2016

SHARFA HASSAN
South campus, KU

[ ACCOUNTING FOR MANAGERS , IST SEMESTER UNIT 3]

Costing is a technique and process of ascertaining costs. This technique consists of principles and rules which govern the
procedure of ascertaining the cost of products or services. The process of costing includes routines of ascertaining costs by
historical or conventional costing, standard costing or marginal costing.

Cost accounting is the classifying, recording and appropriate allocation of expenditure for the determination of the costs of
products or services, and for the presentation of suitably arranged data for purposes of control and guidance of
management. It includes the ascertainment of the cost of every order, job, contract, process, service or unit as may be
appropriate. It deals with the cost of production, selling and distribution. According to Weldon, “cost accounting is the
application of accounting and costing principles, methods and techniques in the ascertainment of costs and the analysis of
saving or excess cost incurred as compared with the previous experience or with the standards.”

Methods and Techniques of costing

Following are the principle methods of costing

1. Job costing: job costing is a system of costing in which costs are ascertained in terms of specific job or order
which are not comparable with each other. The unit of costing in this method is a job or a special work order. The
job or a special work done. The job may consist of a single unit or it may consist of identical or similar products
covered under a single work order. In this method of costing, each job or work order is given a number and all
costs relating to that job are recorded separately for each job. Job costing includes the following methods of
costing;
Batch costing: this method of costing is applied to industries where production is carried on in batches. A batch
of similar products is regarded as one job and the cost of this complete batch is ascertained. The total cost of the
batch is then divided by the total number of units in the batch in order to determine the cost per unit.
Contract costing: this is a method of costing which is used in case of big jobs spread over a period of time. A
contract is a big job and hence the principles of job costing are applied to contract costing. A separate account is
kept for each individual contract. This method is also known as terminal costing as the cost can be terminated at
some point and related to a particular job.
Departmental costing: when it is desired to ascertain the cost of operating a department or the cost of products
turned out by a department, the method of departmental costing is used.

2. Process costing: process costing is the method of costing that is employed by the process. In type of industries
where a product passes through different processes, each distinct and well defined, it is desired to know the cost
of production at each process. In order to know the cost at each stage or process of production, a separate
account is opened for each process and when the material is transferred from one process to another, the cost
incurred up to that process is also transferred to the succeeding process. This method of costing is most suitable
for mass production industries engaged in continuous production of uniform standard product such as textiles,
chemicals, paper, sugar, oil, cement, mining, paints etc. It includes the following methods of costing:
Single output or unit costing: this method of costing is applied where production is continuous and uniform and
the industry is engaged in the production of a single product or a few grades of the same product. Here the total
cost is divided by the number of units produced to ascertain cost per unit and is applied in industries like brick
work, oil drilling, paper mills, flour mills etc.
Operating costing: this method is suitable for the industries which render services rather than manufacture
goods. It is used to ascertain the cost of rendering services such as railways, airways, hotels, water supply.
Operation costing: it is a system of costing which is used in industries engaged in repetitive mass production. If
the manufacture of a product involves a number of operations and not processes, the cost id ascertained for
each operation.

3. Marginal costing: it is a technique of ascertainment of marginal cost by differentiating between fixed and
variable cost. It is used to determine the effect of changes in volume on profit.
4. Absorption costing: is the practice of charging all costs, both fixed and variable to products, processes or
operations.
5. Standard costing: it is a technique of costing under which the cost of s product is determined in advance on
certain pre determined standards. A comparison is made of actual cost with the pre determined standard cost to
find out variances so as to take corrective action as and when needed.
 Cost sheet or statement of cost

Cost sheet is a statement designed to show the output of a particular accounting period along with breakup of costs. The
data incorporated in the cost sheet are collected from various statements of accounts which have been written in cost
accounts, either day to day or regular records. Cost sheet is a memorandum statement. Therefore, it does not form part of
double entry cost accounting records. But cost sheet derives its data from financial accounting, which in a way means that
the relationship between cost sheet and financial accounting is maintained on double entry system.

SPECIMEN OF COST SHEET OR STATEMENT OF COST

Total cost Cost per unit

Direct Materials

Direct Labour

Direct or Chargeable Expenses

Prime Cost

Add Works Overheads

Works Cost

Add Administration Overheads

Cost of Production

Add Selling and Distribution Overheads

Total cost/Cost of Sales

LIST OF COSTS INCLUDED IN EACH MAJOR HEAD

Rupees

Direct Materials
Prime Cost

Direct Labour

Add Works Overheads

Wages of foreman

Electric power

Oil and water

Works Cost
Factory rent

Factory lighting

Depreciation of
factory plant

Add Administration Overheads

Office rent

Office lighting

Office stationery
Cost of Production
Telephone charges

Manager’s salary

Depreciation of
office premises

Add Selling and Distribution Overheads

Carriage outward

Salesmen’s salary Total cost/Cost

of Sales
Advertising

Warehousing
ILLUSTRATION: The following information has been obtained from the records of Software Corporation for the period from
January 1 to June 30, 2016:

2016 2016

On January 1 on June 30

Rs. Rs.

Cost of raw materials 30,000 25000

Cost of work in progress 12000 15000

Cost of stock of finished goods 60,000 55,000

Transactions during six months are:

Purchase of raw materials 4, 50,000 Administration overheads 30,000

Wages paid 2, 30,000 Selling and Distribution overheads 20,000

Factory overheads 92,000 Sales 9, 00,000

Prepare (I) cost sheet showing (a) Materials consumed (b) Prime cost (c) Factory cost (d) Works cost

SOLUTION:

th
Statement of cost for six months ending 30 June, 2016

Opening stock of Raw Materials 30,000

Add: Purchases of raw material 4, 50,000

4, 80,000

Less: Closing stock of raw material 25,000

Cost of materials consumed 4, 55,000

Direct wages 2, 30, 000

Prime cost 6, 85,000

Add: Factory overheads 92,000

Factory cost Incurred 7, 77, 000

Add: opening work in progress 12,000

Less: closing work in progress 15,000

Works cost 7, 74,000

(2) Income statement for the six months showing gross profit and net profit.

th
Income statement for the half year ending 30 June, 2006

Sales 9, 00,000

Less: Cost of goods sold:

Opening stock of finished goods 60,000

Add: works cost of the year 7, 74,000

8, 34,000

Less: closing stock of finished goods 55,000

Gross profit 1, 21,000

Less: Indirect expenses:

Administration expenses 30,000

Selling and distribution expenses 20,000

Net profit 71000

TO BE SOLVED

Question 1: ABC Company is a metal and wood cutting manufacturer, selling products to the home construction market.
Consider the following data for the month of October, 2016:

1-1-2016 31-10-1016

Direct materials 1, 00,000 1, 25,000

Finished goods 2, 50,000 3, 75,000

Work in progress 25,000 35,000

Transactions during the month:

Sand paper 5000 Property taxes on plant and equipment 10,000

Material handling costs 1, 75,000 Fire insurance on plant and equipment 7,500

Lubricants and coolants 12,500 Direct materials purchased 11, 50,000

Miscellaneous indirect manufacturing labour 1, 00,000 Sales revenue 34, 00,000

Direct manufacturing labour 7, 50,000 Marketing promotions 1, 50,000

Plant leasing costs 1, 35,000 Marketing salaries 2, 50,000

Depreciation- plant and equipment 90,000 Customer service costs 2, 50, 000
REQUIRED: Prepare an income statement with a separate supporting schedule of cost of goods manufactured.

ABSORPTION AND MARGINAL COSTING

Absorption costing also known as “full costing” is a conventional technique of ascertaining cost. It is the practice of
charging all costs fixed and variable to operations, processes and products. Under this technique of costing, cost is made up
of direct costs plus overhead costs absorbed on some suitable basis.

ASCERTAINMENT OF PROFIT UNDER ABSORPTION COSTING PROFORMA

Rs. Rs.

Sales

Less Cost of goods manufactured

Direct material

Direct labour

Factory overheads

Variable

Fixed

Add Value of opening stock

Value of closing stock

Add Underabsoption of fixed factory overheads

Or

Less Overabsoption of fixed factory overheads

Gross profit

Less Administration, selling & distribution expenses

Variable

Fixed

Net income or profit

ILLUSTRATION: The following data relate it XYZ Company:

Norma capacity 40,000 units per month Actual production 44,000 units

Variable cost per unit Rs.6. Sales 40,000 units @ Rs. 15 per unit

Fixed manufacturing overheads Rs. 1, 00,000 per month or Rs. 2.50 per unit at normal capacity

Other fixed expenses Rs. 2, 40,000 per month.

Prepare Income Statement under absorption costing.

 INCOME STATEMENT

Sales (40,000*Rs. 15) 6, 00,000

Less: cost of goods manufactured:

Variable cost @ Rs. 6 per unit for 44,000 units 2, 64,000

Fixed manufacturing overhead Rs. 2.50 for 44,000 units 1, 10,000

3, 74,000

Less: closing inventory 4000/44,000 * 3, 74,000 34,000

3, 40,000

Less: over absorption of fixed manufacturing overheads

1, 10,000-1, 00,000 10,000

3, 30,000

GROSS PROFIT 2, 70,000

Less: other fixed expenses 2, 40,000

NET INCOME 30,000

Meaning of marginal costing

The Chartered Institute of Management Accountants, London, defines the term “marginal cost” as follows:

Marginal cost is the amount at any given volume of output by which aggregate costs are changed if the volume of output is
increased or decreased by one unit. In this context a unit may be a single article, a batch of articles, an order, a stage of
production capacity or a department. It relates to the change in output in the particular circumstances under
consideration.

Variable cost of 30,000 units @ Rs. 10 3, 00,000

Fixed cost 1, 50,000

Total cost 4, 50,000

If output is increased by one unit, the following expenditures will be incurred:

Variable cost of 30,001 units @ Rs. 10 3, 00,010

Fixed cost 1, 50,000

Total cost 4, 50,010

Less: Total cost for output of 30,000 units 4, 50,000

Marginal cost of one unit 10

 ASCERTAINMENT OF PROFIT UNDER MARGINAL COST

Ascertainment of marginal cost is different from absorption cost. In marginal cost it is assumed that the difference
between the aggregate sales value and the aggregate marginal cost of the output sold is contribution and provides a fund
to meet the fixed cost and profit of the firm. In respect of each, the difference between its sales value and the marginal
cost is known as contribution made by the product to this fund. This contribution is also the aggregate of fixed expenses
and profit or minus loss.

Product A Product B Product C

Sales value=Rs. 2, 00,000 Sales value=Rs. 1, 00,000 Sales value=Rs. 3, 00,000

Minus Minus Minus

Marginal /variable cost =1, 50,000 Marginal/variable cost=80,000 Marginal/variable cost=2, 20,000

Contribution=50,000 Contribution=20,000 Contribution=80,000

Fund=1, 50,000

Minus

Fixed expenses=1, 00,000

Profit=50,000

INCOME DETERMINATION UNDER MARGINAL COSTING AND ABSORPTION COSTING

ILLUSTRATION: The following data relate to XYZ Company:

Output and sales 40,000 units. Sale price per unit Rs. 15. Material and labour cost per unit Rs. 8

Production overheads:

Variable Rs. 2 per unit, Fixed Rs. 50,000, other fixed overheads Rs. 1, 00,000

Prepare income statement under (1) Absorption costing (2) Marginal costing

Solution: Income statement (absorption costing)

Sales (40,000 units @ Rs. 15 per unit) 6, 00,000

Less: cost of goods manufactured:

Material and labour cost 3, 20,000

Variable manufacturing overheads 80,000

Fixed manufacturing overheads 50,000

4, 50,000

GROSS PROFIT 1, 50,000

Less: other fixed overheads 1, 00,000

NET INCOME 50,000

 Income statement (marginal costing)

Sales 6, 00,000

Less: variable cost

Material and labour cost 3, 20,000

Variable manufacturing overheads 80,000

4, 00,000

CONTRIBUTION 2, 00,000

Less: fixed cost

Manufacturing overheads 50,000

Other fixed cost 1, 00,000

NET INCOME 50,000

ILLUSTRATION: The following data relates to XYZ ltd. which makes and sells toys

Production 1, 00,000 units Sales 80,000 units

Selling price/unit 15 Rs. Direct materials 2, 50,000

Direct labour 3, 00,000 Factory overheads:

Selling and distribution over heads: Variable 1, 00,000

Variable 1, 00,000 Fixed 2, 50,000

Fixed 2, 00,000

Prepare income statement using (1) absorption costing (2) marginal costing
Solution: Income statement (absorption costing)

Sales (80,000*15) 12, 00,000

Less: Cost of goods manufactured:

Direct materials 2, 50,000

Direct labour 3, 00,000

Factory overheads: Variable 1, 00,000

Fixed 2, 50,000

9, 00,000

Less: Closing stock 20,000/1, 00,000*9, 00,000 1, 80,000

GROSS PROFIT 4, 80,000

Less: Selling and distribution expenses

Fixed 2, 00,000

Variable 1, 00,000

NET INCOME 1, 80,000

Income statement (marginal costing)

Sales (80,000*15) 12, 00,000

Less: Variable costs:

Direct material 2, 50,000

Direct labour 3, 00,000

Variable factory overheads 1, 00,000

6, 50,000

Less: Closing stock 20,000/1, 00,000*6, 50,000 1, 30,000

5, 20 000

Add: Variable selling and distribution expenses 1, 00,000

CONTRIBUTION 5, 80,000

Less: Fixed factory overheads 2, 50,000

Fixed selling and distribution expenses 2, 00,000

NET PROFIT 1, 30,000

 COST-VOLUME-PROFIT ANALYSIS

Cost-volume-profit analysis or Break-Even analysis is a logical extension of marginal costing. It is based on the principles of
classifying the operating expenses into fixed and variable. There exists close relationship between the Cost, Volume and
profit. If volume is increased, the cost per unit will decrease and profit will increase. Thus, there is direct relationship
between volume and profit but inverse between volume and cost. Analysis of this relationship can be applied for profit
planning, cost control, evaluation of performance and decision making.

ELEMENTS OF COST-VOLUME-PROFIT ANALYISIS

In order to understand mathematical relationship between cost, volume and profit, the following concepts need due
attention.

1. Marginal cost equation: The elements of costs can be written in the form of an equation as follows
Sales = variable costs + fixed costs + profit or – loss
Sales – variable costs = fixed expenses + profit or – loss
S – V = F + P or – P
S – V = C because fixed expenses plus profits or minus loss = Contribution

In order to make profit, contribution must be more than the fixed expenses and to avoid any loss, contribution
must be equal to the fixed expenses. At breakeven point, contribution is equal to the fixed expense that is a point
of no profit and no loss.

2. Contribution: Contribution is the difference between the sales and the marginal cost of sales and its contribution
towards the fixed expenses and profit. Suppose selling price per unit is Rs. 15, variable cost per unit is Rs. 10,
fixed cost is Rs. 1, 50,000 then contribution per unit will be Rs 5. Contribution for 30,000 units @ Rs is Rs 1,
50,000. This much contribution is just sufficient to meet the fixed costs of Rs 1, 50,000 and no amount is left for
profit. The contribution will first go to meet the fixed expenses and then to earn profit.
Contribution = selling price – marginal cost
Contribution = fixed expenses + profit/–loss
Contribution – fixed expenses = profit/loss

3. Contribution/Sales(C/S) or Profit/Volume (P/V) ratio: This ratio is one of the most important ratios for studying
the profitability of operations of a business and establishes the relationship between contribution and sales.
P/V ratio = contribution/sales (C/S)
= fixed expenses + profit/sales (F+P/S)
= sales – variable costs/ sales (S –V/S)
= change in profits or contribution/change in sales

4. Break Even point: A business is said to break even when its total sales are equal to its total costs. It is a point of
no profit and no loss. At this point, contribution is equal to fixed costs. A concern which attains breakeven point
at less number of units will definitely be better from another concern where breakeven point is achieved at more
units of production. The breakeven point can be calculated by the following formula:
Break even point in units = total fixed expenses/selling price per unit– marginal cost per unit

5. Margin of safety: Margin of safety is the difference between the actual sales and break even sales. Margin of
safety is the excess production over break even points output. Sales or output beyond breakeven point is known
as margin of safety because it gives some profit. It can be expressed as a percentage. If present sales are Rs. 4,
00,000 and break even sales are Rs. 3, 00,000, margin of safety is Rs. 1, 00,000 or 25% (1, 00,000/ 4, 00,000 *
100).
Margin of safety = present sales or actual sales – break even sales
Margin of safety = profit/ PV ratio
Margin of safety (M/S) = profit/ contribution per unit
 APPLICATIONS OF MARGINAL COSTING AND COST VOLUME PROFIT ANALYSIS

The following the important areas where managerial problems are simplified by use of marginal costing:

Acceptance or rejection of a foreign offer

Illustration: The Everest Snow Company manufactures and sells direct to customers 10,000 jars of Everest Snow per month
at Rs. 1.25 per jar. The company’s normal production capacity is 20,000 jars of snow per month. An analysis of cost for
10,000 jars shows:

Direct material Rs. 1000 Direct labour Rs. 2475 Power Rs. 140

Misc supplies Rs. 430 Jars Rs. 600 Fixed cost Rs. 7955

The company has received an offer for the export under a different brand name of 1, 20,000 jars of snow at 10,000 jars per
month at 75 paisa a jar. Give your view on acceptance or non acceptance of the offer.

Solution:

Present position Position after export order Receipt

Rs Rs Rs Rs
. . . .
Sales price
12,500 12,500 7500 20,000

Less Variable cost

Direct material 1,000 2,000

Direct labour 2,475 4,950

Power 140 280

Misc expenses 430 860

Jars 600 1,200

Contribution 7,855 10710

Less Fixed cost 7,955 7,955

Profit or loss 100 2,755

From the above statement it is clear that the offer for export should be accepted as it converts the loss of Rs. 100 into a net
profit of Rs. 2,755.
 KEY OR LIMITING FACTOR

A key factor is that factor which puts a limit on production and profit of a business.

Illustration: A company manufactures and markets three products X, Y and Z. All the three products are made from the
same set of machines. Production is limited by machine capacity. From the data given below, indicate priorities for
products X, Y and Z with a view to maximize profits.

X Y Z

Raw material cost per unit 11.25 16.25 21.25

Direct labour cost per unit 2.50 2.50 2.50

Other variable costs per unit 1.50 2.25 3.55

Selling price per unit 25 30 35

Standard machine time required per unit in minutes 39 20 28

Solution: Statement indicating priorities of different products to maximize profits

X Y Z

Rs Rs Rs Rs Rs Rs
. . . . . .
Sales price per unit
25 30 35

Less Variable cost per unit

Raw material cost per unit 11.25 16.25 21.25

Direct labour cost per unit 2.50 2.50 2.50

Other costs per unit 1.50 2.25 3.55

Contribution per unit (A)

9.75 9 7.70

Standard machine time required per unit in minutes

39 20 28
(B)

Contribution per minute (A)/ (B)

0.25 0.45 0.275

Priorities for products

3 1 2
 MAKE OR BUY DECISION

A concern can utilize its idle capacity by making component parts instead of buying them from market. In arriving such a
decision, the price asked by the outside suppliers should be compared with the marginal cost of producing the component
parts. If the marginal cost is lower than the price demanded by the outside suppliers, the component parts should be
manufactured in the factory itself to utilize unused capacity. Fixed expenses are not taken in the cost of manufacturing
components parts on the assumption that they have been already incurred, the additional cost involved is only variable
cost.

Illustration: A manufacturing company finds that while the cost of making a component part is Rs. 10, the same is available
in the market at Rs. 9 with an assurance of continuous supply. Give your suggestion whether to make or buy the part. The
cost information is as follows:

Materials 3.50

Direct labour 4.00

Other variable expenses 1.00

Fixed expenses 1.50

Solution: To take a decision on whether to make or buy the component part, the fixed expenses being irrelevant cist should
not be added to the cost because these will be incurred even if the part is not produced. Thus, additional cost of the part
will be as follows.

Materials 3.50

Direct labour 4.00

Other variable expenses 1.00

Total 8.50

The company should produce the part if the part is available in the market at Rs. 9 because the production of every part
will give to the company a contribution of 50 paisa (9.00-8.50).

Illustration: A firm can purchase a separate part from an outside source @ Rs. 11 per unit. There is a proposal that the
same part can be produced in the factory itself. For this purpose a machine costing Rs. 1, 00,000 with annual capacity of Rs.
20,000 units and a life of 10 years will be required. A foreman with a monthly salary of Rs. 500 will have to be engaged.
Materials required will be Rs. 4 per unit and wages Rs. 2 per unit. Variable overheads are 150% of direct labour. The firm
can easily raise funds @ 10% p.a. advice the firm whether the proposal should be accepted.

Solution:

Increase in Fixed costs:

Depreciation of machine 10,000 Salary of foreman 6000 Interest on capital 10,000 = 26,000

Contribution per unit:

Purchase price =11

Less: variable cost (materials = 4, wages = 2, variable overheads = 3) = 9

Contribution per unit = 2

Minimum volume = 26000/2 = 13000 units.

In order to accept the proposal it is essential that the volume should be at least 13000 units.
 SELECTION OF A SUITABLE PRODUCT MIX

When a factory manufactures more than one product, a problem is faced by the management as to which product mix will
give the maximum profits. The best product mix is that which yields the maximum contribution.

Illustration: Present the following information to show to the management:

1) The marginal product cost and the contribution per unit

2) The total contribution and profits resulting from each of the following sales mixtures
3) The proposed sale mixes to earn a profit of Rs. 250 and Rs. 300 with total sales of A and B being 300 units.
Product A Product B
Direct materials per unit 10 9
Direct wages per unit 3 2
Sales price per unit 20 15
Fixed expenses Rs. 800
Variable expenses are allocated to products as 100% of direct wages.
Sales mixtures:
(a) 100 units of product A and 200 of B
(b) 150 units of product A and 150 of B
(c) 200 units of product A and 100 of B
Recommend which of the sales mixtures should be adopted.
Solution: (a) Statement of marginal cost and unit contribution

Product A Product B

Rs Rs Rs Rs
. . . .
Sales price per unit
20 15

Less Variable cost per unit

Raw material cost per unit 10 9

Direct labour cost per unit 3 2

Variable overheads 3 2

Contribution 4 2

(b)

Mix (a) Mix (b) Mix (c)

A B Total A B Total A B Total

Sales (units) 100 200 300 150 150 300 200 100 300

Contribution per unit 4 2 4 2 4 2

400 400 800 600 300 900 800 200 1000

Total contribution

Less Fixed costs 800 800 800

Profits ----- 100 200

Mix (c) should be adopted as it gives the maximum contribution and profit.

(d) Proposed mixes

Case 1 Case 2

Required profit 250 300

Fixed cost 800 800

Contribution 1080 1100

Case 1: Let p nos. of A be sold Case 2: Let x nos. of A to be sold

Then (300-p) nos. of B is to be sold Then (300-x) nos. of B are to be sold

Equating 4p + 2(300-p) = 1050 Equating 4x+2(300-x) = 1100

P = 225, proposed mix A = 225, B = 75 x = 250, propose mix A = 250, B = 50

ALTERNATIVE METHODS OF PRODUCTION

Illustration: Product X can be produced either by machine A or machine B. Machine A cab produce 100 units of X per hour
and machine B 150 units per hour. Total machine hours available during the year are 25,000. Taking into account the
following data determine the profitable methods of manufacture:

Per unit of product X

Machine A Machine B

Marginal cost Rs. 5 Rs. 6

Selling price Rs. 9 Rs. 9

Fixed cost Rs. 2 Rs. 2

Solution: Profitability statement

Machine A Machine B

Selling price per unit 9 9

Less: Marginal cost 5 6

Contribution per unit 4 3

Output per hour 100 units 150 units

Contribution per hour 400 units 450 units

Machine hours per year 2500 2500

Annual contribution 10, 00,000 11, 25,000

Hence, production by machine B is more profitable.

 BREAK EVEN CHART

A breakeven chart is a graphical representation of marginal costing. It is considered to be the most useful graphic
presentation of accounting data. It is a readable reporting device that would otherwise require voluminous reports and
tables to make the accounting data meaningful to the management. This graph shows the interrelationship between cost,
volume and profit.

Illustration: from the following data calculate the breakeven point and profit if output is 50,000 units by drawing a break
even chart.

Production Fixed expenses Variable cost per unit Selling price per unit Total cost Total sales

0 1, 50,000 10 15 1, 50,000 0

10,000 1, 50,000 10 15 2, 50,000 1, 50,000

20,000 1, 50,000 10 15 3, 50,000 3, 00,000

30,000 1, 50,000 10 15 4, 50,000 4, 50,000

40,000 1, 50,000 10 15 5, 50,000 6, 00,000

50,000 1, 50,000 10 15 6, 50,000 7, 50,000

60,000 1, 50,000 10 15 7, 50,000 9, 00,000

On the x axis of the graph is plotted the number of units produced, sold and on the y axis are shown costs and sales
revenues.

10

Profits

8
Cost and revenue in lakhs.

4
Variable expenses

Fixed expenses

10,000 20,000 30,000 40,000 50,000 60,000

Output in units
 Arithmetical verification

Breakeven point = fixed expenses/contribution per unit = 1, 50,000/5 = 30,000 units of output

Or 30,000 units*selling price = 30,000*15 = 4, 50,000 sales

Angle of incidence

This is the angle formed at the breakeven point at which the sales line cuts the total cost line. This angle indicates the rate
at which profits are being made. Large angle of incidence is an indication that profits are being made at a higher rate. On
the other hand, a small angle of incidence indicates a low rate of profit and suggests that variable costs form the major part
of the cost of production

Profit- volume graph

Profit volume graph is a simplified version of the breakeven chart and is an improvement over the breakeven chart as it
clearly shows the relationship of profits to volume or sales. It is possible to construct a PV graph for any data relating to a
business from which a break even chart can be drawn. The procedure for construction of this graph is as:

1. A scale for sales on horizontal axis is selected and other scale for profits and fixed costs or loss on the vertical axis
is selected. The area below the horizontal line is the loss area and that above is the profit area.
2. Points of profits of corresponding sales are plotted and joined. The resultant line is the profit/loss line.

Illustration: Prepare a PV graph from the following data:

Units produced = 60,000 Selling price per unit = 15 Variable cost per unit = 10 Fixed costs = 1, 50,000

Show the expected sales on the graph when the profit to be earned is Rs. 87,500

Solution:

Profit
2, 00,000
2, 00,000
1, 50,000
1, 50,000
Profit area

Angle of incidence
1, 00,000
1, 00,000
Breakeven point
Fixed cost

50,000 Margin of safety

50,000

1, 50,000 3,00,000 4,50,000 6,00,000 7, 50,000 9,00,000

50,000
0 0 0 0
Loss area

Sales Rs.
1, 00,000
0
Sales Rs. 7, 12,500
when profit is Rs.
1, 50,000 87, 500

2, 00,000

Arithmetical verification

Sales in units = fixed expenses +profits/contribution per unit= 1, 50,000+ 87,500/5 = 2, 37,500/5 = 47,500 units.

Sales = 47,500 units@ Rs. 15 = Rs. 7, 12,500.