enhance skill development protect intellectual property and build best in class manufacturing infrastructure in the country.
The ‘Make in India’ programme was launched in September 2014 soon after the Modi Government came to power.
The primary objective of this initiative is to attract investments from across the globe and strengthen India’s manufacturing sector.
It is being led by: Department for Promotion of Industry and Internal Trade (DPIIT) Ministry of Commerce and Industry, Government of India.
The Make in India programme is very important for the economic growth of India.
With this scheme, the government has increased the FDI limit in various industries to attract foreign investment and participation.
The Government has established an investor facilitation center to assist foreign businesses to locate partners and sites, while a slew of measures have been initiated for domestic companies, which were revealed after Modi Government unveiled the ‘Stand Up India’ initiative in his Independence Day address in 2015.
The Make in India initiatives is aimed at transforming India into a global manufacturing hub, and contained a raft of proposals to attract investit
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QUICK REVIEW
1. Marginal Costing: It is a costing system where products or services and inventories are valued at variable costs only. It does not consider fixed costs.
Total Contribution (C) = Sales Revenue (S) – Total Variable Cost (V)
Contribution per unit = Sales price per unit – Variable cost per unit
Profit = Contribution – Fixed Cost
Marginal Cost Equation = S – V = C = F ± P
S = Selling price per unit, V = Variable cost per unit, C = Contribution, F = Fixed Cost
Profit Volume (P/V) Ratio: It shows the proportion of sales available to cover fixed costs and profit.
P/V Ratio = Contribution Sales × 100 OR Change in Contribution or profit Change in Sales × 100 OR Fixed Cost Breakeven Sales × 100
Contribution = Sales × P/V Ratio
Sales = Contribution PV Ratio
Fixed cost = Break-even sales × P/V Ratio
Break-even point: It is the point where neither profits nor losses have been made.
BEP (in units) = Fixed Cost Contribution per unit
BEP (in `) = Fixed Cost PV Ratio OR Total Sales – Margin of Safety Sales
Cash Break-even point: When break-even point is calculated only with those fixed costs which are payable in cash. Depreciation and other non-cash fixed costs are excluded from fixed costs.
= Cash Fixed Costs Contribution per unit
14.1
Multi-product break even analysis: Break-even point needs adjustments when more than one product is manufactured by using a common fixed costs. Composite Contribution is calculated by taking weights for the products. Weights = sales mix quantity or sales mix values.
BEP = Common Fixed Cost Composite Contribution per unit
Margin of Safety = Profit PV Ratio or Total sales – Break-even sales
Margin of Safety ratio = Total SalesBreak-even Sales Total Sales × 100
2. Absorption Costing: A method of costing in which all costs, both variable and fixed are charged to operations, process or product.
THEORY QUESTIONS
Q1. What are the characteristics of marginal costing? [ICAI Module]
Ans.
All elements of cost are classified into fixed and variable components. Semi-variable costs are also analyzed into fixed and variable elements.
The marginal or variable costs are treated as the cost of product.
The value of finished goods and work-in-progress is also comprised only of marginal costs. Variable selling and distribution are excluded for valuing these inventories. Fixed costs are not considered for valuation of closing stock of finished goods and closing WIP.
Fixed costs are treated as period costs and are charged to profit and loss account for the period for which they are incurred.
Prices are determined with reference to marginal costs and contribution margin.
Profitability of departments and products is determined with reference to their contribution margin.
Q2. State the advantages of marginal costing. [CA Inter May 2001, 6 Marks]
Ans.
1. Simplified Pricing Policy: The marginal cost remains constant per unit of output whereas the fixed cost remains constant in total. This help in making firm decisions on pricing policy.
2. Proper recovery of Overheads: Overheads are recovered in costing on the basis of pre-determined rates. If fixed overheads are included on the basis of pre-determined rates, there will be under-recovery or over-recovery of. This creates the problem of treatment of such under or over-recovery of overheads. Marginal costing avoids such under or over-recovery of overheads.
3. Shows Realistic Profit: Under the marginal costing, the stock of finished goods and WIP are carried on marginal cost basis and the fixed expenses are written off to profit and loss account as period cost. This shows the true profit of the period.
4. How much to produce: Marginal costing helps in the preparation of break-even analysis which shows the effect of increasing or decreasing production activity on the profitability of the company.
5. More control over expenditure: Segregation of expenses as fixed and variable helps the management to exercise control over expenditure. The management can compare the actual variable expenses with the budgeted variable expenses and take corrective action through analysis of variances.
6. Helps in Decision Making: Marginal costing helps the management in taking a number of business decisions like make or buy, discontinuance of particular product, replacement of machines, etc.
Q3. What are the limitations of marginal costing?
[CA Inter May 2019, May 2001, 5 Marks]
Ans.
(i) Difficulty in classifying fixed and variable elements:
It is difficult to classify exactly the expenses into fixed and variable category. Most of the expenses are neither totally variable nor wholly fixed. For example, various amenities provided to workers may have no relation either to volume of production or time factor.
(ii) Dependence on key factors:
Contribution of a product itself is not a guide for optimum profitability unless it is linked with the key factor.
(iii) Scope for Low Profitability:
Sales staff may mistake marginal cost for total cost and sell at a price; which will result in loss or low profits. Hence, sales staff should be cautioned while giving marginal cost.
(iv) Faulty valuation:
Overheads of fixed nature cannot altogether be excluded particularly in large contracts, while valuing the work-in-progress. In order to show the correct position fixed overheads have to be included in work-in-progress.
(v) Unpredictable nature of Cost:
Some of the assumptions regarding the behaviour of various costs are not necessarily true in a realistic situation. For example, the assumption that fixed cost will remain static throughout is not correct. Fixed cost may change from one period to another. Also, the variable costs do not remain constant per unit of output. There may be changes in the prices of raw materials, wage rates etc. after a certain level of output has been reached.
(vi) Marginal costing ignores time factor and investment: The marginal cost of two jobs may be the same but the time taken for their completion and the cost of machines used may differ. The true cost of a job which takes longer time and uses costlier machine would be higher. This fact is not disclosed by marginal costing.
(vii) Understating of W-I-P: Under marginal costing stocks and work-in-progress are understated.
Q4. Discuss basic assumptions of Cost Volume Profit analysis.
[CA Inter May 2012, May 2003, 4 Marks]
Ans. Assumptions of CVP Analysis:
(i) Changes in the levels of revenues and costs arise only because of changes in the number of products (or service) units produced and sold.
(ii) Total cost can be separated into two components: Fixed and variable.
(iii) Graphically, the behaviour of total revenues and total cost are linear in relation to output level within a relevant range.
(iv) Selling price, variable cost per unit and total fixed costs are known and constant.
(v) The proportion of different products when multiple products are sold will remain constant as the level of total units sold changes.
(vi) All revenues and costs can be added, sub-traded and compared without taking into account the time value of money.
Q5. Explain and illustrate cash break-even chart.
[CA Inter May 2008, May 2001, 3 Marks]
Ans. When break-even point is calculated only with those fixed costs which are payable in cash, such a break-even point is known as cash break-even point. This means that depreciation and other non-cash fixed costs are excluded from the fixed costs in computing cash break-even point. It is computed as under:
Cash Fixed Costs
Cash BEP (Units) = Contribution per unit
Hence for example suppose insurance has been paid on 1st January, 2016 till 31st December, 2020 then this fixed cost will not be considered as a cash fixed cost for the period 1st January, 2018 to 31st December, 2020.
Q6. What is Margin of Safety? What does a large Margin of Safety indicates? How can you calculate Margin of Safety? [CA Inter July 2021, 5 Marks]
Ans.
The margin of safety can be de ned as the difference between the expected level of sale and the break-even sales. Large margin of safety indicates the high chances of making pro ts. The Margin of Safety can also be calculated by identifying the difference between the projected sales and break-even sales in units multiplied by sale price per unit.
Margin of Safety (in units) = Profit Contribution per unit
Margin of Safety (in `) = Profit Profit Volume Ratio
Q7. Write short note on Angle of Incidence. [CA Inter May 2012, 2 Marks]
Ans. Angle of Incidence is formed by the intersection of sales line and total cost line at the break-even point. This angle shows the rate at which profits are being earned once the break-even point has been reached. The wider the angle the greater is the rate of earning profits. A large angle of incidence with a high margin of safety indicates extremely favourable position.
Q8. Differentiate between “Marginal and Absorption Costing”. [CA Inter Nov. 2001, Nov. 2020, 5 Marks]
Ans.
Difference between Marginal costing and Absorption costing
Sl. No.
Marginal costing
(i)Only variable costs are considered for product costing and inventory valuation.
(ii)Fixed costs are regarded as period costs. The Pro tability of different products is judged by their P/V ratio.
(iii)Cost data presented highlight the total contribution of each product.
(iv)The difference in the magnitude of opening stock and closing stock does not affect the unit cost of production.
(v)In case of marginal costing the cost per unit remains the same, irrespective of the production as it is valued at variable cost.
Absorption costing
Both xed and variable costs are considered for product costing and inventory valuation.
Fixed costs are charged to the cost of production. Each product bears a reasonable share of xed cost and thus the pro tability of a product is in uenced by the apportionment of xed costs.
Cost data are presented in conventional pattern. Net pro t of each product is determined after subtracting xed cost along with their variable costs.
The difference in the magnitude of opening stock and closing stock affects the unit cost of production due to the impact of related xed cost.
In case of absorption costing the cost per unit reduces, as the production increases as it is xed cost which reduces, whereas, the variable cost remains the same per unit.
PRACTICAL QUESTIONS
P/V RATIO, MARGINAL OF SAFETY AND BEP
Q1. Product Z has a profit-volume ratio of 28%. Fixed operating costs directly attributable to product Z during the quarter will be ` 2,80,000.
Calculate the sales revenue required to achieve a quarterly profit of ` 70,000. [CA Inter May 2009, 3 Marks]
Ans. Computation of sales revenue: P/V ratio = 28%
Quarterly xed Cost = ` 2,80,000
Desired Pro t = ` 70,000
Sales revenue required to achieve desired profit
Total contribution = Fixed Cost + Desired Pro t = ` 2,80,000 + ` 70,000 = ` 3,50,000
Total sales revenue = Total contribution P/V ratio
= 3,50,000 28% `
= ` 12,50,000
Q2. Following information are available for the years 2020 and 2021 of PIX Limited:
Years 2020 2021 Sales ` 32,00,000 ` 57,00,000 Pro t/(Loss) (` 3,00,000) ` 7,00,000
Calculate:
(i) P/V ratio
(ii) Total fixed cost
(iii) Sales required to earn a Profit of ` 12,00,000. [CA Inter Nov. 2016, May 2010, 5 Marks]
Ans.
(i) P/V Ratio = Change in profit(loss)100 Change in sales × = () () 7,00,0003,00,000100 57,00,00032,00,000
= 10,00,000100 25,00,000 × = 40%
(ii) Total fixed cost = Total contribution – Profit = (Sales × P/V ratio) – Profit = ( ` 57,00,000 × 40%) - ` 7,00,000 = ` 22,80,000 – ` 7,00,000 = ` 15,80,000
(iii) Total contribution = Total fixed cost + Profit required = ` 15,80,000 + 12,00,000 = ` 27,80,000
Total sales revenue = Total contribution P/V ratio = 27,80,000 40% ` = ` 69,50,000
14.8 MARGINAL COSTING
Q3. PQR Ltd. has furnished the following data for the two years: 2019-202020-21 Sales ` 8,00,000?
Ratio (P/V ratio)
of Safety sales as a % of total sales
There has been substantial savings in the fixed cost in the year 2020-21 due to the restructuring process. The company could maintain its sales quantity level of 2019-20 in 2020-21 by reducing selling price. You are required to calculate the following:
(i) Sales for 2020-21 in Value,
(ii) Break-even sales for 2020-21 in Value, (iii) Fixed cost for 2020-21 in Value. [ICAI Module] Ans.
Total Variable cost in 2019-20 = Sales – P/V Ratio
= ` 8,00,000 – 50% = ` 4,00,000
In 2020-21, sales quantity has not changed. Thus, variable cost in 2020-21 will remain the same i.e ` 4,00,000.
P/V ratio (2020-21) = 37.50%
Thus, Variable cost ratio = 100% − 37.5% = 62.5%
(i) Thus, sales in 2020-21 = 4,00,000 62.5% = ` 6,40,000
In 2020-21, Break-even sales = 100% − 21.875% (Margin of safety) = 78.125%
(ii) Break-even sales in 2020-21: In 2020-21, Break-even sales = 100% − 21.875% (Margin of safety) = 78.125%
= 6,40,000 78.125% = ` 5,00,000
(iii) Fixed cost in 2020-21 = B.E. sales P/V ratio = ` 5,00,000 37.50% = ` 1,87,500.
Q4. Following information is available for the 1st and 2nd quarter of the year 2020-21 of ABC Ltd. : Production (in units)Semi-variable cost (`)
You are required to segregate the semi-variable cost and calculate:
(a) Variable cost per unit;
(b) Total fixed cost. [CA Inter May 2009, 2 Marks]
Variable Cost per Unit = Change in Semi Variable Cost Change in Production = 30,000 6000units ` = ` 5 per unit.
Total Fixed Cost = Semi-Variable Cost – (Production × Variable Cost per Unit) = ` 2,80,000 – (36,000 units × ` 5 per unit) = ` 2,80,000 - ` 1,80,000 = ` 1,00,000
Q5. PQ Ltd. reports the following cost structure at two capacity levels: (100% capacity)(75% capacity) 2,000 units1,500 units
Production overhead I ` 3 per unit ` 4 per unit
Production overhead II ` 2 per unit ` 2 per unit
If the selling price, reduced by direct material and labour is ` 8 per unit, what would be its break-even point? [CA Inter Nov. 2008, 3 Marks]
Ans.
Computation of Break-even point in
Selling price – Material and labour (`) (A)
Production Overhead II (Variable Overhead) (B) 22
Contribution per unit (A) – (B) 66 Break-even point
