FIXED, VARIABLE AND SEMI-VARIABLE COSTS

The cost which varies directly in proportion with every increase

or decrease in the volume of output or production is known as
variable cost. Some of its examples are as follows:
• Wages of laborers
• Cost of direct material
• Power
The cost which does not vary but remains constant within a
given period of time and a range of activity in-spite of the
fluctuations in production is known as fixed cost. Some of its
examples are as follows:
• Rent or rates
• Insurance charges
• Management salary
• Machine cost
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 FIXED, VARIABLE AND SEMI-VARIABLE COSTS

The cost which does not vary proportionately but

simultaneously does not remain stationary at all times
is known as semi-variable cost. It can also be named
as semi-fixed cost. Some of its examples are as
follows:
• Telephone charges
• Electricity charges
• Depreciation
• Repairs

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 SEGREGATION OF SEMI-VARIABLE COSTS

 Marginal costing requires segregation of all costs between two

parts fixed and variable. This may be done by any one of the
following methods: -

 1. Level of output compared to level of expenses method.

 2. Range method.
 3. Degree of variability method.
 4. Scatter graph method.

5. Least squares method.

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 SEGREGATION OF SEMI-VARIABLE COSTS

1. LEVEL OF OUTPUT COMPARED TO LEVEL OF EXPENSES METHOD

According to this method, the output at two different levels is
compared with corresponding level of expenses. Since the fixed
expenses remain constant, the variable overheads arrived at by the
ratio of change in expenses to changes in output.
Changes in amount of expenses
Variable Cost =
Changes in activity a quantity

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 SEGREGATION OF SEMI-VARIABLE COSTS

2. RANGE METHOD: -
This method is similar to the previous method except that only the
highest and lowest points of output are considered out of various
levels. This method is also designated as ‘high and low’ method.

Highest am. of expenses – lowest am. of expenses

Variable Cost =
Highest am. of production – lowest am. of production

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 SEGREGATION OF SEMI-VARIABLE COSTS

3. DEGREE OF VARIABILITY METHOD: -

In this method, degree of variability is noted for each item of semi-
variable expenses. Some semi-variable items may have 30%
variability while other may have 70% variability. The method is easy
to apply but difficulty is faced in determining the degree of
variability.

Variable element = Semi-variable cost X Y%

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 SEGREGATION OF SEMI-VARIABLE COSTS
 4. SCATTER GRAPH METHOD: -
In this method the given data are plotted on a graph paper and line of
best fit in drawn. The method is explained as –

1. The values of production cost are plotted on vertical axis and volume
of production is plotted on horizontal axis.
2. Corresponding to each volume of production costs are then plotted on
the paper, thus several point are shown on it.
3. A straight line of best fit is then drawn through the points plotted. This
is the total cost line. The point where this line intersects the vertical axis
is taken to be the amount of fixed element.
4. A line parallel to the horizontal axis is drawn from the point where the
line of best fit intersects the vertical axis. This is the fixed cost line.
5. The variable cost at any level of production can be known by
difference between fixed cost and total cost lines.
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 SEGREGATION OF SEMI-VARIABLE COSTS

4. SCATTER GRAPH METHOD: -

Li n e
C ost
a l
Tot
0 50 60 70 80 90 100
Semi-Variable Cost (in Rs.)

t fi t
b e s
o f
Lin e
Variable Cost

Fixed Cost Line

0 10 20 30 40 50 60 70 80
Production in Units

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 SEGREGATION OF SEMI-VARIABLE COSTS

 5. Method of Least Squares: -

This method is based on the mathematical technique of fitting an equation with
the help of a number of observations. The liner equation i.e. a straight line
equation, can be assumed as: -
Y= a + bx and the various sub-equation shall be

∑y = na + b ∑ x (i)
∑xy = a∑x + b∑x2 (ii)
An equation of second order (a curvilinear equation) can be drawn as y = a
+ bx + cx2 to find out the values of constant a and b with the help of above
equation.

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 Regression Equation y = a + bx

Where,
x and y are the variables.

b = the slope of the regression line is also called as regression coefficient
a = intercept point of the regression line which is in the y-axis.
N = Number of values or elements
X = First Score
Y = Second Score
∑XY = Sum of the product of the first and Second Scores
∑X = Sum of First Scores
∑Y = Sum of Second Scores
∑X2 = Sum of square First Scores.

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  X Values Y Values X Value Y Value X*Y X*X
55 52 2860 3025
55 52
60 54 3240 3600
60 54
65 56 3640 4225
65 56
70 58 4060 4900
70 58 80 62 4960 6400
80 62 330 282 18760 22150

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 ROLE OF COST IN DECISION MAKING

1. Choosing best alternative.

2. Pricing decisions.
3.  Optimum level of operation and behavior.
4.   Make or buy decision.
5.   Replacement of capital equipment.
6.   Deciding the acquisition of fixed assets.
8.  Shut down or continual the operation
9.  An asset is to be bought or hired.
10. Evaluating cost of different projects.

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 MARGINAL COSTING
 Marginal Costing is a technique of determining the amount
of change in the aggregate costs due to an increase or
decrease of one unit over the existing level of production.

 Marginal Cost is the amount at any given level of volume by

which aggregate cost are changed, if the volume of output is
increased or decreased by one unit.
To ascertain the marginal cost, we need the following
elements of cost:
(a)Direct material (b) Direct labour (c)Other direct expenses
Marginal cost = Prime cost + Total variable overheads
OR
Marginal cost = Total Cost - Fixed Cost
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 ABSORPTION COSTING AND MARGINAL COST

Absorption cost per unit: Marginal cost per unit:

direct materials direct materials
direct labour direct labour
variable overheads variable overheads
fixed overheads .
Total Absorption Cost . Total Marginal Cost .

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 COMPARING THE TWO METHODS

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 VARIABLE VERSUS ABSORPTION COSTING

Fixed manufacturing
costs must be assigned Fixed manufacturing
to products to properly costs are capacity costs
match revenues and and will be incurred
costs. even if nothing is
produced.

Variable
Costing
 MARGINAL COST EQUATIONS
 SALES = VARIABLE COST + FIXED COST +/- PROFIT OR LOSS
 SALES - VARIABLE COST = FIXED COST +/- PROFIT OR LOSS
 SALES - VARIABLE COST = CONTRIBUTION
 CONTRIBUTION = FIXED COST + PROFIT
 PROFIT = CONTRIBUTION - FIXED COST

 Contribution is the difference between sales and marginal

cost of sales. Contribution enables to meet fixed costs and
add to the profit. Contribution also known as gross margin.

 CONTRIBUTION = SALES - MARGINAL COST

 MARGINAL COST = PRIME COST + VARIABLE OVERHEAD

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 COST VOLUME PROFIT ANALYSIS
 Cost-volume profit analysis may be defined as management tool showing the
relationship between various ingredients of profit planning i.e. cost (both fixed cost
and variable cost), Selling price and volume of activity etc.
Such an analysis is useful to the Financial Manager in the following aspects: -
 It helps him in forecasting the profit fairly accurately.

 It is helpful in setting up flexible budgets.

 It also assists him in performance evaluation for purposes of management

control.
 It helps in formulating the price policy by projecting the effect which different

price structures will have on cost and profits.

 It helps in determining the amount of overhead cost to be charged at

various levels of operations.

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 COST VOLUME PROFIT ANALYSIS
Cost Volume Profit analysis is the relationship among cost, volume
and profit. When volume of output increases, unit cost of production
decreases, and vice-versa; because the fixed cost remains
unaffected.when the output increases, the fixed cost per unit
decreases. Therefore, profit will be more, when sale price remain
constant. Generally, costs may not change in direct proportion to the
volume. Thus a small change in the volume will affect the profit.
To know the cost volume profit relationship, a study of the following is
essential:-
* Break-Even Analysis,
* Profit Volume Ratio,
* Margin of Safety
* Break-Even Chart
* Key factors
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 BREAK EVEN ANALYSIS
Break even analysis is a widely used technique in study cost volume
profit relationship. The difference between the two terms is very
narrow. CVP analysis includes the entire range of profit planning,
while break even analysis is one of the techniques used in this
process.

This analysis is a tool of financial analysis whereby the impact on

profit of the changes in volume, price, costs and mix can be
estimated with reasonable accuracy.

The break even point and break-even chart are two parts of break-
even analysis.

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 BREAK EVEN ANALYSIS
BREAK EVEN POINT (B.E.P.)
Break-Even Point is a point of no-profit or no loss in the volume of
sales. This is a point where income is exactly equals to
expenditure. It is decrease from this level, loss shall be suffered by
the business.
Fixed Cost
B.E.P. (in units) =
Contribution per unit

Fixed Cost
B.E.P.(of sales) = X S.P./unit
Contribution per unit
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 BREAK EVEN ANALYSIS
PROFIT /VOLUME RATIO (P/V RATIO)
P/V ratio establishes a relationship between the contribution and
the sale value.
P/V Ratio = Contribution/sales x 100
= (Sales – Variable cost) /Sales x 100
= (S-V) / S x 100
This ratio can also be called as ‘Contribution/sales Ratio. It also
be expressed as –
Changes in Contribution or Profit
P/V Ratio = = Change in Sales

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 BREAK EVEN ANALYSIS
PROFIT /VOLUME RATIO (P/V RATIO)
This ratio is useful for the determination of the desired level of output
or profit and for the calculating of variable cost & for any volume
of sales. The variable cost can be expressed as under:-
VC = S (1-P/V Ratio)
The following are the special features of P/V Ratio: -
1. It helps the management in ascertaining the total amount of
contribution for a given volume of sales.
2. It remains constant so long the selling price and the V.C. per unit
remain constant, and fluctuate in same proportion.
3. It remains unaffected by any change in the level of activity.
4. The ratio also remains unaffected by any variation in the fixed
costs.

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 BREAK EVEN ANALYSIS
MARGIN OF SAFETY (MOS)
Total Sales minus the sales at break –even point is known as
margin of safety. The margin of safety refers to the amount
by which sales revenue can fall before a loss is incurred.

MARGIN OF SAFETY = Actual Sales - Sales at BEP

= Profit / (P/V Ratio)
= Profit / Contribution

As a percentage = (MOS *100) / Total sales

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 BREAK EVEN ANALYSIS
MARGIN OF SAFETY
High margin of safety indicates the soundness of a business
because even with substantial fall in sale or fall in production,
some profit shall be made.
Small margin of safety is an indicator of the weak position of the
business and even a small reduction in sale or production will
adversely affect the profit position of the business.
Margin of Safety can be increase by:
(a) Decreasing the fixed cost or variable cost or both;
(b) Increasing the selling price;
(c) Increasing output and sales;
(d) Changing to a product mix that improve P/V Ratio.

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 BREAK EVEN ANALYSIS Li ne
a les
t al S
BREAK-EVEN CHART T o

nc e
de e
0 50 60 70 80 90 100
c i L i n
o f In l Cost
le a
g Tot
Cost and sales (in Rs.)

An
BEP

Variable Cost

Fixed Cost Line

0 10 20 30 40 50 60 70 80
Production in Units

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 BREAK EVEN ANALYSIS Li ne
a les
t al S
BREAK-EVEN CHART T o

0 50 60 70 80 90 100
L i ne
Co st
ta l
To
Cost and sales (in Rs.)

BEP ost
le C
a r iab
V
Line
Fixed Cost Line

0 10 20 30 40 50 60 70 80
Production in Units

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 BREAK EVEN ANALYSIS Li ne
a les
t al S
BREAK-EVEN CHART T o

0 50 60 70 80 90 100 ea d
ver h
l e O
a b
Vari es
Cost and sales (in Rs.)

Wag
BEP Direct

ec t Ma te rial
Dir
Fixed Cost Line

0 10 20 30 40 50 60 70 80
Production in Units

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 ABC Ltd. sells 10 toys for $12. The unit variable cost per toy is $8.80. Total
Fixed costs is $4,800.
Required:
a. What is the contribution margin per toy?
b. What is the break-even point in toys? . . . in dollars?
c. How many toys must be sold to earn a pretax income of $4,000?
d. What is the margin of safety, assuming 1,800 toys are sold?

a. Contribution margin per toy = $12.00 - $8.80 = $3.20

b. N = Break-even point in toys
$12.00N - $8.80N - $4,800 = 0; N = 1,500 toys
Break-even dollars = 1,500 x $12 = $18,000
c. N = Target sales in toys
$12.00N - $8.80N - $4,800 - $4,000 = 0;
N = $8,800/$3.20; N = 2,750 toys
d. Margin of safety = Sales - Break-even sales
= ($12.00 x 1,800) - $18,000
= $21,600 - $18,000 = $3,600
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Angle of Incidence:
In BEP chart, the angle which is formed by intersection of sale line and
total cost line is call as Angle of incidence. A greater Angle of incidence
means that the profits are made at high rate and vice versa.
Key or Limiting Factor :
The Key factor or limiting factor is that factor which puts a limit on the
production and profit of the firm. Shortage of materials, labour, plant-
capacity, capital etc. may be the key or limited factor if a firm is having
demand for the products but not able to fulfill the demand due to above
factor/s. When there is no limiting factor, the production can be on the
basis of the highest P/V Ratio. When two or more limiting factors are in
operation, they will be seriously considered to determine the profitability.
Contribution
Profitability =
Key Factor

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APPLICATION OF MARGINAL COSTING TECHNIQUES

Marginal Costing helps the management in decision-

making in respect of the following important areas:
1. Cost Control
2. Fixation of Selling Price
3. Selection of a Profitable Product Mix
4. Profit Planning
5. Decision to Make or Buy
6. Decision to Accept a bulk order
7. Introduction to a new Product
8. Maintaining a desired level of profit
9. Level of Activity planning
10. Evaluation of Performance
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APPLICATION OF MARGINAL COSTING TECHNIQUES

1. Cost Control:
The two types of costs (variable and fixed) are controllable and
uncontrollable respectively. The variable cost is controlled by
production department and the fixed cost is controlled by the
management.
2. Fixation of Selling Price:
Marginal cost of a product represent the minimum price for that
product and any sale below the marginal cost would cause a
loss of cash. Only those products should be produced or
sold which make the largest contribution towards the
recovery of fixed costs.
Variable Cost
Selling Price =
05/10/20
(1 - P/V Ratio) 32
APPLICATION OF MARGINAL COSTING TECHNIQUES
OR
If selling price changes than new volume of sale to maintain
the same contribution will be:
Contribution
= Old Sales
New Contribution

3. Selection of a Profitable Product Mix:

Product Mix is the ratio in which various products are produced and
sold. The marginal costing technique helps the management in
taking decisions regarding changing the ratio of product mix
which gives maximum contribution or in dropping unprofitable
product line. The product which has comparatively less
contribution, may be reduced or discontinued.
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APPLICATION OF MARGINAL COSTING TECHNIQUES

4. Profit Planning:
Profit planning is a plan for future operation or planning budget
to attain the given objective or to attain the maximum profit.
The volume of sales required to maintain a desired profit
can be known form the formula:
FC + Desired Profit
Desired Sales = (IN Rs.)
P/V Ratio

FC + Desired Profit
Desired Sales = (IN Units)
New Contribution / Unit
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APPLICATION OF MARGINAL COSTING TECHNIQUES

5. Decision to make or buy:

The management must decide which is more profitable to the
firm. If the marginal cost of the product is lower than the price
of buying from outside, then the firm can make the product.

6. Decision to accept a bulk order:

In marginal costing, the offer may be accepted, if the quoted
price is above marginal cost, because of the existing business
contribution can recover the fixed costs (full or a part) and the
margin of profit or loss. In such case, the contribution made by
bulk order will be an additional to profit. But the price should
not be less than the marginal cost.

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APPLICATION OF MARGINAL COSTING TECHNIQUES

7. Introduction to a new Product

The technique to assess the profitability of line extension products is
the incremental contribution estimates. The same technique of
contribution analysis would be followed in assessing the
profitability of a new product line. Sales forecast would result from
a market survey and market research.

8. Maintaining a desired level of profit

See- 4. Profit Planning

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APPLICATION OF MARGINAL COSTING TECHNIQUES

9. Level of Activity planning

What level of activity is optimum for a business to adopt, is an
important problem faced by businesses. Where different levels of
production and/ or selling activities are being considered and the
management has to decide the optimum level of activity, the
marginal costing technique helps the management.

10. Evaluation of Performance

The department or the product or division which gives the
highest P/V Ratio will be the most profitable one or that is
having the highest performance efficiency.

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APPLICATION OF MARGINAL COSTING TECHNIQUES

2. Fixation of Selling Price:

Volume of sale to maintain the same contribution will be:
Contribution
= New Sales
New Contribution

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 TECHNIQUES OF COSTING

Costing has been defined as “the technique and process of

ascertaining costs”.The principles in every method of costing are
the same but the methods of analyzing and presenting the costs
differ with the nature of business.

 Some main techniques are: -

1. JOB COSTING
Where production is not highly repetitive and in addition, consists
of distinct job or lots so that material and labour costs can be
identified by order number, the system of job costing is used. This
method of costing is very common in commercial foundries and
drop forging shops and in plants making specialized equipment.

05/10/20 39
 TECHNIQUES OF COSTING

2. PROCESS COSTING:-
If a product passes through different stages, each distinct
and well defined, it is desired to know the cost of production
at each stage. In order to ascertain the same, process
costing is employed under which separate account is
opened for each step of process. This system of costing is
suitable for the extractive industries e.g. chemical
manufacture, paints, foods, explosives, soap making etc.

NOTE: - Besides the above methods or techniques of costing,

the following types of costing techniques are used by
management only for controlling costs and making some
important managerial decisions.
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 TECHNIQUES OF COSTING

3. MARGINAL COSTING: -
It is technique of costing in which allocation of expenditure to
production is restricted to those expenses which arise as a
result of production i.e. materials, labour, direct expenses
and variable overheads. Fixed overheads are excluded on
the ground that in cases where production varies, the
inclusion of fixed overheads may give misleading
results.The technique is useful in manufacturing industries
with varying levels of output:

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 TECHNIQUES OF COSTING

4. DIRECT COSTING: -
The practice of charging all direct costs to operations
processes of products, leaving all indirect costs to be written
off against profits in the period in which they arise, is termed
as direct costing.
The technique differs from marginal costing because some
fixed costs can be considered as direct costs in appropriate
circumstance.

5. ABSORPTION OR FULL COSTING: - The practice of

charging all costs both variable and fixed to operations,
products or processes is termed as absorption costing.

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 SYSTEMS OF COSTING
 There are two systems of costing: -
 Historical Costing: - Historical costing is the determination
of cost by atuals. It may be in the nature of (i) Post Costing
(means ascertainment cost after the production is
completed) or (ii). Continuous Costing (menas cost is
ascertained as soon as the job is completed or even when
the job is in progress.

 Standard Costing: - Standard Costing is a system of

costing under which the cost of the product is determined in
advance on certain pre-determined standards.

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