Final Project of Cost Accounting
Submitted By:
Maryam Fayyaz 10132
Haneen Agha 10128
Submitted To:
Sir. Mubasshar
1. BREAKEVEN POINT:
The break-even point in any business is that point at which the volume of sales or
revenues exactly equals total expenses -- the point at which there is neither a
profit nor loss -- under varying levels of activity. The break-even point tells the
manager what level of output or activity is required before the firm can make a
profit; reflects the relationship between costs, volume and profits.
A business can work out how what volume of sales it needs to achieve to cover its
costs. This is known as the break even point. The key to break even is to work out
the contribution made from the sale of each unit. The amount of money each unit
sold contributes to pay for the fixed and indirect costs of the business.
Contribution = selling price less variable cost per unit
Examples:
A product sells for £15 and has variable costs per unit of £11. Each unit sale
therefore makes a contribution of £4 towards the fixed costs of the business. If
the business had fixed costs of £20,000, then it would need to sell 5,000 units (£4
x 5,000 = £20,000 contribution) in order to break even.
The margin of safety is the difference between the number of units of planned or
actual sales and the number of units of sales at break even point.
If, using the example above, planned sales were thought to be 6,000 units, then
the margin of safety would be 6,000 units – break even 5,000 units = 1,000 units.
The business would be able to sell 1,000 less than planned before they were in
danger of making a loss.
A break-even chart plots the sales revenue, different costs and helps identify the
break even point and margin of safety.
Drawing break-even charts
To draw a chart the following steps need to be followed:
1. Label the vertical axis “sales and costs in pounds”.
2. Label the horizontal axis “sales/production (units)”.
3. On another piece of paper sketch the scales that you want to use given the
data, then use this plan on the chart.
4. Plot any two points from the sales revenue data for the sales revenue line and
then draw a straight line for sales revenue (assumes that the price per unit does
not change) – if the information is not given for sales revenue, then work out two
points, e.g. for 1000 units sold and 1500 units sold. The start of the line should be
through the origin (where the axes meet).
5. Draw a horizontal line for total fixed costs starting at the point on the vertical
axis at the level of costs.
6. At the same starting point it is possible to draw the total costs line. Total costs
are fixed costs plus variable costs. Work out what the total costs are for say 1000
units and 1500 units. Then draw the straight line starting at the same point as the
fixed costs started and then through the two plotted points.
7. Where the sales revenue crosses the total costs line is the break even point.
Read off the units of sales to give the break even level of sales.
8. The gap between the total costs line and sales revenue line after the break
even point represents the level of profit.
It is important for a business to understand its break-even point because the
contribution from every unit sold above the break-even point adds to profit. The
break-even point provides a focus for the business, but also helps it work out
whether the forecast sales will be enough to produce a profit and whether further
investment in the product is worthwhile.
The main limitations of break-even charts are:
Do not take into account possible changes in costs over the time period.
Do not allow for changes in the selling price.
Analysis only as good as the quality of information.
Do not allow for changes in market conditions in the time period – e.g.
entry of new competitor.
Contribution Margin
Contribution margin is the amount remaining from sales revenue after variable
expenses have been deducted. Thus it is the amount available to cover fixed
expenses and then to provide profits for the period. Contribution margin is first
used to cover the fixed expenses and then whatever remains go towards profits. If
the contribution margin is not sufficient to cover the fixed expenses, then a loss
occurs for the period. This concept is explained in the following equations:
[Sales revenue − Variable cost* = Contribution Margin]
*Both Manufacturing and Non Manufacturing
[Contribution margin − Fixed cost* = Net operating Income or Loss]
*Both Manufacturing and Non Manufacturing
The phrase "contribution margin" can also refer to a per unit measure of a
product's gross operating margin, calculated simply as the product's price minus
its total variable costs.
Consider a situation in which a business manager determines that a particular product has a 35% contribution margin, which is below that of other products in the company's product line. This figure can then be used to determine whether variable costs for that product can be reduced, or if the price of the end product could be increased.
If these options are unattractive, the manager may decide to drop the unprofitable product in order to produce an alternate product with a higher contribution margin.
Variable cost:
Definitions
1. The costs of production that vary directly in proportion to the number of
units produced. Variable costs often include labor expenses and raw
material costs, because labor and raw material usually must be increased to
increase output. Firms for which variable costs represent a high proportion
of total costs are usually less likely to experience large fluctuations in
earnings, because changes in sales and revenues are accompanied by
nearly equal changes in costs
2. A cost of labor, material or overhead that changes according
to the change in the volume of production units. Combined with fixed
costs, variable costs make up the total cost of production. While the total
variable cost changes with increased production, the
total fixed cost stays the same.
Example of variable cost:
A good example of a variable cost is fuel for an airline. This cost changes with the
number of flights and how long the trips are.
Fixed cost:
1. A cost that remains unchanged even with variations in output. An airline
with 20 airplanes has the fixed costs of depreciation and interest (if the
planes are partially financed with debt), regardless of the number of times
the planes fly or the number of seats filled on each flight. Firms with high
fixed costs tend to engage in price wars and cutthroat competition because
extra revenues incur little extra expense. These firms tend to experience
wide swings in profits.
2. An expense that does not change from one time period to other.
3. Fixed costs are those that do not change with the level of
sales. If sales increase or decrease but nothing else changes
then fixed costs remain the same.
Examples of fixed cost:
Common examples of fixed costs include rents, salaries of permanent
employees and depreciation.
Margin of Safety:
Margin of safety (MOS) is the excess of budgeted or actual sales over the break
even volume of sales. It stats the amount by which sales can drop before losses
begin to be incurred. The higher the margin of safety, the lower the risk of not
breaking even.
Formula of Margin of Safety :
The formula or equation for the calculation of margin of safety is as follows:
[Margin of Safety = Total budgeted or actual sales − Break even sales]
The margin of safety can also be expressed in percentage form. This percentage is
obtained by dividing the margin of safety in dollar terms by total sales. Following
equation is used for this purpose.
[Margin of Safety = Margin of safety in dollars / Total budgeted or actual sales]
Example of margin of safety:
Sales(400 units @ $250) $100,000
Break even sales $87,500
Calculate margin of safety
Calculation:
Sales(400units @$250) $100,000
Break even sales $ 87,500
---------
Margin of safety in dollars $ 12,500
=======
Margin of safety as a percentage of sales:
12,500 / 100,000
= 12.5%
It means that at the current level of sales and with the company's current prices
and cost structure, a reduction in sales of $12,500, or 12.5%, would result in just
breaking even. In a single product firm, the margin of safety can also be expressed
in terms of the number of units sold by dividing the margin of safety in dollars by
the selling price per unit. In this case, the margin of safety is 50 units ($12,500 ÷ $
250 units = 50 units).
Graphical presentation of break even point:
The Break-Even point in sales volume is defined as:
“That point in sales volume, or revenue, where direct costs have been recovered,
fixed overhead expenses has been absorbed and where profit begins".
We can relate Break-Even Point to the information in our financial statements,
particularly the Income Statement. The Income Statement should be organized
into the following sections:
1. Revenue
the sum of all sales and other income net of returns and sales commissions.
2. Cost of Sales (Cost of Goods Sold)
The cost of purchases that are resold (merchandise) and/or raw materials plus the
costs of labor to manufacture the product or convert it or install it or deliver it or
construct it on site. These costs are also called direct or variable costs.
3. General & Administrative Costs (Overhead)
These are all the costs not directly, or easily, related to sales volume such as
Advertising, Bank Charges, Computer Expenses, Insurance, Office Wages &
Salaries, Officer’s Compensation, Telephone, Utilities, Depreciation, Interest,
Taxes etc. These costs are also called indirect or fixed costs.
4. 1 minus 2 minus 3 = PROFIT.
Note: If your Income Statement is not organized in this fashion (called managerial
accounting format), you need to have a session with your accountant and
demand it be put into this format so you can manage the business better.
Once you have your financial statements and data in the right format, you can
easily calculate Break-Even using the following formula as:
Break-Even Point = FC/ (1-VC/S)
Where:
FC = Fixed Costs
VC = Variable Costs
S = Sales
Calculation of Breakeven and Marginal Safety
DATA
Actual sales 1,462,411,953 Rs
FIXED COST: Rupees
Cost of sales
Salaries wages and benefits 50,671,082
Support services 35,427,380
Management charges 18,480,000
Insurance 5,666,010
Professional charges 1,160,333
Depreciation 310,374,531
Equipment rental 2,715,745
Administrative expenses
Salaries, wages and benefits 1,877284
Rent, rates and taxes 422,400
Legal and professional charges 2,247,934
Fees and subscription 3,472,200
Management charges 5,760,000
Provision for slow moving and obsolete
Stores, spare parts, and loose tools 41,000,000
Insurance 26,244
Auditors remuneration 820,000
Depreciation 1,317,586
Auditors’ remuneration
Audit fee 400,000
Half yearly review 100,000
Taxation services 300,000
Out of pocket expenses 20,000
Distribution cost
Salaries, wages and benefits 2,572,586
Support services 126,432
Fees and subscription 267,389
Depreciation 1317586
Management charges 5760,000
Finance cost
Markup on long term financing 246,727,700
Markup on short term borrowings 52,549,045
Mark up on advances from related
Parties 47,587,263
Exchange loss – net 1,207,028
Bank charges and commissions 2,618,976
TOTAL 842,992,734
VARIABLE COST:
Cost of sales
Raw and packing material consumed 271,340,574
Fuel power 1,423,331,145
Stores, spare parts and loose tolls consumed 44,260,560
Repairs and maintenance 3,505,043
Utilities 967,570
Traveling, conveyance and subsistence 8,265,148
Communication 338,432
Printing and stationery 746,331
Other manufacturing expenses 778,485
Administrative expenses
Traveling, conveyance and subsistence 366,924
Communication 5993
Printing and stationery 149,534
Entertainment 20,499
Advertising and promotion 214,300
Miscellaneous 153,865
Distribution cost
Repairs and maintenance 63,250
Communication 77415
Freight and handling 1,416,445
Printing and stationary 170,156
Entertainment 410, 24
Miscellaneous 16543
Freight on export 115,974
TOTAL 17556,345210
SOLUTION:
BREAK EVEN (IN UNITS)
= FIXED COST/CONTRIBUTION MARGIN (per unit)
Contribution margin
= sale – variable cost
= 1,462,411,953 – 1756,345210
= (293,933,257)
Break even (in units)
= 842,992,734
- 293,933,257
= (2.868)
BREAK EVEN (IN Rs)
=FIXED COST/CONTRIBUTION MARGIN RATIO
Contribution margin ratio
= contribution margin/sale
= − 293,933,257
1,462,411,953
= (0.201)
Break even in (Rs)
=842,992,734
-0.201
= (4193, 993,701)
MARGIN OF SAFETY
= ACTUAL SALE – BREAK EVEN SALE
= 14, 62,411,953-