COST & MANAGEMENT ACCOUNTING AND FINANCIAL MANAGMENT - icmaiin

65826_2Paper_10_April_2021.pdf

INTERMEDIATE

STUDY NOTES

INTERMEDIATE : PAPER -

10

COST & MANAGEMENT

ACCOUNTING AND

FINANCIAL MANAGMENT

The Institute of Cost Accountants of India

CMA Bhawan, 12, Sudder Street, Kolkata - 700 016

SYLLABUS - 2016

First Edition: August 2016

Reprint: September 2017

Reprint: January 2018

Reprint: June 2018

Reprint: January 2019

Edition: August 2019

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Published by :

Directorate of Studies

The Institute of Cost Accountants of India (ICAI)

CMA Bhawan, 12, Sudder Street, Kolkata - 700 016

Printed at :

M/s. SAP Print Solutions Pvt. Ltd.

28A, Lakshmi Industrial Estate

S.N. Path, Lower Parel (W)

Mumbai - 400 013, Maharashtra

Copyright of these Study Notes is reserved by the Institute of Cost Accountants of India and prior permission from the Institute is necessary for reproduction of the whole or any part thereof.

Syllabus - 2016

PAPER 10: COST & MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT

Syllabus Structure

The syllabus comprises the following topics and study weightage:

ACost & Management Accounting50%

BFinancial Management50%

B 50%
A 50%

ASSESSMENT STRATEGY

There will be examination of three hours.

OBJECTIVE

To provide an in depth knowledge of the detailed procedures and documentation involved in cost ascertainment

systems. To understand the concepts of Financial Management and its application for managerial decision making.

Learning Aims

The syllabus aims to test the student"s ability to:

Understand the cost and management accounting techniques for evaluation, analysis and application in

managerial decision making; &RPSDUHDQGFRQWUDVWPDUJLQDODQGDEVRUSWLRQFRVWLQJPHWKRGVLQUHVSHFWRISURÀWUHSRUWLQJ Apply marginal and absorption costing approaches in job, batch and process environments; Prepare and interpret budgets and standard costs and variance statements; Identify and apply the concepts of Financial Management

Skill Set required

Level B: Requiring the skill levels of knowledge, comprehension, application and analysis. Note: Subjects related to applicable statutes shall be read with amendments made from time to time.

Section A : Cost & Management Accounting50%

1.Cost and Management Accounting - Introduction

2.Decision Making Tools

3.Budgeting and Budgetary Control

4. Standard Costing and Variance Analysis

5. Learning Curve

Section B : Financial Management50%

6. Introduction to Financial Management

7. Tools for Financial Analysis and Planning

8.Working Capital Management

9.Cost of Capital, Capital Structure Theories, Dividend Decisions and Leverage Analysis

10.Capital Budgeting - Investment Decisions

SECTION A: COST & MANAGEMENT ACCOUNTING [50 MARKS]

1.Cost and Management Accounting:

Introduction to Management Accounting - Relationship between Management Accounting and Cost

Accounting

2.Decision Making Tools:

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charts; differential cost analysis; stock valuation under marginal costing vs. absorption costing; applications

of marginal costing in decision making. (b) Transfer Pricing - Determination of Inter-departmental or Inter-company Transfer Price

3.Budgeting and Budgetary Control:

(a) Budgetary Control and Preparation of Functional and Master Budgeting. (b) Fixed, Variable, Semi-Variable Budgets (c) Zero Based Budgeting (ZBB)

4.Standard Costing & Variance Analysis:

Computation of variances for each of the elements of costs, Sales Variances, Investigation of variances -

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5.Learning Curve:

Concept of Learning curve and its application.

SECTION B: FINANCIAL MANAGEMENT [50 MARKS]

6.Introduction to Financial Management:

Meaning - Objectives - Scope of Financial Management sources of Finance - Introduction to Financial Markets.

7.Tools for Financial Analysis and Planning:

Financial Ratio Analysis - Fund Flow Analysis - Cash Flow Analysis.

8.Wroking Capital Management

Working Capital Management - Financing of Working Capital

9.Cost of Capital, Capital Structure Theories, Dividend Decisions and Leverage Analysis

Meaning of Cost of Capital - Computation of Cost of Capital - Capital Structure Theories and Dividend Decisions

Theories (Walters - MM - Gordon Models) - Leverage Analysis

10.Capital Budgeting - Investment Decisions:

Concept of Capital Budgeting - Non-Discounted and Discounted Cash Flow Method - Ranking of Projects.

SECTION A - COST & MANAGEMENT ACCOUNTING

Study Note 1 : Cost and Management Accounting - Introduction

1.1 Introduction 1

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1.3 Objectives of Management Accounting 3

1.4 Role of Management Accounting in Management Process 3

1.5 Functions of Management Accounting 4

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1.7 Limitations of Management Accounting 6

1.8 Relationship between Management Accounting and Cost Accounting 7

Study Note 2 : Decision Making Tools

2.1 Marginal Costing 11

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2.3 Realities about Marginal Costing 15

2.4 Techniques of Marginal Costing 15

2.5 Differential Cost Analysis 27

2.6 Differences between Absorption Costing and Marginal Costing 29

2.7 Application of Marginal Costing in Decision Making 29

2.8 Transfer Pricing 41

2.9 Objectives of Inter Company Transfer Pricing 42

2.10 Methods of Transfer Pricing 42

Study Note 3 : Budgeting and Budgetary Control

3.1 Budgetary Control and Preparation of Functional and Master Budgeting 103

3.2 Fixed, Variable, Semi-variable Budgets 110

3.3 Zero Based Budgeting (ZBB) 112

Study Note 4 : Standard Costing and Variance Analysis

4.1 Introduction 135

4.2 Computation of Variances for each of the Elements of Costs, Sales Variances 138

4.3 Investigation of Variances & Reporting of Variances 152

4.4 Valuation of Stock under Standard Costing 154

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Contents

Study Note 5 : Learning Curve

5.1 Introduction 193

5.2 Phases in Learning Curve 193

5.3 Uses of Learning Curve 195

5.4 Limitations of the usefulness of the Learning Curve 196

5.5 Factors affecting Learning Curve 196

5.6 The Experience Curve 197

5.7 Reasons for use of Learning Curve 198

5.8 Application of Learning Curve 199

SECTION B - FINANCIAL MANAGEMENT

Study Note 6 : Introduction to Financial Management

6.1 Meaning 205

6.2 Objectives 206

6.3 Scope of Financial Management 207

6.4 Sources of Finance 214

6.5 Introduction to Financial Markets 228

Study Note 7 : Tools for Financial Analysis and Planning

7.1 Financial Ratio Analysis 245

7.2 Fund Flow Analysis 272

7.3 Cash Flow Analysis 275

Study Note 8 : Working Capital Management

8.1 Working Capital Management - Financing of Working Capital 313

8.2 Inventory Management 336

8.3 Management of Receivables 337

8.4 Determinant of Credit Policy 339

8.5 Evaluation of Credit Policy 341

8.6 Cash Management 352

Study Note 9 : Cost of Capital, Capital Structure Theories, Dividend Decisions and Leverage Analysis

9.1 Meaning of Cost of Capital - Computation of Cost of Capital 367

9.2 Capital Structure Theories 397

9.3 Dividend Policy 419

9.4 Leverage Analysis 439

9.5 EBIT - EPS Indifference Point/Level 441

Study Note 10 : Capital Budgeting - Investment Decision

10.1 Capital Budgeting 465

10.2 Need of Capital Budgeting Decision 466

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10.4 Process of Capital Budgeting 467

10.5 Control for Capital Expenditure 468

10.6 Investment Criterion - Methods of Appraisal 468

Section A

Cost & Management Accounting

(Syllabus - 2016)

THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 1

This Study Note includes:

1.1 Introduction

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1.4 Role of Management Accounting in Management Process

1.5 Functions of Management Accounting

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1.7 Limitations of Management Accounting

1.8 Relationship between Management Accounting and Cost Accounting

Study Note - 1

COST AND MANAGEMENT ACCOUNTING - INTRODUCTION

1.1 INTRODUCTION

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COST & MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT

6 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA

tation

1.6 SIGNIFICANCE OF MANAGEMENT ACCOUNTING

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1.7 LIMITATIONS OF MANAGEMENT ACCOUNTING

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THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 7

Cost and Management Accounting - Introduction

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THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 9

Cost and Management Accounting - Introduction

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10 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA

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THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 11

This Study Note includes:

2.1 Marginal Costing

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2.3 Realities about Marginal Costing

2.4 Techniques of Marginal Costing

2.5 Differential Cost Analysis

2.6 Differences between Absorption Costing and Marginal Costing

2.7 Application of Marginal Costing in Decision Making

2.8 Transfer Pricing

2.9 Objectives of Inter Company Transfer Pricing

2.10 Methods of Transfer Pricing

Study Note - 2

DECISION MAKING TOOLS

2.1 MARGINAL COSTING

The cost of a product or process can be ascertained using different elements of cost using any of the

following two techniques viz.,

1. Absorption Costing

2. Marginal Costing

Absorption Costing

and variable costs. Thus this technique is also called traditional or total costing. The variable costs are

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with the manufactured products.

Limitations of Absorption Costing

1. Being dependent on levels of output which vary from period to period, costs are vitiated due to

(If, however, overhead recovery rate is based on normal capacity, this situation will not arise).

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of the cost of inventory is a unsound practice because costs pertaining to a period should not be allowed to be vitiated by the inclusion of costs pertaining to the previous period.

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when products are manufactured but only when they are sold.

4. There is no uniformity in the methods of application of overhead in absorption costing. These

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12 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA

5. Absorption costing is not always suitable for decision making solution to various types of problems

of management decision making, where the absorption cost method would be practically ineffective, such as selection of production volume and optimum capacity utilization, selection performance can be had with the help of marginal cost analysis. Sometimes, the conclusion drawn from absorption cost data in this regard may be misleading and lead to losses.

Marginal Costing

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terms in use like direct costing, contributory costing, variable costing, comparative costing, differential

costing and incremental costing are used more or less synonymously with marginal costing.

managerial decisions are taken. The essential feature of marginal costing is division of total costs

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of output. It is to be understood that unit variable cost remains same at different levels of output and

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cost per unit and the number of units.

Features of Marginal Costing

The main features of Marginal Costing may be summed up as follows: $SSURSULDWHDQGDFFXUDWHGLYLVLRQRIWRWDOFRVWLQWRÀ[HGDQGYDULDEOHE\SLFNLQJRXWYDULDEOH portion of semi variable costs also. 9DOXDWLRQRIVWRFNVVXFKDVÀQLVKHGJRRGVZRUNLQSURJUHVVLVYDOXHGDWYDULDEOHFRVWRQO\

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or inventories.

4. Prices are based on Marginal Cost and Marginal Contribution.

5. It combines the techniques of cost recording and cost reporting.

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which they are incurred.

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Advantages or Merits or Applications of Marginal Costing

1. Marginal costing system is simple to operate than absorption costing because they do not involve

the problems of overhead apportionment and recovery. 0DUJLQDOFRVWLQJDYRLGVWKHGLIÀFXOWLHVRIKDYLQJWRH[SODLQWKHSXUSRVHDQGEDVLVRIRYHUKHDG DEVRUSWLRQWRPDQDJHPHQWWKDWDFFRPSDQ\DEVRUSWLRQFRVWLQJ)OXFWXDWLRQVLQSURÀWDUHHDVLHU WRH[SODLQEHFDXVHWKH\UHVXOWIURPFRVWYROXPHLQWHUDFWLRQVDQGQRWIURPFKDQJHVLQLQYHQWRU\ valuation.

3. It is easier to make decisions on the basis of marginal cost presentations, e.g., marginal costing

shows which products are making a contribution and which are failing to cover their avoidable there is the added danger that management may be misled by reliance on unit costs that contain

THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 13

Decision Making Tools

4. Marginal costing is essentially useful to management as a technique in cost analysis and

cost presentation. It enables the presentation of data in a manner useful to different levels of management for the purpose of controlling costs. Therefore, it is an important technique in cost control.

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contribution ratio and marginal cost ratios are very useful to ascertain the changes in selling price,

6. When a business concern consists of several units and produces several products and evaluation

of performance of such components can well be made with the help of marginal costing.

7. It is helpful in forecasting.

8. When there are different products, the determination of number of units of each product, called

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be determined with the help of marginal costing.

10. Apart from the above, numerous managerial decisions can be taken with the help of marginal

(a) Make or buy decisions, ([SORULQJIRUHLJQPDUNHWV (c) Accept an order or not, (d) Determination of selling price in different conditions, (e) Replace one product with some other product, (f) Optimum utilisation of labour or machine hours, (g) Evaluation of alternative choices, (h) Subcontract some of the production processes or not, ([SDQGWKHEXVLQHVVRUQRW M'LYHUVLÀFDWLRQ (k) Shutdown or continue.

Limitations of Marginal Costing

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produces an unrealistic and conservative Balance Sheet, unless adjustments are made in the

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VDOHVYROXPH:KHUHVDOHVDUHVHDVRQDOSURÀWVÁXFWXDWHIURPSHULRGWRSHULRG0RQWKO\RSHUDWLQJ

statements under the marginal costing system will not, therefore, be as realistic or useful as in absorption costing. COST & MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT

14 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA

'XULQJWKHHDUOLHUVWDJHVRIDSHULRGRIUHFHVVLRQWKHORZSURÀWVRULQFUHDVHLQORVVHVDVUHYHDOHG

LQDPDJQLÀHGZD\LQWKHPDUJLQDOFRVWVVWDWHPHQWVPD\XQGXO\FUHDWHSDQLFDQGFRPSHOWKH management to take action that may lead to further depression of the market. 0DUJLQDOFRVWLQJGRHVQRWJLYHIXOOLQIRUPDWLRQ)RUH[DPSOHLQFUHDVHGSURGXFWLRQDQGVDOHV PD\EHGXHWRH[WHQVLYHXVHRIH[LVWLQJHTXLSPHQWVE\ZRUNLQJRYHUWLPHRULQVKLIWVRUE\DQ H[SDQVLRQRIWKHUHVRXUFHVRUE\WKHUHSODFHPHQWRIODERXUIRUFHE\PDFKLQHV7KHPDUJLQDO contribution fails to reveal these.

7KRXJKIRUVKRUWWHUPDVVHVVPHQWRISURÀWDELOLW\PDUJLQDOFRVWVPD\EHXVHIXOORQJWHUPSURÀWLV

correctly determined on full costs basis only. $OWKRXJKPDUJLQDOFRVWLQJHOLPLQDWHVWKHGLIÀFXOWLHVLQYROYHGLQWKHDSSRUWLRQPHQWDQGXQGHU DQGRYHUDEVRUSWLRQRIÀ[HGRYHUKHDGWKHSUREOHPVWLOOUHPDLQVVRIDUDVWKHYDULDEOHRYHUKHDG is concerned.

:LWK LQFUHDVHG DXWRPDWLRQ DQG WHFKQRORJLFDO GHYHORSPHQWV WKH LPSDFW RQ À[HG FRVWV RQ

SURGXFWVLVPXFKPRUHWKDQWKDWRIYDULDEOHFRVWV$V\VWHPZKLFKLJQRUHVÀ[HGFRVWVLVWKHUHIRUH

less effective because a major portion of the cost, such as not taken care of. (j) Marginal costing does not provide any standard for the evaluation of performance. A system of budgetary control and standard costing provides more effective control than that obtained by marginal costing.

2.2 DETERMINATION OF COST AND PROFIT UNDER MARGINAL COSTING

YDULDEOHDQGÀ[HG$OOWKHYDULDEOHFRVWVDUHSDUWRISURGXFWDQGVHUYLFHVZKLOHÀ[HGFRVWVDUHFKDUJHG

against contribution margin. DQG3URÀW6WDWHPHQWXQGHU0DUJLQDO&RVWLQJ

ParticularsAmount (`)Amount (`)

Sales Revenue(A)

Product Cost:

Direct Materials

'LUHFW([SHQVHV

9DULDEOHPDQXIDFWXULQJRYHUKHDGV

---- ---- ---- ----

Total Product Costs (B)-----

Product Contribution Margin (A - B)

9DULDEOH6HOOLQJ 'LVWULEXWLRQRYHUKHDGV

---- ---- 

Contribution Margin (C)

Period Cost:

)L[HGQRQPDQXIDFWXULQJH[SHQVHV (D) ---- ---- &²'

THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 15

Decision Making Tools

2.3 REALITIES ABOUT MARGINAL COSTING

Some of the realities marginal costing are discussed below:

Marginal costing is not a distinct method of costing like job costing, process costing, operating costing

, etc., but a special technique used for managerial decision making. Marginal Costing is used to

processes and cost centres in the course of decision making. It can, therefore, be used in conjunction

with the different methods of costing such as job costing, process costing and with other techniques

like standard costing or budgetary control.

In marginal costing, cost ascertainment is made on the basis of the nature of cost. It gives consideration

to behaviour of costs. In other words, the technique has developed from a particulars conception and

taking. Under the total cost method the total cost is the sum total of the cost of direct material, direct

overheads. In this system, other things being equal, the total cost per unit will remain constant only

ÁXFWXDWLQJWKHDFWXDOWRWDOFRVWZLOOYDU\IURPRQHSHULRGWRDQRWKHU7KLVVLWXDWLRQDULVHVEHFDXVH

RIFKDQJHVLQYROXPHRIRXWSXWDQGWKHSHFXOLDUEHKDYLRXURIÀ[HGH[SHQVHVLQFOXGHGLQWKHWRWDO

FRVW6XFKÁXFWXDWLQJPDQXIDFWXULQJDFWLYLW\DQGFRQVHTXHQWO\WKHYDULDWLRQVLQWKHWRWDOFRVWIURP

period to period poses a serious problem to the management in taking sound decisions. Therefore, the

2.4 TECHNIQUES OF MARGINAL COSTING

Contribution:

In common parlance, contribution is the reward for the efforts of the entrepreneur or owner of a business

LQ&RVWLQJWHUPLQRORJ\FRQWULEXWLRQPHDQVQRWRQO\SURÀWEXWDOVRÀ[HGFRVW7KDWLVZK\LWLVGHÀQHGDV

WKHDPRXQWUHFRYHUHGWRZDUGVÀ[HGFRVWDQGSURÀW

Contribution or contribution margin is the difference between sales revenue and total variable costs

&RQWULEXWLRQ& 6DOHVUHYHQXH6²7RWDO9DULDEOH&RVW9 &RQWULEXWLRQFDQEHFRPSXWHGE\VXEWUDFWLQJYDULDEOHFRVWIURPVDOHVRUE\DGGLQJÀ[HGFRVWVDQG

SURÀW

6\PEROLFDOO\& 6²9
D

Where C = Contribution

S = Selling Price

$OVR & )3
D :KHUH) )L[HG&RVW

3 3URÀW

COST & MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT

16 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA

From (1) and (2) above, we may deduce the following equation called Fundamental Equation of

&RQWULEXWLRQLVKHOSIXOLQGHWHUPLQDWLRQRISURÀWDELOLW\RIWKHSURGXFWVDQGRUSULRULWLHVIRUSURÀWDELOLWLHV

of the products. When there are two or more products, the product having more contribution is more )RUH[DPSOH7KHIROORZLQJDUHWKHWKUHHSURGXFWVZLWKVHOOLQJSULFHDQGFRVWGHWDLOV

ParticularsABC

Selling Price (`)100150200

`)5070100

Contribution (`)5080100

FRQWULEXWLRQ7KLVSURSRVLWLRQRISURGXFWKDYLQJPRUHFRQWULEXWLRQLVPRUHSURÀWDEOHLVYDOLGDVORQJ

DVWKHUHDUHQROLPLWDWLRQVRQDQ\IDFWRURISURGXFWLRQ,QWKLVFRQWH[WIDFWRUVRISURGXFWLRQPHDQV

the factors that are responsible for producing the products such as materials, labour, machine hours,

demand for sales etc.,

Limiting Factor (or) Key Factor

Limiting Factor (or) Key Factor or principal Budget Factor:

factor or limiting factor or principal budget factor as a factor which at a particular time or over a

period will limit the activities of an organisation and which is therefore, taken into account in preparing

budgets.

WKHUHLVDOLPLWDWLRQRQDQ\LQSXWIDFWRUWKHSURÀWDELOLW\RIWKHSURGXFWFDQQRWVLPSO\EHGHWHUPLQHG

E\ÀQGLQJRXWWKHFRQWULEXWLRQRIWKHXQLWEXWLWFDQEHIRXQGRXWE\DVFHUWDLQLQJWKHFRQWULEXWLRQSHU

unit of that factor of production which is limited in the given situation. Such factor of production which

is limited in the question is called key factor or limiting factor.

The three products take some raw material. A takes 1 kg, B requires 2 kgs, C requires 5 kgs and the raw

material is not abundant.

3URÀWDELOLW\ 

Contribution

Key Factor

ABC ` 50` 40` 20

.H\IDFWRUFDQDOVREHFDOOHGDVVFDUFHIDFWRURU*RYHUQLQJIDFWRURU/LPLWLQJIDFWRURU&RQVWUDLQLQJ

factor etc., whatever may be the name, it indicates the limitation on the particular factor of production.

RIWKHSURGXFWVSULRULWLHVIRUSURÀWDELOLW\RIWKHSURGXFWDQGLQSDUWLFXODUSURÀWDELOLWLHVZKHQWKHUHDUH

limitation on any factor.

THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 17

Decision Making Tools

9ROXPH5DWLR395DWLRRUFRQWULEXWLRQ5DWLR

For Example:

3URÀW5DWLR
O*URVVSURÀWLVõWKRIVDOHV
O6DOHVLVWLPHVWKDWRIJURVVSURÀW
O*URVVSURÀWUDWLRLV
O*URVVSURÀWLVRIVDOHVDQGODVWO\
O*URVVSURÀWDQGVDOHVDUHLQWKHUDWLRRI

6\PEROLFDOO\39UDWLR 

Contribution

Sales ∑-  

ð
D

O39UDWLR  C S

× 100)

&RQWULEXWLRQ 6DOHVð39UDWLR
D
O6DOHV 

3  95DWLR

Contribution∑-

 
D When cost accounting data is given for two periods, then:

Change in Contribution

Change in Sales

× 100)or

Change in Profit

Change in Sales

× 100)

It is to be noted that the above two formulas are valid as long as there are no changes in prices, means

input prices and selling prices.

LHLWFDQDOVREHZULWWHQDV6DOHV 9DULDEOH&RVW)L[HG&RVW3URÀWDQGWKLVLVFDOOHGJHQHUDOVDOHV

equation. IRXQGRXW6LPLODUO\JLYHQWKH39UDWLRYDULDEOHFRVWUDWLRFDQEHIRXQGRXW

For example

UDWLRLV6XFKDUHODWLRQVKLSLVFDOOHGFRPSOHPHQWDU\UHODWLRQVKLS7KXV39UDWLRDQGYDULDEOHFRVW

ratios are said to be complements of each other.

SULRULWLHVIRUSURÀWDELOLWLHVRIWKHSURGXFWV,QSDUWLFXODULWLVXVHIXOLQGHWHUPLQDWLRQRISURÀWDELOLWLHVRIWKH

COST & MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT

18 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA

products in the following two situations: (i) When sales potential in value is limited. (ii) When there is a greater demand for the products.

Break Even Analysis

DQGÀ[HGFRVWVWRGHWHUPLQHWKHPLQLPXPYDOXHRISURGXFWLRQQHFHVVDU\WREUHDNHYHQ

%UHDN(YHQPHDQVWKHYROXPHRISURGXFWLRQRUVDOHVZKHUHWKHUHLVQRSURÀWRUORVV,QRWKHUZRUGV

Break Even Point is the volume of production or sales where total costs are equal to revenue. It helps

FRVWYROXPHDQGSURÀWDUHDOZD\VXVHG7KHEUHDNHYHQDQDO\VLVLVXVHGWRDQVZHUPDQ\TXHVWLRQVRI

the management in day to day business.

The formal break even chart is as follows:

D /RVVHVE 3URÀWV

:KHQQRRIXQLWVDUHH[SUHVVHGRQ;D[LVDQGFRVWVDQGUHYHQXHVDUHH[SUHVVHGRQ<D[LVWKUHHOLQHV

DUHGUDZQLHÀ[HGFRVWOLQHWRWDOFRVWOLQHDQGWRWDOVDOHVOLQH,QWKHDERYHJUDSKZHÀQGWKHUH

is an intersection point of the total sales line and total cost line and from that intersection point if a

SDUDOOHOOLQHLVGUDZQWR;D[LVVRWKDWLWFXWV<D[LVZKHUHZHÀQG%UHDN(YHQSRLQWLQWHUPVRIYDOXH7KLV

is how, the formal pictorial representation of the Break Even chart.

At the intersection point of the total cost line and total sales line, an angle is formed called Angle of

Contribution Break-Even Chart

A contribution breakeven chart is based on the same principles as a conventional breakeven chart UHYHQXHUHPDLQWKHVDPH7KHEUHDNHYHQSRLQWDQGSURÀWFDQEHUHDGLQWKHVDPHZD\DVZLWKD conventional chart. It is also possible to read the contribution for any level of activity.

THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 19

Decision Making Tools

Contribution breakeven chart is shown below:

The contribution can be read as the difference between the sales revenue line and the variable cost line.

Angle of Incidence

HDUQLQJFDSDFLW\RIWKHÀUPRYHUWKHEUHDNHYHQSRLQWVDOHV

Angle of Incidence is an angle formed at the intersection point of total sales line and total cost line in

ORZHUWKHUDWHRIJURZWKRISURÀWLVORZHU6RJURZWKRISURÀWRUSURÀWDELOLW\UDWHLVGHSLFWHGE\$QJOH

of Incidence. $QDO\VLV&93DQDO\VLV DQGSURÀW)URPWKHEUHDNHYHQFKDUWVEUHDNHYHQSRLQWDQGSURÀWVDWDJODQFHFDQEHIRXQGRXW %HVLGHVPDQDJHPHQWPDNHVSURÀWSODQQLQJZLWKWKHKHOSRIEUHDNHYHQFKDUWV,WFDQFOHDUO\EH

XQGHUVWRRGE\ZD\RIFKDUWVWRNQRZWKHFKDQJHVLQSURÀWGXHWRFKDQJHVLQFRVWVDQGRXWSXW6XFK

SURÀWSODQQLQJLVPDGHZLWKWKHYDULDEOHVPDLQO\FRVWSURÀWDQGYROXPHVXFKDQDQDO\VLVLVFDOOHG

breakeven analysis. Throughout the charts relationship is established among the cost, volume and DQDO\VLVEUHDN HYHQDQDO\VLVDQGSURÀWJUDSKVDUHLQWHUFKDQJHDEOHZRUGV.

Importance

It provides the information about the following matters: (i) The behaviour of cost in relation to volume 9ROXPHRISURGXFWLRQRUVDOHVZKHUHWKHEXVLQHVVZLOOEUHDNHYHQ LLL6HQVLWLYLW\RISURÀWGXHWRYDULDWLRQLQRXWSXW LY$PRXQWRISURÀWIRUDSURMHFWHGVDOHVYROXPH Y4XDQWLW\RISURGXFWLRQDQGVDOHVIRUDWDUJHWSURÀWOHYHO RIYDULRXVFKDQJHVRQSURÀW ,WH[SODLQVWKHLPSDFWRIWKHIROORZLQJRQWKHQHWSURÀW (i) Changes in selling prices, (ii) Changes in volume of sales, COST & MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT

20 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA

(iii) Changes in variable cost, &KDQJHVLQÀ[HGFRVW

7KHFKDQJHLQSURÀWFDQEHVWXGLHGWKURXJK%UHDNHYHQFKDUWVLQGLIIHUHQWVLWXDWLRQVLQWKHIROORZLQJ

manner: (i) Increase in No. of Units Unit FC B

Total Cost

A

Total Sales

O C

Angle of Incidence

REVHUYHZHÀQGWKDWWKHUHLVQRFKDQJHLQ%(3HYHQLIWKHUHLVLQFUHDVHRUGHFUHDVHLQ1RRIXQLWV

(ii) Increase in Sales due to increase in selling price.

NTS = New Total Sales line

B

)URPWKHDERYHFKDUWZHREVHUYHWKDWSURÀWLVLQFUHDVHGE\LQFUHDVLQJWKHVHOOLQJSULFHDQGDOVRLI

there is change in selling price, BEP also changes. If selling price is increased then BEP decreases. If

selling price is decreased then BEP increases. Thus, we say that there is an inverse relationship between

selling price and BEP.

THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 21

Decision Making Tools

(iii) Decrease in variable cost: FC

Total Cost

Total Sales

O C B

)URP WKH DERYH FKDUW ZH REVHUYH WKDW ZKHQ YDULDEOH FRVWV DUH GHFUHDVHG QR GRXEW SURÀW LV

increased. If there is change in variable cost then BEP also changes. If variable cost is decreased then

BEP also decreases. If variable cost is increased then BEP also increases. Thus there is direct relationship

between variable cost and BEP. &KDQJHLQÀ[HGFRVW FC

Total Cost

Total Sales

O D B E C in BEP.

FRVWLVLQFUHDVHGWKHQ%(3DOVRLQFUHDVHV,IÀ[HGFRVWLVGHFUHDVHGWKHQ%(3DOVRGHFUHDVHV7KXVWKHUH

LVDGLUHFWUHODWLRQVKLSEHWZHHQÀ[HGFRVWDQG%(3 COST & MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT

22 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA

Non linear Break Even Chart:

HYHQSRLQWV,QVXFKDFDVHWKHRSWLPXPSURÀWLVHDUQHGZKHUHWKHGLIIHUHQFHEHWZHHQWKHVDOHVDQG

the total costs is the largest. It is obvious that the business should produce only upto this level. This is

being illustrated in the above chart.

Cash Break-Even Point

EUHDNHYHQSRLQWLVNQRZQDVFDVKEUHDNHYHQSRLQW7KLVPHDQVWKDWGHSUHFLDWLRQDQGRWKHUQRQFDVK

À[HGFRVWVDUHH[FOXGHGIURPWKHÀ[HGFRVWVLQFRPSXWLQJFDVKEUHDNHYHQSRLQW,WVIRUPXODLV

&DVKEUHDNHYHQSRLQW &DVKÀ[HGFRVWV&RQWULEXWLRQSHUXQLW

Illustration 1

` 2,75,000 units of its product at ` ` 17.50 per unit (manufacturing costs of ` 14 and selling cost `

the year and amount to ` 35,00,000 (including depreciation of ` 15,00,000). There is no beginning or

ending inventories.

Required:

Solution:

%UHDNHYHQ6DOHV4XDQWLW\ )L[HGFRVW&RQWULEXWLRQPDUJLQSHUXQLW = ` ` 20 = 1,75,000 units &DVK%UHDNHYHQVDOHV4XDQWLW\ &DVK)L[HG&RVW&RQWULEXWLRQPDUJLQSHUXQLW = ` ` 20 = 1,00,000 units.

THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 23

Decision Making Tools

9ROXPH&KDUW

7KHQRUPDOEUHDNHYHQFKDUWVVXIIHUIURPRQHOLPLWDWLRQ3URÀWFDQQRWEHUHDGGLUHFWO\IURPWKHFKDUW

,WLVHVVHQWLDOWRGHGXFWWRWDOFRVWIURPVDOHWRNQRZWKHSURÀWÀJXUH7KHSURÀWJUDSKRYHUFRPHVWKH

GLIÀFXOW\E\SORWWLQJSURÀWGLUHFWO\DJDLQVWDQDFWLYLW\7KHVHFKDUWVDUHHDV\WRXQGHUVWDQGDQGWKHLU

SUHSDUDWLRQLQYROYHVGUDZLQJVDOHVFXUYHDQGSURÀWFXUYH7KHSRLQWDWZKLFKSURÀWOLQHFXWVWKHVDOHV

OLQHLVFDOOHGEUHDNHYHQSRLQW7DNLQJWKHPHWKRGVDQGREMHFWVXQGHUFRQVLGHUDWLRQWKHSURÀWYROXPH

chart can be further divided into following categories i.e., 6LPSOH3URÀW9ROXPH&KDUW

Its preparation involves the following steps:

)LQGLQJRXWSURÀWDWDQ\WZROHYHOVRIDFWLYLW\

2. Drawing sales line,

'UDZLQJSURÀWOLQH

6LPSOH3URÀW9ROXPHFKDUWLVVKRZQEHORZ

COST & MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT

24 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA

3URÀWYROXPHFKDUWVKRZLQJGLIIHUHQWEUHDNHYHQSRLQWDWGLIIHUHQWSULFHOHYHOVLVVKRZQEHORZ 3URÀW*UDSK

WKHSURÀWDELOLW\RIRQHSURGXFWZLOOOHDGWRDFKDQJHLQWKHSURÀWDELOLW\DVDZKROH3URÀWYROXPHFKDUW

FDQEHSUHSDUHGIRUDJURXSDOVR7KLVFKDUWVKRZVUHODWLYHSURÀWDELOLW\RIGLIIHUHQWSURGXFWV,WLVDOVR

FDOOHGSURÀWYROXPHJUDSKIRUDJURXSRISURGXFWVVHTXHQWLDOSURÀWJUDSKRUSURÀWSDWKFKDUW,WVPDLQ

DGYDQWDJHLVWKDWLWH[KLELWVWKHUHODWLYHSURÀWDELOLW\RIGLIIHUHQWSURGXFWVDWDJODQFH7KLVJUDSKLVDOVR

useful to show average slope and marginal slope.

,QVHTXHQWLDOSURÀWJUDSKRUSURÀWJUDSKIRUDJURXSRISURGXFWVDOLQH´SURÀWSODQµLVGUDZQLQRUGHU

WRGUDZWRWDOSURÀWOLQH)RUGUDZLQJSURÀWSDWKDVWDWHPHQWLVSUHSDUHGVKRZLQJFXPXODWLYHVDOH

DQGFXPXODWLYHSURÀW7KHOLQH¶3URÀWSDWK·LVGUDZQZLWKWKHDLGRIFROXPQVIRUFXPXODWLYHVDPHDQG

FXPXODWLYHSURÀW

6WHSVLQGUDZLQJ3URÀWYROXPHJUDSKRUVHTXHQWLDOSURÀWJUDSK

3UHSDUHDPDUJLQDOFRVWVWDWHPHQWWRNQRZWKH39UDWLRV 3UHSDUHDVWDWHPHQWWRÀQGRXWFXPXODWLYHVDOHDQGFXPXODWLYHSURÀW 'UDZDSURÀWSDWKZLWKWKHKHOSRIFROXPQVFXPXODWLYHVDOHDQGFXPXODWLYHSURÀW 'UDZWRWDOSURÀWOLQHIRUJURXSRISURGXFWV

THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 25

Decision Making Tools

2)%5($.(9(132,17

Break Even Point in value =

F×S

..... (1) =

F×S

C ..... (2) =

F×S

S + P ..... (3) = F ..... (4) Or = F C S Or = F S = 1 F S  ..... (5)

Proof for basic breakeven

U be the volume of output i.e., No. of units

)EHWKH)L[HG&RVW:KHUH

6EHWKH6HOOLQJ3ULFH) )L[HG&RVW

%\VXEVWLWXWLQJWKHQRWDWLRQVLQJHQHUDOVDOHVHTXDWLRQ9 9DULDEOH&RVW

6DOHV )L[HGFRVW9DULDEOHFRVW3URÀW6 6DOHV

68 )9833 3URÀW

$W%UHDN(YHQ68 )986LQFH3 & &RQWULEXWLRQ
D68²98 )
D86²9 )
D8  F OR

No. of Units Contribution per Unit

Contribution Per Unit

Break even sales

SU (Sales) =

F×S

COST & MANAGEMENT ACCOUNTING AND FINANCIAL MANAGEMENT

26 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA

DQGDSSOLFDWLRQVRI%UHDNHYHQ$QDO\VLV2U3URÀW&KDUWV2U&RVW9ROXPH3URÀW$QDO\VLV put to use are:

)RUHFDVWLQJFRVWVDQGSURÀWVDVDUHVXOWRIFKDQJHLQ9ROXPHGHWHUPLQDWLRQRIFRVWVUHYHQXHDQG

variable cost per unit at various levels of output. )L[DWLRQRIVDOHV9ROXPHOHYHOWRHDUQRUFRYHUJLYHQUHYHQXHUHWXUQRQFDSLWDOHPSOR\HGRUUDWH of dividend. 'HWHUPLQDWLRQRIHIIHFWRIFKDQJHLQ9ROXPHGXHWRSODQWH[SDQVLRQRUDFFHSWDQFHRIRUGHU ZLWKRUZLWKRXWLQFUHDVHLQFRVWVRULQRWKHUZRUGVGHWHUPLQDWLRQRIWKHTXDQWXPRISURÀWWREH obtained with increased or decreased volume of sales. 'HWHUPLQDWLRQRIFRPSDUDWLYHSURÀWDELOLW\RIHDFKSURGXFWOLQHSURMHFWRUSURÀWSODQ H6XJJHVWLRQIRUVKLIWLQVDOHVPL[ (f) Determination of optimum sales volume.

(g) Evaluating the effect of reduction or increase in price, or price differentiation in different markets.

+LJKOLJKWLQJWKHLPSDFWRILQFUHDVHRUGHFUHDVHLQÀ[HGDQGYDULDEOHFRVWVRQSURÀW

L6WXG\LQJWKHHIIHFWRIFRVWVKDYLQJDKLJKSURSRUWLRQRIÀ[HGFRVWVDQGORZYDULDEOHFRVWVDQG

YLFHYHUVD

M,QWHUÀUPFRPSDULVRQRISURÀWDELOLW\ N'HWHUPLQDWLRQRIVDOHSULFHZKLFKZRXOGJLYHDGHVLUHGSURÀWIRUEUHDNHYHQ (l) Determination of the cash requirements as a desired volume of output, with the help of cash breakeven charts. %UHDNHYHQDQDO\VLVHPSKDVLVLQJWKHLPSRUWDQFHRIFDSDFLW\XWLOLVDWLRQIRUDFKLHYLQJHFRQRP\ (n) The comparative effects of a shutdown or continued operation at a loss indicated during severe recession. 7KHHIIHFWRQWRWDOFRVWRIDFKDQJHLQWKHÀ[HGRYHUKHDGPRUHFOHDUO\GHPRQVWUDWHGWKURXJK

EUHDNHYHQFKDUWV

Limitations of Break-even Analysis

(a) HOHPHQWV7KLVFDQQRWSRVVLEO\EHGRQHDFFXUDWHO\DQGWKHGLIÀFXOWLHVDQGFRPSOLFDWLRQVLQYROYHG LQVXFKVHJUHJDWLRQPDNHWKHEUHDNHYHQSRLQWLQDFFXUDWH (b) The behavior of both costs and revenue is not entirely related to changes in volume.

(c) Costs and revenue patterns are linear over levels of output being considered. In practice, this is

not always so and the linear relationship is true only within a short run relevant range. )L[HGFRVWVUHPDLQFRQVWDQWDQGYDULDEOHFRVWVYDU\LQSURSRUWLRQWRWKHYROXPH)L[HGFRVWVDUH

constant only within a limited range and are liable to change at varying levels of activity and also

over a long period, particularly when additional plants and equipments are introduced. 6DOHVPL[LVFRQVWDQWRURQO\RQHSURGXFWLVPDQXIDFWXUHG$FRPELQHGDQDO\VLVWDNLQJDOOWKH SURGXFWVRIWKHPL[GRHVQRWUHÁHFWWKHFRUUHFWSRVLWLRQUHJDUGLQJLQGLYLGXDOSURGXFWV I3URGXFWLRQDQGVDOHVÀJXUHVDUHLGHQWLFDORUWKHFKDQJHLQRSHQLQJDQGFORVLQJVWRFNVRIWKH

ÀQLVKHGSURGXFWLVQRWVLJQLÀFDQW

THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 27

Decision Making Tools

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homogeneous factor to represent volume. (h) The activities and productivity of the concern remain unchanged during the period of study.

(i) As output is continuously varied within a limited range, the contribution margin remains relatively

constant. This is possible mainly where the output is more or less homogeneous as in the case of process industries

2.5 DIFFERENTIAL COST ANALYSIS

Differential Cost is the change in the costs which results from the adoption of an alternative course

increasing, reducing or stopping the production of certain items), or methods of production, sales, or

in costs occurs due to change in the activity from one level to another, differential cost is referred to as

incremental cost or decremental cost, if a decrease in output is being considered, i.e. total increase

between differential cost and incremental cost and the two terms are used to mean one and the same thing. The computation of differential cost provides an useful method of analysis for the management for

anticipating the results of any contemplated changes in the level or nature of activity. When policy

decisions have to be taken, differential costs worked out on the basis of alternative proposals are of

great assistance.

The determination of differential cost is simple. Differential cost represents the algebraic difference

between the relevant costs for the alternatives being considered. Thus, when two levels of activities

are being considered, the differential cost is obtained by subtracting the cost at one level from the

cost of another level. The essential features of differential costs are as follows:-

1) The basis data used for differential cost analysis are costs, revenue and the investment factors

which are relevant in the problem for which the analysis is undertaken.

2) Total differential costs rather than the costs per unit are considered.

3) Differential cost analysis is made outside the accounting records.

4) As the differences in the costs at two levels are considered, absolute costs at each level are not

as relevant as the difference between the two. Thus, items of costs which do not change but are identical for the alternatives under consideration, are ignored.

5) The differentials are measured from a common base point or position.

6) The stage at which the differen

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