Examples: Absorption Costing & Marginal Costing

Q. Rajkumar Ltd. provides you the following information

	Sales (Rs.)	Profit (Rs.)
Period 1	10,000	2,000
Period 2	15,000	4,000

You are required to calculate:

P/V ratio
Fixed cost
Break-even sales volume
Sales to earn a profit of Rs. 3,000 and
Profit when sales are Rs. 8,000

	Change in profit
P/V ratio =		x	100
	Change in rate

	2000
=		x	100	=	40%
	5000

ii)

Fixed Cost = Contribution - Profit

	10000
=		x	40 - 2000	=	2000
	100

iii)

	Fixed Cost
Break-even sales volume =
	P/V ratio

	2000
=		X	100
	40

= 5000

iv)

	Fixed cost + Profit
Sales =
	P/V ratio

	2000 + 3000
Sales =
	40%

= 12500

Profit = Sales - Variable cost - Fixed cost
Variable cost = 8000 x (60/100) = 4800
Profit = 8000 - 4800 - 2000 = 1200

Q. From the following information relating to Smith sons, calculate the break-even point and the turnover required to earn a profit of Rs. 3,00,000

Fixed Overhead = 2,10,000 (total)
Variable Cost = 20 per unit
Selling price = 50 per unit

If the company is earning a profit of Rs. 3,00,000, what is the margin of safety available to it? Also state the significance of this margin.

Selling price	= 50
Less variable cost	= 20
Contribution	= 30

	Fixed cost
BEP in units =
	Contribution per unit

	2,10,000
=		=	7,000 units
	30

	2,10,000
BEP in amount =		=	3,50,000
	60%

Calculation of turnover to earn a profit of Rs. 3,00,000

	Fixed cost + Desired Profit
Sales =
	Contribution per unit

	21,000 + 3,00,000
=
	30

= 17000 units

	Fixed cost + Desired Profit
Sales (amount) =
	P/V ratio

	21,000 + 3,00,000
=
	60%

= 8,50,000

Margin of Safety

Margin of safety = Total sales - sales at BEP
MOS (Amount) = 850000 - 350000 = 500000
MOS (Units) = 17000 - 7000 = 10000 units

> For theory part please refer to chapter 9.

Q. Premier Ltd. produces a standard article. The results of the last four quarters of the year 2000 are as follows:

Quarters	Output (unit)
I	1,000
II	1,500
III	2,000
IV	3,000

The cost of direct material is Rs. 30 and direct labour is Rs. 20 per unit. Variable expenses are Rs 10 per unit. Fixed expenses are Rs 6,000 per annum. (i) Find out full cost percent for each quarter. (ii) Find out BEP (Break Even Point) in units for each quarter if selling price is Rs 100 per unit and the entire output is sold.

	I	II	III	IV
Output	1000	1500	2000	3000
Direct material Rs. 30	30000	45000	60000	90000
Direct Labour Rs. 20	20000	30000	40000	60000
Variable Expenses Rs. 10	10000	15000	20000	30000
Fixed Expenses	1500	1500	1500	1500

Annual expenses = 6000
Quaterly expense = 6000/4 = 1500

i) Full cost percent for each quarter

Total	61500	91500	121500	181500
Percentage	13.5	20	26.7	39.80

ii) BEP in units

BEP = Fixed cost/ contribution per unit

Contribution = Sales - Variable cost
= 100 - (30 + 20 + 10)
= 40

BEP = 6000/40 = 150 units

Q. From the following data :

Selling Price = Rs. 40 per unit
Variable manufacturing cost = Rs. 20 per unit
Variable selling cost = Rs. 10 per unit
Fixed factory overheads = 10,00,000 per year
Fixed selling costs 4,00,000 per year

Calculate : i) Break-even point expressed in rupee sales. ii) Number of units that must be sold to earn a profit of Rs. 2,00,000 per year.

Contribution = Sales - variable cost
= 40 - (20 + 10)
= 10

Total fixed cost = Fixed factory overheads + Fixed selling cost
= 10,00,000 + 4,00,000 = 14,00,000

	Fixed cost
BEP in units =
	Contribution per unit

	14,00,000
=
	10

= 1,40,000 units

BEP (Value) = Fixed cost/(P/V ratio)

	Contribution
P/V ratio =		x	100
	Sales

= 10/40 X 100 = 25%

BEP (value) = (14,00,000/25) X 100
= 56,00,000

ii) Number of units must be sold to earn a profit of Rs. 2,00,000 per year

	Fixed cost + Desired Profit
Sales =
	P/V ratio

= (14,00,000 + 2,00,000) / 25%
= 64,00,000

Q. A medical advisory service offers to its subscribers complete information on doctors, paramedicals, health insurance, super speciality hospitals and general health awareness. It now plans to computerise these sevices and has a choice of two systems on which to offer these services. Under option A, a computer system would be leased for Rs. 50 lakhs per year and the subscriber requests would be processed with avariable cost of Rs. 20 per request. Under plan B, a computer system would be leased for Rs. 10 lakhs per year and the subscriber requests would be processed with a variable cost of Rs. 120 per request. Under either option, the subscriber can and is happy to pay Rs 220 per request that is processed. On the basis of this data
(i) Which option is more risky?
(ii) Draw break even charts for both options.
(iii) At what volume of business would the operating profit under either option be the same?
(iv) Which plan has a higher degree of operating leverage?

(i)

PLAN A

BEP (units) = Fixed costs/contribution per unit
= 50,00,000/(220 - 20)
= 25,000 requests

PLAN B

BEP (units) = Fixed costs/contribution per unit
= 10,00,000/(220 - 120)
= 10,000 requests

Plan is more risky because initial fixed cost is very high. If sales fall below 25,000 requests, losses will be incurred.

(ii) Break even chart

iii) Profit under plan A = (Price - Varaible cost) X Units - FC
= (220 - 20) X (x) - 50,00,000

Profit under plan B = (220 - 120) X (x) - 10,00,000

Equating both the equations we get

(220 - 20) X (x) - 50,00,000 = (220 - 120) X (x) - 10,00,000
100x = 40,00,000
x = 40,000 requests

iv) Operating Leverage

Degree of operating leverage = %change in net operating income / % change in units sold or sales
= Contribution/EBIT

Where EBIT is Earning before interest & tax

In both the plans the contribution is calculated taking hypothetical data of 50,000 requests because the question does not provide any information.

PLAN A

	50000 X (Rs. 220 - Rs. 20)
=
	50000 X (220 - 20) - Rs. 50,00,000

= 2

PLAN B

	50000 X (Rs. 220 - Rs. 120)
=
	50000 X (220 - 120) - Rs. 10,00,000

= 1.25

Plan A has greater operating leverage owing to higher fixed costs.

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