Revision of Breakeven Analysis Marginal Costing Absorption Costing

1. Marginal costing
Absorption Costing
and the
Break-even Point
INTRODUCTION TO MANAGEMENT ACCOUNTING
WEEK 5
1

2. RECAP
• Fixed cost
• Variable cost
• Variable cost per unit
• Under/over - absorption
2

3. Cost-Volume-Profit Analysis (CVP)
/
Breakeven analysis
PART A
3

4. Contribution
• Contribution is an important measure in marginal costing,
• It is calculated as the difference between sales (value) and
marginal (or variable) cost.
• Contribution is:
• 'sales value – variable cost of sales'
- CIMA Official Terminology
• The term 'contribution' is really short for:
• 'contribution towards covering fixed overheads and making a
profit’.
• Can be expressed in per unit or in total
• It is the surplus after variable costs have been covered
4

5. Contribution
• EXAMPLE
If Sales value is £12,000,
and the Variable cost is £5,600.
What is the Contribution ?
£
Sales 12,000
less Variable cost (5,600)
Contribution 6,400
5

6. Contribution
•Central role in Marginal costing theory
•Excludes fixed costs, hence helpful for
decision-making
•Fundamental to CVP analysis
•Change in contribution = Change in profit
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7. CVP Analysis / Breakeven analysis
•Contribution to sales (C/S) ratio
•Breakeven point (BEP)
•Target profit
•Margin of safety
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8. Contribution to Sales
(C/S) ratio
FORMULA
C/S ratio = Contribution x 100%
Sales
A higher Contribution to Sales ratio means that
Contribution grows more quickly as Sales levels
increase.
8

9. Contribution to Sales (C/S) ratio
Example:
A product has an operating statement for the Sales of 1,000
units.
You are required to calculate the:
Contribution to sales ratio
9
£
Sales 10,000
Variable cost 6,000
Fixed cost 2,500

10. Contribution to Sales (C/S) ratio
Contribution = Sales – Variable cost
10,000 – 6,000 = 4,000
C/S ratio = Contribution x 100%
Sales
C/S ratio = 4,000 x 100%
10,000
= 40%
40% of Sales remain as Contribution
10

11. Break-even Point (BEP)
The breakeven point is the 'level of activity at
which there is neither profit nor loss'.
- CIMA Official Terminology
It follows that, to break even, the amount of
Contribution must exactly match (equal) the
amount of Fixed costs.
Can be calculated in units or as Sales revenue
Can be determined arithmetically or graphically
11

12. Breakeven point (BEP)
Calculation/arithmetic method:
FORMULA
BEP (in units): Fixed costs
Contribution per unit
BEP (Revenue): Fixed costs
C/S ratio
12

13. Break-even Point (BEP)
Example:
A company manufactures a product which has:
- a Variable cost of £8 per unit and
- a Selling price of £13 per unit.
Fixed costs are £25,000.
Calculate the breakeven point in units and revenue.
13

14. Breakeven point (BEP)
Solution:
A company manufactures a product which has a variable cost of
£8 per unit and a selling price of £13 per unit.
Fixed costs are £25,000.
Calculate break-even in units and revenue.
Contribution calculation = £13 – 8 (SP – VC) = 5
BEP (units): 25,000 = 5,000 units
5
BEP (revenue): 25,000 = £65,000
5/13
14

15. Target profit
The target profit is achieved when sales revenue equals
variable costs plus fixed costs plus target profit
(S = V + F + Pr)
In other words, Sales must cover all costs and leave the
required profit.
FORMULA:
Target profit (units): Fixed cost + Target profit
Contribution per unit
Target profit (revenue): Fixed cost + Target profit
C/S ratio
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16. Target profit
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Example:
A company manufactures a product which has a
variable cost of £8 per unit and
a selling price of £13 per unit.
Fixed costs are £25,000.
Calculate how many units and the necessary sales
required if the target profit is £10,000

17. Target profit
17
SOLUTION:
A company manufactures a product which has a variable cost of £8
per unit and a selling price of £13 per unit.
Fixed costs are £25,000.
Calculate how many units and the necessary sales required if the
target profit is £10,000
Contribution calculation = 13 – 8 =(SP – VC) = 5
Sales level (in units) to achieve target profit:
£25,000 + £10,000 = 7,000 units
£5
Sales level (in Revenue) to achieve Target profit:
25,000 + 10,000 = £91,000
5 / 13

18. Margin of safety
• Represents a comparison between the budgeted/expected
level of Sales and the Break-even point of the organization
• (Budgeted sales level – BEP)
• Margin of safety is a measure of the amount by which the
Sales may decrease before a company suffers a loss.
• This can be expressed as a number of units, the sales value or
as a percentage of sales
18

19. Margin of safety
Example:
A company manufactures 4,000 units of a product,
which has a variable cost of £15 per unit and a selling
price of £23 per unit.
Fixed costs are £25,000.
Determine the Margin of safety
19

20. Margin of safety
Contribution = £23 - £15 = £8 (SP – VC)
BEP (units): 25,000 = 3,125 units
8
Margin of safety = 4000 – 3125 = 875 units
OR: £23 x 875 units =
£20,125
OR:
As a percentage: 875 units x 100 = 21.87%
4000 units
20

21. 21
Marginal Costing /
use of Contribution
- v -
Absorption Costing
PART B
21

22. Marginal Costing
Alternative approach to treating overheads
Differs from Absorption costing and Activity-based costing.
CIMA Official Terminology defines Absorption costing as:
‘A method of costing that, in addition to direct costs, assigns
all, or a proportion of, production overhead costs to cost
units by means of overhead absorption rates’
Marginal (or variable) costing:
'assigns only variable costs to cost units while fixed costs are
written off as period costs in full against the aggregate
contribution’ - CIMA Official Terminology
22

23. Marginal Costing
Principal costing technique used in short-term decision
making.
Key reason for this is that the marginal costing approach
allows management's attention to be focussed on the
changes which result from the decision under
consideration:
•Determining costs of products or services
•Calculation of a break-even point
•What-if analysis
23

24. Marginal costing (variable)
vs. Absorption (full) costing
STATEMENTS
24

25. Profit/loss statement Marginal costing
£ £
Sales X
Less Variable Cost of Sales:
Opening stock X
add Variable cost of Production X
less Closing stock (X)
(X)
X
Less Other Variable costs (X)
Contribution X
Less Fixed costs (X)
Profit/loss X
25

26. Marginal costing
Revenue statement
Example
If 400 skateboards are manufactured and sold in the period for £20
each,
determine the Profit using a Marginal costing format.
26
Total Cost =
(£)
Fixed Cost (£) + Variable
Cost (£)
Direct labour 200 200
Direct material 2,100 - 2,100
Fixed Overhead
Variable Overhead
3,340
60
3,340
60
5,700 3,340 2,360

27. Less Unit Variable costs
Total contribution 5,640 (14.10 x 400)
Less Fixed costs (3,340)
Profit 2,300
Unit VC remains constant
£
Unit Sales 20.00
Less Unit Variable
costs (5.90) (2360 / 400)
Unit contribution 14.10
£
Sales 8,000 (400 x £20)
Less Variable
costs
(2,360)
Contribution 5,640
Less Fixed
costs
(3,340)
Profit 2,300
Marginal costing
Revenue statement
Solution
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28. Profit/loss statement Absorption costing
£ £
Sales X
Less Cost of sales:
Opening stock X
Variable Cost of Production X
Fixed overhead absorbed X
Less Closing stock (X)
(X)
X
(Under)/over - absorption (X)/X
Gross Profit X
Less Non- production costs (X)
Profit/loss X
28