Cost Accounting-

A method of accounting in which all costs incurred in carrying out an activity or accomplishing a
purpose are collected, classified, and recorded. This data is then summarized and analyzed to
arrive at a selling price, or to determine where savings are possible.
In contrast to financial accounting (which considers money as the measure of economic
performance) cost accounting considers money as the economic factor of production.

Fixed Cost:
 Amortization. This is the gradual charging to expense of the cost of an intangible
asset (such as a purchased patent) over the useful life of the asset.
 Depreciation. ...
 Insurance. ...
 Interest expense. ...
 Property taxes. ...
 Rent. ...
 Salaries. ...
 Utilities.

Variable Cost: Direct materials. The most purely variable cost of all, these are the
raw materials that go into a product.
 Piece rate labor. ...
 Production supplies. ...
 Billable staff wages. ...
 Commissions. ...
 Credit card fees. ...
 Freight out.

Marginal Cost: In economics, marginal cost is the change in the total costwhen
the quantity produced changes by one unit. It is thecost of producing one more unit
of a good. Marginal cost includes all of the costs that vary with the level of
production.

Average Cost :Under the 'Average Cost Method', it is assumed that the cost of
inventory is based on the average cost of the goods available for sale during the period.
The average cost is computed by dividing the total cost of goods available for sale by the
total units available for sale.

Average Cost Method Example

Purchase date Number of items Total cost

02/17 30 Rs.31,500
02/20 10 Rs.12,000
03/05 25 Rs.34,500
Total 100 Rs.113,300

Sunk Cost: Once the company's money is spent, that money is considered a sunk cost.
Regardless of what money is spent on, sunk costs are money already spent and
permanently lost. Sunk costs cannot be refunded or recovered. For example, once rent is
paid, that money amount is no longer recoverable

Technique/Method of Costing
Cost Sheet : Cost sheet is a document which provides for the assembly of the estimated
detailed cost in respect of a cost centre or a cost unit. It is a detailed statement of the
elements of cost arranged in a logical order under different heads. It is prepared to show
the detailed cost of the total output for a certain period.
Breakeven Analysis

The break-even point (BEP) or break-even level represents the sales amount—in either
unit (quantity) orrevenue (sales) terms—that is required to cover total costs, consisting of
both fixed and variable costs to the company. Total profit at the break-even point is zero.

What is a Break-Even Analysis?

A break-even analysis is a financial tool which helps you to determine at what stage
your company, or a new service or a product, will be profitable. In other words, it’s a
financial calculation for determining the number of products or services a company
should sell to cover its costs (particularly fixed costs). Break-even is a situation
where you are neither making money nor losing money, but all your costs have been
covered.
Break-even analysis is useful in studying the relation between the variable cost, fixed
cost and revenue. Generally, a company with low fixed costs will have a low break-
even point of sale. For an example, a company has a fixed cost of Rs.0 (zero) will
automatically have broken even upon the first sale of its product.

Components of Break Even Analysis

Fixed costs
Fixed costs are also called as the overhead cost. These overhead costs occur after
the decision to start an economic activity is taken and these costs are directly related
to the level of production, but not the quantity of production. Fixed costs include (but
are not limited to) interest, taxes, salaries, rent, depreciation costs, labour costs,
energy costs etc. These costs are fixed no matter how much you sell.
Variable costs
Variable costs are costs that will increase or decrease in direct relation to the
production volume. These cost include cost of raw material, packaging cost, fuel and
other costs that are directly related to the production.

Calculation of Break-Even Analysis

The basic formula for break-even analysis is driven by dividing the total fixed costs of
production by the contribution per unit (price per unit less the variable costs).

Contribution Per Unit = Selling price per unit – Variable Cost

Break-Even Point ( In Qty ) = Fixed Cost / Contribution Per Unit

= FC/ P-VC ( P- selling Price per unit)
For an example:
Variable costs per unit: Rs. 400 Sale price per unit: Rs. 600 Desired profits: Rs.
4,00,000 Total fixed costs: Rs. 10,00,000 First we need to calculate the break-even
point per unit, so we will divide the Rs.10,00,000 of fixed costs by the Rs. 200 which
is the contribution per unit (Rs. 600 – Rs. 200). Break Even Point = Rs. 10,00,000/
Rs. 200 = 5000 units Next, this number of units can be shown in rupees by
multiplying the 5,000 units with the selling price of Rs. 600 per unit. We get Break
Even Sales at 5000 units x Rs. 600 = Rs. 30,00,000. (Break-even point in rupees)

Contribution Margin
Break-even analysis also deals with the contribution margin of a product. The excess
between the selling price and total variable costs is known as contribution margin.
For an example, if the price of a product is Rs.100, total variable costs are Rs. 60 per
product and fixed cost is Rs. 25 per product, the contribution margin of the product is
Rs. 40 (Rs. 100 – Rs. 60). This Rs. 40 represents the revenue collected to cover the
fixed costs. In the calculation of the contribution margin, fixed costs are not
considered.

When is Break even analysis used?

Starting a new business: If you wish to start a new business, a break-even analysis
is a must. Not only it helps you in deciding, whether the idea of starting a new is
viable, but it will force you to be realistic about the costs, as well as guide you about
the pricing strategy.
Creating a new product: In the case of an existing business, you should still do a
break-even analysis before launching a new product—particularly if such a product is
going to add a significant expenditure.
Changing the business model: If you are about to the change your business
model, like, switching from wholesale business to retail business, you should do a
break-even analysis. The costs could change considerably and this will help you to
figure out the selling prices need to change too.

Breakeven analysis is useful for the

following reasons:
 It helps to determine remaining/unused capacity of the concern once the
breakeven is reached. This will help to show the maximum profit on a
particular product/service that can be generated.
 It helps to determine the impact on profit on changing to automation from
manual (a fixed cost replaces a variable cost).
 It helps to determine the change in profits if the price of a product is altered.
 It helps to determine the amount of losses that could be sustained if there is a
sales downturn.

Additionally, break-even analysis is very useful for knowing the overall ability of a
business to generate a profit. In the case of a company whose breakeven point is
near to the maximum sales level, this signifies that it is nearly impractical for the
business to earn a profit even under the best of circumstances.
Therefore, it’s the management responsibility to monitor the breakeven point
constantly. This monitoring certainly reduces the breakeven point whenever
possible.

Ways to monitor Break even point

 Pricing analysis: Minimize or eliminate the use of coupons or other price
reductions offers, since such promotional strategies increase the breakeven
point.
 Technology analysis: Implementing any technology that can enhance the
business efficiency, thus increasing capacity with no extra cost.
 Cost analysis: Reviewing all fixed costs constantly to verify if any can be
eliminated can surely help. Also, review the total variable costs to see if they
can be eliminated. This analysis will increase the margin and reduce the
breakeven point.
 Margin analysis: Push sales of the highest-margin (high contribution earning)
items and pay close attention to product margins, thus reducing the
breakeven point.
 Outsourcing: If an activity consists of a fixed cost, try to outsource such
activity (whenever possible), which reduces the breakeven point.

Benefits of Break-even analysis

 Catch missing expenses: When you’re thinking about a new business, it’s very much
possible that you may forget about few expenses. Therefore, if you do a break-even analysis
you have to review all your financial commitments to figure out your break-even point. This
analysis certainly restricts the number of surprises down the road.
 Set revenue targets: Once the break-even analysis is complete, you will get to know how
much you need to sell to be profitable. This will help you and your sales team to set more
concrete sales goals.
 Make smarter decisions: Entrepreneurs often take decisions in relation to their business
based on emotion. Emotion is important i.e. how you feel, though it’s not enough. In order to
be a successful entrepreneur, your decisions should be based on facts.
 Fund your business: This analysis is a key component in any business plan. It’s generally
a requirement if you want outsiders to fund your business. In order to fund your business, you
have to prove that your plan is viable. Furthermore, if the analysis looks good, you will be
comfortable enough to take the burden of various ways of financing.
 Better Pricing: Finding the break-even point will help in pricing the products better. This
tool is highly used for providing the best price of a product that can fetch maximum profit
without increasing the existing price.
 Cover fixed costs: Doing a break-even analysis helps in covering all fixed cost.

Limitations of Break Even Analysis (Marginal Costing):

Though very effective planning tool, break even analysis is not free from short
comings. The limitations of break even analysis are:

1. It is difficult to separate ‘Fixed’ and ‘Variable’ costs clearly.

2. There are some semi-variable costs. They are not considered in the analysis.

3. Sales revenue and variable costs do not increase in rigid proportion with the value
of production. At higher level of production, they are less proportionate than what
they should be. This is due to trade discounts, economies of bulk buying,
concessions for higher sale etc.

4. Since variable overheads are appropriated on estimated basis, problem of under

or over recovery cannot be eliminated.

5. Price fixation and comparison between two jobs cannot be done without
considering fixed costs.

6. It ignores time element as over a long periods all costs change. Therefore,
comparison of performance between two periods on the basis of contribution is not
possible.

7. If the amount of fixed costs of two firms differ, the comparison of both the firms on
the basis of contribution is likely to mislead.
8. Guided by marginal cost principle, a firm may opt for excessive order at a lower
price, ignoring the plant capacity. It may necessitate overtime working, extension of
production capacity which in turn may increase cost of production and bring change
in fixed costs. Many times, the firm may incur losses.

9. Indiscriminate acceptance of order at lower price may affect local price market.

10. Valuation of closing stock at marginal cost will lead to under-estimating it in the
final accounts. Consequently, profits are suppressed and the balance sheet is
distorted.

11. In controlling costs, marginal costing is not useful in concerns where fixed costs
are huge in relation to variable costs.

12. Since stock is undervalued at marginal costs, in case of loss by fire, full loss
cannot be recovered from insurance company.

13. It is found unsuitable in industries like ship building, etc. If fixed expenses are
ignored in valuation of work in progress, losses may be incurred every year till the
contract is completed. It may create income tax problems.

Limitations. Breakeven analysis is a useful tool for working out the minimum sales needed to
avoid losses. However, it has its limitations. It makes assumptions about various factors - for
example that all units are sold, that forecasts are reliable and the external environment
is stable.