CHAPTER 3

CVP ANALYSIS & DECISION MAKING

BASIC CONCEPTS & FORMULAE
1.

Marginal Costing
According to CIMA, Marginal costing is the system in which variable costs are
charged to cost units and fixed costs of the period are written off in full against the
aggregate contribution.
Marginal costing is not a distinct method of costing like job costing, process
costing, operating costing, etc. but a special technique used for marginal decision
making. Marginal costing is used to provide a basis for the interpretation of cost
data to measure the profitability of different products, processes and cost centre
in the course of decision making.

2.

Cost-volume-profit analysis
Cost-volume-profit analysis (as the name suggests) is the analysis of three
variable viz., cost, volume and profit. Such an analysis explores the relationship
existing amongst costs, revenue, activity levels and the resulting profit. It aims at
measuring variations of cost with volume. In the profit planning of a business,
cost-volume-profit (C-V-P) relationship is the most significant factor.

3.

Important Factors in Marginal Costing Decisions

In all recommendations of marginal costing decisions, the following factors are to
be considered:
(i)

Whether the product or production line in question makes a contribution.

(ii)

Where a choice is to be made between two courses of action, the additional

fixed overhead, if any, should be taken into account.

(iii)

The continuity of demand after expansion or renovation or installation of the

sophisticated machine and its impact on the selling price should also be
considered.

(iv)

Cost is not the only criterion for decision making. Non-cost factors like the
necessity to retain the experienced employees, etc. should also be
considered.

The Institute of Chartered Accountants of India

Advanced Management Accounting

4.

Pricing Decisions under Special Circumstances

If goods were sold in the normal circumstances under normal business conditions,
the price would cover the total cost plus a margin of profit. Selling prices are not
always determined by the cost of production. They may be determined by market
conditions but in the long run they tend to become equal to the cost of production
of marginal firm. Therefore, a business cannot continue to sell below the total cost
for a long period. Occasionally, a firm may have to sell below the total cost.
The problem of pricing can be summarised under three heads:

5.

(i)

Pricing in periods of recession,

(ii)

Differential selling prices, and

(iii)

Acceptance of an offer and submission of a tender.

Make or Buy Decision

Very often management is faced with the problem as to whether a part should be
manufactured or it should be purchased from outside market. Under such
circumstances two factors are to be considered:

6.

(a)

whether surplus capacity is available, and

(b)

the marginal cost.

Shut Down or Continue Decision

Very often it becomes necessary for a firm to temporarily close down the factory
due to trade recession with a view to reopening it in the future. In such cases, the
decision should be based on the marginal cost analysis. If the products are
making a contribution towards fixed expenses or in other words if selling price is
above the marginal cost, it is preferable to continue because the losses are
minimised. By suspending the manufacture, certain fixed expenses can be
avoided and certain extra fixed expenses may be incurred depending upon the
nature of the industry, say, for example, extra cost incurred in protecting the
machinery. So the decision is based on as to whether the contribution is more
than the difference between the fixed expenses incurred in normal operation and
the fixed expenses incurred when the plant is shut down.

7.

Export V/S Local Sale Decision

When the firm is catering to the needs of the local market and surplus capacity is
still available, it may think of utilising the same to meet export orders at price
lower than that prevailing in the local market. This decision is made only when the
local sale is earning a profit, i.e., where its fixed expenses have already been

3.2

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

recovered by the local sales. In such cases, if the export price is more than the
marginal cost, it is preferable to enter the export market. Any reduction in the
price prevailing in the local market to fulfil surplus capacity may have adverse
effect on the normal local sales. Dumping in the export market at a lower price will
not, however, have any such adverse effect on local sales.
8.

Expand or Contract Decision

Whenever a decision is to be taken as to whether the capacity is to be expanded
or not, consideration should be given to the following points:

9.

(a)

Additional fixed expenses to be incurred.

(b)

Possible decrease in selling price due to increase in production.

(c)

Whether the demand is sufficient to absorb the increased production.

Product Mix Decision

Many times the management has to take a decision whether to produce one product
or another instead. Generally decision is made on the basis of contribution of each
product. Other things being the same the product which yields the highest
contribution is best one to produce. But, if there is shortage or limited supply of
certain other resources which may act as a key factor like for example, the machine
hours, then the contribution is linked with such a key factor for taking a decision.

10.

Price-Mix Decision
When a firm can produce two or more products from the same production facilities
and the demand of each product is affected by the change in their prices, the
management may have to choose price mix which will give the maximum profit,
particularly when the production capacity is limited. In such a situation, the firm
should compute all the possible combinations and select a price-mix which yields
the maximum profitability.

BASIC FORMULAS
1.

Sales-Variable Cost = Contribution = Fixed Cost + Profit

2.

P/V ratio (or C/S ratio)

= Contribution

Sales

= Contribution per unit

Selling price per unit

= Change in Contribution Change in Sales

3.

Break-even Point: Point where there is no profit or no loss.

(i)

at BEP, Contribution

= Fixed Cost

Thus, Break Even Sales (in sales value) = Fixed Cost P/V ratio
3.3

The Institute of Chartered Accountants of India

Advanced Management Accounting

4.

Margin of safety

= Sales BEP sales

= Contribution / PV ratio - Fixed cost / PV ratio
= Profit / PV ratio

5.

BEP Calculation in different scenario:

(i)

With out limiting factor (non- attributable to a single product)

BEP in units = Fixed cost Average contribution p.u.
(when sales mix in units are given)
BEP in Rs. = Fixed cost composite p\v ratio
(when sales mix in rupee are given )
where composite p\v ratio = [ Sales Mix P\V Ratio ]

(ii)

With limiting factor (attributable to a single product)

Find contribution per limiting factor & give rank. Find total contribution from 1st
rank product. Calculate the amount of fixed cost still to recover. Whether it can
be recovered by 2nd rank product or not ?

(iii)

6.

For Perishable product apply the same concept in case of opening stock with
different variable cost.
e.

BEP in case of process costing is expressed in terms of total raw

material input

f.

In capital budgeting, BEP is that sales volume where discounted Cash

in flow = discounted Cash out flow. In case of perpetuity, the financing
charge p.a.= CIF pa

g.

Potential BE: On the basis of sales out of current period production

only.

h.

Multiple BE: Different BE due to change in sales price, variable costs &
fixed costs for different production level.

i.

Cash BEP = Cash fixed cost contribution p.u. So do not consider the
sunk cost.

j.

BEP for decision making purpose: Accept that proposal where BEP is
lowest provided the profit can not be calculated.

Shut down point =

Total fixed cost Shut down costs

Contribution per unit

3.4

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

Question 1
Enumerate the limitations of using the marginal costing technique.
Answer
Marginal costing is defined as the ascertainment of marginal cost and of the effect on
profit of changes in volume or type of output by differentiating between fixed costs and
variable costs. Limitations of Marginal Costing Techniques:
The limitations of using the marginal costing technique are as follows:
1.

It is difficult to classify exactly the expenses into fixed and variable category. Most
of the expenses are neither totally variable nor wholly fixed.

2.

Contribution itself is not a guide unless it is linked with the key factor.

3.

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.

4.

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.

5.

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.

Question 2
Briefly discuss on curvilinear CVP analysis.
Answer
In CVP analysis, the usual assumption is that the total sales line and variable cost line will
have linear relationship, that is, these lines will be straight lines. However, in actual
practice it is unlikely to have a linear relationship for two reasons, namely:

after the saturation point of existing demand, the sales value may show a
downward trend.

the average unit variable cost declines initially, reflecting the fact that, as output
increase the firm will be able to obtain bulk discounts on the purchase of raw
materials and can also benefit from division of labour. When the plant is operated
at further higher levels of output, due to bottlenecks and breakdowns the variable
cost per unit will tend to increase. Thus the law of increasing costs may operate

3.5

The Institute of Chartered Accountants of India

Advanced Management Accounting

and the variable cost per unit may increase after reaching a particular level of
output.
In such cases, the contribution will not increase in linear proportion i.e. based on
the phenomenon of diminishing marginal productivity; the total cost lie will not be
straight, as assumed but will be of curvilinear shape. This situation will give rise to
two break even points. The optimum profit is earned at the point where the distance
between sales and total cost is the greatest.

To
ta l

Tota l (Rs.)

Re
ve
nu
e

Loss
A2

al
Tot
Loss

A 1 and A 2 are
break-even points

Profit

st s
Co

A1

Quantity

Question 3
A company manufactures two types of herbal product, A and B. Its budget shows profit
figures after apportioning the fixed joint cost of Rs.15 lacs in the proportion of the
numbers of units sold. The budget for 2002, indicates:
A

1,50,000

30,000

Selling price / unit (Rs.)

200

120

P/V ratio (%)

40

50

Profit (Rs.)

You are required to advise on the best option among the following, if the company expects
that the number of units to be sold would be equal.
(i)

Due to exchange in a manufacturing process, the joint fixed cost would be reduced
by 15% and the variables would be increased by 7 %.

(ii)

Price of A could be increased by 20% as it is expected that the price elasticity of

demand would be unity over the range of price.

(iii)

Simultaneous introduction of both the option, viz, (i) and (ii) above.

3.6

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

Answer
1.

Contribution per unit of each product:

Product

Contribution per unit

(Sales P/V ratio)
2.

Rs.

Rs.

80

60

(Rs.20 40%)

(Rs.12 50%)

Number of units to be sold:

We know that:
Total contribution Fixed cost = Profit
Let x be the number of units of each product sold, therefore:
(80x + 60x) Rs.15,00,000

= Rs.1,50,000 + Rs.30,000

or x

= 12,000 units

(i)

Option: Increase in profit when due to change in a manufacturing process

there is reduction in joint fixed cost and increase in variable costs.
Rs.
Revised contribution from 12,000 units of A due to
7.5% increase in variable cost

8,52,000

(12,000 units (Rs.200 Rs.129)

Revised contribution from 12,000 units of B due to
7.5% increase in variable cost

6,66,000

12,000 units (Rs.120 Rs.64.50)

Total revised contribution

15,18,000

Less: Fixed cost

12,75,000

(Rs.15,00,000 15% Rs.15,00,000)

Revised Profit

2,43,000

Less: Existing profit

1,80,000

Increase in profit

63,000

3.7

The Institute of Chartered Accountants of India

Advanced Management Accounting

(ii)

Option: Increase in profit when the price of product A increased by 20% and
the price elasticity of its demand would be unity over the range of price.
Rs.
Budgeted revenue from Product A

24,00,000

(12,000 units Rs.200)

Revised demand (in units)

10,000

(Rs.24,00,000 / Rs.240)
Revised contribution (in Rs.)

12,00,000

[10,000 units (Rs.240 Rs.120)]

Less: Existing contribution

9,60,000

(12,000 units Rs.80)

Increase in profit (contribution)

2,40,000

*Note: Since price elasticity of demand is 1, therefore the revenue in respect

of products will remain same.
(iii)

Option: Increase in profit on the simultaneous introduction of above two

options
Rs.
Revised contribution from Product A

11,10,000

[10,000 units (Rs.240 Rs.129)]

Revised contribution from Product B

6,66,000

[12,000 units (Rs.120 Rs.64.50)]

Total revised contribution

17,76,000

Less: Revised fixed cost

12,75,000

Revised profit

5,01,000

Less: Existing profit

1,80,000

Increase in profit
3,21,000
Advise: A comparison of increase in profit figures under above three options
clearly indicates that the option (iii) is the best as it increases the profit of
the concern by Rs.3,21,000.

3.8

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

Note: The budgeted profit/(loss) for 2002 in respect of products A and B
should be Rs.2,10,000 and (Rs.30,000) respectively instead of Rs.1,50,000
and Rs.30,000.
Question 4
Use of absorption costing method for the valuation of finished goods inventory provides
incentive for over-production. Elucidate the statement.
Answer
When absorption costing method is used, production fixed overheads are charged to
products and are included in product costs. Consequently, the closing stocks are valued
on total cost (including fixed overheads) basis. The net effect is that the charge of fixed
overheads to P/L account gets reduced, if the closing stock is greater than the opening
stock. This situation has the effect of inflating the profit for the period.
Where stock levels are likely to fluctuate significantly, profits may be distorted if
calculated on absorption costing basis. If marginal costing is used, since the fixed costs
are charged off to P/L account as period cost, such a situation will not arise. The impact
of using absorption costing on profits can be summerised as under:

When sales are equal to production, profits will be the same under absorption
costing and marginal costing.

If production is higher than sales, the absorption costing will post higher profits that
marginal costing.

If sales are in excess of production, absorption costing will show lower profits than
marginal costing.

Since profit calculation in absorption costing can produce strange result, the managers
may deliberately alter the stock levels to influence the profits if absorption costing is used.
Hence, it is true to say that if absorption costing method is used managers have the
incentive to over produce to show better result.
Question 5
A Pharmaceutical company produces formulations having a shelf life of one year. The
company has an opening stock of 30,000 boxes on 1st January, 2005 and expected to
produce 1, 30,000 boxes as was in the just ended year of 2004. Expected sale would be
1,50,000 boxes. Costing department has worked out escalation in cost by 25% on variable
cost and 10% on fixed cost. Fixed cost for the year 2004 is Rs40 per unit. New price
announced for 2005 is Rs100 per box. Variable cost on opening stock is Rs40 per box.
You are required to compute breakeven volume for the year 2005.

3.9

The Institute of Chartered Accountants of India

Advanced Management Accounting

Answer
Shelf life is one year hence opening stock of 30,000 boxes is to be sold first. Contribution
on these boxes is 30,000(100 40) = Rs18,00,000.
In the question production of 2004 is same as in 2005. Hence fixed cost for the year 2004
is Rs52, 00,000 (1, 30,00040). Therefore fixed cost for the year 2005 is Rs57, 20,000
(52, 00,000 + 10% of 52, 00,000).
Variable Cost for the year 2005 (Rs40 + 25% of Rs40) = Rs50 per Unit
Hence Contribution per unit during 2005 is Rs50 (100 50)
Break even volume is the volume to meet the fixed cost i.e. fixed cost equals to
contribution. Therefore, remaining fixed cost of Rs39, 20,000 (57, 20,000 18, 00,000) to
be recovered from production during 2005.
Production in 2005 to reach BEP = 3920000 / 50 = 78,400 units
Therefore BEP for the year 2005 is 1, 08,400 boxes (30000 + 78400)
Question 6
Jay Kay Limited is a single product manufacturing company. The following information
relates to the months of May and June, 2003:

(i)

May

June

Rs.

Rs.

2.00

2.20

Total fixed manufacturing cost

(based on budgeted output of 25,000 units per month)

40,000

44,000

Total fixed marketing cost

14,000

15,400

5.00

5.50

Units

Units

Production

24,000

24,000

Sales

21,000

26,500

Budgeted Costs and Selling prices:

Variable manufacturing cost per unit

Selling price per unit

(ii)

Actual production and sales:

(iii)

There was no stock of finished goods at the beginning of May, 2003. There was no
wastage or loss of finished goods during May or June, 2003.

(iv)

Actual costs incurred corresponded to those budgeted for each month.

3.10

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

You are required to calculate the relative effects on the monthly operating profits of
applying: (i) Absorption costing and (ii) Marginal costing.
Answer
(a)

Quantity tally:
May 2003

June 2003

Opening Stock

units

3,000

Production

units

24,000

24,000

Total

units

24,000

27,000

Sales

units

21,000

26,500

Closing Stock

units

3,000

500

Fixed manufacturing overheads

Rs.

40,000

44,000

Budgeted output

units

25,000

25,000

Fixed overheads absorption rate per

unit

Rs.

1.60

1.76

(i)

Profitability based on absorption costing:

May 2003

June 2003

Rs.

Rs.

Sales:
May: 21,000 units @ Rs. 5.00

1,05,000

June: 26,500 units @ Rs. 5.50

1,45,750

Production Costs:
Variable: May 24,000 units @ Rs. 2.00

48,000

June 24,000 units @ Rs. 2.20

Fixed: May 24,000 units @ Rs. 1.60

52,800
38,400

June 24,000 units @ Rs. 1.76

Total production costs

42,240
86,400

95,040

Add: Opening stock

May

Nil

June 3,000 units @ Res. 3.60*

Total

86,400

3.11

The Institute of Chartered Accountants of India

10,800
1,05,840

Advanced Management Accounting

Less: Closing stock
May 3,000 units @ Rs. 3.60*

10,800

June 500 units @ Rs. 3.96*

1,980

Production cost of goods sold

75,600

1,03,860

Marketing fixed costs

14,000

15,400

Total cost of goods sold

89,600

1,19,260

Profit (Sales COGS)

15,400

26,490

Budgeted output

25,000 units

Actual output

24,000 units

Shortfall

1,000 units

Under recovery of fixed overheads

May 1,000 units @ Rs. 1.60

1,600

June 1,000 units @ Rs. 1.76

Net profit

1,760
24,730

13,800

*Total cost =

VC + FC

May 2.00 + 1.60 = 3.60

June 2.20 + 1.76 = 3.96
(ii)

Profitability based on marginal costing:

May 2003 June 2003
Sales
Production cost variable

Rs.

Rs.

1,05,000

1,45,750

48,000

52,800

Add: Opening stock

May

Nil

June

3,000 units @ Rs. 2.00

Total

6,000
48,000

58,800

Less: Closing stock

May 3,000 units @ Rs. 2.00

6,000

June 500 units @ Rs. 2.20

Variable cost of goods sold

42,000
3.12

The Institute of Chartered Accountants of India

1,100
57,700

CVP Analysis & Decision Making

Contribution
Fixed costs:

May

June

Production

40,000

44,000

Marketing

14,000

15,400

63,000

88,050

54,000

59,400

9,000

28,650

Net profit
Question 7

X Ltd. manufactures a semiconductor for which the cost and price structure is given
below:
Rs. per unit
Selling price

500

Direct material

150

Direct labour

100

Variable overhead

50

Fixed cost = Rs. 2 lakhs.

The product is manufactured by a machine, whose spare part costing Rs. 2,000 needs
replacement after every 100 pieces of output. This is in addition to the above costs.
Assume that no defectives are produced and that the spare part is readily available in the
market at all times at Rs. 2,000.
(i)

Prepare the profitability statement for production levels of 2,000 units and 3,000
units, when fixed cost = Rs. 1 lakhs.

(ii)

What is the break-even point (BEP) for the above data?

(iii)

Comment on the BEP, if the fixed cost can be reduced to Rs. 1,80,000 from the
existing level of 2 lakhs.

Answer
(i)

X Ltd. Profitability Statement:

Volume Level
Particulars

2000 units

3000 units

Rs.000
Sales

1,000

3.13

The Institute of Chartered Accountants of India

1,500

Advanced Management Accounting

Variable costs
Direct Material

300

450

Direct Labour

200

300

Variable overhead

100

150

Part costs*

40

60

Fixed cost

100

100

Total cost

740

1,060

Profit

260

440

*Part cost:
(ii)

2,000
100

2,000 = 40,000

3,000
100

60,000 = 2,000

For computing the BEP: Parts cost although a step fixed cost can be considered
as variable for the limited purpose of computing the range in which BEP occurs.
2,000
The variable parts cost per unit is Rs. 20
.
100
1,00,000

Range in which the BEP occur

(200 20)

Range
General Fixed Cost
Parts cost

= 555.55

(200 20)

= 1,111.11

501600

1,1011,200

1,00,000*

2,00,000

(6 2,000) = 12,000 (12 2,000) = 24,000

Total Fixed Cost

Gross Contribution/unit**
BEP

1,12,000

2,24,000

200

200

560 units

1,120 units

**Gross Contribution per unit

Sales Direct Material Direct Labour Variable Overheads
Rs. 500 Rs. 150 Rs. 100 Rs. 50 = Rs. 200

3.14

The Institute of Chartered Accountants of India

2,00,000

CVP Analysis & Decision Making

(iii)

When fixed cost is Rs. 1,80,000. Range of BEP will be

1,80,000
180

= 1,000 (901 1,000)

Since the BEP of 1,000 falls on the upper most limits in the range 901 1,000
there will be one more BEP in the subsequent range in 1,001 1,100.
Range

901 1,000

1,001 1,100

Rs.

Rs.

1,80,000

1,80,000

20,000

22,000

10 2,000

11 2,000

2,00,000

2,02,000

200

200

1,000 units

1,010 units

Gross fixed cost

Parts cost
Total fixed cost
Gross contribution/unit
BEP
Question 8

A company has produced 1,500 units against a budgeted quantity of 2,000 units. Actual
sales were 1,300 units. The companys policy is to value stocks at standard absorption
cost.
Other data are:
Direct material

Rs. 100 per unit

Direct labour

Rs. 100 per unit at normal efficiency

Variable OH

Rs. 50 per unit

Fixed OH at budgeted capacity

Rs. 1,00,000

Variable selling OH

Rs. 26,000

Budgeted fixed selling OH

Rs. 30,000

Actual fixed selling OH

Rs. 25,000

Selling price

Rs. 400 per unit

There was no opening stock.

(i)

Present the profitability statement under absorption costing system.

(ii)

Assuming actual labour was 25% below normal efficiency and that 100 units of
production had to be scrapped after complete manufacture, compute the actual
profit or loss.

(iii)

Reconcile the profits under (i) and (ii) above.

3.15

The Institute of Chartered Accountants of India

Advanced Management Accounting

Answer
(i & ii) Profitability under absorption costing system Actual profit and loss account
Particulars

Rs. 000s Particulars

Sales (1,300400)

520 Sales (1,300400)

Closing Stock (100300)

Absorption costs
Opening Stock

Nil Total

Cost of production
1,500 units 300
Less: Closing stock (200300)
Net Absorption costs
Add: Under-absorption (50050)

Rs. 000s
520
30
550

Cost
450 Direct materials (1,500100)
60 Direct labour (1,500100/75%)

150
200

390 Variable overhead (1,50050)

75

25 Fixed manufacturing overhead

100

Total absorption costs

415 Fixed Selling overhead

25

Gross profit

105 Variable selling overhead

26

Less: Selling overhead variable

26 Total costs

Selling overhead fixed

25

Profit/(loss)

54 Profit / (Loss)

576
(26)

Working Notes:
Rs.

Units

Absorption cost per unit

Budgeted capacity

Direct materials

100 Production

Direct labour

100 Under-absorption

Variable overhead

50 Sales

Fixed Overhead (1,00,000 / 2,000)

50 Closing stock

Total
(iii)

300

Reconciliation
Rs. 000s
Profit under absorption costing

54

Less: Labour inefficiency**

(50)

Less: Value of units scrapped

(30)

Actual profit / (loss)

(26)

** (1,500 (133 1/3100)

3.16

The Institute of Chartered Accountants of India

2,000
1,500
500
1,300
200

CVP Analysis & Decision Making

Note: In case budgeted fixed selling overheads are considered while arriving at
absorption profit a saving of Rs. 5,000 shall need to be identified as part of
reconciliation.
Question 9
The following information of a company is available for the year 2006:
Rs.
Sales

40,000

Raw materials

20,000

Direct wages

6,000

Variable and fixed OH

10,000

Profit

4,000

Units sold

200 Nos.

In the year 2007, wages rate will increase by 50% and fixed cost will decrease by Rs. 600.
If 300 units are sold in 2007, the total fixed and variable OH will be 11,400. How many
units should be sold in 2007, so that the same amount of profit per unit as in year 2006
may be earned?
Answer
Particulars (Data per unit)

2006

2007

Rs.

Rs.

Selling price (40,000 /200)

200

Raw materials (20,000 /200)

100

Direct wages (6,000 /200)

30

(30 150%) 45

Variable overhead

20

Total variable cost

165

Contribution

35

Profit per unit (4,000 /200)

20

Net contribution per unit to cover fixed overheads

15

Fixed overheads

6,000

No. of units

5,400/15 = 360 units

3.17

The Institute of Chartered Accountants of India

5,400

Advanced Management Accounting

Working Notes:
No. of units sold
Total variable and fixed overheads

200

300

10,000

11,400 + 600 = 12,000

Differential cost in 2007

100 units Rs. 2,000

Variable overhead per unit

2,000 / 100 = 20

Total variable cost

4,000

6,000

Total fixed cost

6,000

(6,000 600) 5,400

Question 10
A company makes 1,500 units of a product for which the profitability statement is given
below:
Rs.
Sales

1,20,000

Direct materials

30,000

Direct labour

36,000

Variable OH

15,000

Subtotal variable cost

81,000

Fixed cost

16,800

Total cost

97,800

Profit

22,200

After the first 500 units of production, the company has to pay a premium of Rs. 6 per unit
towards overtime labour. The premium so paid has been included in the direct labour cost
of Rs. 36,000 given above.
You are required to compute the Break-even point.
Answer
Data / Unit

1 500

501 1,500

Rs.

Rs.

Sales (1,20,000 / 1,500)

80

80

Direct material (20,000 / 1,000)

20

20

Direct labour

20

26

Variable overheads 15,000 / 1,500

10

10

3.18

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

Contribution

30

No. of units

500

24

Total contribution

15,000

Fixed costs

16,800

Shortfall

1,800

No. of units required above 500 to recover shortfall

1,800 / 24 = 75

Break even point

(500 + 75) = 575 units

Let X be the Direct Labour per unit upto 500 units.

Total Direct Labour 500X + 1,000 (X + 6) = 36,000
1,500X + 6,000 = 36,000
X = 20.
Therefore, up to 500 units the Direct Labour is Rs. 20. After 500 units it is Rs. 26.
Question 11
A Ltd. Makes and sells a single product. The companys trading results for the year are:
Figs. Rs. 000 (Year 2007)
Sales

3,000

Direct materials

900

Direct labour

600

Overheads

900

Profits

600

For the year 2008, the following are expected:

(i)

Reduction in the selling price by 10%.

(ii)

Increase in the quantity sold by 50%.

(iii)

Inflation of direct material cost by 8%.

(iv)

Price inflation in variable overhead by 6%.

(v)

Reduction of fixed overhead expenses by 25%.

It is also known that:

(a)

In 2006, overhead expenditure totalled to Rs. 8,00,000.

(b)

Total overhead cost inflation for 2007 has been 5% more than 2006.
3.19

The Institute of Chartered Accountants of India

2,400

Advanced Management Accounting

(c)

Production and sales volumes have been 25% higher in 2007 than in 2006.

The high-low method is being used by the company to estimate overhead expenditure.
You are required to:
(i)

Prepare a statement showing the estimated trading results for 2008.

(ii)

Calculate the Break-even point for 2007 and 2008.

(iii)

Comment on the BEP and profits of the years 2007 and 2008.

Answer
(a)

(i)

Trading Results
Figures Rs. 000
2006

Sales:

2008

Workings

3,000

4,050
(Refer to Note 1)

(3,000 1.5 .9)

Direct Material

900

Direct Labour

600

Variable
Overhead
Total
Cost

Total Overhead

2,835 Total variable cost

1,200

1,215

600
(Refer to Note 3)

450

900

927

2,400

3,285

600

765

800

Profits

Contribution/ Sales 40% 30%

BEP Fixed Cost/PV Ratio

(600 1.5 1)

1,800

Total Cost

P/V Ratio

900

477 (300 1.06 1.5)

Variable

Fixed Overhead

1,458 (900 1.5 1.08)

300*
(Refer Note 2)

Contribution

(ii)

2007

600
450
= 1,500
= 1,500
40%
30%

3.20

The Institute of Chartered Accountants of India

(600 .75)

CVP Analysis & Decision Making

(Note 1)

3,000 1.5 0.9

(Note 2)

Overhead Cost in 2006 = 800

Increase in price = 5%
Overhead cost for same production 800 5% + 800 = 840.
Overhead increase due to quantity = 900 840 = Rs. 60
Rs. 60 represents increase in variable Overhead in 2007 due to
increase
in quantity by 25%.
1
Variable Overhead amount in 2007 = 1 times
4

i.e.

5
1

= 5 times th quantity
4
4

= 5 60 = 300

(Note 3)
In 2007 Total Overhead

900

Variable Overhead (Refer to Note 2)

300

Fixed Overhead

600

(iii)
2007

2008

Difference

1,500

1,500

Fixed Overhead

600

450

150

PV Ratio

40%

30%

10%

Profit

600

765

165

BEP

BEP =

%
25%
25%

10
40

27.5%

Fixed Cost
P/V ratio

Both Fixed Cost and P/V ratio have declined by 25% equally. So BEP sales
remains the same.
The contribution is only Rs. 1,215 in 2008 though quantity is increased by 50%.
This is due to increase in production cost and decrease in selling price. This is
more than made up by decrease in fixed cost so that overall profit has increased by
27.5%.
3.21

The Institute of Chartered Accountants of India

Advanced Management Accounting

Alternative Solution (for identifying variability and fixedness of overheads):

V 1 q 1 = Variable Overhead / unit in 2007 quantity in 2007

V 2 q 2 = Variable Overhead / unit in 2008 quantity in 2008
V 2 q 2 = V 1 (1.06) (1.5)q 1 = 1.59 v 1 q 1
V0 q0 + F0

= 800

V1 q0 + F0

= 840 where q 0 1.25 = q 1

V1 q0 V0 q0

= 40

V 0 q 0 = V 1 q 0 40
V 1 q 0 + F 1 (V 0 q 0 + F 0 )
i.e.

V1 q0 + F1

5
800 = 40
100

= 840

V1 q1 + F1

= 900

V 1 (q 0 q 1 )

= 60

V 1 (q 1 1.25q)

= 60 1.25

V 1 ( .25)q 1 = 75
V1q1 =

75
= 300
.25

Variable Overhead

300

Fixed Overhead

600

Year 2007
900
Question 12
Draw and explain the angle of incidence in a break-even chart. What is its significance to
the management?

3.22

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

Answer
(c)

Cost & Revenue (Rs.)

es
al
lS
ta
o
T

B
st
l Co
Tota

0
Units (Nos.)

Angle of incidence (0) is the angle between the total cost line and the total sales line.
If the angle is large, the firm is said to make profits at a high rate and vice-versa.
A high angle of incidence and a high margin of safety indicate sound business conditions.
Question 13
A single product manufacturing company has an installed capacity of 3,00,000 units per
annum. The normal capacity utilization of the company is 90%. The company has
prepared the following budget for a year:
Variable costs:
Factory costs

Rs. 33 per unit

Selling and Administration costs

Rs. 9 per unit

Fixed costs:
Factory costs

Rs. 21,60,000

Selling and Administration costs

Rs. 7,56,000

Selling Price
Selling price per unit

Rs. 60

3.23

The Institute of Chartered Accountants of India

Advanced Management Accounting

The actual production, sales, price and cost data relating to the year under review are as
given below:
Production

2,40,000 units

Sales

2,25,000 units

Finished goods stock in the beginning of the year:

15,000 units

Actual factory variable costs exceeded the budget by

Rs. 1,20,000

Required:
(i)

Calculate the budgeted profit and break-even point in units.

(ii)

What increase in selling price was necessary during the year under review to
maintain the budgeted profit?

(iii)

Prepare statements showing the actual profit during the year under review by using
(1) absorption costing method and (2) marginal costing method.

Answer

(i)

Contribution per unit:

Rs.

Rs.

Selling price per unit

60

Variable costs per unit:

Factory

33

Selling & Administration

42

Contribution per unit (Selling price Variable cost)

18

Budgeted Profit:
Units

Installed capacity

3,00,000

Normal capacity utilization (3,00,000 90%)

2,70,000

Rs.

Total contribution (A) (Contribution per unit

Normal capacity utilization) (2,70,000 18)

Rs.

48,60,000

Fixed Costs (B)

Factory Costs

21,60,000

Selling and Administration costs

7,56,000

Profit (A B)

19,44,000
3.24

The Institute of Chartered Accountants of India

29,16,000

CVP Analysis & Decision Making

Break - even point (in units) =

=
(ii)

1.

Fixed costs
Contribution per unit

29,16,000
= 1,62,000.
18
Actual variable costs per unit

Rs.

Budgeted factory costs

Rs.

33

Increase in Factory costs per unit

1,20,000

2,40,000

0.50

Selling and Administration costs

33.50
9.00
42.50

2.

Selling price required to maintain the budgeted profit:

A.

Total contribution required (Rs.)

B.

Actual production (units)

C.

Contribution desired per unit (A B) (Rs.)

20.25

D.

Variable cost per unit (Rs.)

42.50

E.

Selling price required to maintain budgeted profit

(C + D) (Rs.)

62.75

F.
(iii)

Increase in selling price necessary Rs. (62.75 60)

48,60,000
2,40,000

2.75

Fixed overhead recovery rate:

Fixed factory overheads

Rs. 21,60,000

Normal Production

2,70,000 units

Absorption Rate per unit : 21,60,000 / 2,70,000 = Rs. 8

Stock analysis:

Units
Opening stocks

15,000

Add : Production

2,40,000

Total

2,55,000

Less : Sales

2,25,000

Closing stocks

30,000
3.25

The Institute of Chartered Accountants of India

Advanced Management Accounting

1.

Profitability based on Absorption Costing Method:

Rs.

A.

Sales (2,25,000 units @ Rs. 60)

B.

Production costs:

Rs.

1,35,00,000

Variable factory cost:(2,40,000 units Rs. 33)

Increase in cost

79,20,000
1,20,000

Fixed factory costs (2,40,000 units Rs. 8)

19,20,000

Total production costs

99,60,000

Less : Closing stock

(30,000 units 99,60,000) / 2,40,000

12,45,000
87,15,000

Add : Opening stock 15,000 units Rs. 41 *

6,15,000

Production cost of goods sold

C.

93,30,000

Selling and Administration Costs:

Variable costs: 2,25,000 units Rs. 9
Fixed Costs

D.

20,25,000
7,56,000

Less : Total cost of goods sold (B + C)

27,81,000
1,21,11,000
13,89,000

Less : Under absorption of factory fixed overheads

(2,40,000 2,70,000 units) Rs. 8

2,40,000

Profit

11,49,000

Cost of opening stock (per unit)

= Variable Factory cost + Fixed overhead

recovery rate
= Rs. 33 per unit + Rs. 8 per unit
= Rs. 41 per unit.

Profitability based on Marginal Costing Method:

Rs.

Sales (2,25,000 units @ Rs. 60)

1,35,00,000

Production variable costs:

Variable cost (2,40,000 units Rs. 33)
3.26

The Institute of Chartered Accountants of India

Rs.

79,20,000

CVP Analysis & Decision Making

Increase in cost

1,20,000

Total

80,40,000

Less : Closing stock:

(30,000 80,40,000) / 2,40,000

10,05,000
70,35,000

Add : Opening Stock (15,000 units Rs. 33)

4,95,000

Production variable cost of goods sold

75,30,000

Variable Selling & Administrative Expenses

(2,25,000 Rs. 9)

20,25,000

Total variable costs (B + C)

95,55,000

Contribution (A D)

39,45,000

Less : Fixed overheads: Factory

21,60,000

Selling & Administration

G

7,56,000

29,16,000

Profit (E F)

10,29,000

Question 14
Bloom Ltd. makes 3 products, A, B and C. The following information is available:
(Figures in Rupees per unit)
A

Selling price (peak-season)

550

630

690

Selling price (off-season)

550

604

690

Material cost

230

260

290

Labour (peak-season)

110

120

150

Labour (off-season)

100

99

149

Variable production overhead

100

120

130

Variable selling overhead

(only for peak-season)

10

20

15

Labour hours required for one unit of

production

11

7 (hours)

Material cost and variable production overheads are the same for the peak-season and
off-season. Variable selling overheads are not incurred in the off-season. Fixed costs
amount to Rs. 26,780 for each season, of which Rs. 2,000 is towards salary for special
3.27

The Institute of Chartered Accountants of India

Advanced Management Accounting

technician, incurred only for product B, and Rs. 4,780 is the amount that will be incurred
on after-sales warranty and free maintenance of only product C, to match competition.
Labour force can be interchangeably used for all the products. During peak-season, there
is labour shortage and the maximum labour hours available are 1,617 hours. During offseason, labour is freely available, but demand is limited to 100 units of A, 115 units of B
and 135 units of C, with production facility being limited to 215 units for A, B and C put
together.
You are required to:
(i)

Advise the company about the best product mix during peak-season for maximum
profit.

(ii)

What will be the maximum profit for the off-season?

Answer
(a)

Bloom Ltd.
Peak Season.
Statement of Contribution and BEP (in units)
Figures Rs.

Product

550

630

690

Direct Material

230

260

290

Direct Labour

110

120

150

Variable Overhead Production

100

120

130

10

20

15

B. Total Variable Cost

450

520

585

C. Contribution / unit (A B)

100

110

105

11

12.5

10

15

A. Selling Price per unit

Variable Costs per unit:

Variable Overhead-Selling

D. Direct Labour hours / required per

unit
E. Contribution per Labour Hour (C / D)
F. Ranking
General Fixed Overhead

20,000

3.28

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

Specific Fixed overhead

2,000

4,780

G. Total Fixed Overhead

6,780
26,780

H. BEP (units) (for only 1 Product at a

time) (G/C)

20,000
24,780
22,000
= 20
= 20
= 23
100
110
105

Maximum units that can be produced of product C with limited labour hours 1,617.
=

1,617
= 231.
7

231 < Break Even units.

Hence, Bloom Ltd. cannot produce C.
Next rank = A
Maximum units of A that can be produced with limited labour hours =

1,617
= 202 units.
8

Break Even units of A = 200

Profit if only A is produced
Rs.

Contribution = Rs. 202 100

20,200

Fixed Cost

20,000

Profit

200

Off Season
Bloom Ltd.
Off Season
Statement of Contribution and demand
Figures Rs. per unit
Product

Selling Price

550

604

690

Direct Material

230

260

290

Direct Labour

100

99

149

Production-Variable Overhead

100

120

130

3.29

The Institute of Chartered Accountants of India

Advanced Management Accounting

Total Variable Cost

430

479

569

Contribution per unit (A B)

120

125

121

100

115

135

Ranking
Maximum demand
Overall limit of production

215 units

Statement of profitability under different options

(limit of production = 215 units)
A

120

125

121

Option 1: Units

115

100

215

Contribution (Rs.)

14,375

12,100

26,475

100

115

215

12,000

14,375

26,375

80

135

215

9,600

16,335

25,935

Contribution per unit

Option 2: Units

Contribution (Rs.)
Option 3: Units

Contribution (Rs.)

Total Fixed Cost

Profit
(loss)

26,780

(305)

22,000

4,375

24,780

1,155

Best strategy is to produce 100 units of product A and 115 units of product B during offseason.
Maximum profit = Rs. 4,375.
(i)

Best strategy for peak-season is to produce 202 units of A.

(ii)

Maximum profit for off-season Rs. 4,375.

Question 15
A company has prepared the following budget for the forthcoming year:
Rs. lakhs
Sales

20.00

Direct materials

3.60

Direct labour

6.40

Factory overheads:
Variable

2.20

3.30

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

Fixed

2.60

Administration overheads

1.80

Sales commission

1.00

Fixed selling overheads

0.40

Total costs

18.00

Profit
2.00
The policy of the company in fixing selling prices is to charge all overheads other than the
prime costs on the basis of percentage of direct wages and to add a mark up of one-ninth
of total costs for profit.
While the company is confident of achieving the budget drawn up as above, a new
customer approached the company directly for execution of a special order. The direct
materials and direct labour costs of the special order are estimated respectively at Rs.
36,000 and Rs. 64,000. This special order is in excess of the budgeted sales as
envisaged above. The company submitted a quotation of Rs. 2,00,000 for the special
order based on its policy. The new customer is willing to pay a price of Rs. 1,50,000 for
the special order. The company is hesitant to accept the order below total cost as,
according to the company management, it will lead to a loss.

You are required to state your arguments and advise the management on the acceptance
of the special order.
Answer
Analysis of Cost and profit:

Rs. (lakhs)
Direct material

3.60

Direct labour

6.40

Prime cost

Rs. (lakhs)

10.00

Overhead:
Variable factory overhead

2.20

Fixed factory overhead

2.60

Administration overheads

1.80

Selling commission

1.00

Fixed selling overheads

0.40

Total cost

18.00
3.31

The Institute of Chartered Accountants of India

8.00

Advanced Management Accounting

Profit

2.00

Rate of profit on costs (2/18) = 1/9

Overhead absorption rate based on direct wages = (8.00 / 6.40) 100 = 125% of direct
wages
Break up of new order:

Rs.

Direct Materials

36,000

Direct Labour

64,000

Overheads 125% of direct wages

80,000

Total costs
Profit

1,80,000
1/9

20,000

Selling Price

2,00,000

The following points emerge:

(i)

Factory overheads only are to be recovered on the basis of direct wages.

(ii)

The special order is a direct order. Hence commission is not payable.

(iii)

The budgeted sales are achieved. Hence all fixed overheads are recovered. Hence,
no fixed overheads will be chargeable to the special order.

Based on the above, the factory variable overheads recovery rate may be calculated as
under:
Total variable factory overheads

Rs. 2.20 lakhs

Direct wages

Rs. 6.40 lakhs

Factory overhead rate = (2.20 / 6.40) 100 = 34.375%

Applying this rate the cost of the special order will be as under:
Rs.

Direct materials

36,000

Direct labour

64,000

Overheads 34.375% of direct wages

22,000

Total costs

1,22,000

Price offered

1,50,000

Margin

28,000 (more than 1/9)

3.32

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

Hence, the order is acceptable at the price of Rs. 1,50,000.

Question 16
Paints Ltd. manufactures 2,00,000 tins of paint at normal capacity. It incurs the following
manufacturing costs per unit:
Rs.
Direct material

7.80

Direct labour

2.10

Variable overhead

2.50

Fixed overhead

4.00

Production cost / unit

16.40

Each unit is sold for Rs. 21, with an additional variable selling overhead incurred at
Rs. 0.60 per unit.
During the next quarter, only 10,000 units can be produced and sold. Management plans
to shut down the plant estimating that the fixed manufacturing cost can be reduced to Rs.
74,000 for the quarter.
When the plant is operating, the fixed overheads are incurred at a uniform rate throughout
the year. Additional costs of plant shut down for the quarter are estimated at Rs. 14,000.
You are required:
(i)

To advise whether it is more economical to shut down the plant during the quarter
rather than operate the plant.

(ii)

Calculate the shut down point for the quarter in terms of numbering units.

Answer

Contribution per tin

= Selling Price Variable cost

= 21 (7.8 + 2.1+ 2.5 + 0.6)
= Rs. 8 per tin.

Loss on operation:

Fixed cost per annum = 2,00,000 units 4 per unit = 8 lakhs.

Fixed cost for 1 quarter =

8
= 2 lakhs
4

3.33

The Institute of Chartered Accountants of India

Advanced Management Accounting

Rs.

Fixed cost for the quarter

2,00,000

Less: Contribution on operation (8 10,000)

Expected loss on operation

80,000
(1,20,000)

Loss on shut down:

Rs.

Unavoidable Fixed Cost

74,000

Additional shut down cost

14,000

Loss on shut-down

(88,000)

Conclusion: Better to shut down and save Rs. 32,000.

Shut-down point (number of units) =
=
=

Avoidable Fixed Cost

Contribution per unit
2,00,000 88,000
8

1,12,000
= 14,000 units.
8

Question 17
XYZ Ltd. has two divisions, A and B. Division A makes and sells product A, which can be
sold outside as well as be used by B. A has a limitation on production capacity, that only
1,200 units can pass through its machining operations in one month. On an average,
about 10% of the units that A produces are defective. It may be assumed that out of each
lot that A supplies, 10% are defectives.
(12 Marks)
When A sells in the outside market, the defectives are not returned, since the
transportation costs make it uneconomical for the customer. Instead, A's customers sell
the defectives in the outside market at a discount.
But, when B buys product A, it has to fix it into its product, which is reputed for its quality.
Therefore, B returns all the defective units to A. A can manually rework the defectives,
incurring only variable labour cost and sell them outside at Rs.150 and not having to incur
any selling costs on reworked units. If A chooses not to rework, it can only scrap the
material at Rs.30 per unit. B can buy product A from outside at Rs.200 per unit, but has to
incur Rs.10 per unit as variable transport cost. B can insist to its outside suppliers also
that it will accept only good units.

3.34

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

A incurs a variable selling overhead only on units (other than reworked units) sold outside.
The following figures are given for the month:
Variable cost of production Dept. A (Rs./unit)

120

Variable selling overhead (Rs./u)

20

Selling price per unit in the outside market (Rs./u)

200

Current selling price to B (Rs./u)

190

Additional variable labour cost of reworking defectives (Rs./u)

100

Selling price of reworked defectives (Rs./u)

150

Fixed costs for the month (Rs.)

36,000

Maximum demand from B at present (no. of units)

630

The outside demand can be freely had upto 900units.

Given the demand and supply conditions, you are required to present appropriate
calculations for the following:
(i)

Evaluation of the best strategy for A in the present condition.

(ii)

If B can buy only upto 540 units and the outside demand is only 600 units, how
much should A charge B to maintain the same level of profit as in (i) above?

Answer

(i)

Contribution per unit against sale to outside = Rs ( 200-120-20) = Rs 60

In case of transfer, good units and rejected units are in proportion of 9:1
In case of transfer, contribution per good unit = Rs ( 190 120) = Rs 70
In case of transfer, contribution per rejected unit = Rs ( 150 120-100) = Rs -70
Thus, effective contribution per unit of transfer = Rs ( 70 x 0.9 70x 0.1) = Rs 56
As contribution per unit aginst outside sale is higher, the best strategy should be to
sell maximum number of unit to outside marker.
Contribution from outside market from sale of 900 units

Rs 54,000
Rs.(900 x 60)

Contribution from transfer of 300 units to B

Rs 16,800
Rs (300 x 56)

(ii)

Total Contribution from best strategy

Rs 70,800

If Bs demand is 540 unit, total production required

600 units.

3.35

The Institute of Chartered Accountants of India

Advanced Management Accounting

(540 /0.9)
Taking outside market demand of 600, it is within production capacity of 1200 units.
Now contribution from 600 units of outside sale

Rs 36,000
Rs ( 600 x 60 )

Contribution from rejected 60 units

Rs (4,200)
Rs ( 60 x 70)

Rs 31,800

To keep same level of contribution as in (i), the contribution required from transfer
of 540 unit to B
= Rs 39,000
(Rs 70,800 31,800)
Thus, contribution required per unit

= Rs 72.22
Rs 39,000 /540

Hence price to be charged per unit against transfer to B = Rs 192.2

Rs ( 120 + 72.22)
Alternative Solution:

Let x be the number of units sold outside and y be the number of units sold to B, before B
returns 10% as defectives.
Then, x + y = 1,200, is the limitation on production capacity of A.
Department A
Outside
Rs.

to B
Rs.

Selling Prices

200

190

Variable Cost Production

120

120

Variable Cost Sale

20

--

Total Variable Cost

140

120

Contribution
Contribution on x units sold outside = 60x

60

70

Out of y units to B, 10% =

1
y = .1y is returned to A. If A scraps, amount got = 30 per
10

unit.

3.36

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

If A reworks and sells, it gets 150 100

= 50 / unit.

Decision to reworks all defectives. i.e. (.1) (y)

Contribution on good units of B = 0.9y 70

= 63y

Contribution on reworked units of B = (.1) (y) 50

= 5y

Amount of material lost on manufacture of defectives to B = 12y

(.1) (y) 120
Contribution on y gross units transferred to B

= 56y

63y + 5Y 12y
Total contribution earned by A

= 60x + 56y

where x + y

= 1200

To maximize contribution, maximize units sold outside.

900 units sell outside.

Balance

300
units (gross transfer to B, of which B gives back 30 defectives)
1200

Contribution :

Rs.60 (900) + Rs.56 (300)

= Rs.54,000 + Rs.16,800

Contribution = Rs.70,800
Fixed Cost = Rs.36,000
(i)

Profit = Rs.34,800

(ii)

Outside demand

= 600 units

Contribution = 600 Rs.60

= Rs.36,000

Balance to be got

= Rs.34,800
= Rs.70,800

Out of Rs.34,800, defectives of B will give

Rs.

3,000 60 50

Rs.

31,800 charge to B for 540 units

Contribution to be obtained from 540 units of B

= Rs. 31,800

Add : Production cost of 600 units @ 120/-

= Rs. 72,000

Amount changed for 540 units

= Rs.1,03,800

3.37

The Institute of Chartered Accountants of India

Advanced Management Accounting

Price to be charged to B =

1,03,800
= 192.22
540

Per good unit transferred, to maintain the same level of profit as in (a).
Question 18
Ret Ltd., a retail store buys computers from Comp Ltd. and sells them in retail. Comp Ltd.
pays Ret Ltd. a commission of 10% on the _selling price at which Ret sells to the outside
market. This commission is paid at the end of the month in which Ret Ltd. submits a bill
for the commission. Ret Ltd. sells the computers to its customers at its store at Rs.30,000
per piece Comp Ltd. has a policy of not taking back computers once dispatched from its
factory. Comp Ltd. sells a minimum of 100 computers to its customers.
Comp Ltd. charges prices to Ret Ltd. as follows:
Rs.29,000 per unit, for order quantity 100 units to 140 units.
Rs.26,000 per unit, for the entire order, if the quantity is 141 to 200 units. Ret Ltd. cannot
order less than 100 or more than 200 units from Comp Ltd.
Due to the economic recession, Ret Ltd. will be forced to offer as a free gift, a digital
camera costing it Rs.4,500 per piece, which is compatible with the computer. These
cameras are sold by another Co., Photo Ltd. only in boxes, where each box contains 50
units. Ret Ltd. can order the cameras only in boxes and these cameras cannot be sold
without the computer.
In its own store, Ret Ltd. can sell 110 units of the computer. At another far of location, Ret
Ltd. can sell upto 80 units of the computer (along with its free camera), provided it is
willing to spend Rs.5,000 per unit on shipping costs. In this market also, the selling price
that each unit will fetch is Rs.30,000 per unit.
You are required to:
(i)

State what is Ret's best strategy along with supporting calculations.

(ii)

Compute the break-even point in units, considering only the above costs.

Answer
Order Qty
100-140 (Rs.)

Selling Price Rs./u

Order Qty
141-200 (Rs.)

30,000

30,000

Commission @ 10%

3,000

3,000

Sales revenue p. u.

33,000

33,000

3.38

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

Less : Variable purchase cost

Contribution / unit (before shipping)

29,000

26,000

4,000

7,000

Less : Shipping cost > 110 units

5,000

Contribution/ units after Shipping

2,000

(i)

Upto 110 units, Reference will earn a contribution of Rs.4,000/u.

(ii)

Between 110 & 140 units, contribution of 4,000 will be wiped out by 5,000 on
shipping costs. Hence we should not consider 110 140 range.

(iii)

101 110 not to be considered since additional fixed costs 2,25,000 will not be
covered by 10 units.

(iv)

Valid consideration, 100 units or 141 to 190 units.

Fixed cost of box of 50 cameras is Rs. 2,25,000

Units

100

141

150

190

No. of Camera Boxes

Cost of Cameras (Rs.)

4,50,000

6,75,000

6,75,000

9,00,000

Contribution (Rs/u) Rs. 4,000

400,000

Contribution (Rs.) first 110 units

@ 7,000/u

7,70,000

7,70,000

7,70,000

Contribution (Rs.) Balance units

@ 2,000/u

62,000

80,000

1,60,000

Total Contribution (F = C + D +
E) (Rs.)

8,32,000

8,50,000

9,30,000

Profit (F) (B) (Rs.)

G
- 50,000 1,57,000 1,75,000
Best strategy buy 150 units from Comp. sell 110 at store and 40 outside.

30,000

4,00,000

BEP should be between 151 191 units

Extra Camera box cost beyond 150 units

= 2,25,000

Less: Profit for 150 units

= 1,75,000

Extra profit acquired

= 50,000

No. of units to cover this additional costs at contribution 2000 Rs./u

BEP = 150 + 25 = 175 units

3.39

The Institute of Chartered Accountants of India

50,000
= 25
2,000

Advanced Management Accounting

Alternative Solution to (ii)

The problem involves fixed cost of 50 Computers i.e Rs 2,25,000 for incremental sale of 50.
Units sold
110

Margin per unit = Sales price

buying price + commission ( Rs)
Margin ( Excluding shipping cost)

140

150

190

4000

4000

7000

7000

4,40,000

5,60,000

10,50,000

13,30,000

30 x 5000
= 1,50,00

40 x 5000
= 2,00.000

80 x 5000
= 4,00,000

Shipping cost ( Rs)

For sale beyond 110 units
Contribution ( Rs)

4,40,000

4,10,000

8,50,000

9,30,000

Fixed cost ( Cost of Computers)

6,75,000

6,75,000

6,75,000

9,00,000

-2,75,000

-2,65,000

1,75,000

30,000

Profit

Best strategy is sales level at 150 units.

The variations of profit is due to incremental fixed cost.
From the profits at different levels, it is seen that the BEP lies between 151 and 190.
Let BEP = X Units
Margin = 7000 X
Shipping Cost = ( X -110)x 5000
Cost of Computers = Rs 9,00,000
We have, 7000 X = ( X -110) x 5000 + 900000
Or 7X = 5X 550 +900
Or 2X = 350 or X = 175
Thus, BEP = 175 units.
Question 19
Lee Electronic manufactures four types of electronic products, A,B,C and D. All these
products have a good demand in the market. The following figures are given to you:
A

Material cost (Rs./u)

64

72

45

56

Machining Cost (Rs/u @ Rs. 8 per hour)

48

32

64

24

Other variable costs (Rs/u)

32

36

44

20

3.40

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

Selling Price (Rs/u)
Market Demand (Units)

162

156

173

118

52,000

48,500

26,500

30,000

Fixed overhead at different levels of operation are :

Level of operation (in production hours)

Total fixed cost (Rs.)

Upto 1,50,000

10,00,000

1,50,000 30,00,000

10,50,000

3,00,000 4,50,000

11,00,000

4,50,000- 6,00,000

11,50,000

At present, the available production capacity in the company is 4,98,000 machine hours.
This capacity is not enough to meet the entire market demand and hence the production
manager wants to increase the capacity. The company wants to retain the customers by
meeting their demands through alternative ways. One alternative is to sub-contract a part
of its production. The sub-contract offer received as under :
Sub-contract Price (Rs./u)

146

126

155

108

The company seeks your advice in terms of products and quantities to be produced and/or
sub-contracted, so as to achieve the maximum possible profit. You are required to also
compute the profit expected from your suggestion.
Answer

Demand

52,000

48,500

26,500

30,000

Direct Material

64

72

45

56

M/c

48

32

64

24

Other Variable Cost

32

36

44

20

Total Variable Cost

144

140

153

100

Selling Price

162

156

173

118

Contribution (Rs./u)

18

16

20

18

M/s Hours per unit

Contribution (Rs./ M/c hr.)

2.5

Ranking

III

II

IV

3.41

The Institute of Chartered Accountants of India

Advanced Management Accounting

Sub-Contract Cost Rs./u)

146

126

155

108

Contribution (Rs./u) on (SubContract)

16

30

18

I Division: It is more profitable to sub-contract B, since contribution is higher sub-contract.

1 st Level of Operations : 1,50,000 hours, Produce D as much as possible.

Hours required = 30,000 units 3 = 90,000 hours

Balance hours available: 60,000 hours.
Produce the next best (i.e. A, Since B is better outsourced)
60,000 hrs
= 10,000 units of A.
6 hrs / u

1 st Level of Operation :
Contribution (units)

Contribution (Rs.)

Produce 10,000 units

18

1,80,000

Outsource 42,000 units

16

6,72,000

48,500 units
30

14,55,000

Outsource fully
C

26,500 units
Outsource fully

18

30,000 units
Fully produce

18

5,40,000

Total Contribution:

33,24,000

Less: Fixed cost

10,00,000

Net Gain
2 nd Level of Operation:

23,24,000

Both A and C increase contribution by own manufacture only by Rs.2/- per unit. 1,50,000
hrs can produce 25,000 units of A.
Contribution increases by 25,000 2 = 50,000

(Difference in Contribution sub-contract and own manufacturing) = 2

But increase in fixed Cost = 50,000

3.42

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

At the 2 nd level of operation, the increase in contribution by own manufacturing is exactly

set up by increase in fixed costs by Rs.50,000/-. It is a point of financial indifference, but
other conditions like reliability or possibility of the sub-contractor increasing his price may
be considered and decision may them but towards own manufacture.
3 rd Level Additional: 1,50,000 hrs available
Unit of A that are needed = [52,000 25,000 (2 nd Level) 10,000 (1 st Level)]
=

17,000 units 6 hrs/u = 1,02,000 hrs.

Balance 48,000 hrs are available for C to produce 6,000 units.

Increase in Contribution over Level 1 st or 2 nd :
A:

17,000 2

= Rs.34,000

C:

6,000 2

= Rs.12,000
= Rs.46,000

Increase in fixed costs

= Rs.50,000

Additional Loss

= Rs. 4,000

4 th Level Additional: 1,50,000 hrs can give

1,50,000
= 18,750 unit of C.
8

Increase in Contribution 18,750 2

= Rs. 37,500

Increase in Cost

= (Rs. 50,000)

Level 3 rd loss c/fd

= (Rs. 4,000)

Level 1 st profit will order by

=(Rs. 16,500)

Advice : Do not expand capacities; sell maximum

No. of units by operating at 1,50,000 hrs. capacity (level 1st ) and gain Rs.23,24,000.
Summary :
Product

Produce
(Units)

Sub-Contract
(Units)

Contribution
(Production)

Contribution
(Sub-Contract)

Total
Contribution

10,000

42,000

1,80,000

6,72,000

8,52,000

48,500

14,55,000

14,55,000

26,500

4,77,000

4,77,000

30,000

5,40,000

5,40,000

3.43

The Institute of Chartered Accountants of India

Advanced Management Accounting

33,24,000
Fixed Cost

10,00,000

Profit

23,24,000

Question 20
TQM Limited makes engines for motor cars for its parent company and for two other motor
car manufacturers.
On 31st December, the company has sufficient work order for January and one further
order for 21,000 engines. Due to recession in the economy, no further order are expected
until May when it is hoped economic prospect for the motor car industry will have
improved. Recently factory has been working at only 75% of full capacity and the order for
21,000 engines represents about one month production at this level of activity.
The board of directors are currently considering following two options:
(i)

Complete the order in February and close the factory in March and April.
OR

(ii)

Operate at 25 per cent of full capacity for each of three months of February, March
and April.
The costs per month at different levels of activities are as. follows:
At 75% (Rs.)

At 25% (Rs.)

Idle (Rs.)

Direct Material

5,25,000

1,75,000

--

Direct Labour

5,23,600

1,73,250

--

8,400

4,900

4,900

1,01,500

59,500

--

Repairs and maintenance

28,000

28,000

--

Others expenses

52,500

34,300

26,600

1,48,400

98,000

67,550

28,000

19,950

11,200

Factory overhead:
Indirect material
Indirect labour
Indirect expenses:

Office overheads:
Staff salaries
Other overheads

3.44

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

Other information is as follows:

Material cost and labour cost will not be incurred where there is no
production.

On the reopening of the factory, one time cost of training and engagement of
new personnel would be Rs.65,800 and overhauling cost of plant would be
Rs.14,000.

Parent company can purchase engines from open market at reasonable

price.

Required:
(i)

To express your opinion, along with calculations, as to whether the plant

should be shut down during the month of March and April or operate 25% of
full capacity for three months.

(ii)

To list and comment on cost and non-costs factors which might to relevant to
the discussion.

Answer
(i)
Option I

Option II

At 75% in Feb and close in

March and April (Rs.)

At 25% each from Feb

April (Rs.)

Direct Material

5,25,000

5,25,000

Direct Labour

5,23,600

5,19,750

10,48,600

10,44,750

Indirect Material

8,400

14,700

Two months idle

9,800

Factory Overhead :

Indirect Labour

1,01,500

Training cost

1,78,500

65,800

Indirect Exp. :
Repairs & Maintenance

28,000

Over hauling cost

14,000

Others Expenses

52,500

Idle 2

53,200

Office overhead:
3.45

The Institute of Chartered Accountants of India

84,000
1,02,900

Advanced Management Accounting

Staff Salaries

1,48,400

Idle 67,550 2

1,35,100

Other overheads

28,000

Idle

22,400

Total overhead cost

Total cost

2,94,000
59,850

6,67,100

7,33,950

17,15,700

17,78,700

The more economic course of action is to operate at 75% capacity for a month only,
and close the plant for March and April. This option will save (Rs.17,78,700
Rs.17,15,700) = Rs.63,000.
(ii)

Cost Factors and Non Cost Factors

In regard to the decision on close down of operations or continuing with operations,

the factors to be considered are:
(a)

Cost factors:
(1)

The proposal which involves the lower total costs will be selected.

(2)

If the company has contracted the purchases from high qulaity and
high price suppliers, a change in the procurement policy to shop
around may be considered to obtain economics in purchases.

(3)

The services of unskilled labour, if any, who do not require re-training

may be dispensed with. They may be recruited and put on work
without incurring training cost on re-opening of the factory. This will
save training and idle time cost.

(4)

The possibility of wage freeze may reluctantly be considered as an

extreme measure.

Question 21
Fairbilt Furniture Ltd. manufactures three products: Tables, Chairs and Cabinets. The
company is in the process of finalizing the plans for the coming year; hence the
executives thought it would be prudent to have a look at the product-wise performance
during the current year. The following information is furnished:
Tables

Chairs Cabinets

Unit selling price

80

60

36

Direct material

28

24

16

Direct labour

20

12

12

3.46

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

Factory overheads:
Variable

Fixed

1.28

64

48

33.28

Variable

Fixed

1.52

72

56

36.80

(0.80)

Sales volume (units)

10,000

15,000

15,000

Profit (loss)

80,000

60,000 (12,000)

Cost of production
Selling, distribution and general administration expenses :

Unit cost (I)

Unit profit (loss) (II)

For the coming period, the selling prices and the cost of three products are expected to
remain unchanged. There will be an increase in the sales of tables by 1,000 units and the
increase in sales of cabinets is expected to be 8,000 units. The sales of chairs will remain
to be unchanged. Sufficient additional capacity exists to enable the increased demands to
be met without incurring additional fixed costs. Some among the executives contend that
it will be unwise to go for additional production and sale of cabinets, since it is already
making losses at Rs.0.80 per unit. The suggestion is that cabinets should be eliminated
altogether.
Do you agree? Substantiate with necessary analysis and determine the product wise and
overall profits for the coming year.
Answer
Note: Reconciliation of the figures given for cabinets reveals the fact that the selling
price is 36(36.80 .80)
Fairbilt Furniture Ltd.
Statement showing Product-wise Contribution and Total Profit

Tables
Per Unit
Sales
(units
Selling
(Rs.)

Total

Chairs
Per unit

Total

volume

10,000

15,000

price

80 800,000

60 900,000

3.47

The Institute of Chartered Accountants of India

Cabinets
Per unit

Total

Total
15,000

36 540,000 22,40,000

Advanced Management Accounting

Direct Material

28 280,000

24 360,000

16 240,000

880,000

Direct Labour

20 200,000

12 180,000

12 180,000

560,000

Variable factory
overheads

80,000

90,000

60,000

230,000

Variable selling,
distribution and
administration
overhead

40,000

30,000

30,000

100,000

Total
cost

variable

60 600,000

44 660,000

20 200,000

16 240,000

Fixed
factory
overheads

80,000

Fixed
selling,
distribution and
administration
overheads

40,000

Contribution

Total
overheads

34 510,000 1,770,000
2

30,000

470,000

90,000

19,200

189,200

90,000

22,800

152,800

fixed

342,000

Total Profit
128,000
The above analysis shows the cabinets make a contribution of Rs.2 per unit. The loss
sustained in the previous year is because of the falling sales volume below breakeven level.
Fairbilt Furniture Ltd.

Budgeted Performance for the Coming Year

Tables

Chairs

Cabinets

Unit Contribution (Rs.)

20

16

Sales Volume (Units)

11,000

15,000

23,000

Total Contribution (Rs.)

220,000

240,000

40,000

Less: Fixed Cost (Rs.)

120,000

180,000

42,000

Profit (Rs.)

100,000

60,000

4,000

The company makes a total profit of Rs.164,000 if all the products are continued.
However, if the production of cabinets is discontinued, there will be an adverse effect on

3.48

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

the overall profit of the company. This is because cabinets also contribute toward meeting
the fixed costs of the company.
Question 22
An agro-products producer company is planning its production for next year. The following
information is relating to the current year:
Products/Corps

A1

A2

B1

B2

Area occupied (acres)

250

200

300

250

Yield per acre (ton)

50

40

45

60

Selling price per ton (Rs.)

200

250

300

270

Seeds

300

250

450

400

Pesticides

150

200

300

250

Fertilizers

125

75

100

125

Cultivations

125

75

100

125

Direct wages

4,000

4,500

5,000

5,700

Variable cost per acre (Rs.)

Fixed overhead per annum (Rs.) 53,76,000.

The land that is being used for the production of B1 and B2 can be used for either crop,
but not for A1 and A2. The land that is being used for A1 and A2 can be used for either
crop, but not for B1 and B2. In order to provide adequate market service, the company
must produce each year t least 2,000 tons each of A1 and A2 and 1,800 tons each of B1
and B2.
You are required to:
(i)

Prepare a statement of the profit for the current year.

(ii)

Profit for the production mix by fulfilling market commitment.

(iii)

Assuming that the land could be cultivated to produce any of the four products and
there was no market commitment, calculate: Profit amount of most profitable crop
and break-even point of most profitable crop in terms of acres and sales value.

Answer
(i)

Calculation of selling price and contribution per acre:

Products

A1

A2

B1

B2

Yield per acre in (tones)

50

40

45

60

Selling price per tones (Rs.)

200

250

300

270

3.49

The Institute of Chartered Accountants of India

Total

Advanced Management Accounting

Sales revenue per acre (Rs.)

10,000

10,000

13,500

16,200

Variable cost per acre (Rs.)

4,700

5,100

5,950

6,600

Contribution per acre (Rs.)

5,300

4,900

7,550

9,600

Area (acres)

2,50

200

300

250

Total contribution (Rs.)

(ii)

13,25,000 9,80,000 22,65,000 24,00,000 69,70,000

Less: Fixed Cost

53,76,000

Profit (Rs.)

15,94,000

Profit Statement for recommended mix

Products

Contribution per acre

Rank

A1

A2

B1

B2

5300

4900

7550

9600

2000/40
= 50

1800/45
= 40

50

40

Minimum
Sales
Requirement in acres
Recommended Mix (in
Acres)
Total
(Rs.)

(iii)

400

Total

510

Contribution 21,20,000 2,45,000 3,02,000 48,96,000 75,63,000

Less: Fixed Cost

53,76,000

Profit

21,87,000

Most profitable crop: Production should be concentrated on B2 which gives highest

contribution per acres Rs.9,600.
Overall contribution if complete land is used for B2 (1,000 9,600)

= Rs.96,00,000

Less : Fixed Cost

= Rs.53,76,000

Profit:

= Rs.42,24,000

Break even point in acres for B2 = 5376000 9600 = 560 acres

Break even point in sales value = 560 (270 60) = Rs.90, 72,000
Question 23
LMV Limited manufactures product Z in departments A and B which also manufacture
other products using same plant and machinery. The information of product Z is as
follows:

3.50

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

Items

Department A (Rs.)

Department B (Rs.)

Direct material per unit

30

25

Direct labour per unit (Rs.10 per hour)

30

40

Fixed

8 per hour

4 per hour

Variable

6 per hour

3 per hour

25 lakhs

15 lakhs

Overhead rates:

Value of Plant and Machinery

Overheads are recovered on the basis of direct labour hours. Variable selling and
distribution overheads relating to product Z are amounting to Rs.30, 000 per month. The
product requires a working capital of Rs.4, 00,000 at the target volume of 1,500 units per
month occupying 30 per cent of practical capacity.
You are required:
(i)

To calculate the price of product Z to yield a contribution to cover 21 percent rate of

return on investment.

(ii)

Set the minimum selling price of the product if (1) the product is well established in
the market; (2) the product is first time launched in the market.

Answer
(i)

Statement showing price of Product Z

Direct Material

Deptt. A

30

Deptt. B

25

Deptt. A

30

Deptt. B

40

Deptt. A 36

18

Deptt B 43

12

30

Variable selling and distribution overhead 30,000/1,500

20

Direct Labour
Variable overhead

Total Variable Cost per unit

55
70

175

Total hours required for a target of 1,500 units of product Z

Deptt. A1500 3

4500 hours

Deptt. B1500 4

6000 hours
10500 hours

3.51

The Institute of Chartered Accountants of India

Advanced Management Accounting

10500 hours represent 30% capacity

So total capacity per month 10500 / 0.30 = 35000 hours.
Yearly capacity is 35000 12 = 420000 hours.
Fixed capital employed in both department

= 40.00 Lakhs

(25 lakhs + 15 Lakhs)

Expected return

= 0.21 40,00,000

= 840000

Contribution per hour

= 840000 / 4200000

= 2.00 per hour

Working Capital

= 0.21 400000

= 84000

Contribution per unit 84000 / 18000 unit

Total contribution required

= 4.67 per unit

Rs.

To cover fixed cost 3 hours of A and 4 of B = 7 2

To working capital

= 14.00
= 4.67
18.67

Fixed charges recovery is based on usage. Full capacity is not being used by
product Z and departments are also producing other products using same plant and
machinery. Price of Product = Variable cost + contribution required = 175 + 18.67 =
193.67 per unit.
(ii)

Price of product when product is well established in market:

Variable Cost

175

Fixed Cost (24 + 16)

40

Total price

215

The product is first time launched in the market, and then variable cost Rs.175 should
form the basis for price fixation.

3.52

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

EXERCISE
Question 1
AB Ltd. Manufacture foam, carpets and upholstery in its there divisions. Its operating
statement for 1995-96 showing the performance of these divisions drawn for the use of
management is reproduced below:
(Rupees in 000)
Manufacturing Divisions

Total

Foam

Carpets

Upholstery

1,600 (A)

1,200

1,200

4,000

1,200

700

680

2,580

100

20

120

1,200

800

700

2,700

Gross Profit

400

400

500

1,300

Expenses: Administration

134

116

172

422

Selling

202

210

232

644

336

326

404

(B) 1,066

Net Income

64

74

96

234

Divisions Ranking

3 rd

2 nd

1 st

Sales revenue
Manufacturing Costs Variable
Fixed (Traceable)

(A)

Sales include foam transferred to the Upholstery division at its manufacturing cost
Rs.2,00,000.

(B)

Common expenses of Rs.1,30,000 and Rs.1,00,000 on account of administration

and selling respectively stand apportioned to these divisions at 10% of Gross Profit
in case of administration and 2.5 % of Sales in case of selling expense. Rest of
Rs.8,36,000 of the expense are traceable to respective divisions.
The manager of the foam division is not satisfied with the above approach of
presenting operating performance. In his opinion his division is best among all the
divisions. He requests the management for preparation of revised operating
statement using contribution approach and showing internal transfer at market
price.
You are required to:
(a)

Draw the revised operating Statement using contribution approach and

pricing the internal transfer at market price.
3.53

The Institute of Chartered Accountants of India

Advanced Management Accounting

(b)

Compute relevant rations to show comparative profitability of these division

and rank them in the light of your answer at (a) above. Further, other your
comments on the contention of the manager of foam division.

(c)

State why the contribution approach and pricing of internal transfer at market
price are more appropriate in realistic assessment of the performance of
various divisions.

Answer

(Rs.000)
Divisions

Foam

Carpets Upholstery

Total

(a) Contribution:

480

500

440

1,420

(b) Fixed Cost

256

356

344

956

(c) Net Income of the company

234

Question 2
K. Ltd. Manufactures and sells a range of sport goods. Management is considering a
proposal for an advertising campaign, which would cost the company Rs.3,00,000. The
marketing department has put forward the following two alternative sales budgets for the
following year.
Product (000)
A

Budget 1 Without Advertising

216

336

312

180

Budget 2 With Advertising

240

372

342

198

Selling prices and variable production costs are budgeted as follow:

Product (Rs. Per unit)
A

11.94

14.34

27.54

23.94

Direct Material

5.04

6.60

15.24

12.48

Direct Labour

2.04

2.04

3.36

3.18

Variable overheads

0.72

0.72

1.20

1.08

Selling prices
Variable Production Costs:

3.54

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

Other Data:
(1)

The variable overheads are absorbed on a machine hour basis at a rate of Rs.1.20
per machine hour.

(2)

Fixed overheads total Rs.30,84,000 per annum.

(3)

Production capacity during the budget period 8,15,000 machine hours.

(4)

Products A and C could be bought in at Rs.10.68 per unit and Rs.24 per unit
respectively.

Required:
(i)

Determine whether investment in the advertising campaign would be worthwhile

and how production facilities would be best utilised.

(ii)

Explain the assumptions and reasoning behind your advise.

Answer
Statement of production facilities utilisation
Product

Machine hours utilised

1,44,000

2,23,200

2,69,600

1,78,000

Total

8,15,000

Question 3
You have been approached by a friend who is seeking your advice as to whether he
should give up his job as an engineer, with a current salary of Rs.14,800 per month and
go into business on his own, assembling and selling a component which he has invented.
He can procure the parts required to manufacture the component from a supplier.
It is very difficult to forecast the sales potential of the component, but after some
research, your friend has estimated the sales as follows:
(i)

Between 600 to 900 components per month at a selling price of Rs.250 per
component.

(ii)

Between 901 to 1,250 components per month at a selling price of Rs.220

component for the entire lot.

3.55

The Institute of Chartered Accountants of India

Advanced Management Accounting

The cost of the parts required would be Rs.140 for each completed component. However
if more than 1,000 components are produced in each month, a discount of 5% would be
received from the supplier of parts on all purchases.
Assembly costs would be Rs.60,000 per month upto 750 components. Beyond this level of
activity assembly costs would increase to Rs.70,000 per month.
Your friend has already spent Rs.30,000 on development, which he would write-off over
the first five years of the venture.
Required:
(i)

Calculate for each of the possible sales levels at which your friend could expect to
benefit by going into the venture on his own.

(ii)

Calculate the break-even point of the venture for each of the selling price.

(iii)

Advise your friend as to the viability of the venture.

Answer

It is not worthwhile to sell between 900 and 1,000 units when no discount is available.
Also, it is worthwhile selling at Rs.220 if sales units are in excess of 1,000 units and a
discount of 5% is available on the purchase of all components parts.
Profit on the sale of 1,250 units = 1,250 units Rs.87 Rs.84,800 = Rs.23,950
Question 4
SWEET DREAMS LTD. Manufactures and markets three products A, Band C in the State
of Haryana and Rajasthan. At the end of first half of 1996-97 the following absorption
based profit statement has been drawn by the accountant:
(Rs. in 000)
Haryana

Rajasthan

Total

Sales

3,000

900

3,900

Manufacturing Costs of Sales

2,331

699

3,030

Gross Profit

699

201

870

Administration Expenses (A)

120

36

156

Selling Expenses (B)

184

169

353

Total Expenses

304

205

509

Net Profit

365

(-) 4

361

3.56

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

(A)

The expenses are constant and common to both the States. They stand allocated
on the basis of Sales.

(B)

The expenses are semi-fixed but specifically relate to the respective State.
The management is worried to note that the decision taken to market the products
in Rajasthan to utilise idle capacity has proved wrong and wish to cover only
Haryana State. The incharge marketing division is not satisfied with the above way
of profit presentation. He is of the firm opinion that sales effected in the State of
Rajasthan is contributing profits. For the next half year he expects no increase in
demand in Haryana while for Rajasthan he anticipates to sell B or C more by 50%
of existing sales. This will utilise the idle capacity in full.
The product-wise relevant details for the first half of 1996-97 are:
A

Haryana

1,200

900

900

Rajasthan

300

300

300

Manufacturing

40

35

30

Selling

570

470

610

Sales (in Rs.000):

Variable Costs (as a % on sales) :

Specific fixed manufacturing expenses

(in Rs.000)
You are required to:
(a)

Prepare s State-wise profit statement for the first half of 1996-97 using
contribution approach. Also offer your views on the contention of the
management and opinion expressed by incharge marketing division.

(b)

Prepare a product wise profit statement for the same period using
contribution approach.

(c)

Submit your well thought out recommendation as to which product should be

produced to utilise idle capacity.

Answer

P/V ratio (Contribution/Sales) 100

3.57

The Institute of Chartered Accountants of India

Total

57%

63%

68%

62.23%

Advanced Management Accounting

Recommendation for utilising idle capacity:

A review of the above P/V ratios shows that the increase of output of product C in
Rajasthan is the best. The increase of production after utilising the idle capacity in
Rajasthan to the extent of Rs.1,50,000 (i.e. 50% of Rs.3,00,000) would increase the
contribution of the company in the state of Rajasthan by Rs.1,02,000 (68%
Rs.1,50,000).
Question 5
The relevant data of X Ltd. For its three products A, B and C are as under:
A

Direct Material (Rs./Unit)

260

300

250

Direct Labour (Rs./Unit)

130

270

260

Variable Overheads (Rs./Unit)

110

230

180

Selling Price (Rs./Unit)

860

1040

930

12

Machine Hours Required (per Unit)

The estimated fixed overheads at four different levels of 3,600; 6,000; 8,400 and 10,800
machine hours are Rs.1,00,000; Rs.1,50,000; Rs.2,20,000 and Rs.3,00,000 respectively.
The maximum demand of A, B and C in a cost period are 500; 300 and 1,800 units
respectively.
You are required to find out (i) the most profitable product-mix at each level and (ii) the
level of activity where the profit would be maximum.
Answer
Product

Maximum demand in units

500

300

1,800

Recommendation:
At 8,400 machine hour level of capacity the company would earn maximum profit i.e.
Rs.3,20,000.
* Refer to working note.
Question 6
Navbharat Commerce College, Bombay has six sections of B.Com, and two section of
M.Com with 40 and 30 students per section respectively. The college plans one-day
pleasure trip around the city for the students once in an academic session during winter
break to visit park Zoo, planetarium and aquarium.
3.58

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

A transporter used to provide the required number of buses at a flat rate of Rs.700 per bus
for the aforesaid purpose. In addition, a special permit fee of Rs.50 per bus is required to
the deposited with city Municipal Corporation. Each bus is 52 seater. Two seats are
reserved for teachers who accompany in each bus. Each teacher is paid daily allowance of
Rs.100 for the day. No other costs in respect of teachers are relevant to the trip.
The approved caterers of the college supply breakfast, lunch and afternoon tea
respectively at Rs.7; Rs.30 and Rs.3 per student.
No entrance fee is charged at the park. Entrance fees come to Rs.5 per the zoo and the
aquarium. As regards planetarium the authorities charge block entrance fee as under for
group of students of educational institutions depending upon the number of students in a
group:
No. of students in a Group

Block Entrance Fee

Upto 100

200

101-200

300

201 & above

450

Cost of prizes to be awarded to the winner in different games being arranged in the park
depend upon the strength of students in a trip. Cost of prizes to be distributed are:
No. of students in a Trip

Cost of Prizes

Rs.
Upto 50

900

51-125

1,050

126-150

1,200

151-200

1,300

201-250

1,400

251 & above

1,500

To meet the above costs the college collects Rs.65 from each student who wish to join the
trip. The college release subsidy of Rs.10 per student in the trip towards it.
You are required to:
(a)

Prepare a tabulated statement showing total costs at eth levels of 60, 120, 180,
240 and 300 students indicating each item of cost.

(b)

Compute average cost per student at each of the above levels.

3.59

The Institute of Chartered Accountants of India

Advanced Management Accounting

(c)

Calculate the number of students to break even for the trip as the college suffered
loss during the previous year despite 72% of the students having joined the trip.

Answer
(a)
No. of students

Total costs

60

120

180

240

300

5,850

9,600

13,500

17,400

21,150

(b)

No. of students:

60

120

180

240

300

Average cost (Rs.)

97.50

80

75

72.50

70.50

(c)

No. of students in
the trip

51-100

101-125

126-150

151-200

201-250

251-300

No. of students to
break even:

105

140

145

180

220

255

Question 7
A Company produces three products from an imported material. The Cost Structure per
unit of the products are as under:
Product
A

Rs.

Rs.

Rs.

Sales Value

200

300

250

Direct Material

50

80

60

Direct Wages Rs.6 per hour

60

120

108

Variable Overheads

30

60

54

Out of Direct Material 80% is of the imported material @ Rs.10 per kg.
Prepare a statement showing comparative Profitability of the three products under the
following scenarios.
(i)

Imported Material is in restricted supply.

(ii)

Production Capacity is limiting factor.

3.60

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

(iii)

When maximum sales potential of products A and B are 1,000 units each and that
of product C is 500 units for specific requirement, availability of imported material
is restricted 10,000 kgs per month, how the profit could be maximised?

Answer
Products

Contribution per kg (Rs.)

No. of units

15

6.25

5.83

4,000

3,600

2,400

1,000

562

500

Question 8
Elegant Hotel has a capacity of 100 single rooms and 20 double rooms. It has a sports
centre with a swimming pool, which is also used by persons other than residents of the
hotel. The hotel has a shopping arcade at the basement and a specialty restaurant at the
roof top.
The following information is available:
(i)

Average occupancy: 75% for 365 days of the year.

(ii)

Current costs are:

Single Room
(iii)

Variable cost

Fixed cost

Rs./per day

Rs./per day

400

200

Double Room
500
250
Average sales per day of restaurant Rs.1,00,000; contribution is at 30%. Fixed cost
Rs.10,00,000.

(iv)

The sports centre/swimming pool is likely to be used by 50 non-residents daily;

average contribution per day per non-resident is estimated at Rs.50; fixed cost is
Rs.5,00,000 per annum.

(v)

Average contribution per month from the shopping arcade is Rs.50,000; fixed cost
is Rs.6,00,000 per annum.

You are required to find out:

(a)

Rent chargeable for singe and double room per day, so that there is a margin of
safety of 20% on hire of rooms and that the rent for a double room should be kept
at 120% of a single room.

3.61

The Institute of Chartered Accountants of India

Advanced Management Accounting

(b)

Evaluate the profitability of restaurant, sports centre and shopping arcade

separately.

Answer

(b)

Rent per day of single room (in Rs.)

756 (approx.)

Rent per day of double room (in Rs.)

907 (approx.)

Profitability of restaurant:

Rs. 99,50,000

Profitability of sports centre:

Rs.
Contribution of sports centre per day:

4,12,500

Profitability of shopping arcade:

Nil

Question 9
ACE Office Supplies Corporation retails two products a standard and a deluxe version of
a designer ball point pen. The budgeted income statement is as under :
Standard

Deluxe

Total

1,50,000

50,000

2,00,000

Rs.

Rs.

Rs.

@ Rs.20 per unit

30,00,000

At Rs.30 per unit

15,00,000

45,00,000

At Rs.14 per unit

21,00,000

At Rs.18 per unit

9,00,000

30,00,000

9,00,000

6,00,000

15,00,000

Sales (in units)

Sales:

Variable Costs:

Contribution
Fixed Costs

12,00,000

Profit

3,00,000

Required:
(i)

Calculate the breakeven point in units assuming that the planned sales mix is
maintained.

(ii)

Calculate the breakeven point in units:

(a)

if only standard version is sold, and

3.62

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

(b)
(iii)

if only deluxe version is sold.

Suppose 2,00,000 units are sold, but only 20,000 units are of deluxe quality.
Calculate the profit. Calculate the breakeven points if these relationships persist in
the next accounting period. Compare your answer with the original plan and the
answer in requirement (b). what is your major finding?

Answer

(a)

Break even point in units (if only Standard version is sold)

= 2,00,000 units

(b)

Break even point in units (if only Deluxe version is sold)

= 1,00,000 units

Major findings on comparing budgeted sales plan and original sales plan
Sales mix ratio of Standard
and Deluxe

3:1

Unites to be sold at
breakdown

Standard

Deluxe

1,20,000

40,000

Total units
sold

1,60,000

Profit on the sale

of 2,00,000 unit

3,00,000

Question 10
The details of the output presently available from a manufacturing department of Hitech
Industries Ltd. Are as follows:
Average output per week 48,000 units from 160 employees
Saleable value of output Rs.6,00,000
Contribution made by the output towards fixed
Expenses and profit Rs.2,40,000
The Board of Directors plans to introduce more automation in the department at a capital
cost of Rs.1,60,000. The effect of this will be to reduce the number of employees to 120,
but to increase the output per individual employee by 60%. To provide the necessary
incentive to achieve the increased output the Board intends to offer a 1% increase in the
piecework rate of one rupee per article for every 2% increase in average individual output
achieved. To sell the increased output, it will be necessary to decrease the selling price
by 4%.
Required:
Calculate the extra weekly contribution resulting from the proposed change and evaluate,
for the Boards information, the worth of the project.
3.63

The Institute of Chartered Accountants of India

Advanced Management Accounting

Answer

(a)

Proposed piece work rate

= Rs.130 per unit

(b)

Proposed sale price per unit

= Rs.12

(c)

Present marginal cost (excluding wages) per unit.

= Rs.6.50 p.u.

Question 11
Satish Enterprises are leading exporters of Kids Toys. J Ltd. of U.S.A. have approached
Satish Enterprises for Exporting a special toy named Jumping Monkey. The order will be
valid for next three years at 3,000 toys per month. The export price of the toy will be 84.
Cost data per toy is as follows:
Rs.
Materials

60

Labour

25

Variable overheads

20

Primary packing of the toy

15
The toys will be packed in lots of 50 each. For this purpose a special box, which will
contain the 50 toys will have to be purchased, cost being Rs.400 per box.
Satish Enterprises will also have to import a special machine for making the toys. The
cost of the machine is Rs.24,00,000 and duty thereon will be at 12%. The machine will
have an effective life of 3 years and depreciation is to be charged on straight-line method.
Apart from depreciation, annual fixed overheads is estimated at Rs.4,00,000 for the first
year with 6% increase in the second year. Fixed overheads are incurred uniformly over
the year.
Assuming the average conversion rate to be Rs.50 per $, you are required to:
(i)

Prepare a monthly and yearly profitability statements for the first year and second
year assuming the production at 3,000 today per month.

(ii)

Compute a monthly and yearly break even units in respect of the first year.

(iii)

In what contingency can there be a second break-even point for the month and for
the year as a whole?

(iv)

Have you any comments to offer on the above?

Answer
(b)

(i)

Profit Statement of M/s Satish Enterprises for first and second year on
monthly and yearly basis.
3.64

The Institute of Chartered Accountants of India

CVP Analysis & Decision Making

First year

Profit

Second Year

Monthly Rs.

Yearly Rs.

Monthly Rs.

Yearly Rs.

108

1,296

106

1,272

Question 12
Cost is not the only criterion for deciding in favour of shut down Briefly explain.
Answer

Refer to Chapter 3: Paragraph 3.5

Question 13
M Companys Central Services Department is evaluating new coping machines to replace
the firms current copier, which is worn out. The analysis of alternative machines has been
narrowed to three and the estimated costs of operating them are shown below:
Cost per 100 copies
Machine A

Machine B

Machine C

Rs.

Rs.

Rs.

Materials Cost

60

40

20

Labour Cost

80

30

20

30,000

58,000

1,00,000

Annual Lease Cost

Required:
(i)

Compute the cost indifference points for the three alternatives.

(ii)

What do the cost indifference points suggest as a course of action in this regard?

(iii)

If the management expects to need 87,000 copies next year which copier would be
most economical?

Answer

Cost indifference point for two machines viz.,

(a)

A&B

= 400 Nos. (Multiple of 100 copies)

(b)

B&C

=1,400 Nos. (Multiple of 100 copies)

(c)

C&A

= 700 Nos. (Multiple of 100 copies)

(d)

Hence from the above we conclude as follows:

From 0 to 400 Nos. (Multiple of 100 copies) use Machine A

3.65

The Institute of Chartered Accountants of India

Advanced Management Accounting

From 400 to 1,400 Nos. (Multiple of 100 copies) use Machine B

Above 1,400 Nos. (Multiple of 100 copies) use Machine C.
(e)

machine B would be most economical.

Question 14
Somesh of Agra presently operates its plant at 80% of the normal capacity to manufacture
a product only to meet the demand of Government of Tamil Nadu under a rate contract.
He supplies the product for Rs.4,00,000 and earns a profit margin of 20% on sales
realisations Direct cost per unit is constant.
The indirect costs as per his budget projections are:
Indirect costs

20,000 units (80%

capacity) Rs.

22,500 units (90%

capacity) Rs.

25,000 units (100%

capacity) Rs.

Variable

80,000

90,000

1,00,000

Semi-variable

40,000

42,500

45,000

Fixed

80,000

80,000

80,000

He has received an export order for the product equal to 20% of its present operations.
Additional packing charges on this order will be Rs.1,000.
Arrive at the price to be quoted for the export order to give him a profit margin of 10% on
the export price.
Answer

Price to be quoted

Rs. 50,000

Export price per unit

Rs. 12.50

Question 15
ACE Ltd. has an inventory of 5,000 units of a product left over from last years production.
This model is no longer in demand. It is possible to sell these at reduced prices through
the normal distribution channels. The other alternative is to ask someone to take them on
as is where is basis. The latter alternative will cost the company Rs.5,000.
The company produced 2,40,000 units of the product, last year, when the unit costs were
as under:
Manufacturing Costs:
Variable

6.00

Fixed

1.00
3.66

The Institute of Chartered Accountants of India

7.00

CVP Analysis & Decision Making

Selling & Distribution Cost:
Variable

3.00

Fixed

1.50

4.50

Total Cost

11.50

Selling Price per Unit

14.00

Required:
Should the company scrap the items or sell them at a reduced price? If you suggest the
latter, what minimum price would you recommend?
Answer

If the company can get anything more than Rs.2/- per unit, then it is worthwhile to sell the
stock of 5,000 units and earn an additional contribution.

3.67

The Institute of Chartered Accountants of India