Few concepts at a quick glance………

MARGINAL COSTING

MARGINAL COST STATEMENT SALES XXX (-) VARIABLE COST XXX CONTRIBUTION XXX (-) FIXED COST XXX PROFIT XXX LOSS REPRESENTS UNRECOVERED FIXED COST

RATIOS P/V RATIOV/C RATIO CONTRIBUTION X 100 SALES VARIABLE COST X 100 SALES P/V RATIO = 100% - V/C RATIO

BREAK EVEN POINT(BEP) LEVEL OF SALES WHERE THERE IS NO PROFIT NO LOSS SITUATION i.e. CONTRIBUTION = FIXED COST BREAK EVEN POINT(in Rs.) = FIXED COST P/V RATIO BREAK EVEN POINT(in Units) = FIXED COST CONTR. P. u.

SIGNIFICANCE OF BREAK EVEN POINT LEVEL OF SALESIMPACT ON PROFITS LESS THAN BEPFIRM INCURS LOSSES (CONTRIBUTION < F.C.) EQUAL TO BEPNO PROFIT NO LOSS (CONTRIBUTION = F.C.) GREATER THAN BEPFIRM EARNSPROFIT (CONTRIBUTION > F.C.)

MARGIN OF SAFETY (MOS) IT IS THE DIFFERENCE B/W TOTAL SALES AND BREAK EVEN SALES MOS (in Rs.) = TOTAL SALES – BREAK EVEN SALES OR PROFIT / PV RATIO MOS (in Qty.) = PROFIT / CONTRIBUTION PER UNIT

INDIFFERENCE POINT IT IS THAT LEVEL OF SALES WHERE THE COSTS AND PROFITS OF TWO OPTIONS ARE EQUAL. PROFIT OF OPTION 1 PROFIT OF OPTION 2 INDIFFERENCE POINT AMOUNT (in Rs.) QUANTITY

FORMULA: A)INDIFFERENCE POINT (in Rs.) = DIFFERENCE IN FIXED COST DIFFERENCE IN V/C RATIO OR = DIFFERENCE IN FIXED COST DIFFERENCE IN P/V RATIO

FORMULA: B) INDIFFERENCE POINT (in Units) = DIFFERENCE IN FIXED COST DIFFERENCE IN VARIABLE COST p.u OR = DIFFERENCE IN FIXED COST DIFFERENCE IN CONTR. p.u.

LEVEL OF SALESMOST PROFITABLE OPTION REASON BELOW INDIFFERENCE POINT OPTION WITH LOWER FIXED COST LOWER THE FIXED COST, LOWER THE BEP, HENCE MORE PROFIT BEYOND BEP AT INDIFFERENCE POINT BOTH OPTIONS ARE EQUALLY PROFITABLE INDIFFERENCE POINT ABOVE INDIFFERENCE POINT OPTION WITH HIGHER PV RATIO (LOWER VARIABLE COST) THE HIGHER THE PV RATIO, THE BETTER IT IS. SIGNIFICANCE OF INDIFFERENCE POINT

SHUT DOWN POINT IT INDICATES THE LEVEL OF OPERATIONS BELOW WHICH IT IS NOT JUSTIFIED TO PURSUE PRODUCTION. FOR THE ABOVE PURPOSE DIVIDE THE FIXED COST AVOIDABLE OR DISCRETIONARY FIXED COST UNAVOIDABLE OR COMMITTED FIXED COST

FORMULAS: SHUT DOWN POINT (in Rs.) = AVOIDABLE FIXED COST P/V RATIO SHUT DOWN POINT (in Qty.) = AVOIDABLE FIXED COST CONTRIBUTION p.u. AVOIDABLE F.C. = TOTAL F.C. – UNAVOIDABLE F.C.

LEVEL OF SALESDECISIONREASON BELOW SHUT DOWN POINT CLOSE DOWN OPERATIONS AVOIDABLE FIXED COSTS ARE NOT BEING RECOVERED AT SHUT DOWN POINT CONTINUE OPERATIONS AVOIDABLE FIXED COSTS ARE JUST RECOVERED ABOVE SHUT DOWN POINT CONTINUE OPERATIONS AVOIDABLE F.C. ARE RECOVERED, FURTHER CONTR. RECOVERS BALANCE F.C. SIGNIFICANCE OF SHUT DOWN POINT

KEY FACTOR OR THE LIMITING FACTOR IT REPRESENTS A RESOURCE WHOSE AVAILABILITY IS LESS THAN ITS REQUIREMENT. IT IS ALSO CALLED CRITICAL FACTOR OR BUDGET FACTOR. EXAMPLES OF KEY FACTOR: 1.SHORTAGE OF RAW MATERIAL 2.LABOUR SHORTAGE 3.RESTRICTIONS IN PLANT CAPACITY 4.DEMAND OR SALE EXPECTANCY 5.CASH AVAILABILITY

KEY FACTOR- DECISION MAKING STEPS  IDENTIFY THE KEY FACTOR.  COMPUTE TOTAL CONTRIBUTION OR CONTRIBUTION PER UNIT OF PRODUCT.  COMPUTE CONTRIBUTION PER UNIT OF THE KEY FACTOR i.e. CONTRIBUTION per DIRECT LABOUR HOUR.  RANK THE PRODUCTS BASED ON CONTRIBUTION PER UNIT OF THE KEY FACTOR  ALLOCATE THE KEY RESOURCES BASED ON RANKS GIVEN ABOVE.

RELEVANT COSTING

MATERIAL COST ALREADY AVAILABLETO BE PURCHASED REGULARLY USED RARELY USED CURRENT REPLACEMENT COST IS RELEVANT AS INCREMENTAL COST NET REALISABLE VALUE IS RELEVANT AS OPPURTUNITY COST PURCHASE PRICE, BEING OUT OF POCKET COST IS RELEVANT

SITUATIONRELEVANT COST 1.LABOUR FORCE ALREADY AVAILABLE A) EXCESSIVE LABOUR FORCE- NO RETRENCHMENT POLICY NIL B) EXCESSIVE LABOUR FORCE- REDUCTION IN IDLE TIME COST NIL C) USED FOR SPECIAL CONTRACT NECESSITATES REPLACEMENT REPLACEMENT COST i.e. WAGES OF NEW WORKERS D) YIELDING CONTRIBUTION IN A DIFFERENT DEPARTMENT VARIABLE COST + OPPORTUNITY COST (CONTR. FOREGONE) 2. WORKERS TO BE APPOINTED OUT OF POCKET COST i.e. WAGES OF NEW WORKERS 3. LABOUR SHORTAGE SITUATIONS VARIABLE COST + OPPORTUNITY COST (CONTR. FOREGONE) LABOUR COST

NATURE OF COSTRELEVANT COST VARIABLE OVERHEADS IRRELEVANT IF ALREADY INCURRED RELEVANT, ONLY IF SUCH COSTS ARE TO BE INCURRED IN FUTURE FIXED OVERHEADS RELEVANT ONLY UNDER SPECIFIC SITUATIONS. (REFER NEXT SLIDE) DEPRECIATION IRRELEVANT AS IT IS AN APPORTIONMENT OF HISTORICAL COST OTHER DEPARTMENT COSTS IRRELEVANT IF ALREADY INCURRED RELEVANT IF THEY ARE TO BE INCURRED SPECIFICALLY FOR ANY CONTRACT OVERHEAD & OTHER COSTS

FIXED COST FIXED COSTS ARE IRRELEVANT FOR DECISION MAKING EXCEPTIONS: 1. SPECIFICALLY INCURRED FOR A CONTRACT 2. INCREMENTAL 3. INCREASE DUE TO CHANGE IN LEVEL OF ACTIVITY 4. AVOIDABLE OR DISCRETIONARY FIXED COST 5. ONE COST IS INCURRED IN LIEU OF ANOTHER (DIFFERENCE IN COSTS WILL WE RELEVANT )

OPPORTUNITY COST VALUE OF SACRIFICE MADE/BENEFIT OF OPPORTUNITY FOREGONE BY SELECTING ONE ALTERNATIVE IN PREFERENCE TO OTHERS. FEATURES OF OPPORTUNITY COST: TAKEN INTO CONSIDERATION ONLY WHEN ALTERNATIVES ARE COMPARED. ARISES ONLY IN RESOURCE SHORTAGE SITUATIONS i.e. KEY FACTOR SITUATION. USEFUL ONLY FOR DECISION MAKING & NOT FOR ACCOUNTING, REPORTING & COST CONTROL. ARISES ONLY IN SHORT RUN.

TRANSFER PRICING

TRANSFER DIVISION RECIPIENT DIVISION PRODUCT / SERVICES TRANFERED CONSIDERATION = TRANSFER PRICE OBJECTIVE: TO SELL INTERNEDIATE PRODUCT & MAXIMISE REVENUE OBJECTIVE: TO BUY INTERNEDIATE PRODUCT & MAXIMISE REVENUE REVENUE COST

FIXATION OF MINIMUM & MAXIMUM TRANSFER PRICE MINIMUM TRANSFER PRICE (ALWAYS FROM TRANSFER DIVISION VIEW): IT IS THE TOTAL OF FOLLOWING ITEMS: a) VARIABLE COST UPTO THE POINT OF INTERNAL TRANSFER. b) FIXED COST, IF SPECIFIC. c) OPPORTUNITY COST, IF APPLICABLE. NOTES: 1.SELLING OVERHEADS ARE INCURRED FOR EXTERNAL SALES ONLY. 2. OPPORTUNITY COST ARISES ONLY IF- - TRANSFERRING DIVISION PRODUCES MARKETABLE PRODUCTS - TRANSFERRING DIVION OPERATES AT FULL CAPACITY

FIXATION OF MINIMUM & MAXIMUM TRANSFER PRICE MAXIMUM TRASFER PRICE (ALWAYS FROM RECIPIENT DIVISION VIEW): IT IS THE LEAST OF FOLLOWING ITEMS: 1.MARKET PRICE OF INTERMEDIATE PRODUCT (AS QUOTED BY OUTSIDE SUPPLIER) 2. INTERNAL TRANSFER PRICE (AS QUOTED BY TRANSFERRING DIVISION) NOTES: IF THE PRICE QUOTED BY THE TRANSFERRING DIVISION IS MORE THAN THE PRICE QUOTED BY THE OUTSIDE SUPPLIER THEN IT IS ALWAYS BETTER TO PURCHASE FROM OUTSIDE.

ACTIVITY BASED COSTING

COST OBJECTS: ITEM FOR WHICH COST MEASUREMENT IS REQUIRED. ACTIVITY BASED COSTING MEANING: IT IS THE IDENTIFICATION OF COST WITH EACH COST DRIVING ACTIVITY AND MAKING IT AS THE BASIS FOR APPORTIONMENT / ASSIGNMENT OF COSTS OVER DIFFERENT COST OBJECTS /JOBS/ PRODUCTS/ CUSTOMERS/SERVICES. COST DRIVER: IT IS THE FACTOR THAT CAUSES A CHANGE IN THE COST OF AN ACTIVITY. RESOURCE COST DRIVERS: MEASURE OF QUANTITY OF RESOURCES CONSUMED BY AN ACTIVITY & USED TO ASSIGN THE COST OF A RESOURCE TO AN ACTIVITY/COST POOL ACTIVITY COST DRIVER: MEASURE OF FREQUENCY AND INTENSITY OF DEMAND, PLACED ON ACTIVITES BY COST OBJECTS & USED TO ASSIGN ACTIVITY COSTS TO COST OBJECTS.

STEPPARTICULARS 1. IDENTIFY VARIOUS ACTIVITES WITHIN FIRM INTO- PRIMARY AND SECONDARY. 2. RELATE THE OVERHEADS TO ACTIVITIES USING RESOURCE COST DRIVERS. 3.APPORTION THE COST OF SUPPORT ACTIVITIES OVER PRIMARY ACTIVITIES. 4.DTERMINE ACTIVITY COST DRIVERS FOR EACH ACTIVITY / COST POOL. 5.COMPUTE ABC RATE = TOTAL COST OF ACTIVITY ACTIVITY COST DRIVER 6.ASSIGN COSTS TO THE COST OBJECTS USING THE FORMULA = RESOURCES CONSUMED X ABC RATE STAGES IN ABC

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