COST & MANAGEMENT ACCOUNTING (CMA)

Cost-Volume-Profit Analysis: Contribution Margins,

Breakeven Point, Target Operating Income, Target Net
Income and Income Taxes, Sensitivity Analysis and
Margin of Safety
COST & MANAGEMENT ACCOUNTING:
SHORT-TERM DECISION-MAKING USING CONCEPTS OF CVP ANALYSIS

Decisions related with EXCESS SUPPLY:

1. Processing of Special Order
2. Determination of price for stimulating demand
3. Local vs. Export sale
4. Determination of minimum price for price quotations
5. Shut-down or continue decision etc.
COST & MANAGEMENT ACCOUNTING:
SHORT-TERM DECISION-MAKING USING CONCEPTS OF CVP ANALYSIS

Decisions related with EXCESS DEMAND:

1. Make or Buy/ In-house-processing vs. Outsourcing
2. Product mix decision under resource constraints (limiting factors)
3. Sales Mix decisions
4. Sale or further processing etc.
COST & MANAGEMENT ACCOUNTING:
LIMITING FACTOR
Limiting factor restricts the activity.

Limiting factor determines the level of Sale and Production and is also known
as KEY FACTOR.

From the Supply side the limiting factor may be Men, Materials and Machine
(capacity), or Money.

From the demand side the limiting factor may be demand for the product.
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
A Ltd. Producing products 'X', 'Y' and 'Z' decides to analyse its production mix
You have the following information:
X Y Z
Direct Materials (per unit) 160 120 80
Variable Overheads (per unit) 8 20 12
Direct Labour:
COST & MANAGEMENT ACCOUNTING:
Budgeted Production details:

There is a constraint on supply of labour in Department-A.

Find the BEST POSSIBLE PRODUCT MIX.

Find the TOTAL CONTRIBUTION from the best possible product mix.
COST & MANAGEMENT ACCOUNTING:
COST & MANAGEMENT ACCOUNTING:
EXISTING TOTAL HOURS = 2,80,000 HRS.
X – (10,000 x 6hrs) + Y – (12,000 x 10 hrs) + Z – (20,000 x 5 hrs)
Allocation of Hours on the basis of Contribution Ranking
Produce X = 12,000 units
Hrs. needed for producing 12,000 Units of X = 72,000 hrs (12,000 units × 6 hrs.)
Remaining Hrs. available = 2,08,000 (2,80,000 hrs. – 72,000 hrs.)
Produce Y = 16,000 units
Hrs. needed for producing 16,000 Units of Y =1,60,000 hrs (16,000 units × 10 hrs.)
Remaining Hrs. available = 48,000 (2,08,000 hrs. – 1,60,000 hrs.)
Produce Z (balance) = 9,600 units (48,000 hrs./ 5 hrs.)
COST & MANAGEMENT ACCOUNTING:
CONTRIBUTION STATEMENT::
COST & MANAGEMENT ACCOUNTING:
Achieving Profit Targets – PROFIT PLANNING
Factors that affect Profit are
Selling Price
Quantity sold
Variable Cost per unit
Total Fixed Cost
Sales Mix
Changing any of the above mentioned affect the overall profitability.
Marginal Costing allows us to evaluate the impact of the changes in above
mentioned variables so that the desired profit can be achieved.
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
A Company produced and sold 50,000 unit @ Rs.25 and earned Profit =
1,00,000. This year it plans to invest 10,00,000 in new plant with expected
rate of return = 15%. Fixed cost at present = 4,00,000 p.a. and Variable
Cost per unit = 15.

Explain how management can achieve the target expected rate of return by
varying different variables such as Fixed Costs / Variable Cost per unit /
Quantity sold / Selling Price.
COST & MANAGEMENT ACCOUNTING:
BY CHANGING THE FIXED COST
Sales - Variable Cost = Contribution S – VC = C
Fixed Cost + Profit = Contribution FC + P = C
Sales (50,000 x 25) =12,50,000
Less Variable Cost (50,000 x 15) = 7,50,000
Contribution = 5,00,000
Fixed Cost = Contribution – Profit
= 5,00,000 – 1,50,000
= 3,50,000
Fixed Cost have to be brought down from 4,00,000 to 3,50,000 to earn the
desired rate of return or profit on Investment of Rs1,50,000
COST & MANAGEMENT ACCOUNTING:
BY CHANGING VARIABLE COST PER UNIT
Sales - Variable Cost = Contribution S – VC = C
Fixed Cost + Profit = Contribution FC + P = C
4,00,000 + 1,50,000 = Contribution
Contribution = 5,50,000
Sales - Variable Cost = Contribution
12,50,000 – 5,50,000 = Variable Cost = 7,00,000
Variable Cost per unit = 7,00,000 / 50,000 = 14

Variable Cost have to be brought down from Rs15/unit to Rs14/unit for earning the
desired profit of Rs1,50,000.
COST & MANAGEMENT ACCOUNTING:
BY CHANGING QUANTITY SOLD
Sales - Variable Cost = Contribution S – VC = C
Fixed Cost + Profit = Contribution FC + P = C
S(Q) – V(Q) = FC + P
Q(S-V) = FC + P
Contribution = Q ( S – V )
5,50,000 = Q ( 25 – 15 )
Q = 5,50,000 / 10
Q = 55,000
Company should produce and sell 55,000 for earning the desired profit of 1,50,000
COST & MANAGEMENT ACCOUNTING:
BY CHANGING QUANTITY SOLD
Sales - Variable Cost = Contribution S – VC = C
Fixed Cost + Profit = Contribution FC + P = C
S(Q) – V(Q) = FC + P
Q(S-V) = FC + P
Contribution = Q ( S – V )
5,50,000 = Q ( 25 – 15 )
Q = 5,50,000 / 10
Q = 55,000
Company should produce and sell 55,000 for earning the desired profit of 1,50,000
COST & MANAGEMENT ACCOUNTING:
INFERENCES:
1. INCREASE in Variable Cost
Contribution decreases.
P/V ratio decreases.
Profit decreases.
BEP increases
2. INCREASE in Fixed Cost
Decrease in Profit.
BEP point increases.
Contribution remains same.
P/V ratio remains same
COST & MANAGEMENT ACCOUNTING:
SHORT-TERM DECISION-MAKING USING CONCEPTS OF CVP ANALYSIS

Decisions related with EXCESS SUPPLY:

1. Processing of Special Order
2. Determination of price for stimulating demand
3. Local vs. Export sale
4. Determination of minimum price for price quotations
5. Shut-down or continue decision etc.
COST & MANAGEMENT ACCOUNTING:
SHORT-TERM DECISION-MAKING USING CONCEPTS OF CVP ANALYSIS

PROCESSING OF SPECIAL ORDER:

When the resources for production are excess in supply, demand for the
products becomes the limiting factor. Any additional demand for the product
can earn an additional contribution to recover fixed costs.

Special orders are non-repetitive.

COST & MANAGEMENT ACCOUNTING:
PROCESSING OF SPECIAL ORDER:
A Ltd. manufactures medals. Its has the capacity to produce 10,000 medals
each month. The Company has current production and sales level of 7,500
medals per month. The Current domestic market price of the medal is Rs.150.
The cost data for the month is:
Co. has received a special
one-time only order for 2,500
medals at 120 per medal.

Should Co. accept the special

order?
Why? EXPLAIN briefly
COST & MANAGEMENT ACCOUNTING:
Installed Capacity = 10,000 medals.
Utilized Capacity = 7,500 medals
IDEL CAPACITY = 2,500 medals
Any additional order could increase the existing profit.???????
COST & MANAGEMENT ACCOUNTING:
Installed Capacity = 10,000 medals.
Utilized Capacity = 7,500 medals
IDEL CAPACITY = 2,500 medals
Any additional order could increase the existing profit provided the offered
price is MORE THAN THE MARGINAL COST.
COST & MANAGEMENT ACCOUNTING:

65
COST & MANAGEMENT ACCOUNTING:

The offered price for additional 2,500 medals (Rs.120) is more than
the Variable Cost per unit.
ADDITIONAL ORDER will contribute towards FIXED COSTS AND PROFIT. .
COST & MANAGEMENT ACCOUNTING:

The offer for 2,500 unit should be ACCEPTED as it increases the overall
Profitability by 87,500 (1,25,000 – 37,500)
COST & MANAGEMENT ACCOUNTING:
SHORT-TERM DECISION-MAKING USING CONCEPTS OF CVP ANALYSIS

MAKE OR BUY DECISION:

A Decision whether the product should be made IN HOUSE or OUTSOURCED.
A Decision where Demand for the product is more than the Supply of
resources (Material, Men, Machine etc.).

Here resource is limiting or key factor and decision is to be made keeping

OPTIMUM UTILIZATION of the Key or Limiting Resource and the maximization
of profitability.
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
Cost of manufacturing a 2,00,000 units:
Direct materials cost 375 per unit
Direct labour cost 80 per unit
Variable factory overhead 16 per unit
Fixed factory overhead 500,00,000 lakhs
The PURCHASE PRICE of the units is 485. The fixed overhead would continue
to be incurred even when the component is bought from outside.
Should the part be made or bought from outside considering that the present
facility would remain idle following a decision to buy.
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
The present Cost Structure:
Variable Cost per unit is:
Direct materials cost 375
Direct labour cost 80
Variable Factory Overhead 16
Total Variable Cost per unit 471

Marginal Cost of MAKING 471

Marginal Cost of BUYING 485
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
Product X with Selling Price 40 per unit and the Variable Cost is 16 per unit.
If the Fixed Costs are 4,80,000 and the Annual Sales are at 60% Margin of
Safety. CALCULATE Profit.
Contribution per unit = Selling price – Variable cost
= 40 – 16 = 24
Break-even Point = 4,80,000 / 24 = 20,000 units
Percentage Margin of Safety = (Actual Sales – Break-Even Sales) / Actual Sales
60% = (Actual Sales – 20,000 units)/ Actual Sales
60% x Actual Sales = Actual Sales – 20,000
Actual Sales = 50,000 units
COST & MANAGEMENT ACCOUNTING:

Sales Value (50,000 units × 40) 20,00,000

Less: Variable Cost (50,000 units × 16) 8,00,000
Contribution 12,00,000
Less: Fixed Cost 4,80,000
Profit 7,20,000
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
The profit for the year is 12.5% of the Capital Employed 4,00,000
Sales 5,00,000
Direct Materials 2,50,000
Direct Labour 1,00,000
Variable Overheads 40,000
Profit for the next year is estimated at 23% on Capital Employed, provided
the SALES VOLUME is increased by 10% with simultaneous increase in Selling
Price of 4% and an overall Cost Reduction in all the elements of cost by 2%.
Comment on acceptability of the profit estimate for the next year.
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
The profit for the year is 12.5% of the Capital Employed 4,00,000
Sales 5,00,000
Direct Materials 2,50,000
Direct Labour 1,00,000
Variable Overheads 40,000
Profit for the next year is estimated at 23% on Capital Employed, provided
the SALES VOLUME is increased by 10% with simultaneous increase in Selling
Price of 4% and an overall Cost Reduction in all the elements of cost by 2%.
Comment on acceptability of the profit estimate for the next year.
COST & MANAGEMENT ACCOUNTING:
S – VC = C = FC + P or FC = S – VC – P
Profit is 12.5% on Capital Employed = (12.5% of 4,00,000) = 50,000
FC = S – VC – P or 5,00,000 – 3,90,000 – 50,000 = 60,000
EXISTING
Sales 5,00,000
Less Direct Materials 2,50,000
Direct Labour 1,00,000
Variable OHs 40,000
CONTRIBUTION 1,10,000
Less Fixed Cost 60,000
PROFIT 50,000
COST & MANAGEMENT ACCOUNTING:
S – VC = C = FC + P or FC = S – VC – P
Profit is 12.5% on Capital Employed = (12.5% of 4,00,000) = 50,000
FC = S – VC – P or 5,00,000 – 3,90,000 – 50,000 = 60,000
after 10% Increase + 4% and – 2%
Sales 5,50,000 5,72,000 (+)
Less Direct Materials 2,75,000 2,69,500 (-)
Direct Labour 1,10,000 1,07,800 (-)
Variable OHs 44,000 43,120 (-)
CONTRIBUTION 1,21,000 1,51,580
Less Fixed Cost 60,000 58,800
PROFIT 61,000 92,780
COST & MANAGEMENT ACCOUNTING:
Estimated Profit of 92,780 is more than 23% of Capital Employed, the
proposal of the Sales Manager can be accepted.
23% of 4,00,000 = 92,000
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
Product Sales PV Ratio Sales Mix
A 250000 50 20
B 400000 40 32
C 600000 30 48
Fixed Cost = 502200
Calculate Profit or Loss at this level.
Calculate change in Sales value of each product as well as changes in the total Sales value
maintaining same sales mix for eliminating the loss.
Calculate additional Sales product wise to cover the LOSS.
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
PV Ratio = Contribution / Sales x 100
Or Contribution = PV Ratio x Sales .
Fixed Cost = 502200 (Given)
Product Sales PV Ratio Contribution Sales Mix
A 250000 50 125000 20
B 400000 40 160000 32
C 600000 30 180000 48
TOTAL CONTRIBUTION 465000
Sales – Variable exp. = Contribution = Fixed Cost + Profit
Contribution – Fixed Cost = Profit or Loss or 465000 – 502200 = (-) 37,200
COST & MANAGEMENT ACCOUNTING:
To cover the loss of (-) 372000 additional sales is needed for generating
Contribution = Amount of loss to reach at BEP.
Sales = Contribution / PV Ratio.
Product wise additional Sales required
Product Additional Sales
A 37200 / 50% = 74400
B 37200 / 40% = 93000
C 37200 / 30% = 124000
COST & MANAGEMENT ACCOUNTING:
Additional sales product wise to cover the loss
A B C
Total Sales 1250000 1250000 1250000
Additional Sales A 74400
Additional Sales B 93000
Additional Sales C 124000

Total New Sales 1324400 1343000 1374000

COST & MANAGEMENT ACCOUNTING:
Existing Contribution 465000 465000 465000
Additional Contribution
From Increased Sales
A 74400 x 50% 37200
B 93000 x 40% 37200
C 124000 x 30% 37200
Total Contribution 502200 502200 502200
Less Fixed Cost 502200 502200 502200
COST & MANAGEMENT ACCOUNTING:
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COST & MANAGEMENT ACCOUNTING (CMA)