|---|---|
Material | 40 | 60 |
Labour (at Rs 2 per hour) | 20 | 12 |
Variable overheads (50% of labour) | 10 | 6 |
Fixed cost (at the current capacity level) | 15 | 30 |
Selling price | 140 | 180 |
Units sold | 900 | 2,000 |
Maximum labour hours available per month = 3,000 hours
If maximum profit is to be attained using the remaining capacity by producing and selling the best product when labour time is limited (present production of either one of the products should be kept as the minimum output), determine the maximum profit.
Solution: Statement showing key factor contribution
Note: Labour hours required to produce the products: hours hours
When availability of labour hours is the limiting factor, product Y with Rs 17 per hour contribution is more profitable compared to product X with Rs 7 per hour contribution. Therefore, product Y should be produced and sold to the maximum possible extent.
Calculation of optimum production of products X and Y:
Maximum labour hours available per annum = 3,000 × 12 = 36,000 hours
Less: Labour hours to be spent for the minimum production required of X = 900 × 17 = 15,300 hours
Labour hours available for the production of Y = 20,700 hours
Number of units of production of
∴ Most profitable product mix = X (minimum) = 900 units
Y (maximum possible) = 4,500 units
Statement showing estimated contribution and profit per annum
Particulars | Rs | Rs |
---|---|---|
Contribution: | ||
Product X | 900 × 70 | 63,000 |
Product Y | 4,500 × 102 | 4,59,000 |
Total estimated contribution | 5,22,000 | |
Less: fixed cost (as per current capacity level) | ||
Product X | 900 × 15 = 13,500 | |
Product Y | 2,000 × 30 = 60,000 | 73,500 |
Estimated maximum profit | 4,48,500 |
Illustration 31
(This illustration shows fixing of priorities for different products with reference to the key factor.) A company manufactures and markets three products X, Y and Z. All the three products are made using the same set of machines. Production is limited by machine capacity. From the following data, indicate priorities for products X, Y and Z with a view to maximizing profits
Solution: Statement indicating priorities of different products to maximize profits
Illustration 32
(This illustration shows the case when different key factors are involved.) The following particulars are extracted from the records of a company:
Per unit | ||
---|---|---|
Product A | Product B | |
Sale price (Rs) | 120 | 130 |
Consumption of materials (kg) | 5 | 4 |
Material cost (Rs) | 24 | 14 |
Direct wages (Rs) | 2 | 3 |
Machine hours used | 2 | 3 |
Variable overheads | 4 | 6 |
Comment on the profitability of each product (both use the same raw material) when
Solution
Per unit | ||
---|---|---|
Product A | Product B | |
Sale price | Rs 120 | Rs 130 |
Less: variable costs | Rs 30 | Rs 23 |
Contribution | Rs 90 | Rs 107 |
Contribution per rupee of sales (P/V Ratio) | 0.75 paise | 0.82 paise |
Contribution per kilogram of material | Rs 18 | Rs 26.75 |
Contribution per machine hour | Rs 45 | Rs 35.67 |
Illustration 33
A radio manufacturing company finds that while it costs Rs 6.25 to make each component X 2730, the same is available in the market at Rs 4.85 with an assurance of continued supply. The breakdown of cost is as follows:
Materials | Rs 2.75 each |
Labour | Rs 1.75 each |
Other variables | Rs 0.50 each |
Depreciation and other fixed costs | Rs 1.25 each |
Rs 6.25 each |
Should the company make or buy the component?
(I.C.W.A.)
Solution: The variable cost of manufacturing is Rs 5 (that is, Rs 6.25 − Rs 1.25); but the market price is Rs 4.85. If the fixed cost of Rs 1.25 is also added, it is not profitable to make the component. Because there is a profit of Rs 0.15 even in variable cost, it is profitable to procure the component from outside.
Illustration 34
An automobile manufacturing company finds that the cost of making Part Number 208 in its workshop is Rs 8. The same part is available in the market at Rs 6.60 with an assurance of continuous supply. The cost data to make the part are as follows:
Material | Rs 2 |
Direct labour | Rs 3 |
Other variable costs | Re 1 |
Fixed cost allocated | Rs 2 |
Rs 8 |
Show your calculations clearly.
(Madras, 1987)
Solution: To make a decision regarding whether to make or buy the part, fixed cost is to be ignored as it is irrelevant. But the additional costs being variable costs must be considered
Materials | Rs 2 |
Direct labour | Rs 3 |
Other variable costs | Re 1 |
Total variable costs | Rs 6 |
Note: The aforementioned conclusions are made on the assumption that the production facilities that become ‘idle’ once the production of the part is discontinued and the part is bought from the market cannot be used to derive any income. However, if the idle facilities can be leased out or can be used to produce some other product or part that can give some contribution, this should also be considered while making the make or buy decision.
Illustration 35
Green Ltd produces 20,000 units of Part Number 47 every month and uses it in assembling a product. Its cost structure is as follows:
Variable cost = Rs 10
Fixed cost = Rs 8
Total cost = Rs18
It is proposed to obtain the part from open market at Rs 15 per unit. It is possible to do one of the following:
You are required to advise the management on the aforementioned options and help in arriving at the correct decision—whether to make or buy.
Solution:
Cost of purchase of 20,000 units = Rs 20,000 × 15 = Rs 3,00,000
Less: Income from hiring idle facilities = Rs 35,000
Effective cost of outside purchase of Part Number 47 = Rs 2,65,000
Less: Variable cost of making 20,000 units = 20,000 × 10 = Rs 2,00,000
Excess cost of outside supply of the part = Rs 65,000
Conclusion: The part should not be bought. It should be continued to be made in the factory.
Sale value of the product to be produced with the use of idle facilities = Rs 5,000 × Rs 55 = Rs 2,75,000
Less: Variable cost of the product = Rs 5,000 × Rs 40 = Rs 2,00,000
Net contribution from idle facilities = Rs 75,000
Cost of purchase of 20,000 units = 20,000 × Rs 15 = Rs 3,00,000
Less: Income from using idle facilities = Rs 75,000
Effective cost of outside purchase of Part Number 47 = Rs 2,25,000
Less: Variable cost of making 20,000 units = 20,000 × Rs 10 = Rs 2,00,000
Saving in cost by purchasing the part from outside = Rs 25,000
Conclusion: The part should be bought from outside and the idle facilities should be used.
Note: Since facilities become idle only when outside purchase is made, contribution from idle facilities has to be reduced from the price offered to obtain the effective cost of purchase.
Illustration 36
A manufacturing company finds that while the cost of making a component part is Rs 10, the same is available in the market at Rs 9 with an assurance of continuous supply. Give your suggestions regarding whether to make or buy this part. Also give your views for the case the supplier reduces the price from Rs 9 to Rs 8. The cost information is as follows:
Materials = Rs 4
Direct labour = Rs 4
Other variable expenses = Rs 2
Fixed expenses = Rs 2
Total = Rs 12
Solution:
Materials = Rs 4
Direct labour = Rs 4
Other variable expenses = Rs 2
Fixed expenses = Rs 2
Total = Rs 12
The company should produce the part if the part is available in the market at Rs 9.00 because the production of every part gives to the company a contribution of 50 paise (that is, Rs 9.00 − Rs 8.50). The company should not manufacture the part if it is available in the market at Rs 8.00 because the additional cost of producing the part is 50 paise (that is, Rs 8.50 − Rs 8.00) more than the price at which it is available in the market. In some cases, in spite of lower variable cost of production there may be an increase in fixed costs. In such cases an increase in fixed cost becomes the relevant cost and it should be considered when making the make or buy decision. It becomes essential to find out the minimum requirement of volume in order to justify the making of a component part over buying it. This volume can be calculated by the following formula =
Illustration 37
A firm can purchase a separate part from an outside source at Rs 11 per unit. There is a proposal that the spare part be produced in the factory itself. For this purpose, a machine costing Rs 1,20,000 with an annual capacity of 20,000 units and a life of 10 years is required. A foreman with a monthly salary of Rs 600 has to be engaged. Materials required are Rs 4 per unit and wages are Rs 2 per unit. Variable overheads are 150% of direct labour. The firm can easily raise funds at 10% per annum. Advise the firm whether the proposal should be accepted.
Solution:
Increase in fixed costs:
Contribution per unit:
Purchase price = Rs 11
Less: variable cost:
Materials = Rs 4
Wages = Rs 2
Variable overheads = Rs 3
Contribution per unit = Rs 2
In order to accept the proposal, it is essential that the volume is at least 15,600 units. If there is no idle capacity and the making of the spare part in the factory involves the loss of other work, the loss of contribution arising from displacement of work should also be considered along with variable cost of production. The loss of contribution is found with reference to a key or limiting factor. If the purchase price is higher than the total variable cost of production plus traceable fixed costs plus the loss of contribution of production, it will be more profitable to manufacture.
Illustration 38
The following are the operating details of two plants operating under the same management:
Plant A (Rs) | Plant B (Rs) | |
---|---|---|
Sales | 12,00,000 | 10,00,000 |
Variable costs | 6,00,000 | 5,00,000 |
Fixed costs | 2,00,000 | 1,00,000 |
Capacity of operation | 100% | 50% |
It is proposed to merge both the plants. You are required to ascertain
Solution: Statement showing cost and profit of plants A and B before and after merger
Note: It is necessary to merge both the plants at a common capacity level, preferably at 100% capacity.
Profit and profitability of operating the merged plant at 90% capacity:
90% capacity of the merged plant = Rs 32,00,000 × 90% = Rs 28,80,000
Contribution = sales × P/V
= Rs 28,80,000 × 50% = Rs14,40,000
Profit = contribution − fixed cost
= Rs 14,40,000 − Rs 3,00,000 = Rs 11,40,000
Capacity level of operation required to make a profit of Rs 4,00,000:
Illustration 39
The budgeted results for Joseph & Co. Ltd include the following
Product | Sales (Rs) | Variable cost as percentage of sales value |
---|---|---|
A | 50,00,000 | 60 |
B | 40,00,000 | 50 |
C | 80,00,000 | 65 |
D | 30,00,000 | 85 |
E | 44,00,000 | 80 |
2,44,00,000 | 65.77 |
Fixed overheads for the period is Rs 87,00,000. You are required to
(Madras, 1989)
Solution:
Statement of marginal cost and contribution
Change in the sales volume of each product to eliminate the expected loss:
P/V ratio of each product = 100 − variable cost percentage given
∴ P/V ratio of each product = 100 − 60 = 40%; B = 100 − 50 = 50%
C = 100 − 65 = 35%; D = 100 − 80% = 20%; E = 100 − 75 = 25%
Increased sales volume required to get an additional contribution of Rs 5,00,000 and eliminate the current loss:
Note: Increase in the sales of any one of the products is enough to eliminate loss.
Illustration 40
Jayant company produces three products A, B and C for which the standard variable costs and standard selling prices are as follows:
In two successive periods, the sales are as follows:
The fixed overheads amounted to Rs 1,50,000 for each period. In spite of increased sales, the profit for period II has fallen below that of period I. Provide figures to the management to show why this fall in profit should or should not have occurred.
(Madras, 1987)
Solution: Statement showing comparative profit of sales mixes
Contribution per unit: A = Rs 8, B = Rs 10 and C = Rs 23
In period II, the sale of product C, which has the maximum contribution per unit, is reduced by 50% from 10,000 units to 5,000 units. Increase in the sales of products A and B could not fully compensate the decreas in contribution due to decrease in the volume of C. The change of sales mix should not have occurred. The objective should be to increase the sales of products having high contributions.
Illustration 41
Present the following information to show to the management (a) the marginal product cost and the contribution per unit; (b) the total contribution and profits resulting from each of the following sales mixtures
Product A | Per unit | |
---|---|---|
Direct materials | A | Rs 10 |
B | Rs 9 | |
Direct wages | A | Rs 3 |
B | Rs 2 |
Fixed expenses are Rs 8,000.
Variable expenses are allocated to products as 100% of direct wages.
Sales price of A = Rs 25
Sales price of B = Rs 20
Sales mixtures:
(M.Com., Madurai)
Solution: Marginal cost statemen
A (Rs) | B (Rs) | |
---|---|---|
Direct materials | 10 | 9 |
Direct wages | 3 | 2 |
Variable overheads (100%) | 3 | 2 |
Marginal cost | 16 | 13 |
Sales price | 25 | 20 |
Contribution | 9 | 7 |
Product mix choice
Therefore, sales mixture (iii) gives the highest profit and, as such, mixture (iii) can be adopted.
Illustration 42
Present the following information to show to the management:
The marginal product cost and the contribution per unit
The total contribution and profits resulting from each of the sales mixtures
The proposed sales mixtures to earn a profit of Rs 250 and Rs 300 with the total sales of A and B being 300 units.
Product A (Rs) | Product B (Rs) | |
---|---|---|
Direct materials (per unit) | 10 | 9 |
Direct wages (per unit) | 3 | 2 |
Sales price (per unit) | 25 | 20 |
Fixed expenses = Rs 700
(Variable expenses are allocated to products as 100% of direct wages.)
Sales mixtures:
Recommend which sales mixture should be adopted.
Solution:
Statement of marginal cost and unit contribution
Mix c should be adopted as it gives the maximum contribution and profit.
Proposed mixes:
Case I (Rs) | Case II (Rs) | |
---|---|---|
Required profit | 250 | 300 |
Fixed cost | 700 | 700 |
Contribution | 950 | 1,000 |
Case I
Let p numbers of A be sold.
Then (300 − p) numbers of B are to be sold
Equating 4p + 2(300 − p) = 950
4p + 600 − 2p = 950
2p = 350
∴ p = 175
Proposed mix: A = 175units and B = 125 units (that is, 300 − 175)
Case II
Say x numbers of A are to be sold. Then 300 − x numbers of B are to be sold
Equating, 4x + 2 (300 − x) = 1,000
4x + 600 − 2x = 1,000
2x = 400
∴ x = 200
Proposed mix: A = 200 units and B = 100 units
Illustration 43
A manufacturer with an overall (interchangeable among the products) capacity of 1,00,000 machine hours has been so far producing a standard mix of 15,000 units of product A and 10,000 units each of products B and C. From experience, the total expenditure exclusive of the manufacturer's fixed charges is found to be Rs 2,09,000 and the cost ratio among the products approximates to 1:1.5:1.75 for A, B and C per unit. The fixed charges come to Rs 2 per unit. When the unit selling prices are Rs 6.25 for A, Rs 7.50 for B and Rs 10.50 for C, the manufacturer incurs a loss. The manufacturer desires to change the product mix as follows:
As a cost accountant what mix do you recommend?
Solution: Calculation of contribution per unit
Statement showing the profitability different mixes
From the aforementioned data, it is clear that mix 3 is more profitable, and hence it is recommended.
Illustration 44
A company manufactures three products, and their respective details are furnished as follows:
The management proposes to discontinue line X. It intends to utilize the disengaged capacity in the lines Y and Z equally. Advise the management suitably.
(Madras, 1987)
Solution: Statement showing comparative profitability of products X, Y and Z
Working Note: Calculation of fixed cost
X − 2,000 × 20 = 40,000
Y − 5,000 × 19 = 95,000
Z − 6,000 × 20 = 1,20,000
2,55,000
Conclusion:
Illustration 45
The records of Ram Ltd, which has three departments, give the following figures:
The management wants to discontinue department C immediately as it gives the maximum loss. How would you advise the management?
Solution: Marginal cost statement
Here, department A gives negative contribution, and as such it can be given up. Department C has a contribution of Rs 7,000. If department C is closed, then it may lead to further loss. Therefore, C should be continued.
Illustration 46
The P/V ratio is 60% and marginal cost of the product is Rs 40. What will be the selling price?
Solution:
Illustration 47
From the data given, calculate the following:
Given: Fixed expenses = Rs 4,000
BEP = Rs 10,000
(B.Com., Delhi)
Solution:
= sales × P/V ratio − fixed expenses
= Rs 30,000 × 40% − 4,000
= Rs 12,000 − Rs 4,000 = Rs 8,000
Variable cost per unit = Rs 100 − 40% = Rs 60
Illustration 48
A company has a P/V ratio of 40%. By what percentage must its sales be increased to offset
(B.Com., Delhi)
Solution: If sales are 100 units at Re 1 per unit, then
Sales = Rs 100
Contribution = Rs 40
Variable cost = Rs 60
Sales = Rs 80
Contribution = Rs 20
Variable cost = Rs 60
Thus, if the selling price is reduced by 20%, the volume of sales must be increased by 20%.
New sales = Rs 75
New contribution = Rs 15
Variable cost = Rs 60
Thus, if selling price is reduced by 25%, sales must be increased by 100%.
Illustration 49
A company produces and sells 100 units of product A per month at Rs 25. Marginal cost per unit is Rs 16 and fixed costs are Rs 3 per month. It is proposed to reduce the selling price by 20%. Find the additional sales required to earn the same profit as before.
(B.Com., Osmania)
Solution:
Present profit:
Selling price of 100 units at Rs 25 = Rs 2,500
Less: marginal cost of 100 units (100 × 12) = Rs 1,200
Contribution = Rs 1,300
Less: fixed cost = Rs 300
Net profit = Rs 1,000
100 units (sold at present)
100 units (additional)
Additional units = 100
Check:
Sales = Rs 162.5 × Rs 20 = Rs 3,250
Less: variable (162.5 × 12) = Rs 1,950
Contribution = Rs 1,300
Less: fixed cost = Rs 300
Net profit = Rs 1,000
Illustration 50
The Delhi Mixers Co. manufactured and sold 1,000 mixies last year at a price of Rs 800 each. The cost structure of a mixy is as follows:
Rs | |
---|---|
Materials | 200 |
Labour | 100 |
Variable cost | 50 |
Marginal cost | 350 |
Factory overhead (fixed) | 200 |
Total cost | 550 |
Profit | 300 |
Sales price | 850 |
Due to heavy competition, price must be reduced to Rs 780 in the coming year. Assuming no change in costs, state the number of mixies that would have to be sold at the new price to ensure the same amount of total profits as that of the previous year.
(B.Com.)
Solution:
Profit for 1,000 mixies = 1,000 × 300 = Rs 3,00,000
Contribution at the price of Rs 750 = 750 − 350 = Rs 400
Verification:
Sales = 1,250 × Rs 750 = Rs 9,37,500
Less: variable cost = 1,250 × Rs 350 = Rs 4,37,500
= Rs 5,00,000
Less: fixed cost = Rs 2,00,000
Profit = Rs 3,00,000
Illustration 51
Two businesses, Y Ltd and Z Ltd, sell the same type of product in the same type of market. Their budgeted profit and loss accounts for the coming year are as follows
Y Ltd (Rs) | Z Ltd (Rs) | |
---|---|---|
Sales | 1,50,000 | 1,50,000 |
Less: variable cost | 1,20,000 | 1,00,000 |
Contribution | 30,000 | 50,000 |
Less: fixed cost | 20,000 | 40,000 |
Budgeted net profit | 10,000 | 10,000 |
You are required to
Solution:
(c)
(d) Under conditions of heavy and low demands:
Illustration 52
A decision is to be made by the management of a company regarding the possible introduction of a new product. There can be three models of this product, aimed at different sections of the consumer market. The relevant figures are as follows:
You are required to prepare a statement of relative profitability and determine for each model the percentage of net profit to selling price at the expected sales volume. Also state, keeping in mind all factors, the production of which model should be commenced by the company?
(M.Com., Agra)
Solution: Profitability Statement
The management is advised to commence the production of model III, as the contribution percentage is the highest and the percentage of net profit to selling price is satisfactory.
Illustration 53
The variable cost of the power drill manufactured by Home Tools Limited is Rs 4 and the selling price is Rs 10. The company expects its net profit for the year ending to be Rs 2,75,000 after charging fixed costs amounting to Rs 85,000. The company's production capacity is not fully utilized and market research suggests the following three alternative strategies for the forthcoming year:
Strategy | Reduce selling price by | Sales volume expected to increase by |
---|---|---|
1 | 5% | 10% |
2 | 7% | 20% |
3 | 10% | 25% |
(a) Assuming the same cost structure as that of the current year, evaluate the alternative strategies available to the company and state the most profitable one.
(CA)
Solution:
Rs | |
---|---|
Selling price per unit | 10 |
Less: variable cost | 4 |
Contribution per unit | 6 |
Net profit | 2,75,000 |
Add: fixed cost | 85,000 |
Total contribution | 3,60,000 |
Units to be sold = Rs 3,60,000 ÷ Rs 6 = 60,000 units
(a) Alternative strategies:
Therefore, strategy 2 is the most profitable one.
Illustration 54
Product A can be produced by either machine X or machine Y. Machine X can produce 200 units of A per hour and machine Y 300 units per hour. Total machine hours available during a year are 2,750 hours. Taking into account the following data, determine the most profitable method of manufacture
Per unit of product A | ||
---|---|---|
Machine X (Rs) | Machine Y (Rs) | |
Marginal cost | 10 | 12 |
Selling price | 18 | 18 |
Fixed cost | 4 | 4 |
(B.Com., Madurai)
Solution:
Machine X | Machine Y | |
---|---|---|
Selling price per unit | Rs 18 | Rs 18 |
Less: marginal cost | Rs 10 | Rs 12 |
Contribution per unit | Rs 8 | Rs 6 |
Output per hour | Rs 200 | Rs 300 |
Contribution per hour | Rs 1,600 | Rs 1,800 |
Machine hour per year | 2,750 hours | 2,750 hours |
Annual contribution | Rs 44,00,000 | Rs 49,50,000 |
Therefore, the production of A by machine Y is more profitable.
Illustration 55
Product X can be produced by either machine A or machine B. Machine A can produce 100 units of X per hour and machine B 150 units per hour. Total machine hours available during a year are 2,750 hours. Taking into account the following data, determine the most profitable method of manufacture:
Per unit of product X | ||
---|---|---|
Machine A (Rs) | Machine B (Rs) | |
Marginal cost | 5 | 6 |
Selling price | 9 | 9 |
Fixed cost | 2 | 2 |
Solution: Profitability Statemen
Per unit of product X | ||
---|---|---|
Machine A | Machine B | |
Selling price per unit | Rs 9 | Rs 9 |
Less: Marginal cost | Rs 5 | Rs 6 |
Contribution per unit | Rs 4 | Rs 3 |
Output per hour | 100 units | 150 units |
Contribution per hour | 400 | 450 |
Machine hours per year | 2,750 hours | 2,750 hours |
Annual contribution | Rs 11,00,000 | Rs 12,37,500 |
Hence, production by machine B is more profitable.
Illustration 56
(Selection of machine) X Limited has been offered a choice to buy either machine A or machine B. You are required to compute
The relevant data is as follows:
Machines | ||
---|---|---|
A | B | |
Annual output (in units) | 12,000 | 12,000 |
Fixed cost (Rs) | 30,000 | 16,000 |
Profit above the level of production (Rs) | 30,000 | 24,000 |
The market price of the product is expected to be Rs 10 per unit.
Solution:
If x is the output when total costs of the machines are the same, we have total cost of machine A = 5x + Rs 30,000 and that of machine B = 6.67x + Rs 16,000
Therefore,
At a production level of 8,383 units, the profits made by the machines A and B are equal.
Illustration 57
A company produces and markets industrial containers and packing cases. Due to competition, the company aims to reduce the selling price. If the present level of profit is to be maintained, indicate the number of units to be sold for the following proposed reductions in selling price:
(a) 10%, (b) 20% and (c) 25%. The following additional information is available:
Rs | Rs | |
---|---|---|
Present sales turnover (30,000 units) | 3,00,000 | |
Variable cost (30,000 units) | 1,80,000 | |
Fixed cost | 70,000 | 2,50,000 |
Net profit | 50,000 |
Solution:
Present price is Rs 10.
Contribution at various proposed selling prices:
The contribution required to maintain the present level of profit is as follows:
Fixed expenses = Rs 70,000
Profit at present = Rs 50,000
Total = Rs 1,20,000
Units to be sold to earn the total contribution of Rs 1,20,000 to maintain the present level of profits:
Total fixed costs | Rs 2,250 |
Total variable costs | Rs 3,750 |
Total sales | Rs 7,500 |
Units sold | 5,000 units |
Also calculate the volume of sales required to earn a profit of Rs 3,000.
Solution:
Total | Per unit | |
---|---|---|
Sales (Rs) | 7,500 | 1.50 |
(−) Variable cost (Rs) | 3,750 | 0.75 |
Contribution (Rs) | 3,750 | 0 |
Volume of sales required to earn a profit of Rs 3,000:
Calculate the following:
Solution:
Margin of safety = actual sales − break-even sales
Let actual sales be Rs 100. Margin of safety is Rs 37.50. Hence, break-even sales will be Rs 62.50 in cost. Break-even sales are Rs 62.50 and actual sales are Rs 100.
Hence, if break-even sales are Rs 12,50,000,
Hence, total variable costs = 60% of Rs 20,00,000
= Rs 12,00,000
Contribution | Rs 56,250 | |
Less (fixed cost) | Rs 45,000 | |
Profit | Rs 11,250 |
First half | Second half | |
---|---|---|
Sales | Rs 24,00,000 | Rs 30,00,000 |
Total costs | Rs 21,80,000 | Rs 26,00,000 |
You are required to determine
Solution: Computation of contribution/sales ratio
Solution:
Total cost of production (Rs) | Volume of production |
---|---|
14,600 | 800 |
19,400 | 1,200 |
What is the best estimate of the fixed costs per period?
Solution:
Solution:
Selling price per unit = Rs 25
Direct material cost per unit = Rs 8
Direct labour cost per unit = Rs 5
Fixed overhead = Rs 24,000
Variable overhead at 60% on direct labour trade discount 4%.
If sales are 15% and 20% above the break-even volume, determine the profits.
Solution: Statement showing BEP of output and sale
Selling price per unit | Rs 25 | |
---|---|---|
(−) Trade discount at 4% | 1 | 24 |
(−) Variable cost (Rs): | ||
Direct material per unit | 8 | |
Direct labour per unit | 5 | |
Variable overheads | 3 | 16 |
Contribution per unit | 8 |
BEP at sales:
Sales at BEP = 3,000 × 25 = Rs 75,000
Less: trade discount 4% = Rs 3,000
Net sales value = Rs 72,000
Statement showing net profit if sales are 15% above the break-even volume
Units | Rs | |
---|---|---|
Sales at BEP | 3,000 | |
Add: 15% BEP | 450 | |
Total | 3,450 | |
Contribution on 3,450 units (3,450 × 8) | 27,600 | |
Less: fixed cost | 24,000 | |
Profit | 3,600 |
Statement showing net profit if sales are 20% above the break-even volume
Units | Rs | |
---|---|---|
Sales at BEP | 3,000 | |
Add: 20% BEP | 600 | |
Total | 3,600 | |
Contribution on 3,600 units (3,600 × 8) | 28,800 | |
Less: fixed cost | 24,000 | |
Profit | 4,800 |
Solution:
Solution:
After reading this chapter, one is able to understand the cost concept in marginal costing and its relevance in the decision-making process. It also helps in proper planning in a futuristic business environment.
Objective-type questions
I. State whether the following statements are true or false
[Ans: 1—true, 2—true, 3—true, 4—true, 5—true, 6—true, 7—false, 8—false, 9—true, 10—true]
II. Choose the correct answer
Ans: (a)
Ans: (a)
Ans: (d)
Ans: (c)
Ans: (a)
Ans: (d)
Ans: (c)
Ans: (b)
Ans: (a)
Ans: (a)
Rs | |
Raw materials | 10 |
Direct expenses | 8 |
Labour charges | 2 |
Variable overheads | 4 |
Fixed overheads | 6 |
Total cost per unit | 30 |
Profit per unit | 2 |
Selling price per unit | 32 |
(Madras, B.Com., March 1995)
[Ans: Break-even quantity—7,500 units; fixed cost—10,000 × 6 = Rs 60,000]
Fixed expenses: | |
---|---|
Depreciation | Rs 1,00,000 |
Salaries | Rs 1,00,000 |
Variable expenses: | |
Materials | Rs 3 per unit |
Labour | Rs 2 per unit |
Selling price | Rs 10 per unit |
(B.Com., Delhi)
[Ans: 40,000 units; 50,000 units if selling price is reduced by 10%]
Budgeted output = 1,00,000 units
Fixed expenses = Rs 5,00,000
Variable expenses = Rs 10 per unit
Selling price = Rs 20 per unit
(Madras, B.A. Corp. C & M (ICE) May 1998)
[Ans: BEP = 50,000 units; break-even sales = Rs 10,00,000; if selling price is reduced to Rs 18, BEP = 62,500 units; break-even sales = Rs 11,25,000]
Rs | |
Sales | 10,00,000 |
Variable cost | 4,00,000 |
Fixed cost | 4,00,000 |
(Madras, B.Com., March 1997)
[Ans: P/V ratio = 0.6 or 60%; margin of safety = Rs 3,33,333]
Calculate the revised BEP if
[Ans: (A) 5,000 units. (B) (i) 4,000 units; (ii) 6,667 units; (iii) 6,667 units; (iv) 4,000 units; (v) 6,250 units; (vi) 3,750 units]
Rs | |
Total fixed costs | 1,80,000 |
Total variable cost | 3,00,000 |
Selling price is Rs 6 per unit, number of units sold | 2,00,000 |
(Madras, B.Com., Sep. 1987)
[Ans: (a) 40,000 units or Rs 2,40,000; (b) 1,60,000 units or Rs 9,60,000]
Sales | Rs 1,00,000 |
Total cost | Rs 80,000 |
Fixed cost | Rs 20,000 |
Net profit | Rs 20,000 |
(Madras, B.A. Corp. April 1998)
[Ans: (a) 4 or 40% (b) Rs 50,000 (c) 50,000]
Selling price per unit = Rs 10
Direct material per unit = Rs 3
Fixed overheads = Rs 10,000
Variable overhead per unit = Rs 2
Direct labour cost per unit = Rs 2
(Madras, B.Sc. C & M, Oct. 1998)
[Ans: (a) 3,333.33 or 3,334 units; (b) profit if sales are 10% above BEP sales = 3,334 + 333.4 or 334 units = 3,668 units; profit = Rs 1,004; profit if sales are 15% above BEP sales = 3,334 + 500 = 3,834 units; profit = Rs 1,502]
Rs | |
Total sales | 3,60,000 |
Selling price per unit | 100 |
Variable cost per unit | 50 |
Fixed costs | 1,00,000 |
If the selling price is reduced to Rs 90, by how much is the margin of safety reduced?
(Madras, M.Com., April 1994)
[Ans: (a) 0.5 or 50%; (b) 2,000 units or Rs 2,00,000; (c) current margin of safety = 3,60,000 − 2,00,000 = Rs 1,60,000; new margin of safety = 3,24,000 − 2,25,000 = Rs 99,000; reduction in margin of safety with reduction in selling price = Rs 61,000]
3.22.249.48