Cost and Management Accounting

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Cost & Management Accounting (MGT-402)
VU
LESSON# 31
BREAK EVEN ANALYSIS ­ MARGIN OF SAFETY
A company sold fans at Rs 2,000 each. Variable cost Rs. 1200 each and fixed cost Rs. 60,000.
Calculate:
a. Calculate break even sales in Rupees.
b. Break even sales in units.
c. Sales in units to earn a profit of Rs. 20,000.
Contribution to sales ratio = Contribution margin
Sales
= 800 / 2,000 = 0.4
a) Break-even sales in Rupees =
Fixed cost
C/S Ratio
= 60,000 / 0.4 = Rs. 150,000
b) Break-even sales in units =
Fixed cost
Contribution margin per unit
= 60,000 / 800 = 75 units
c) Target profit Rs 20,000
Target contribution = Target profit + Fixed cost
=
Target contribution margin
Contribution margin per unit
= 80,000 / 800 = 1,000 units
Check Break even sales
Sales 75 x 2,000
150,000
Less Variable cost (150,000 x 60%)
90,000
Contribution margin
60,000
Less Fixed cost
60,000
Profit
0
Check Target Profit
Sales 100 x 2,000
200,000
Less Variable cost (200,000 x 60%)
90,000
Contribution margin
80,000
Less Fixed cost
60,000
Profit
20,000
Margin of Safety (MOS)
The margin of safety is the difference between budgeted sales volume and break-even sales
volume; it indicates the vulnerability of a business to a fall in demand. It is often expressed as a
percentage of budgeted sales
Budgeted sales ­ Break-even sales = Margin of safety
MOS ratio =
MOS  x 100 = %
Budgeted Sales
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Cost & Management Accounting (MGT-402)
VU
PRACTICE QUESTION
Q. 1
Budgeted Income statement
Rs.
Budgeted Sales 700 units x Rs 8
5,600
Variable cost 700 units x Rs 8
4,200
Contribution margin
1,400
Fixed cost
1,000
Profit
400
Break even Sales 500 units x Rs 8
4,000
Variable cost 500 units x Rs 6
3,000
Contribution margin
1,000
Fixed cost
1,000
Profit
0
Percentage of MOS can be calculated in different ways:
·  Based on Budgeted sales
Budgeted sales ­ Break-even sales
= 5,600 ­ 4,000 = 1,600
Margin of safety x 100 = %
Budgeted sales
1,600 x 100 = 28.57%
5,600
·
Using Budget profit
Budgeted profit
x 100 = %
Budgeted contribution margin
400 x 100 = 28.57%
1,400
·
Using profit and contribution ratio
Profit to sales ratio x 100 = %
Contribution to sales
Profit to sales ratio =
400 / 5,600 x 100 = 7.14%
Contribution to sales ratio = 1,400 / 5,600 x 100 = 25%
7.14% x 100 = 28.57%
25%
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Cost & Management Accounting (MGT-402)
VU
Q. 2
Budgeted Income Statement
Rs.
Budgeted sales
10,000
Less variable cost
6,000
Contribution margin
4,000
Less Fixed cost
2,500
Profit
1,500
Calculate Margin of safety ratio?
Budgeted profit
x 100 = %
Budgeted contribution margin
1,500 / 1,000 x 100 = 37.5%
P/S Ratio x 100 = %
C/S Ratio
Profit / Sales x 100 = 1,500 / 10,000 x 100 = 15%
Contribution margin / Sales x 100 = 4,000 / 10,000 x 100 = 40%
Margin of safety ratio =
15% x 100 = 37.5%
40%
Q. 3
Sales  = Rs. 50,000
Margin of safety = 25%
Calculate break even sales?
Step I
Calculate absolute amount of MOS
MOS = 50,000 x 25% = Rs. 12,500
Step II
Calculate: Breakeven sales through the following formula:
MOS = Budgeted sales - Break even sales
Budgeted sales - MOS = Break even sales
50,000 -12,500 = 37,500
Q. 4
Sales = Rs. 50,000
MOS ratio = 25%
Budgeted profit = Rs. 2,500
a). Compute projected profit
b). Prepare Budgeted sales sheet
Budgeted sales
50,000
Less Variable cost
40,000
Contribution margin
10,000
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Cost & Management Accounting (MGT-402)
VU
Less Fixed cost
7,500
Profit
2,500
MOS ratio =
Profit
Contribution margin
=
2500
Contribution margin
0.25 contribution margin = 2,500
Contribution margin = 2,500 / 0.25
Contribution margin = Rs. 10,000
Break even sales =
Fixed cost
C/S ratio
Budgeted sales
37,500
Less variable cost
30,000
Contribution margin
7,500
Less Fixed cost
7,500
Profit
0
Q. 4
Combined Break-even sales
X
Y
Z
Rupees
Rupees
Rupees
Selling price (P.U)
2.50
4
10
Variable cost (P.U)
(1.50)
(2)
(4)
Contribution
margin
1
2
6
(P.U)
Sales Volume
80,000
30,000
15,000
Fixed cost
Rs. 1,50,000
Solution
X
Y
Z
Total
Rupees
Rupees
Rupees
Rupees
Contribution
(1 x 80,000)
(2 x 30,000)
(6 x 15,000)
2,30,000
margin
=80,000
= 60,000
= 90,000
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Cost & Management Accounting (MGT-402)
VU
Sales
(2.5 x 80,000)
(4 x 30,000)
(10 x 15,000)
4,70,000
= 2,00,000
= 1,20,000
= 1,50,000
Product wise contribution to sales ratio
X
Y
Z
Contribution
80,000 /
60,000 / 1,20,000 x 90,000 / 1,50,000 x
margin ratio
2,00,000 x 100
100
100
= 40%
= 50%
= 60%
Combined contribution to sales ratio
230,000
470,000
= 48.936 or 0.489
Break even sales = Target contribution margin
C/S ratio
=
150,000
0.48936
= 306,523
PRACTICE QUESTION
Q. 1
Victoria Company produces a single product. Last year's income statement is as follows:
Sales (29,000 units)
Rs. 1,218,000
Less: Variable costs:
812,000
Contribution margin
406,000
Less: Fixed expenses
300,000
Net income
106,000
Required:
1. Compute the break-even point in units and sales Rs.
2.  What was the margin of safety for Victoria last year?
3.  Suppose that Victoria Company is considering an investment in new technology that will
increase fixed costs by Rs. 250,000 per year but will lower variable costs to 45% of sales.
Units sold will remain unchanged. Prepare a budgeted income statement assuming that
Victoria makes this investment. What is the new break-even point in units and sales Rs,
assuming that the investment is made?
Q. 2
Crown Star Products produces two different types of lamps, a floor lamp and a desk lamp. Floor
lamps sell for Rs. 30, Desk lamps for Rs. 20, the projected income statement for the coming year
follows:
Sales
Rs. 600,000
Less: Variable costs;
400,000
Contribution margin
200,000
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Cost & Management Accounting (MGT-402)
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Less: Fixed expenses
150,000
Net income
50,000
The owner of Crown Star estimates that 60% of the sales revenues will be produced by floor lamps
with the remaining 40% by desk lamps. Floor lamps are also responsible for 60% of the variable
expenses. Of the fixed expenses, one third is common to both products, and one-half are directly
to the floor lamp product line.
Required:
1. Compute the sales revenue that must be earned for Crown Star to reach at break even.
Compute the number of floor lamps and desk lamps separately that must be sold for Crown Star
to break even.
Question No. 3
Unicorn Enterprises produces two strategy games, Mystical Wars and Magical Dragons. The
projected income for the coming year, segmented by product line, follows:
Wars
Dragons
Total
Sales
Rs. 500,000
Rs. 800,000
Rs. 1,300,000
Less: Variable costs
230,000
460,000
690,000
Contribution margin
270,000
340,000
10,000
Less: Direct fixed expenses
120,000
180,000
300,000
Product margin
150,000
160,000
310,000
Less: Common fixed expenses
210,000
Operating income
100,000
The selling prices are Rs. 10 for Mystical Wars and Rs. 20 for Magical Dragons. Required:
1.  Compute the number of games of each kind that must be sold for Unicorn Enterprises to
reach its break-even.
2. Compute the revenue that must be earned to produce a net income of 10% of sales revenue.
Question No. 4
Khalid is a salt merchant who supplies salt to general merchants in Lahore city. In the year of 2000
he sold 35,000 bags of salt. One bag consists of 50kg salt. He purchases slat in raw form and then
grinds it, fills it in bags and then sold it, Sale price per bag is Rs. 45.
He purchases the raw salt ® Rs. 400 per ton (1 ton consist of 1000 kg). Grinding cost is Rs, 7 per
bag, carriage outward cost is Rs. 5 per bag, he also purchases empty bags ® 400 per 100 bags. Rent
of shop Rs, 1500 per month. Electricity and phone expense is Rs, 16000 per year (assume fixed).
Depreciation of plant is Rs. 3,680 per year.
In the year 2001 it is expected that sale price and demand will remain the same but all the variable
costs will increased by 15%. All the fixed costs will also increase by 10%.
Required:
1. Break even point in units and Rs. in both years.
2. Income statements of both years.
3. If he wants to earn Rs. 350,000 in the year of 2001 how many bags he has to sell.
4. Assume that demand in 2001 will remain the same he wants to keep same contribution margin
ratio as in year 2000 what'-will be the new selling price per bag.
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