Application of Cost Accounting for Business Decisions: formula sheet

Key formulas

Marginal cost

Marginal cost = Direct material + Direct labour + Direct expenses + Variable overheads

Variable overheads include variable factory, administration and selling overheads when asked for total variable cost.

Contribution

Contribution = Sales − Variable cost

Variable cost here includes variable selling cost on units sold.

Marginal cost equation

Sales − Variable cost = Contribution; Contribution − Fixed cost = Profit

Equivalent form: Sales − Variable cost = Fixed cost + Profit.

Contribution per unit

Contribution per unit = Selling price per unit − Variable cost per unit

Total contribution = Contribution per unit × Units sold.

P/V ratio

P/V ratio = Contribution ÷ Sales × 100

Also called contribution to sales ratio. Contribution = Sales × P/V ratio.

Profit difference between the two methods

Absorption profit − Marginal profit = Fixed overhead in closing stock − Fixed overhead in opening stock

Use the fixed overhead rate per unit × change in stock units, when the rate is the same in both years.

Contribution

Contribution = Sales − Variable cost = Fixed cost + Profit

Works per unit or in total.

P/V ratio

P/V ratio = Contribution ÷ Sales × 100

Also = Change in profit ÷ Change in sales × 100, when fixed cost is unchanged.

Break-even point (units)

BEP (units) = Fixed cost ÷ Contribution per unit

Use when per-unit data is given.

Break-even point (value)

BEP (₹) = Fixed cost ÷ P/V ratio

Also = BEP units × selling price per unit.

Margin of safety

MOS = Actual sales − Break-even sales = Profit ÷ P/V ratio

MOS ratio = MOS ÷ Actual sales × 100.

Target profit sales

Required sales (₹) = (Fixed cost + Target profit) ÷ P/V ratio

In units: (Fixed cost + Target profit) ÷ Contribution per unit.

Profit from P/V ratio

Profit = Sales × P/V ratio − Fixed cost

Quick way to find profit at any sales level.

Contribution

Contribution = Sales − Variable cost

Per unit or in total. Profit = Contribution − Fixed cost.

Make or buy rule

Make if variable cost of making (plus avoidable fixed cost, if any) < buying price

Ignore unavoidable fixed costs. If capacity is limited, use the key factor rule instead.

Special order rule

Accept if offer price > variable cost per unit (and spare capacity exists, no extra fixed cost)

If the order needs extra fixed cost, deduct it from the total extra contribution.

Key factor ranking

Contribution per unit of key factor = Contribution per unit ÷ Key factor units per product unit

Rank products from highest to lowest and allocate the scarce resource in that order, up to demand.

Shutdown rule

Continue if Segment contribution > Avoidable fixed cost of the segment

Shut down if segment contribution is less than the fixed costs saved by closing it.

Key factor (limiting factor)

Maximise total contribution subject to the single scarce resource

Valid with only one limiting factor. More than one needs linear programming.

Material Cost Variance (MCV)

MCV = (SQ × SP) − (AQ × AP)

SQ is standard quantity for actual output. Positive result is F, negative is A.

Material Price Variance (MPV)

MPV = AQ × (SP − AP)

If the variance is computed at the time of purchase, AQ is the quantity purchased. Otherwise AQ is the quantity used. Follow what the question states; if it says nothing and purchases equal usage, the two are the same.

Material Usage Variance (MUV)

MUV = SP × (SQ − AQ)

SQ is standard quantity for actual output. AQ is the quantity used. Valued at standard price.

Check for material

MCV = MPV + MUV

Works when the quantity purchased equals the quantity used. Use this to verify your answers.

Labour Cost Variance (LCV)

LCV = (SH × SR) − (AH paid × AR)

SH is standard hours for actual output. AH paid is the hours the workers were paid for, including idle hours.

Labour Rate Variance (LRV)

LRV = AH paid × (SR − AR)

Uses hours paid. AH paid = AH worked + idle hours.

Labour Efficiency Variance (LEV)

LEV = SR × (SH − AH worked)

Uses hours actually worked, not hours paid. AH worked = AH paid − idle hours.

Idle Time Variance

Idle time variance = Idle hours × SR

Always adverse (A). Idle hours = AH paid − AH worked.

Check for labour

LCV = LRV + LEV + Idle time variance

LRV uses hours paid and LEV uses hours worked. If there is no idle time, the idle time variance is zero.

Variable Overhead Cost Variance

VOH variance = (SH × Standard rate per hour) − Actual variable overhead

Standard rate = budgeted variable overhead ÷ budgeted hours.

Fixed Overhead Cost Variance

FOH cost variance = (Actual output × Standard rate per unit) − Actual fixed overhead

This is absorbed overhead minus actual overhead. Positive is F.

Fixed Overhead Expenditure Variance

Budgeted fixed overhead − Actual fixed overhead

Positive is F.

Fixed Overhead Volume Variance

Absorbed fixed overhead − Budgeted fixed overhead

Equals standard rate × (actual output − budgeted output). Positive (over-absorption) is F.

Check for fixed overhead

FOH cost variance = Expenditure variance + Volume variance

(Budgeted − Actual) + (Absorbed − Budgeted) = Absorbed − Actual. Use this to verify your overhead answers.

Production budget (units)

Production = Budgeted sales + Closing stock − Opening stock

Use finished goods units. Closing stock is the target at period end.

Purchase budget (units of material)

Purchases = Material consumed + Closing stock of material − Opening stock of material

Material consumed = Production units × material per unit.

Flexible budget cost

Total cost at new level = Fixed cost + (Variable cost per unit × Units at new level)

Fixed cost stays the same in total within the relevant range. Variable cost per unit stays the same.

Variable cost per unit from a budget

Variable cost per unit = Total variable cost ÷ Units of budgeted activity

Semi-variable costs must first be split into fixed and variable parts.

Closing cash balance

Closing cash = Opening cash + Receipts − Payments

Leave out non-cash items such as depreciation. Include only actual cash timing.

Key factor rule

Start the budgets from the limiting factor

If sales is the key factor, the sales budget is prepared first.

Quick revision

• Contribution = Sales − Variable cost.
• Profit = Contribution − Fixed cost.
• P/V ratio = Contribution ÷ Sales × 100.
• Break-even point (units) = Fixed cost ÷ Contribution per unit.
• Break-even sales (₹) = Fixed cost ÷ P/V ratio.
• Margin of safety = Actual sales − Break-even sales.
• Sales for a target profit = (Fixed cost + Target profit) ÷ P/V ratio.
• In marginal costing, fixed costs are treated as period costs and stock is valued at variable cost.
• With a scarce resource, rank products by contribution per unit of that resource.
• Material cost variance = (Standard quantity × Standard price) − (Actual quantity × Actual price).
• Material price variance = (Standard price − Actual price) × Actual quantity.
• A flexible budget changes with the level of activity; a fixed budget does not.

Common mistakes

• Treating fixed cost as part of product cost under marginal costing. Fix: Under marginal costing, only variable costs go into product cost and stock value. Fixed cost is deducted in full from contribution.
• Calculating contribution on units produced instead of units sold. Fix: Contribution and sales always relate to units sold. Production matters only for stock valuation and absorption costing.
• Using selling price instead of contribution per unit in the BEP formula. Fix: Always compute selling price − variable cost per unit first and divide by that.
• Forgetting to add target profit to fixed cost. Fix: Required contribution = Fixed cost + Target profit. Divide this by contribution per unit or P/V ratio.
• Using full cost (including absorbed fixed overhead) to compare make with buy. Fix: Use only variable cost plus any fixed cost that can really be saved if you stop making.
• Ranking products by contribution per unit when a resource is scarce. Fix: Rank by contribution per unit of the scarce resource, such as per machine hour.
• Using budgeted output instead of actual output to find standard quantity. Fix: Always scale standards to actual units produced before comparing with actual quantities.
• Reversing the sign and calling an adverse variance favourable. Fix: Use standard (or absorbed) minus actual (or budgeted) in the forms given on this page, so positive is always F, then confirm by logic: higher actual cost means adverse.
• Scaling all costs in proportion to activity in a flexible budget. Fix: Scale only variable costs. Keep fixed costs as they are.
• Including depreciation in the cash budget. Fix: Depreciation is a non-cash item. Leave it out of cash payments.

Exam tips

• Most questions are numeric and fast. Write S − V = F + P first, then fill in the numbers.
• Always check whether the question gives units produced and units sold separately. Use sold units for contribution.
• For profit differences between the two methods, calculate only the fixed overhead in stock change. It saves time.
• Watch for the words 'marginal cost' and 'variable cost' used interchangeably in options, and read each option fully.
• Since there is no negative marking, attempt every question. Eliminate options that ignore fixed cost or use the wrong units.
• Most questions need only contribution, P/V ratio and fixed cost. Compute these first.
• Check whether the answer is asked in units or rupees before choosing an option.
• If a question gives profit at two sales levels, find P/V ratio from the change in profit ÷ change in sales.