Cost Sheet MODULE - 6B

Elementary Cost Accounting

29 Notes

COST SHEET

You are running a factory which manufactures electronic toys. You incur
expenses on raw material, labour and other expenses which can be directly
attibuted to cost and which cannot be directly attributed but are incurred
upto their sales. You need to know the composition of cost at different
stages. This will help you in the analysis of cost of a product so that same
can be used for its proper management. In this lesson you will learn about
cost sheet and its various components.

OBJECTIVES
After studying this lesson, you will be able to:

state the meaning and type of Cost Sheet;

state the importance of Cost Sheet;

explain the components of total cost;

prepare the cost sheet as per format.

29.1 COST SHEET : MEANING AND ITS IMPORTANCE

Cost sheet is a statement, which shows various components of total cost
of a product. It classifies and analyses the components of cost of a product.
Previous periods data is given in the cost sheet for comparative study. It
is a statement which shows per unit cost in addition to Total Cost. Selling
price is ascertained with the help of cost sheet. The details of total cost
presented in the form of a statement is termed as Cost sheet. Cost sheet
is prepared on the basis of :
1. Historical Cost 2. Estimated Cost

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Historical Cost
Historical Cost sheet is prepared on the basis of actual cost incurred. A
statement of cost prepared after incurring the actual cost is called Historical
Cost Sheet.
Notes
Estimated Cost
Estimated cost sheet is prepared on the basis of estimated cost. The
statement prepared before the commencement of production is called
estimated cost sheet. Such cost sheet is useful in quoting the tender price
of a job or a contract.

Importance of Cost Sheet

The importance of cost sheet is as follows:

Cost ascertainment
The main objective of the cost sheet is to ascertain the cost of a product.
Cost sheet helps in ascertainment of cost for the purpose of determining
cost after they are incurred. It also helps to ascertain the actual cost or
estimated cost of a Job.

Fixation of selling price

To fix the selling price of a product or service, it is essential to prepare the
cost sheet. It helps in fixing selling price of a product or service by providing
detailed information of the cost.

Help in cost control

For controlling the cost of a product it is necessary for every manufacturing
unit to prepare a cost sheet. Estimated cost sheet helps in the control of
material cost, labour cost and overheads cost at every point of production.

Facilitates managerial decisions

It helps in taking important decisions by the management such as: whether
to produce or buy a component, what prices of goods are to be quoted in
the tender, whether to retain or replace an existing machine etc.

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INTEXT QUESTIONS 29.1

I. State the meaning of cost sheet.
................................................................................................................
Notes
................................................................................................................
II. Fill in the blanks with suitable words:
(i) Cost sheet classifies and analyses the ............... of cost of a
product.
(ii) ............... is ascertained with the help of cost sheet.
(iii) ............... Cost sheet is prepared on the basis of actual cost
incurred.
(iv) Cost sheet also helps to ascertain the actual cost or ............... cost
of a job.
(v) Cost sheet helps in fixing ............... of products or services by
providing detailed cost information.
(vi) ............... cost sheet helps in the control of material cost of a
product/service.

29.2 COMPONENTS OF TOTAL COST

The Components of cost are shown in the classified and analytical form
in the cost sheet. Components of total cost are as follows:

Prime Cost
It consists of direct material, direct wages and direct expenses. In other
words “Prime cost represents the aggregate of cost of material consumed,
productive wages, and direct expenses”. It is also known as basic, first, flat
or direct cost of a product.
Prime Cost = Direct material + Direct Wages + Direct expenses
Direct material means cost of raw material used or consumed in production.
It is not necessary that all the material purchased in a particular period is
used in production. There is some stock of raw material in balance at
opening and closing of the period. Hence, it is necessary that the cost of
opening and closing stock of material is adjusted in the material purchased.
Opening stock of material is added and closing stock of raw material is
deducted in the material purchased and we get material consumed or used
in production of a product. It is calculated as :
Material Consumed = Material purchased + Opening stock of material
– Closing stock of material.

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Illustration 1
Calculate prime cost from the following particulars for a production unit:
Rs.

Notes Cost of material purchased 30,000

Opening stock of material 6,000
Closing stock of material 4,000
Wages paid 3,000
Rent of hire of a special machine for production 5,000

Solution:
Statement showing Prime Cost
Details Amount
(Rs.)
Direct Material: Material Consumed
Opening stock of material 6,000
Add : Material Purchased 30,000
Material available for consumption 36,000
Less : Closing stock of material 4,000
Material consumed 32,000
Direct Labour : Wages 3,000
Direct Expenses: Rent of hire a special machine 5,000
Prime cost 40,000

Factory Cost
In addition to prime cost it includes works or factory overheads. Factory
overheads consist of cost of indirect material, indirect wages, and indirect
expenses incurred in the factory. Factory cost is also known as works cost,
production or manufacturing cost.

Factory Cost = Prime cost + Factory overheads

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Illustration 2
Calculate factory cost from the following particulars:
Rs.
Material consumed 60,000
Notes
Productive wages 20,000
Direct Expenses 5,000
Consumable stores 2,000
Oil grease/Lubricating 500
Salary of a factory manager 6,000
Unproductive wages 1,000
Factory rent 2,000
Repair and Depreciation on Machine 600

Solution:
Statement showing Factory cost
Details Amount
(Rs.)
Direct Material: Material Consumed 60,000
Direct Labour: Productive wages 20,000
Direct Expenses 5,000
Prime cost 85,000
Add : Factory overheads
Indirect Material:
Consumable stores 2,000
Oil grease/lubricants 500 2,500
Indirect Labour:
Unproductive wages 1,000
Salary of a factory Manager 6,000 7,000
Indirect Expenses:
Factory rent 2,000
Repair and Depreciation on Machine 600 2,600
Factory cost 97,100

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Adjustment for stock of work-in-progress
In the process of production, some units remain to be completed at the end
of a period. These incomplete units are known as work-in-progress.
Normally, the cost of incomplete units include direct material, direct Labour,
direct expenses, and average factory overheads. Hence, at the time of
Notes
computing factory cost, it is necessary to make adjustment of opening and
closing stock of work in progress to arrive at the net Factory cost/works
cost.

Illustration 3
From the following information calculate the works cost.
Rs.
Direct material 80,000
Direct Labour 22,000
Direct Expenses 5,000
Factory overheads 12,000
Work-in-progress: Opening stock 13,000
Closing stock 7,000

Solution:
Statement showing Factory cost
Details Amount
(Rs.)
Direct Material: Material Consumed 80,000
Direct Labour: Productive wages 22,000
Direct Expenses 5,000
Prime cost 1,07,000
Factory overheads 12,000
Factory Cost (Gross) 1,19,000
Add: Opening stock of work-in-progress 13,000
1,32,000
Less: Closing stock of work-in-progress 7,000
Works or Factory cost (Net) 1,25,000

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INTEXT QUESTIONS 29.2

Fill in the blanks with suitable words:

(i) The Component of cost shown in the ................ and ................ form Notes
is the cost sheet.

(ii) Prime cost is also known as ................ first, flat or ................ cost of
a job.

(iii) Material Consumed = Material purchased + ................ – Closing stock

of material.

(iv) Factory cost is also known as works cost, ................ or manufacturing

cost.

(v) Some units are not completed in process, they are known as ................

29.3 TOTAL COST AND COST SHEET

If office and administrative overheads are added to factory or works cost,
total cost of production is arrived at. Hence the total cost of production is
calculated as:

Total Cost of production = Factory Cost + office and administration

overheads

Illustration 4
From the following information calculate the total cost of production

Rs.

Direct material 90,000

Direct Labour 32,000

Direct Expenses 9,000

Factory overheads 25,000

Office and administration overheads 18,000

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Solution:
Statement showing total cost of production
Details Amount
(Rs.)
Notes
Direct Material: Material Consumed 90,000
Direct Labour: Productive wages 32,000
Direct Expenses 9,000
PRIME COST 1,31,000
Factory overheads 25,000
FACTORY COST 1,56,000
Office and administration overheads 18,000
TOTAL COST OF PRODUCTION 1,74,000

Cost of goods sold

It is not necessary, that all the goods produced in a period are sold in the
same period. There is stock of finished goods in the opening and at the end
of the period. The cost of opening stock of finished goods is added in the
total cost of production in the current period and cost of closing stock of
finished goods is deducted. The cost of goods sold is calculated as:
Cost of goods sold = Total cost of production + Opening stock of
Finished goods – Closing stock of finished goods

Illustration 5
From the following information calculate the cost of goods sold.
Rs.
Total Cost of Production 1,22,000
Opening stock of finished goods 12,000
Closing stock of finished goods 16,000

Solution:
Cost of goods sold = Cost of Production + Opening stock of Finished
goods - closing stock of Finished goods

Cost of goods sold = Rs.1,22,000 + 12,000 – 16,000 = Rs.1,18,000

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Total Cost i.e, Cost of Sales
If selling and distribution overheads are added to the total cost of
production, total cost is arrived at. This cost is also termed as cost of Sales.
Hence the total cost is calculated as:
Total Cost = Cost of Goods sold + Selling and distribution overheads Notes

Illustration 6
From the following information calculate the total cost.
Rs.
Direct material 1,60,000
Direct Labour 52,000
Direct Expenses 19,000
Factory overheads 45,000
Office and administration overheads 28,000
Selling and distribution overheads 33,000

Solution:
Statement showing total cost
Details Amount
(Rs.)
Direct Material: 1,60,000
Direct Labour: 52,000
Direct Expenses 19,000
PRIME COST 2,31,000
Factory overheads 45,000
FACTORY COST 2,76,000
Office and administration overheads 28,000
TOTAL COST OF PRODUCTION 3,04,000
Selling and distribution overheads 33,000
Total cost = cost of sales 3,27,000

Sales
If the profit margin is added to the total cost, sales are arrived at. Excess
of sales over total cost is termed as profit. When total cost exceeds sales,
it is termed as Loss.
Sales = Total Cost + Profit

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Sometimes profit is calculated on the basis of given information in
percentage of cost or sales. In such a situation, the amount is assumed 100
in which the percentage is calculated. Then the Profit is calculated in the
following ways:

Notes Case 1

If Cost is Rs.10,000 and profit on cost 10%. Assume the cost is Rs.100 and
profit on cost is Rs.10. Hence Profit on cost of Rs.10,000 is

10,000 × 10/100 = Rs.1,000

Thus the sales value is Rs 11000 (10,000 + 1000)

Case 2

If Cost is Rs.10,800 and profit on sales price is 10%. Assume sales price
is Rs.100. cost price is Rs.90 [i.e. Rs.100 – Rs.10]. When profit on cost
of Rs.90 is Rs.10. Hence profit on cost of Rs.10,800 is

10,800 × 10/90 = Rs.1,200

10,800 + 1200 = 12,000 sales value

Case 3

If sales price is Rs.12,100 and profit on cost is 10%. Assume Cost price
is Rs.100. Sales price is Rs.110 [i.e.100 + 10]. If sales price is Rs.110, profit
is Rs.10. Profit on sales price of Rs.12,100 is

12,100 × 10/110 = Rs.1,100 profit

Illustration 7
From the following information, calculate the value of goods sold.

Rs.

Total Cost of Production 1,45,000

Opening stock of finished goods 22,000

Closing stock of finished goods 6,000

Selling and distribution overheads 25,000

Profit 22,000

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Solution
Statement showiniz Sales
Details Amount
(Rs.)
Notes
Total cost of production 1,45,000
Add : Opening stock of finished goods 22,000
1,67,000
Less Closing stock of finished goods 6,000
Cost of Goods sold 1,61,000
Selling and distribution overheads 25,000
Total Cost 1,86,000
Profit 22,000
Sales 2,08,000

There is no prescribed format of a Cost sheet. It may change from industry

to industry. A specimen format of a Cost Sheet is given as under:
Particulars Total (Rs.)
A. Materials Consumed :
Purchases ..............
Add : Opening Stock of Raw material ..............
Expenses on Purchases ..............
Less : Closing Stock of Raw Material ..............
Direct Material consumed .............. ..............
B. Direct Labour (Wages) ..............
C. Direct Expenses ..............
D. Prime Cost (A + B + C) ..............
E. Factory/Works Overheads ..............
Add : Opening Stock of Work-in-Progress ..............
Less : Closing Stock of Work-in-Progress ..............
F. Works/Factory Cost (D + E) ..............
G. Office and administration overheads ..............

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H. Total Cost of Production (F + G) ..............
Add : Opening Stock of finished Goods ..............
Cost of Goods available for sale ..............

Notes Less : Closing Stock of finished Goods ..............

I. Cost of production of goods Sold or cost of good sold ..............
J. Selling and Distribution Overheads ..............
K. Total Cost (I + J) = Cost of Sales ..............
L. Profit ..............
M. Sales (K + L) ..............

Preparation of cost sheet

The various components of cost explained above are presented in the form
of a statement. Such a statement of cost consists of prime cost, works cost,
cost of production of goods, cost of goods sold, total cost and sales and
is termed as cost sheet. The Preparation of a cost sheet can be understood
with the help of following illustration:

Illustration 8
From the following information, prepare a cost sheet for period ended on
31st March 2006.
Rs.
Opening stock of raw material 12,500
Purchases of raw material 1,36,000
Closing stock of raw material 8,500
Direct wages 54,000
Direct expenses 12,000
Factory overheads 100% of direct wages
Office and administrative overheads 20% of works cost
Selling and distribution overheads 26,000
Cost of opening stock of finished goods 12,000
Cost of Closing stock of finished goods 15,000
Profit on cost 20%

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Solution:
Cost sheet
Details Amount
(Rs.)
Notes
Direct Material : Material consumed 12500
Opening ‘stock of raw material 136000
Add: Purchases 148500
Less: Closing stock of raw material 8500 1,40,000
Direct wages 54,000
Direct expenses 12,000
Prime cost 2,06,000
Factory overheads: 100% of direct wages 54,000

FG 54000 IJ
H
(i.e. 100 ×
100 K
Works cost 2,60,000
Office and administrative overheads
20% of works cost, (2,60,000 × 20/100 52,000
Total cost of production 3,12 000
Add : opening stock of finished goods 12,000
Cost of Goods available for sale 3,24,000
Less : Closing stock of finished goods 15,000
Cost of goods sold 3,09,000
Selling and distribution overheads 26,000
Total Cost = cost of sales 3,35,000
Profit (20% On Cost i.e. 3,35,00 × 20/100) 67,000
Sales 4,02,000

Illustration 9
The following information is given to you from which you are required to
prepare Cost Sheet for the period ended on 31St march 2006:

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 MODULE - 6B Cost Sheet
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Consumable material: Rs.
Opening stock 20,000
Purchases 1,22,000
Closing stock 10,000
Notes Direct wages 36,000
Direct Expenses 24,000
Factory overheads 50 % of direct wages
Office and administration overheads 20% of works cost
Selling and distribution expenses Rs.3 per unit sold
Units of finished goods
In hand at the beginning of the period (Value Rs. 12500) 500
Units produced during the period 12,000
In hand at the end of the period 1,500
Find out the selling price per unit if 20% profit on selling price. There is
no work-in-progress either at the beginning or at the end of the period.

Solution:
Cost Sheet for the period ended on 31st March 2006 (output 12000units)
Particulars Total cost Cost per
unit

Material Consumed:
Opening Stock 20000
Add: Purchases 122000
142000
Less: Closing Stock 10000
Cost of raw material consumed 132,000 132000 11.00
Direct wages 36000 3.00
Direct Expenses 24000 2.00
Prime Cost 192000 16.00
Factory Overheads
50% of Direct Wages (i.e. 12000 × 1.50) 18000 1.50
Works/Factory overheads 210000 17.50
Office overheads
20% of works cost 42000 3.50
Total Cost of production 252000 21.00

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Add: Opening stock of finished goods (500 units @ 25) 12500
Cost of goods available for sale (12000 + 500) 264500
Less : Closing stock of Finished goods @ 21per 31500
unit (1500 units)
Cost of goods sold (12500 – 1500 = 11000 units) 233000 21.18
Notes
Add: Selling & Distribution overheads @ per unit 330001 3.00
Cost of Sales 266000 24.18
Add: Profit 20% On Selling Price i.e. 25% of cost of sales 66500 6.04

FG 266000 × 25 IJ
Sales
H 100 K
332500 30.22

INTEXT QUESTIONS 29.3

Fill in the blanks with suitable words:
(i) ...................... is also termed as administrative cost or total cost of
production.
(ii) Cost of production of goods sold = ...................... + opening stock
of Finished goods – closing stock of finished goods
(iii) Total cost is also termed as ......................
(iv) If profit is added to the total cost ...................... are arrived at.
(v) Sales = ...................... + Profit.

WHAT YOU HAVE LEARNT

Cost Sheet: Meaning :
Cost sheet is a statement, which shows various components of total cost
of a particular product. Cost sheet is prepared on the basis of :

Historical Cost

Estimated Cost

The importance of cost sheet is follows:

Cost ascertainment

Fixation of selling price

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 MODULE - 6B Cost Sheet
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Help in cost control

Facilitates managerial decisions

Components of Total Cost

Notes Prime Cost = Direct material + Direct Wages + Direct expenses works/
factory cost;
Factory Cost = Prime cost + Factory overheads
Cost of production/office cost = Factory Cost + office and administration
overheads
Cost of production of goods sold = Cost of Production + Opening stock
of Finished’ goods – closing stock of finished goods
Total Cost = Cost of Production of goods sold + Selling and distribution
overheads
Sales = Total Cost + Profit

The various components of cost explained above are presented in the
form of a statement.

TERMINAL QUESTIONS
1. What is meant by cost sheet? Explain the importance of Cost Sheet.
2. Define various components of total cost.
3. Compute the cost of material consumed from the following data:
Opening stock of raw material Rs.9,000
Purchases of raw material Rs.1,27,000
Closing stock of raw material Rs.12,000
4. Compute Prime cost from the data given below:
Rs.
Direct Material 1,80,000
Expenses on purchases 20,000
Rent of special machine taken on hire for production 40,000
Productive wages 65,000

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5. From the following information., prepare cost sheet.
Rs.
Direct material 1,60,000
Direct Labour 45,000
Direct Expenses 15,000 Notes
Factory overheads 35,000
Office and administration overheads 20% of works cost
Selling and distribution overheads 45,000
Opening stock of finished goods 25,000
Closing stock of finished goods 10,000
Profit on Sales 10%

ANSWERS TO INTEXT QUESTIONS

Intext Questions 29.1

II. (i) Components (ii) Selling price
(iii) Historical (iv) estimated
(v) selling price (vi) Estimated

Intext Questions 29.2

I. Direct material + Direct wages + Direct expenses
II. (i) Classified, analysis (ii) basic, direct
(iii) Opening stock of material (iv) production
(v) work-in-progress.

Intext Questions 29.3

(i) Office cost (ii) cost of production
(iii) cost of Sales (iv) sales
(v) Total Cost or cost of sales.

Answers to Terminal Questions

3. Materials consumed Rs.1,24,000
4. Prime cost Rs.305,000
5. Sales Rs 4,07,000

ACCOUNTANCY 137
 Cost-Volume-Profit
Relationships
6

Accountants and Managers are continually planning operations and

making analyses to find best alternatives – whether to accept a certain
business at a specified price or not, whether aggressively push the sales
of one product or other, whether to exploit more intensively one or the
other of the territories. Managers must understand the interrelationship of
cost, volume, and profit for planning and decision making. In making
their decision, managers need to understand relationship between selling
price, sales volume, and costs. The method of studying the relationship
among these factors is known as cost-volume- profit analysis (C-V-P
analysis). They are also required to understand which costs should vary
with changes in volume and which costs would stay the same. Without
the knowledge of the behavior of cost, that have already discussed in
detail in unit 2 of this book, they can not accurately determine the effect
of price, volume or cost changes on the company’s operating profit. In
this unit, we discuss C-V-P analysis that provides accountants and
managers with a comprehensive overview of the effects on revenue and
costs of all kinds of short run financial changes.
School of Business

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Lesson-1: Basics of Cost-Volume-Profit Relationships

After completing this lesson, you are expected to be able to:
 Know the meaning objectives and assumptions of cost-volume profit
analysis.
 Know the importance of cost-volume profit analysis.
 Know what contribution margin is and how it is calculated.
 Solve the problems relating to cost-volume profit.

Introduction
In simple words, cost-volume-profit (hereafter C-V-P) analysis is the
most fundamental tool because it provides straightforward ways to study
the effects of changes in costs and volume on a company’s profits. C-V-
P analysis is important in profit planning. In C-V-P analysis executives
and accountants recognize that there are many interacting variables that
affect an organization’s profits-such things as the sales price of a
product, the variable costs per unit, and the volume of production and
sales. C-V-P analysis evaluates the relationships among these interacting
variables and the effect that changes in these variables have on an
organization’s profits. As the term itself suggests, C-V-P analysis is an
C-V-P analysis is an
analytical technique which examines costs and revenue behavioral analytical technique
patterns and their relationships with profit. The analysis separates costs which examines costs
into fixed and variable components and determines the levels of activity and revenue beha-
where costs and revenues are in equilibrium. We define C-V-P analysis vioral patterns and
their relationships
as a mature model in such management decisions as setting selling
with profit.
prices, determining cost, determining the best product mix, and making
maximum use of production facilities. The usual starting point in such an
analysis is the determination of the company’s break – even point. Thus,
break – even analysis forms often a key component of the total system of
C-V-P analysis which gives the executives and accountants many
insights in profit planning.

Basic Components:/Assumptions of C-V-P Analysis

The technique of C-V-P analysis rests on a set of assumptions. These
assumptions may be identified as the fundamental base of such analysis.
The importance of identifying and criticising the underlying assumptions
of C-V-P analysis rests on the practical application of C-V-P analysis.
The assumptions underlying C-V-P analysis are mentioned below:
1. Total costs are separated into fixed and variable costs.
2. A firm’s total revenue changes in direct proportion to changes in
its unit sales volume. That is, the average sales price per unit of
product is constant.
3. Fixed costs remain fixed over a relevant range of activity.
4. Variable cost per unit is also constant. Therefore, total variable
costs are directly proportional to volume. There is either no

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 School of Business

inflation or, if it can be forecasted, it is incorporated into the C-V-P

analysis. This eliminates the possibility of cost changes.
5. Selling prices are constant per unit.
6. Prices of factors of production e.g. material price, wage rate etc.
are constant.
7. There will be no changes in firm’s efficiency or productivity.
8. Changes in activity are the only factors that affect costs.
9. All units produced are sold. Inventories are significants.
10. In a multi-product firm , the sales mix will remain constant. If this
assumption is not made, no weighted average contribution margin
could be computed for the company.
11. There will not be any significant change in the inventory level at
the beginning and at the end of the year.
12. The firm is assumed to make analysis under short run .
13. The analysis will be effective for a limited range of operation over
which the firm was operating in the past and expected to operate in
future. It is known as relevant range. Relevant range is the levels of
activities within which a particular cost behavior does not change.
[C-V-P analysis under uncertainty is treated separately.]
14. Uncertainty and risks do not exist.
It is frequently found that students are quite happy to apply C-V-P
analysis principles in theoretical setting but may be unaware of these
assumptions and how restrictive they really are. When these assumptions
are not valid, the results of C-V-P analysis may be inaccurate. These
assumptions are also termed as limitations of C-V-P analysis.

Objectives of C-V-P analysis

Accountants and executives are uncertain about some of the variables
The basic objective of
C-V-P analysis is to
used in C-V-P analysis, though this analysis can be used to answer
establish what will several types of questions and can be helpful in decision making. The
happen to the basic objective of C-V-P analysis is to establish what will happen to the
financial position if financial position if the output level fluctuates. This analysis will help the
the output level management to:
fluctuates.
1. Make reasonably accurate forecast of future profits;
2. Assess the degree of risk involved in output fluctuation. If the
present activity level of the organization is very near to no profit
no loss situation or the proportion of fixed cost in the cost structure
is very high, the degree of risk will be high in as much as a slight
fall in output will lead to a significant fall in profit. This is also
known as operating risk.

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 Bangladesh Open University

3. Take different decisions that are important for the operations of

business. It includes pricing decisions, make or buy decision, shut
down decision and like.
4. Prepare budget for future activities. (jayanta ghosh; p.9.15)

Contribution Margin (CM)

One of the key relationships in C-V-P analysis is the contribution margin
(CM) . Contribution margin is the excess of revenue over the variable
costs of generating that revenue.

Contribution Margin = Sales - Variable Costs of Sales

This amount indicates the taka figure available to ‘contribute’ to the
Contribution margin
coverage of all fixed expenses, both manufacturing and non- is used first to cover
manufacturing. The sequence here is that, contribution margin is used the fixed expenses,
first to cover the fixed expenses, and then whatever remains goes toward and then whatever
profit. If the contribution margin is not sufficient to cover the fixed, then remains goes toward
a loss occurs for the period. profit.

We will use following relevant data of the Appollo Company to

understand various important issues relating to C-V-P analysis.
Unit selling price : Tk.50
Unit variable costs : Tk.30
Total monthly fixed costs : Tk.20,000
Units sold : 1000 units
Therefore, Contribution Margin is : (Sales – Variable Costs of Sales)
: (1000 units  Tk.50) – (1000 units
 Tk.30) = Tk.20,000
This contribution margin is then available to cover fixed costs and to
contribute income for the Appollo Company. In other words, this
indicates how much revenue is available to cover all period expenses and
potentially to provide net income.
Viewers differ as to the best way to express contribution margin (CM).
Some executives and accountants favor a per unit basis. We can
determine the amount that each unit contributes – the contribution
margin per unit (CMPU) in two different ways. In the first way we
merely subtract the variable cost per unit from the sales price per unit:

Contribution Margin Per Unit (CMPU) : Sales price per unit –

Variable costs per unit
At the Appollo Company, the CMPU is Tk. 20, computed as follows:
CMPU= Tk.50 – Tk.30 = Tk.20
The contribution margin per unit indicates that for every unit sold,
Appollo company will have Tk.20 to cover fixed costs and contribute to
income. In other words, this means that each time a unit is sold, it
provides, or contributes, the difference between the sales price and the

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unit variable costs toward covering the fixed costs needed to produce and
sell all the units.
Since fixed costs are Tk.20,000, Appollo must sell 1000 units (Tk.20,000
/ Tk.20) before there is any income. Above the sales volume of 1000
units, every unit sell will contribute Tk.20 to income.
The second way to calculate CMPU is to divide the total contribution
margin by the number of units sold. :
Contribution Margin Per Unit (CMPU) : Total Contribution margin
--------------------------------
Units sold
Contribution Margin Ratio (CM Ratio): In addition to being expressed
on a per unit basis, sales revenue, variable costs, and contribution
margin, some executives and accountants prefer to use another
relationship in C-V-P analysis , which is known as contribution margin
ratio. The contribution margin ratio (or contribution margin percentage)
represents the portion of total sales that remains after the variable costs
have been subtracted. This ratio is computed as follows:
Contribution Margin Ratio =
Total contribution margin
---------------------------------  100 %
Total sales Taka

Tk.20,000  100 = 40%

At the Appollo company, the CM ratio is : -----------------------------------
(1000 units  Tk.50)
The CM ratio of 40% means that 40 paisa of each sales taka (Tk.1 
40%) is available to apply to cover fixed costs and to contribute to
income. The CM ratio is extremely useful since it shows how the
contribution margin will be affected by a change in total sales. This
expression of contribution margin is important in determining the effect
of changes in sales on income.
A second way to determine the CM ratio involves the contribution
margin per unit and sales price per unit:
CMPU
Contribution Margin Ratio : --------------------------  100 %
Sales price per unit
Finally , we can calculate the contribution margin ratio by subtracting
the variable cost percentage from 100% , or the variable cost ratio from
1.
Contribution Margin Ratio : 100%- Variable Cost % (VC%)
or
1 – Variable cost % (VC%)
If the contribution margin ratio = 1 – VC% , then conversely the VC% =
1 – CM ratio.

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Variable cost percentage (VC%) can be calculated in total sales form or

per unit basis in the following ways:
Variable cost percentage (VC%) =
Total variable costs of Sales
----------------------------------  100%
Total sales taka
Or
Variable cost per unit
-------------------------------
Sales price per unit
We have seen several ways to calculate contribution margin, contribution
margin per unit and contribution margin ratio. It is not necessary to use
all of these approaches in any one situation, it is likewise improbable
that you can use a single approach in all situations. It is probably a good
idea for you to understand each of the approaches, but the approach you
will follow depends on the exact information you are provided with.

Demonstration Problem
Problem no. 6.1.1
The following information relates to three months' activities of a
company which manufactures a single product.
Month Production (Units) Total Cost (Tk.)
June 2004 12,500 1,15,000
July 14,000 1,24,000
August 16,400 1,38,400
Required:
Examine the above figures and calculate:
(a) Variable cost per unit, and
(b) Total fixed cost

Solution to the Demonstration Problem:

(a) Calculation of variable cost per unit
Month Units Monthly Total Cost Monthly Variable
produced changes in Tk. change in cost per
units costs unit
Tk. Tk.
June 12,500 - 1,15,000 - -
July 14,000 1,500 1,24,000 9000 6.00

(b) Calculation of Fixed cost

Fixed Cost = Total Cost - Variable Cost

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For the month of July Tk.1,24,000-(14000 units  Tk.6.00) = Tk.40,000

For the month August Tk.1,38,400-(16,400 units  Tk.6.00) = Tk.40,000

Problem 6.1.2
The 2004 sales of Misu Company were Tk.76,40,000. Fixed Cost was
Tk.24,51,000 and variable cost totaled Tk.47,36,800.
Required: (a) Computes the contribution margin
(b) Computes the contribution margin ratio.
Solution to the Demonstration Problem:
(a) Contribution Margin = Sales - Variable costs
= Tk.(76,40,000 – 47,36,800)
= Tk.29,03,200
Total Contribution Margin
(b) Contribution Margin ratio :  100
Total Sales

Tk.29,03,200
=  100
76,40,000
= 38%
Problem 6.1.3
XY Corporation estimates the following results for 2004:
Sales revenue (30,000 units @ Tk.8.00) Tk.2,40,000
Cost of Goods Sold
Finished Goods Inventory, beginning Tk.9,000
Cost of Goods manufactured 1,53,000
Total Goods available for sale 1,62,000
Finished goods inventory, ending 9,000
Cost of Goods Sold 1,53,000
Gross Margin 87,000
Selling and Administrative expenses
Variable 30,000
Fixed 36,000
Total Selling and administrative expenses 66,000
Operating income Tk.21,000

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There will be no beginning or ending work-in-process inventory. Cost of

goods manufactured will consist of Tk.60,000 in direct materials,
Tk.45,000 in direct labor, Tk.30,000 in variable overhead and Tk.18,000
in fixed overhead.

Required:
(a) Calculate contribution margin.
(b) Calculate contribution margin per unit.
(c) Calculate contribution margin ratio.

Solution to the Demonstration Problem:

(a) Contribution margin = Sales - Variable Costs
Sales revenue Tk.2,40,000
Variable Costs:
Direct materials Tk.60,000
Direct Labor 45,000
Variable overhead 30,000
Variable selling and administrative expenses 30,000 1,65,000
Contribution margin Tk.75,000

Total Contribution Margin

(b) Contribution Margin per unit = -----------------------------------
Units Sold

Tk.75,000
= -------------------- = Tk.2.50 per unit
30,000 units

Total Contribution Margin

(c) Contribution Margin ratio =  100
Total Sales

Tk.75,000
=  100
Tk.2,40,000
= 31.25%

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ASSIGNMENT MATERIALS
A. Quizzes Questions:
1. Which of the following statements are true and which are
false?
(i) Cost-volume-profit relationships that are not linear can be analyzed
linearly by considering only the relevant range of volume.
(ii) In Cost-volume-profit analysis, the volume index is always stated
in takas.
(iii) When cost-volume-profit analysis is used, the need for a cost
accounting system is eliminated.
(iv) A method used to estimate how changes in the total fixed costs,
unit sales price, sales volume, unit variable costs, and sales mix
will affect profit is known as C-V-P analysis.
(v) The contribution margin is the difference between total revenue
and fixed costs.
(vi) The contribution margin increases in proportion to any increase in
variable costs.
(vii) If product A has a higher unit contribution margin than product B,
then product A will always have a higher contribution margin ratio
than product B.
(viii) Item A sells for Tk.5. Fixed cost per unit is Tk.1, and variable
costs per unit is Tk.3. The contribution margin ratio for item A is
20%.
(ix) For a given increase in sales dollars, a high CM ratio will result in
a greater increase in profits than will a low CM ratio.
(x) Product B sells for Tk.12. Fixed costs per unit are Tk.4, and
variable costs are Tk.7. The unit contribution margin is Tk.5.
(xi) If a company's cost structure shifts toward greater fixed costs and
lower variable costs, one would expect the company's CM ratio to
fall.
(xii) In cost-volume-profit analysis, the number of units sold is assumed
to be equal to the number of units produced.

B. Multiple-choice:
2. Choose the best answer for each of the following questions by
placing the identifying letter in the space provided to the left.
(i) In cost-volume-profit analysis, income tax expense:
(a) Is included among the monthly operating expenses as a
variable cost.
(b) Is considered as a fixed cost of doing business.
(c) Is treated as a semi-variable cost that is partially dependent
upon sales volume.
(d) Is generally ignored.

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(ii) Within the relevant range of production, average variable cost per
unit tends to:
(a) Fluctuate drastically.
(b) Vary inversely with the level of production.
(c) Vary directly and proportionately with the level of
production
(d) Remain relatively constant.

(iii) The contribution margin ratio is computed as:

(a) Sales minus variable costs, divided by sales.
(b) Fixed costs plus variable costs, divided by sales.
(c) Sales minus fixed costs, divided by sales.
(d) Sales divided by variable costs.

(iv) The contribution margin ratio is the ratio of the contribution

margin to sales revenues. If sales revenue and variable costs both
increase 10% and fixed costs do not change, what is the effect on
the contribution margin ratio?
(a) The contribution margin ratio will remain unchanged.
(b) The contribution margin ratio will increase.
(c) The contribution margin ratio will decrease.
(d) The change cannot be determined.

(v) The present unit cost data for a product are : Selling price Tk.15,
variable cost Tk.8. If selling price is reduced by 10% and variable
cost is increased by 12.5%, which of the following is the amended
contribution to sales ratio?
(a) 0.50
(b) 0.666
(c) 0.333
(d) 0.25

(vi) The contribution margin is also known as?

(a) Marginal income
(b) Net income
(c) Net operating profit.
(vii) If the fixed costs attendant to a product increase while variable
costs and sales price remain constant, what will happen to
contribution margin?
(a) Increase
(b) Decrease
(c) Unchanged

(viii) Using the following information calculate contribution margin

ratio.
Sales Revenue (47,500 units) Tk.1,18,750
Variable costs 57,000
Contribution margin 61,750
Fixed costs 50,000
Operating income Tk.11,750

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(a) 10%
(b) 42%
(c) 48%
(d) 52%
(ix) From the above information what is the contribution margin per
unit?
(a) Tk.1.30
(b) Tk.1.20
(c) Tk.1.08
(d) Tk.0.52
(x) Lester Company has a single product. The selling price is Tk.50
and the variable cost is Tk.30 per unit. The company's fixed
expenses are Tk.2,00,000 per month. What is the companys' unit
contribution margin?
(a) Tk.50
(b) Tk.30
(c) Tk.20
(d) Tk.80
(xi) Refer to the data for Lester Company in question # (X). What is
the Companys' contribution margin ratio?
(a) 0.60
(b) 0.40
(c) 1.67
(d) 20.00
(xii) In the area of cost-volume-profit analysis, the contribution margin
ratio shows how much each taka of sales contributes to:
(a) Covering the fixed costs of the business and providing
operating income.
(b) Fixed expenses and variable expenses.
(c) Variable expenses and interest charges.
(d) Variable expenses when production is at normal capacity.

(xiii) A companys' relevant range of production is?

(a) The production range from zero to 100% plant capacity.
(b) The production range over which output may reasonably be
expected to vary.
(c) The production range beyond the break-even point.
(d) The production range that covers fixed but not variable
costs.
(xiv) A 40% contribution margin ratio means that:
(a) The company should contribution 40% of its operating
income.
(b) 60% of the companys' revenue is consumed by fixed and
variable costs.
(c) The companys' revenue has increased by 40% during the
current accounting period.
(d) 40% of the companys' revenue is available to cover fixed
costs and to contribute toward operating income.

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(xv) Which of the following is not applied to a companys' contribution

margin?
(a) It is the amount of revenue left over after fixed and variable
costs have been paid.
(b) It may be expressed in total takas or on a per-unit basis.
(c) Part of it provides the company's operating profit.
(d) Expressed as a percentage of sales, it is called the
contribution margin ratio.

C. Descriptive Questions:
1. "Cost-volume-Profit (C-V-P) analysis is based entirely on unit
costs'. Do you agree? Explain.
2. What is cost-volume-profit analysis? What are its objectives? State
the assumptions behind cost-volume-profit analysis.
3. What is meant by the term "cost-volume-profit" analysis? Why is
this analysis important in business management?
4. In classifying a particular cost as fixed or variable, the volume or
activity level is extremely important". Discuss and illustrates this
statement.
5. What is contribution? How does it help the management in solving
various business problems?
6. "The contribution approach is the foundation of C-V-P logic and
related techniques" Discuss.
7. What are the assumptions underlying cost-volume-profit analysis?
Since these assumptions may not meet in any given situation, are
the results of CVP analysis totally useless to management?
8. What is the difference between a company's gross margin at its
total contribution margin?
9. What does the term relevant range mean? Why is it important to
consider what the relevant range is in individual applications?

Key to Quizzes
(i) T; (ii) F; (iii) F; (iv) T; (v) F; (vi) F; (vii) F; (viii) F; (ix) T; (x) T; (xi)
F; (xii) T.
Key to Multiple Choice Questions:
(i) d; (ii) d; (iii) a; (iv) a; (v) c; (vi) a; (vii) c; (viii) d; (ix) a; (x) c; (xi) b;
(xii) a; (xiii) b; (xiv) d; (xv) a.

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Lesson-2 : Break-Even Analysis

After completing this lesson, you should be able to :








Introduction
Break-even analysis is a technique that helps management accountants
planning profit. Sometimes managers may wish to know the sales
required to just cover fixed costs without earning any profit or showing
any loss. In a business context, the break-even analysis is of interest if
managers have a reasonably good idea of future sales levels and want to
know how much cushion they have between expected sales and sales at
break-even. The break-even analysis is the most widely known form of
the cost-volume -profit analysis. The study of CVP/CPV analysis is
frequently referred to as break-even analysis. However, some state that
up to the point of activity where total revenue equals total expenses, the
study can be called as break-even analysis, while, beyond that point, it is
the application of cost-volume profit analysis. But this concept is not
widely used.

Meaning of Break-Even Analysis

Break - even analysis is a second key relationship in cost-volume profit
The point of sales analysis where the level of activity at which total revenues equal total
volume (in units or in costs, both fixed and variable. This level of activity is called break-even
money value), at
which total cost is
level. The point of sales volume (in units or in money value), at which
equal to total revenue, total cost is equal to total revenue, is identified under the cost-volume-
is identified under the profit analysis as the break-even point. It is also known as no profit no
cost-volume-profit loss point because at this point the organization's revenues and expenses
analysis as the break- are equal i.e. the organization's has no profit no loss; it breaks even.
even point.
If the production and sales exceed the break-even point profit earning
process starts. In a reverse manner if the production and sales fall below
this level, operating costs are not covered and the firm suffers a loss. So,
break-even analysis is useful for evaluating organization's alternatives
and the change in profitability with changes in production and sales
activity levels.

Assumptions of Break -Even Analysis:

Before the student draws any conclusions with respect to the accuracy of
or the desirability of the break-even point, it is essential that he is

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acquainted with the assumptions which have been made in this analysis.
The underlying assumptions of a break-even point are given below:
a) The behavior of cost and revenue has been reliably determined and is
linear over the relevant range. The relevant range of activity is a
range of activity in which the fixed costs do not respond to changes
in activity.
b) All costs are divided into fixed and variable.
c) Fixed costs will remain constant over the relevant volume range of
the break even analysis.
d) Variable costs are proportional to volume.
e) Selling price are to be unchanged.
f) Prices of cost factors are to be unchanged.
g) Efficiency and productivity are to be unchanged.
h) The analysis either covers a single product or it assumes that a given
sales mix will be maintained as total volume changes.
i) Revenue and costs are being compared on a common activity base.
j) Perhaps the most basic assumption is that volume is the only
relevant factor affecting cost. Of course, other factors also affect
costs and sales. Ordinarily cost-volume-profit analysis is a crude
over simplification when these factors are unjustifiably ignored.
k) Changes in beginning and ending inventory levels are insignificant
amount.

Uses of Break -Even Analysis:

Break -even analysis may be used by management accountants and
executives as a tool in the decision -making process. It may give some
guidelines for taking optimum decisions. Some of the uses of the break-
even analysis are given below:
(a) A sales manager can have the idea about the sales volume that
must be sold either to make desired amount of profit or to break-
even.
(b) A producer may know the percentage of capacity to be utilized to
cover the amount of fixed costs.
(c) Management can know the effect of changes in selling price,
volume of sales and costs of production on profitability.
(d) Management can use it to find out the comparative profitability of
product lines.
(e) It may be used to determine the suitability of alternative
machineries.

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(f) It may help the management in the following situations:

(i) Determine the optimum sales volume.
(ii) Suggestions for shift in sales mix.
(iii) Acceptance of special orders.
(iv) Changes in fixed costs.

Break -Even Computation

As stated in the definition break -even point can be expressed either in
sales taka or sales units and can be approached in three following ways.
1. Computed from a mathematical equation.
2. Computed by using contribution margin.
3. Derived from a cost-volume-profit (CVP) graph and break-even
chart.
1. Mathematical Equation Approach: Under the mathematical
equation approach break-even can easily be computed based on the
profit equation. We know that, income( or profit) is equal to sales
revenue minus expenses. Keeping in mind that expenses are
separated in to fixed and variable expenses , the essence of income
(profit) statement is captured in the equation form as follows:
Sales revenue –
Variable expenses – Sales revenue – Variable expenses – Fixed expenses = Profit
Fixed expenses =
Profit Taking the above equation little bit further, it can be restated as follows:
[(unit sales price) x (sales volume in units)] - [(unit variable
expenses) x (sales volume in units)] - (fixed expenses ) = profit
Since it cannot be known how many units would have to be sold in
order to know break- even, we substitute the letter X in the equation for
sales volume in units, and as at the break-even point profit is zero, let net
income (profit) = 0, or break-even. Therefore, the break-even point can
be computed by finding the point where sales i.e. X just equal the total of
the variable expenses plus the fixed expenses.
2. Contribution Margin Approach: As mentioned in the previous
lesson, contribution margin equals the difference between total
revenues and total variable costs of sales. In fact this approach is
actually just a shortcut version of the mathematical equation
approach. The approach centers on the idea that at the break -even
point, contribution margin must equal total fixed costs. On the
basis of this relationship, we can find out break-even point by
using either the contribution margin per unit or the contribution
margin ratio or M/I ratio or P/V ratio.
When the contribution margin per unit is used, the general formula for
computing the break-even sales volume in units is given below:

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Fixed Costs
Break-even point (in units) =
Unit contribution per unit
Sometimes management prefers to determine break-even point in sales
taka rather than units. The following formula provides an alternative
method to determine the break-even point in sales taka.

Fixed Costs
Break-even point (in sales taka) =
Unit contribution margin
Unit sales price
As we have mentioned earlier that unit contribution margin divided by
the unit sales price is called the contribution margin ratio, the above
formula can be rearranged as follows:

Fixed Cost
Break-even point (in sales taka) =
Contribution ratio
Both the methods are same approaches for determining the break -even
point. Selecting between the two is based on personal preference. But the
contribution margin approach enjoys an added advantage over
mathematical approach because the latter method is useful in those
situations where an organization has multiple product lines and wishes to
determine a single break-even point for the organization as a whole.
3. Cost-Volume -Profit (CVP) Graphic Presentation: An effective
way to derive the break-even point is to prepare a break -even
graph. A break - even graph is a graphic approach to the study of
the relationship of cost, revenue and profit. Because this graph
also shows costs, volume , and profits, it is referred to as the
cost-volume-profit (CVP) graph. The graphic presentation
instead of other methods discussed earlier is often used because it
tends to be more easily understood by persons whose acquaintance
with mathematics is minimal and because it provides an immediate
view of variable expenses, fixed expenses and profit at any level of
activity.

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Margin of Safety
Margin of
safety Angle of Sales S
Incidence Profit
BEP Profit C

BE C1
(sales Total Cost B
O1 F
Loss
BEP (unit)
O X
Sales Volume (Output in Units) Margin of Safety

Sales volume (Output in Units)

We can illustrate break even analysis by means of the above graph. Such
a graph is often referred to as a break even chart, which depicts sales
revenues, and fixed, variable, and total costs, with a break even point at
the intersection of the sales revenue and total cost curve.
The following steps are used to prepare CVP graph.
Step 1 : Sales volume (output in units) is shown in OX horizontal
axis.
Step 2 : Costs and Revenues is shown in OY vertical axis.
Step 3 : O1F line is drawn which is the total cost curve and parallel to
the OX horizontal axis because fixed costs are constant at all
activity levels.
Step 4 : OS is the Total sales revenue curve which intercept the fixed
costs line and O1C is the variable costs curve.
Step 5 : At point B total costs and total sales are equal because at this
The break even point point the sales revenue curve has intersected the total costs
is indicated by the
point at which the
curve. This B point is the break-even point. So the break
total cost curve even point is indicated by the point at which the total cost
intersects the total curve intersects the total sales revenue curve, because profit
sales revenue curve. equals zero when total costs equals total sales revenues.
Step 6 : FX is the fixed costs, CF is the variable costs and SC is the
profit earned.
Step 7 : The area of the triangle SBC is the profit earning area, while
SBC1 is the area indicating margin of safety.

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Step 8 : The angle lying in the right side of the point of intersection
Angle lying in the
of the sales revenue curve and total cost curve (i.e. point B)
right side of the point
is the angle of incidence. So <SBC is the angle of incidence. of intersection of the
This angle explains the interrelation between sales and sales revenue curve
profit. It also indicates the profit earning capacity of and total cost curve
organization over its break-even level of sales. A large angle (i.e. point B) is the
angle of incidence.
of incidence is an indicator of high profit margin and vice-
versa.
In addition to identifying the break-even point, the CVP graph also
depicts the loss area. It is very useful because the effects of a change in
any elects in the CVP analysis can be easily portrayed and observed.

Break-even Point: Accounting Viewpoint vs Economics

Viewpoint
The accountants and the economists draw break-even charts in two
different ways as shown below:
T.R.

T.C.
T.C.

T.R. F.C.

Economists' Break-even chart Accountants' Break-even chart

(i) Accountants assume that variable costs per unit will remain constant
with the change in volume, Economists do not do it.
(ii) Accountant draw the sales line on the assumption that selling price
per unit will not change with the change in production volume. The
economists assume that the price will go down with the increase in
supply.
The economies and diseconomies of scale are taken into account by the
economists. The economists, break-even chart is more realistic, but it
will be relatively expensive. The accountants' one is simple and less
costly.

Limitations of Break-even Analysis

The break-even analysis is a deterministic one. The major limitations of a
break-even analysis stem from the fact that it is subject to certain
assumptions which make the same unrealistic. The assumptions are as
follows:

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(i) Exact and accurate classification of costs into fixed and variable is not
possible in real world. Fixed costs vary beyond a certain level of output.
Variable per units is constant and it varies in preparation to the volume.
(ii) Constant selling price is not true. A change in price may increase or
decrease sales volume.
(iii) Total variable costs are proportional to volume. This may not be
true. With the increase in volume of sales, total variable costs may
increase with a decreasing rate.
(iv) Prices of factors of production - material, labor etc. are to be
unchanged. Management should carefully bear this at the time of using
break-even analysis.
(v) Efficiency and productivity are to be unchanged. But in reality, these
change with the changes in volume of production, labor mix, experience
etc.
(vi) Importance is given to opening and closing inventory.
(vii) Product mix will remain unchanged. But market may not behave as
expected.
(viii) Units of measurement for various products are identical. This may
not always be true.
(ix) The behavior of total cots and total revenues is linear. In real world
situation, this is a rare event.
Therefore, the particular assumptions limit the use of break-even analysis
in all situations.

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Demonstration Problem
Problem no. 6.2.1
The annual profit plan of the PM Ltd. is given in the following table.
From the data given in the table, calculate the break-even point.
Fixed Variable
expenses expenses Total
Tk. Tk. Tk.
Budgeted sales (20,000 units @ Tk.20) 4,00,000
Budgeted Costs:
Direct labor 70,000
Direct material 1,00,000
Manufacturing overhead 64,000 20,000
Administrative expenses 50,000 10,000
Distribution expenses 30,000 20,000
Total 1,44,000 2,20,000 3,64,000
Budgeted Profit 36,000

Capacity of production : 25,000 units.

Solution to the Demonstration Problem

Contribution margin = Sales – Variable costs

= (Tk.4,00,000 – Tk.2,20,000) = Tk.1,80,000
Total Contribution Margin
Contribution margin per unit = -------------------------------------
Units sold

Tk.1,80,000
= ------------------------- = Tk.9
20,000 units

Fixed Expenses
Break-even point (in units) = ----------------------------------
Unit Contribution margin

Tk.1,44,000
= ------------------------ = 16,000 units.
Tk.9

Break-even sales (in taka) = break even units x selling price

= 16,000 units x Tk.20
= Tk.3,20,000

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Alternatively,
Fixed expenses
Break-even point (in taka) = ---------------------------------
Unit Contribution
---------------------------------
Unit sales price
Tk.1,44,000
= ----------------------- = Tk.3,20,000
9
------------------
20

Problem no. 6.2.2

The Campus Barber Shop employs four barbers. One Barber, who also
serves as the manager, is paid a salary of Tk.1,200 per month. The other
barbers are paid Tk.1,000 per month. In addition, each barber is paid a
commission of Tk.4 per haircut, depreciation on equipment Tk.500,
barber supplies 40 paisa per haircut, utilities Tk.300, and advertising
Tk.200. The price of a haircut is Tk.10.

Required:
(a) Determine the variable cost per haircut and the total monthly fixed
costs.
(b) Compute the break-even point in units and takas.
(c) Prepare a CVP graph, assuming a maximum of 1800 haircuts in a
month. Use increments of 300 haircuts on the horizontal axis and
in 3,000 increments on the vertical axis.
(d) Determine the net income, assuming 1,400 haircuts are given in a
month.
Solution to the Demonstration Problem
(a) Calculation of Variable costs (per haircut)
Barber’s commission Tk.4.00
Store rent 0.6
Barber supplies 0.40
-------------
Tk.5.00

Calculation of Fixed costs (per month)

Barber’s salaries Tk.4200
(1200+1000+1000+1000)
Store rent 800
Depreciation on equipment 500
Utilities 300
Advertising 200
---------------
Tk.6,000

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(b) Selling Price  Units sold = Variable Costs + Fixed Costs

or, Tk.10 X = Tk.5X + Tk.6000
or, Tk.5X = Tk.6000
X = 1200 units

Again Break-even sales (in Tk.) = Variable Costs + Fixed Costs

X = 0.50 X + Tk.6000
0.50X = Tk.6000
X = 6000/0.50 = Tk.12,000
or
Break-even sales (in Tk.) = 1200 units x Tk.10 per haircut = Tk.12,000
(c)

18
Sales Line
15 Total Cost
Break-even point
Line
12

6 Fixed Cost Line

X
0 300 600 900 1200 1500 1800
Number of Haircuts

(d) Net Income = Sales – (Variable Cost + Fixed Costs)

Net Income = (1,400 haircuts  Tk.10) – [(1,400 haircuts 
Tk.5.00) + Tk.6,000]
= Tk.14,000 – Tk.13,000
 Net Income = Tk.1,000

Problem no. 6.2.3

Shafkat and Sanjana, two recent business school graduates, have decided
to open their own copy service business on a part time basis. They
estimate that their annual fixed costs are Tk.64,000 and their average
variable cost for each copy sold at Tk.0.60. They expect their selling
price to average Tk.1.40 per copy.

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Required:
(a) Draw the break-even chart for their business, and indicate all the
relevant costs.
(b) What is their break-even point in Taka? In number of copies?
(c) After their final year of operations, in which they generated
Tk.1,68,000 in revenue, Shafkat and Sanjana decide to pay
themselves each Tk.10,000 per year in salaries. What does their
annual sales now have to be if they want to make the same amount
of profit as they did in their final year?

Solution to the Demonstration Problem

(a)
Total Revenue = 1.40 X

Total Cost = 64000 + 0.60 X

56,000

32,000

Volume (X)

Note : Graph is not to scale

(b) Break-even point (in units) = Variable costs + Fixed Costs

1.40 X = 0.60 X + Tk.64,000
or, Tk.0.80 X = Tk.64,000
X = 80,000 copies.

Again Break-even point Sales = Variable Cost + Fixed Cost

 X = 0.60 X + Tk.64000
 X = 0.60(80,000) + Tk.64,000
 X = 48,000 + 64,000
 X = Tk.1,12,000

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(c) Selling price per copy = Tk.1.40, Total Revenue (Tk.) =

Tk.1,68,000
Number of copies = Tk.1,68,000/Tk.1.40 = 1,20,000 copies.
Total Cost (TC) = Tk.64,000 + Tk.0.60 X 1,20,000 copies
= Tk.1,36,000
Profit = TR – TC
= Tk.1,68,000 – Tk.1,36,000 = Tk.32,000 for the first year.

Fixed Cost for the next year : Tk.64,000 + 2(Tk.10,000) = Tk.84,000

Profit = TR – TC
 Tk.32,000 = (1.40 X – (Tk.84000 + 0.60 X)
 32,000 = 1.40 X – Tk.84,000 – 0.60 X
 32,000 = 0.80 X – Tk.84,000
 0.80X = Tk.1,16,000
X = 1,16,000/0.80 = 1,45, 000 copies

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ASSIGNMENT MATERIALS
A. Quizzes Questions:
1. Which of the following statements are true and which are
false?
(i) At break-even point, the total cost and the total revenue may on
may not be the same.
(ii) The volume of output which course fixed costs to be equal in
amounts to variable costs is called the break-even point.
(iii) In Break-even analysis it is assumed that variable cost will vary
with production in direct ratio and fixed cost will remain fixed.
(iv) The break-even point occurs where the contribution margin is
equal to total variable expenses.
(v) One of the assumptions of break-even analysis is that there is no
change in inventories.
(vi) In real life situations "Break-even charts" are usually curvilinear
and might show more than one break-even point.
(vii) The break-even point can be expressed either in terms of units sold
or in terms of total sales taka.
(viii) At volume levels above the break-even point, a cost-volume-profit
graph will show the revenue line to be above the total cost line.
(ix) Once the break-even point has been reached, net income will
increase by the unit contribution margin for each additional unit
sold.
(x) One way to compute the break-even point is to divide total sales by
the contribution margin ratio.
B. Multiple Choice Questions:
2. Choose the best answer for each of the following questions by
placing the identifying letter in the space provided to the left.
(i) The break-even point in a cost volume profit graph is always
found:
(a) At 50% of full capacity.
(b) At the sales volume resulting in the lowest average unit cost.
(c) At the volume at which total revenue equals total variable
costs.
(d) At the volume at which total revenue equals total fixed costs
plus total variable costs.

(ii) Which of the following will ease the break-even point to decrease?
(a) a decrease in the contribution margin per unit.
(b) an increase in the unit sales price.
(c) an increase in the unit variable costs.
(d) all of the above.

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(iii) As a company's sales move further from its break-even point, one
would expect the degree of operating leverage to :
(a) decrease
(b) increase
(c) remain unchanged
(d) vary in direct proportion to change in the activity level.

(iv) One of the following is not involved in CVP analysis. That factor
is:
(a) sales mix
(b) unit selling price
(c) Fixed cost per unit
(d) volume or level of activity.

(v) Sales are Tk.1,00,000 (500 units), variable costs are Tk.60,000,
fixed costs are Tk.24,000. If selling price is reduced by 10% which
of the following is the break-even sales quantity?
(a) 450 units
(b) 500 units
(c) 400 units
(d) 334 units

(vi) Which of the following is true at break-even point?

(a) Sales revenue = Variable costs
(b) Profit = Fixed Cost + Variable Cost
(c) Sales revenue = total Cost - Variable Cost
(d) Contribution = Fixed Cost

(vii) The break-even point will

(a) increase if sales increase
(b) decrease if sales decrease
(c) increase if variable costs increase
(d) decrease if variable costs increase

(viii) At a break-even point of 400 units sold, the variable costs were
Tk.400 and the fixed costs were Tk.200. What will the 401st unit
sold contribution to profit before income taxes?
(a) 0
(b) Tk.0.50
(c) Tk.1.00
(d) Tk.1.50

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(ix) Agni Company has a single product. The selling price is Tk.50 and
the variable cost is Tk.30 per unit. The company's fixed expenses
are Tk.2,00,000 per month. What is the company's break-even in
sales taka?
(a) Tk.5,00,000
(b) Tk.33,333
(c) Tk.2,00,000
(d) Tk.4,00,000

(x) In comparison to selling a product with a low contribution margin

ratio, selling a product with a high contribution margin ratio
always:
(a) Requires less taka sales volume to cover a given level of
fixed costs,
(b) Results in a greater margin of safety
(c) Results in a higher operating income
(d) Results in a higher contribution margin per unit sold.

(xi) The break-even point in a given situation would be decreased by

an increase in :
(a) the ratio of variable costs to sales
(b) the CM ratio
(c) total fixed costs
(d) none of the above.

(xii) The most important use of the cost volume profit graph is to show :
(a) the break-even point
(b) the CM ratio at various levels of sales activity
(c) the relationship between volume, costs, and revenue over
wide range of activity
(d) none of these.

(C) Descriptive Questions

1. Define "Break-even point". Discuss how it is determined.
2. What are the underlying assumptions in break-even analysis?
Enumerate those assumptions.
3. What are the principal difference between the economist's and the
accountant's break-even models?
4. What do you understand by the term "break-even point?" Why
should it be calculated?
5. "Break-even analysis is of limited use to management because a
company cannot survive by just breaking even. Do you agree?
Explain.

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6. What is Break-even Chart? State the methods and purpose of

constructing such chart.
7. What are the limitations of break-even analysis?
8. "A break-even chart must be interpreted in the light of the
limitations of its underlying assumptions" Discuss.
9. How do the following reflect on break-even volume?
(i) Increase in total fixed cost
(ii) Increase in total physical sales; and
(iii) Decrease in variable cost per unit.
10. Briefly explain each of the following methods of computing a
break-even point in units.
(i) contribution margin approach
(ii) equation approach, and
(iii) graphical approach.

Key to Quizzes
(i) F; (ii) F; (iii) T; (iv) F; (v) T; (vi) ; (vii) T; (viii) T; (ix) T; (x) F.
Key to Multiple Choice Questions:

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Lesson-3: Margin of Safety and Sales Mix

After completing this lesson, you should be able to :







Introduction
Earlier in this unit we have discussed the use of cost-volume-profit
analysis for managerial decision making. To recapitulate, managers must
understand the interrelationship of cost, volume, and profit for planning
and decision-making. Moreover, in making decision, the executives need
to understand relationships between selling prices, sales, volume, and
costs. They also need to understand the volume of sales at which the
firm’s revenues and total costs will be exactly equal. In this lesson we
will look in another relationship and several common applications in
cost-volume-profit analysis.
Margin of Safety:
Margin of safety is the difference between actual or expected sales and
Margin of safety is the sales at the break-even point. In other words, the margin of safety or
difference between
actual or expected safety margin of an enterprise is the difference between the budgeted
sales and sales at the sales revenue and break-even sales revenue. So, this tells the managers
break-even point. the margin between current sales and the break-even point. In a sense,
margin of safety indicates the risk that an organization faces of losing
money. That is, the margin by which sales can fall before the
organization is in the loss area. In other words, margin of safety refers to
the amount by which sales revenue can fall before a loss is incurred.
The margin of safety serves as a guide and is a reliable indicator of the
organizations strength and soundness because even with substantial fall
in sales volume or fall in production, some profit can be made. Narrow
margin of safety, on the other hand, is a pointer of the weak position of
the organization and even a small reduction in sales volume and
production will adversely affect the profit position of the organization.
Margin of safety can be expressed in absolute sales amount or in
percentages.

The formula for stating the margin of safety in taka is :

Actual (Expected Sales) - Break-even Sales = Margin of Safety (in

taka)

In contrast., the formula for determining the margin of safety ratio is:

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Margin of Safety( in taka) Actual (Expected Sales) = Margin of

Safety ratio
Profit -Volume Ratio:
Profit-volume ratio is also memorized as " Marginal Income Ratio". The
The ratio that is used
ratio that is used to analyze the relation between contribution and sales is to analyze the relation
known as profit-volume ratio. The more appropriate term might be the between contribution
Contribution Margin Ratio. It is the relationship between marginal and sales is known as
income and marginal sales volume. This ratio is also called contribution- profit-volume ratio.
sales ratio or marginal income ratio or variable profit ratio. This is often
expressed as a percentage. Generally it is calculated as follows:

Variable cost of sales

1  ---------------------------  Profit-volume ratio(P/V ratio)
Total Sales Taka
There are other ways to calculate P/V ratio:

Contribution
Profit-volume ratio (P/V ratio) =   100
Sales

Changes in contribution
Profit-volume ratio (P/V ratio) =   100
Changes in sales

Profit -volume ratio is a significant tool of cost-volume profit analysis.

The rate of profitability can be measured through this ratio. A high P/V
ratio indicates high profitability and a low ratio indicates low
profitability of the firm.

It is also closely connected to the break-even analysis. For calculating the

amount of break-even sales, the amount of fixed cost is divided by the
P/V ratio. The formula for calculating break even sales is given below:

Fixed costs
Break-Even Sales  
P/V ratio

Profit volume ratio may be augmented either by increasing the selling

price or by reducing the variable costs or both. The adequacy of the
margin of safety should be evaluated by management in terms of such
factors as the vulnerability of the product to competitive strain and to
stagnation in the economy.
Target Net Income:
Sometimes management want to know the sales required to earn a
particular profit that they have set as an objective. This objective called
target net income is extremely useful to management because it indicates
the sales necessary to achieve a specified level of income. The matter of

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finding the volume of sales required to earn a particular target net income
is very similar to the problem of finding the break-even point. The
amount of sales necessary to achieve target net income can be
determined from each of the following modified approaches used in
determining break-even sales.

1. Mathematical Equation
2. Contribution Margin Technique
3. Graphic Presentation.

1. Mathematical Equation: We know that at the break-even point no

profit no loss results for the organization. To modify by adding a factor
for target net income to the break-even equation stated in the lesson 2,
we obtain the following formula for determining required sales.

Target net income = (Unit sales price)  (sales volume required to

earn target net income)  Unit variable expenses)  (sales volume
required to earn target net income)  (Fixed expenses)

Since it can not be known sales volume required to earn target net
income, we substitute the letter X in the equation for sales volume
required to earn target net income. Therefore, sales volume required to
earn target net income can be computed by finding the value of X.

2. Contribution Margin Technique: The unit contribution margin and

contribution margin ratio may be used in calculating income and sales
required to earn particular target net income. When the contribution
margin ratio is used to solve for required sales volume, the required
volume is expressed in sales taka , rather than sales units. The total taka
sales required to earn a target net income is determined as follows:

Fixed Expenses + Target net profit

Taka sales required to earn target net profit = 
Contribution margin ratio

On the other hand, with the help of unit contribution margin, number of
sales units required to earn target net profit can be determined as follows:

Fixed expenses + target net profit

Number of sales units required to earn target net profit = 
Unit contribution

The contribution margin ratio has a distinct advantage over the unit
contribution margin when the organization has more than one product.
In the profit area of 3. Graphic Presentation: Cost-volume -profit graph presented in the
the graph, the lesson 2, shows profit and loss area for various levels of sales volume,
distance between the which enables executives to examine the sales revenue or units required
sales line and the cost to attain different levels of target net income. In the profit area of the
line at any point
depicts net income.
graph, the distance between the sales line and the cost line at any point
depicts net income. One of the important advantage of CVP graph is that

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any targeted net income and its related sales figure can easily be
demonstrated (within the range included in the graph) without
performing separate calculations for each case.
Target Return on Sales: As executives are interested in many types of
analysis, they sometimes wish to earn a net income that is a given
percentage of sales. This ratio, income/ sales, is called return on sales
and is frequently used a measure of profitability. In simplified formula
form, the sales required is calculated as follows:

Fixed Expenses
Sales required = 
Contribution margin ratio  Target return on sales

The logic behind this formula is that of each taka of sales, some percent
(variable -cost ratio) goes to covering fixed expenses and some
percentage goes to providing the desired return on sales.

Sales Mix:

In the foregoing discussion, we have concentrated our discussion only on

one product. Sales mix- is a term that has meaning only for a multi-
product firm. In simple words, the term sales mix means the relative
proportions in which a organization's products are sold. In other words
sales mix refers to the proportionate quantities of the products that make
up the total sales of the company. The sales mix for a multi-product firm
represents the percentage of total sales that is distributed to each product
line. The sales mix percentage for each product line can be calculated as
follows:

Sales of individual product line

Sales mix % = 
Sales of all product lines combined
The term sales mix is an weighty assumption in multi-product CVP
analysis. Break-even sales can be computed for a mix of two or more
products by determining the weighted average unit contribution margin
of all the products. The sales mix is used to compute a weighted average
unit contribution margin. This is the average of the several products' unit
contribution margin, weighted by the relative sales proportion of each
product.

The organization's break-even point in units is computed using the

following method:

Fixed expenses
Break-even point = 
Weighted average unit contribution margin
Management should analysis the company's sales mix by investigating
the impact on profit of changes in sales volume, prices, variable
expenses, fixed expenses, or the sales mix itself. Some important factors

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affecting the sales mix of a company are product selling price, sales force
compensation, and advertising expenditures. A change in one or all of
these factors may cause a company's sales mix to shift. At any levels of
units sold, net income will be greater if more high contribution margin
units are sold than low contribution margin units. Furthermore, an
analysis of this connection reveals that a shift from low-margin sales to
high -margin sales may increase net income, even though there is a
decline in total units sold. Correspondingly, a shift from high-to low-
margin sales may result in a decrease in net income, even despite there
is an addition in total units sold.

Demonstration Problem
Problem No. 6.3.1
Moti Company makes pocket diary that sells for Tk.40 each. For the
coming year, management expects fixed costs to totaled Tk.4,40,000 and
variable costs to be Tk.18.00 per unit.

Required:
(a) Compute break-even sales in taka using mathematical equation.
(b) Compute break-even sales using the contribution margin (CM)
ratio.
(c) Compute the margin of safety percentage assuming actual sales are
Tk.10,00,000.
(d) Compute the sales required to earn net income of Tk.3,30,000.

Solution to the Demonstration Problem

(a) Break-even Sales = Variable costs + Fixed costs
Tk.18
X = ( -----------) X + Tk.4,40,000
Tk.40
X = 0.45 X + 4,40,000
0.55 X = 4,40,000
X = Tk.8,00,000

(b) Contribution Margin per unit = Unit selling price - Unit variable costs
= (Tk.40 - Tk.18)
= Tk.22
Contribution Margin per unit
Contribution margin ratio = ------------------------------------ X 100
Unit selling price
Tk.22
= --------------------- X 100 = 55%
Tk.40

Fixed Costs
Bank-even Sales = ---------------------------------------------
Contribution Margin ratio

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Tk.4,40,000
= -----------------------
55%

= Tk.8,00,000

Actual sales - Break-even Sales

(c) Margin of Safety ratio = ----------------------------------------------
Actual sales

Tk.10,00,000 - Tk.8,00,000
= ------------------------------------------------
Tk.10,00,000
= 20%

(d) Required Sales = Total Variable Costs + Fixed Costs + Net Income
X = 0.45 X + Tk.4,40,000 + Tk.3,30,000
X .55 X = Tk.7,70,000
X = Tk.14,00,000

Problem No. 6.3.2

BOL Ltd. furnished you the following information relating to the half
year ended 30th June, 2004.
Fixed Costs Tk.50,000
Sales value Tk.2,00,000
Profit Tk.50,000
During the second half of the same year the company has projected a loss
of Tk.10,000.

Required:
(a) The P/V ratio, break-even point and the margin of safety and
margin of safety ratio for six months ended 30th June, 2004.
(b) Expected sales volume for second half of the year assuming that
selling price and fixed expenses remain unchanged in the second
half year also.
(c) The break even point and the margin of safety for the whole year
2004.

Solution to the Demonstration Problem

Contribution = Fixed Costs + Profits

= Tk.50,000 + Tk.50,000
= Tk.1,00,000

Contribution
(a) Profit volume ratio (P/V ratio) = -------------------------- X 100
Sales

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Tk.1,00,000
= ---------------------- X 100 = 50%
Tk.2,00,000
Fixed Costs
Break even Point = ----------------------
P/V ratio

Tk.50,000
= ------------------ = Tk.1,00,000
50%

Margin of safety = Actual sales - Break-even sales

= Tk.2,00,000 - Tk.1,00,000
= Tk.1,00,000

Margin of safety (in taka)

Margin of safety ratio = ---------------------------------------------- X 100
Actual sales

Tk.10,000
= --------------------- X 100 = 50%
Tk.2,00,000

(b) Expected sales volume for the second half of the year.
Contribution = Fixed Costs - Loss
= Tk.50,000 - Tk.10,000 = Tk.40,000

Contribution
Expected Sales = --------------------------------
P/V ratio

Tk.40,000
= -------------------------------- = Tk.80,000
50%

(c) Break-even point and margin of safely for the whole year.
Fixed costs for the whole year (50,000 X 2) = Tk.1,00,000
Profit (Tk.50,000 - Tk.10,000) = Tk.40,000
Contribution : Tk.1,40,000

Total sales volume for the whole year (Tk.2,00,000 + Tk.80,000) =

Tk.2,80,000

Margin of Safety : Tk.280,000 – Tk.200,000 = Tk.80,000

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Self-Assessment Questions (SAQs)

A. Quizzes Questions:
1. Which of the following statements are true and which are
false?
(i) One of the key assumptions in break-even analysis is that the sales
mix will not change.
(ii) Margin of safety is the excess of actual sales over break even sales.
(iii) A shift in sales mix toward less profitable products will cause the
overall break-even point to fall.
(iv) Margin of safety has got no relation with the fixed cost.
(v) If the product mix changes, a break-even point that was valid in the
past may no longer be valid.
(vi) A high P/V ratio indicates that with a slight increase in volume, the
profit of the firm can be significantly increased.
(vii) A key assumption in break-even analysis when there is more than
one product is that the sales mix will not change.
(viii) As sales exceed the break-even point a high CM ratio will result in
lower profits than will a low CM ratio.
(ix) P/V ratio can be improved by reducing fixed cost.
(x) In a cost volume profit graph, the taka amount by which actual
sales exceed break-even sales volume is called the margin of
safety.

B. Multiple Choice Questions:

2. Choose the best answer for each of the following questions by
placing the identifying letter in the space provided to the left.
(i) Under a multi-product situations, break-even point is calculated by
using the ratio which is the
(a) simple average of the P/V ratio of all the products
(b) weighted average P/V ratio which takes into consideration
the expected sales mix.
(ii) In multiple product firms, a shift in the sales mix from less
profitable products to more profitable products will cause the
company's break-even point to:
(a) increase
(b) decrease
(c) there will be no charge
(d) none of these.
(iii) The mathematical equation for computing required sales to obtain
target net income is :
(a) Variable costs + Target net income

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(b) Variable costs + Fixed costs + Target net income

(c) Fixed costs + Target net income
(d) None of the above
(iv) The following figures are taken from Parker Company's income
statement; Net Income, Tk.30,000; Fixed Costs Tk.90,000; Sales
Tk.2,00,000 and CM ratio is 60%. The company's margin of safety
in taka is:
(a) Tk.1,50,000
(b) Tk.30,000
(c) Tk.50,000
(d) None of these.
(v) Refer to the data in question (v) above. The margin of safety in
percentage form is :
(a) 60 percent
(b) 75 percent
(c) 40 percent
(d) 25 percent
(vi) Margin of safety may be improved by :
(a) Increasing sales volume
(b) Lowering variable cost
(c) lowering fixed cost
(d) All the above.
(vii) Glory Company is planning to sell 2,00,000 pocket calendar for
Tk.4 per unit. The contribution margin ratio is 25%. If glory will
break-even at this level of sales, what are the fixed costs?
(a) Tk.1,00,000
(b) Tk.1,60,000
(c) Tk.2,00,000
(d) Tk.3,00,000
(viii) When fixed cost is Tk.7,000, profit is Tk.3,000 and sales
Tk.50,000. The P/V ratio is :
(a) 14%
(b) 20%
(c) 25%
(d) Cannot be calculated.
(ix) Noor Company had actual sales of Tk.6,00,000, when break-even
sales were Tk.4,20,000 what is the margin of safety ratio?
(a) 25%
(b) 30%
(c) 331/3%
(d) 45%
(x) An increase in fixed costs will result in the following?
(a) A decrease in the contribution : sales ratio

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(b) A decrease in the contribution per unit

(c) An increase in the break even point sales level
(d) An increase in the margin of safety.
(xi) Hello Company has two products, X and Y, with the following
total sales and total variable costs:
Product X Product Y
Total Sales Tk.20,000 Tk.40,000
Total variable costs Tk.8,000 Tk.28,000
(a) 70%
(b) 50%
(c) 30%
(d) 40%
(xii) Tony Company has sales of Tk.2,00,000 with variable expenses of
Tk.1,50,000, fixed expenses of Tk.60,000, and an operating loss of
Tk.10,000. By how much would Tom have to increase its sales in
order to achieve an operating income of Tk.10% of sales.
(a) Tk.4,00,000
(b) Tk.2,51,000
(c) Tk.2,31,000
(d) Tk.2,00,000

C. Descriptive Questions:
1. What information is conveyed by a cost-volume-profit graph in
addition to a company's break-even point?
2. What does the term sales mix mean? How is a weighted average
unit contribution margin computed?
3. (a) What do you know by margin of safety?
(b) Explain the formula for computation of this margin.
(c) How can the margin of safety be increased?
4. What are the similarities and differences between a CVP income
statement and a traditional income statement?
5. An MBA student defines contribution margin as the amount of
profit available to cover operating expenses. Is the any both in this
definition? Discuss?
6. The rise of the margin of safety is an extremely valuable guide to
the strength of the business. Discuss what are the possible steps to
receptive the position when the "margin of safety" is
unsatisfactory.
7. "The effect of price reduction is always to reduce the P/V ratio, to
raise break-even point, and to station the margin of safety".
Explain and illustrate with numerical examples.

Management Accounting Page-39

School of Business

8. What is profit volume ratio? Describe its importance? How can it

be imparted?
9. A firm's variable cost ratio is 30%, its fixed costs are Tk.3,50,000,
and it wishes to earn a targeted income of Tk.1,40,000. Do you
have enough information to compute the required sales in Taka? If
so, how much sales revenue is needed to earn the targeted income?
If not, what additional information is needed?
10. If there is a charge in the sales mix, does the Contribution Margin
ratio per mix (CMRM) normally remain unchanged? Explain.

Key to Quizzes
(i) T; (ii) T; (iii) T; (iv) F; (v) T; (vi) T; (vii) T; (viii) F; (ix) F; (x) .
Key to Multiple Choice Questions:
(i); (ii); (iii); (iv); (v); (vi); (vii); (viii); (ix); (x) .

Unit-6 Page-40
COST SHEET :

Cost sheet is a statement, which shows various components of total cost of a product. It classifies and
analyses the components of cost of a product. Previous periods data is given in the cost sheet for
comparative study. It is a statement which shows per unit cost in addition to Total Cost. Selling price is
ascertained with the help of cost sheet.

Cost sheet is prepared on the basis of :

1. Historical Cost :

Historical Cost sheet is prepared on the basis of actual cost incurred. A statement of cost prepared after
incurring the actual cost is called Historical Cost Sheet.

2. Estimated Cost :

Estimated cost sheet is prepared on the basis of estimated cost. The statement prepared before the
commencement of production is called estimated cost sheet. Such cost sheet is useful in quoting the
tender price of a job or a contract.

Importance of Cost Sheet

The importance of cost sheet is as follows:

Cost ascertainment :The main objective of the cost sheet is to ascertain the cost of a product. Cost
sheet helps in ascertainment of cost for the purpose of determining cost after they are incurred. It also
helps to ascertain the actual cost or estimated cost of a Job.

Fixation of selling price : To fix the selling price of a product or service, it is essential to prepare the cost
sheet. It helps in fixing selling price of a product or service by providing detailed information of the cost.

Help in cost control : For controlling the cost of a product it is necessary for every manufacturing unit to
prepare a cost sheet. Estimated cost sheet helps in the control of material cost, labour cost and
overheads cost at every point of production.

Facilitates managerial decisions : It helps in taking important decisions by the management such as:
whether to produce or buy a component, what prices of goods are to be quoted in the tender, whether
to retain or replace an existing machine etc.

COMPONENTS OF TOTAL COST :

• Prime Cost : It consists of direct material, direct wages and direct expenses. It is also known as
basic, first, flat or direct cost of a product. Direct material means cost of raw material used or
consumed in production. It is not necessary that all the material purchased in a particular period
is used in production. There is some stock of raw material in balance at opening and closing of
the period. Hence, it is necessary that the cost of opening and closing stock of material is
adjusted in the material purchased.

Prime Cost = Direct material + Direct Wages + Direct expenses

Material Consumed = Material purchased + Opening stock of material – Closing stock of material.

• Factory Cost : In addition to prime cost it includes works or factory overheads. Factory
overheads consist of cost of indirect material, indirect wages, and indirect expenses incurred in
the factory. Factory cost is also known as works cost, production or manufacturing cost.

Factory Cost = Prime cost + Factory overheads

• Adjustment for stock of work-in-progress : In the process of production, some units remain to
be completed at the end of a period. These incomplete units are known as work-in-progress.
• Total Cost And Cost Sheet
If office and administrative overheads are added to factory or works cost, total cost of
production is arrived at. Hence the total cost of production is calculated as: Total Cost of
production = Factory Cost + office and administration overheads
• Cost of goods sold :

Cost of goods sold = Total cost of production + Opening stock of Finished goods – Closing stock of
finished goods.

It is not necessary, that all the goods produced in a period are sold in the same period. There is stock of
finished goods in the opening and at the end of the period.

The cost of opening stock of finished goods is added in the total cost of production in the current period
and cost of closing stock of finished goods is deducted.

• Total Cost i.e, Cost of Sales :

If selling and distribution overheads are added to the total cost of production, total cost is arrived at.
This cost is also termed as cost of Sales. Hence the total cost is calculated as:

Total Cost = Cost of Goods sold + Selling and distribution overheads

• Sales

If the profit margin is added to the total cost, sales are arrived at. Excess of sales over total cost is
termed as profit. When total cost exceeds sales, it is termed as Loss.

Sales = Total Cost + Profit