MANAGEMENT ACCOUNTING THEORY
CHAPTER: COST VOLUME PROFIT ANALYSIS
 This chapter is based on Marginal Costing
 What is the change with change in volume (breakeven etc)
Variable cost
Meat
 Variable cost change
with change in output
 Proportionate change
 10% activity increases
 10% V.C also increased
 Examples
 Direct material
 Direct labor
 Variable FOH
 V.Selling Exp
 V. Admin Exp
 Variable cost must be
shown in percentage or
per unit.
 When we use variable cost
in marginal costing it means
all five v.c mentioned in
examples.
SYED SHAHBAZ RAZA ZAIDI
COST CLASSIFICATION
Fixed cost Semi variable cost
Bone Meat + Bone
 Not change with change  Contain both V.C and F.C
in output elements
 Sometime changes  Methods
within relevant range,  High – low
not proportionate  Regression
change (step up F.C)  Scatter diagram
 Inflationary change  Purpose of using above
 Contractual change methods
 Rent increases  To Bifurcate V.C and
F.C
 Examples  Examples
 Factory Fixed cost  ICMA classes (v.c)
  Admin dep (f.c)
Admin Fixed cost
  Exam dep (f.c)
Selling Fixed cost
 Financial charges  Library (f.c)
 Electric bill of all above
(variable + fixed)
 Fixed cost must be
shown in total amount
(absolute).
 If F.C is given in per unit
so convert in absolute
amount
 Use production units for
factory fixed FOH
 Use units sold in case of
fixed selling OH
 Use units sold in case of
fixed admin OH (In case
of silence only)
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 - - Formula Costing Explanation
 IFRS not accept
Contribution Revenue – variable cost this
CM Marginal
margin  Use in short run

 Long run costing

GM Gross Revenue – COGS Absorption  All factory cost
margin are product
costs
Throughput Revenue – Direct  Only direct material is variable cost
TM margin material Throughput

CONTRIBUTION MARGIN

 It covers fixed cost and has ability to generate profit.

 Difference between revenues and variable costs.

BREAK-EVEN POINT

 No profit no loss
 Fixed cost = Contribution margin

BULLET POINTS
 Variable cost includes all (5) variable costs either related to factory or others
(product cost)
 Fixed cost includes all (4) fixed cost either related to factory or others (period
cost)
 If Contribution margin is 40%, so variable cost is 60% of sales
 If Margin of Safety is 30%, so Break Even is 70% of budgeted sales
 Breakeven tak sara C.M, fixed cost ki recovery me lgega

PRODUCT COST PERIOD COST

 Sales bases cost  Non inventoriable cost
 Jis year me sale hogi usi year ke  Jis period(year) ki cost he usi ke
P&L me jae gi P&L me close hojae gi

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SYED SHAHBAZ RAZA ZAIDI
WHEN
 C.M > F.C = PROFIT
 C.M < F.C = LOSS
 C.M = F.C = BREAK EVEN

Absorption costing Marginal costing


Factory ka har expense product  Only fixed FOH and other fixed
cost he expenses ko as a period cost
 Non factory ka har exp period he charge kry ge taky ending
(non manufacturing) inventory ki overcosting na ho,
Why companies use this profit bhi overstate na ho
1. To show improved profit
2. Increase production
3. Window-dressing
4. Manipulation(fraud)

HOW TO DEAL WITH TARGET SALES

 If farmaishi program (f.p) is given, toh wo kiska he? Sales ka or other than sales
 Farmaishi program may be in
1. Absolute form
2. Per unit
3. In percentage/ ratio
 If fp is in absolute form so add it into fixed cost
 If fp is of sales and in units or ratio so less it from contribution margin per unit or
ratio
1. Ratio ko ratio se
2. Per unit ko per unit se
𝐹. 𝑃 𝑃𝐸𝑅 𝑈𝑁𝐼𝑇
× %(𝑅𝐴𝑇𝐼𝑂)
𝑆𝐴𝐿𝐸𝑆 𝑃𝑅𝐼𝐶𝐸 𝑃𝐸𝑅 𝑈𝑁𝐼𝑇

= F.P % × SALES PRICE EPR UNIT

 If fp is of other than sales so phele usko absolute me convert kro then f.c me add
krdo

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SYED SHAHBAZ RAZA ZAIDI
CONDITION ARISE AFTER TAX PAYMENT

 All percentage/ absolute/ per units should be converted into before tax amount by
using formula.
𝐹𝑃 𝐴𝐹𝑇𝐸𝑅 𝑇𝐴𝑋
Gross up = 1−𝑇𝐴𝑋%
YE SUB AFTER TAX HN
1. EARNING AFTR TAX
2. DIVIDEND TO ORDINARY SHARE HOLDERS
3. DIVIDEND TO PREFERENCE SHARE HOLDERS
4. TRANSFER TO RESERVES ( appropriated with name tag) i.e (for building, plant ,
contingencies, loan redemption)
5. TRANSFER TO RETAINED EARNING (unappropriated)
We need to gross up all of the above

NET AND GROSS CONCEPTS

1. If CM is 40% of net sales, so 60% is other variable cost (excluding sales commission)
2. If Cm is 38% of gross sales, so 62% are other variable cost and sales commission
(Total variable cost)
CONVERSION OF NET INTO GROSS
= CM% of NET × (1 - commission%)
CONVERSION OF GROSS INTO NET
CM% of GROSS
(1 − commission%)
HI -LO METHOD

𝑪𝑶𝑺𝑻 𝑶𝑭 𝑯𝑰𝑮𝑯𝑬𝑺𝑻 𝑳𝑬𝑽𝑬𝑳 − 𝑪𝑶𝑺𝑻 𝑶𝑭 𝑳𝑶𝑾𝑬𝑺𝑻 𝑳𝑬𝑽𝑬𝑳

=
𝑨𝑪𝑻𝑰𝑽𝑰𝑻𝒀 𝑶𝑭 𝑯𝑰𝑮𝑯𝑬𝑺𝑻 𝑳𝑬𝑽𝑬𝑳 − 𝑨𝑪𝑻𝑰𝑽𝑰𝑻𝒀 𝑨𝑻 𝑳𝑶𝑾𝑬𝑺𝑻
HI -LO METHOD THEORY
WHEN THERE ARE TWO LEVEL OF ACTIVITIES SO WE NEED TO USE HIGH LOW METHOD
1. SUB SE PHELE YE DEKH LO KE DIVIDE KIS LEVEL KI ACTIVITY SE KRNA HE?
 UNITS
 HOURS (LABOUR OR MACHINE)
 DOLLARS/ RS.
2. FIXED COST KISKI HE?
 FACTORY COST = USE PRODUCTION UINITS
 SELLING AND ADMIN COST = USE SALES UNITS
3. HIGH LOW KI AMOUNT KIS PERIOD KA HE (MONTHLY, QUARTERLY, ANNUALY)

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 Factors of changes in cost and revenues
1. Change in volume, units, activity(v)
 There might be an increase or decrease in volume
 If volume increases so revenue increases & variable cost also increase with
same proportion
(i.e) volume increased by 30%
Sales revenue = 100000
v.c = 80000
Answer:
sales =100000 × 1.3
v.c =80000 × 1.3
 No effect or impact on fixed cost
2. Inflation(i)
 Changes in price or rates

i. Changes for All (revenue, v.c, f.c)

Change in price of material, labor rate. Sales price or rent increased.

ii. Specific change (not proportionate)

 If sales price increased, so it is not compulsory that variable cost also increases
 Examiner jis bhi element ke price ko change kry ga ap uski bat mano!

iii. Inflation have no relationship with past & committed cost

Jo cost continuous he ya carry hori he
(i.e)
 Abhi abhi mene rent pr house liya he to haj hi thori rent increase hoga
 New labor ka increment nahi lgta
 Past ke depreciation include nahi hota
3. Losses/ efficiency
 Specific
 Inefficient/ efficient work
 Material kgs reduced(meter)
 Economies of scale
 Labor hours changes
 Idle time
Formulas
𝑠𝑎𝑙𝑒𝑠 (𝑛𝑒𝑥𝑡 𝑝𝑒𝑟𝑖𝑜𝑑)
1. Overall % =
𝑠𝑎𝑙𝑒𝑠 𝑙𝑎𝑡𝑒𝑠𝑡
Or
= (1 ± i %) × (1 ± v %)

𝑂% 𝑂%
2. Inflation % = 3. Volume % =
𝑉% 𝑖%

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SYED SHAHBAZ RAZA ZAIDI
  CM MUST BE ADJUSTED WITH INFLATION AND LOSSES ONLY!
 THEN GO TO CALCULATE CHANGE IN VOLUME %

 INCREMENTAL FIXED COST

“New product ki waja se jo fixed cost ari he uspy alag se break even calculate kro”

LEVERAGED VS CONSERVATIVE
LEVERAGED
 This is capital intensive (AUTOMATION)
 Positive thinking
 High fixed cost
 Takes too much time in breakeven
 Once you achieved breakeven, then Eid hojae gi
𝑪.𝑴
Degree of operating leverage =
𝑪.𝑴−𝑭𝑰𝑿𝑬𝑫 𝑪𝑶𝑺𝑻

CONSERVATIVE
 Labor intensive ( too much labour hours, less machinery)
 Negative thinking
 Low C.M
 Low fixed cost
 But breakeven cab be reached quickly

Which approach I can use?

(Ans) Use sensible approach (na agay bhago, na ziyada phichy rho)

Point of indifference?
Yani konsi approach se jae? Breakeven units dono approach ke compare kro apny
budgeted sales units se! jo closest ho usko follow kro

𝑪𝑨𝑷𝑰𝑻𝑨𝑳 𝑰𝑵𝑻𝑬𝑵𝑺𝑰𝑽𝑬 𝑭.𝑪− 𝑳𝑨𝑩𝑶𝑹 𝑰𝑵𝑻𝑬𝑵𝑺𝑰𝑽𝑬 𝑭.𝑪

POI =
𝑪𝑨𝑷𝑰𝑻𝑨𝑳 𝑰𝑵𝑻𝑬𝑵𝑺𝑰𝑽𝑬 𝑪.𝑴 𝑷𝑬𝑹 𝑼𝑵𝑰𝑻− 𝑳𝑨𝑩𝑶𝑹 𝑰𝑵𝑻𝑬𝑵𝑺𝑰𝑽𝑬 𝑪.𝑴 𝑷𝑬𝑹 𝑼𝑵𝑰𝑻

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