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Cosmopolitan’s Valia CL College of Commerce, BSc. (IT) & BMS.

D.N.Nagar, Andheri (w), Mumbai-400053.

A PROJECT

ON

“Break-Even Analysis and Break-Even Point”

In the subject of Advanced Cost Accounting

SUBMITTED TO

UNIVERSITY OF MUMBAI,

FOR SEMESTER-2 OF

MASTER OF COMMERCE

By

Avinash Vilas Chavan

Roll No. 04

UNDER THE GUIDANCE OF

Prof. C.A. Dipen Bhayani

YEAR: 2014-2015

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Cosmopolitan’s Valia CL College of Commerce, BSc. (IT) & BMS.

D.N.Nagar, Andheri (w), Mumbai-400053.

DECLARATION BY THE STUDENT

I, Avinash Vilas Chavan

Roll No. 04 hereby declare that the project for the paper

Advanced Cost Accounting, titled,

“Break-Even Analysis and Break-Even Point”

Submitted by me for semester-2 during the academic year 2014-2015, is based on

actual work carried out by me under the guidance and supervision of

Prof C.A. Dipen Bhayani.

I, further state that this work is original and not submitted anywhere else for any

examination.

Signature of Student

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EVALUATION CERTIFICATE

This is to certify that the under signed have assessed and

evaluated the project on “Break-Even Analysis and Break-Even

Point”

Submitted by Avinash Vilas Chavan Student of M.Com. Part-I

(Semester-II).

This project is original to the best of our knowledge and has

been accepted for Internal Assessment.

Internal Examiner External Examiner Principal

(Prof. C.A. Dipen Bhayani) (Prof. ) (Dr. Satheesh menon)

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Acknowledgement

To list who all helped me is difficult because they are so

numerous and depth is so enormous.

I would like to acknowledge the following as being idealistic

channel and fresh dimension in the completion of this project.

I take this opportunity to thank the University of Mumbai for

giving me chance to do this project.

I would like to thank my Principal Dr. Satheesh menon, for

providing the necessary facilities required for completion of this

project.

I take this opportunity to thank our co-ordinator Prof.

V.M.Mathew, for his moral support and guidance.

I would also like to express my sincere gratitude towards my

project guide Prof. C.A. Dipen Bhayani under whose guidance

and care made the project successful.

I would like to thank my college library, for having provided

various reference books and magazines related to my project.

Lastly, I would like to thank each and every person who directly

or indirectly helped me in the completion of the project,

especially my parents and my peers who supported me

throughout my project.

(Avinash V. Chavan)

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Cosmopolitan’s Valia CL College of Commerce, BSc. (IT) & BMS.

D.N.Nagar, Andheri (w), Mumbai-400053.

Internal Assessment: Protect 40 marks

Name of the Student: Chavan Avinash Vilas

Class:M.Com. Part-I Semester-II Roll Number: 04

Subject: Advanced Cost Accounting

Topic for the project: Break-Even Analysis and Break-Even Point

Marks Awarded Signature

Documentation

Internal Examiner

(Out of 10 Marks)

External Examiner

(Out of 10 Marks)

Presentation

(Out of 10 Marks)

Viva and Interaction

(Out of 10 Marks)

Total Marks(out of 40)

College Stamp

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INDEX

S.R.

NO.

PARTICULAR

1. BREAK EVEN ANALYSIS

2. BREAK EVEN CHART

3. DEFINITION AND EXPLANATION

FIXED COST

VARIABLE COST

SELLING PRICE

SEMI VARIABLE COST

4. ASSUMPTION OF BREAK EVEN ANALYSIS

5. LIMITATION OF BREAK EVEN ANALYSIS

6. BREAK EVEN POINT DEFINITION OF BEP

EQUATION METHOD

CONTRIBUTION MARGIN METHOD

7. BIBILOGRAPHY

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BREAK EVEN ANALYSIS AND BREAK EVEN POINT

Break Even Analysis:

Break-even analysis is a technique widely used by production and management and

management accountants. It is based on categorizing production costs between those which are

“variable’ (costs that change when the production output changes) and those that are “fixed”

(costs not directly related to the volume of production).

Total variable and fixed costs are compared with sales revenue in order to determine the

level of sales volume, sales value or production at which the business makes a neither a profit

nor a loss (the “break-even-point”).

Definition:

A calculation of the sales volume (in units) required to just cover costs. A lower sales volume

would be unprofitable and a higher volume would be profitable. Break even analysis focuses on

the relationship between fixed cost, variable cost (or cost per units), and selling price (or selling

price per unit).

The Break Even Chart:

In its simplest form, the break even chart is a graphical representation of costs at various levels

of activity shown on the same chart as the variation of income (or sales, revenue) with the same

variation in activity. The point at which neither profit nor loss is made is known as the “break-

even point” and is represented on the chart below by the intersection of the two lines:

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In the diagram above, the line OA represent the variation of income at varying levels of

production activity (“output”). OB represent the total fixed costs in the business. As output

increases, variable costs are incurred, meaning that total costs (fixes + variable) also increase. At

low levels of output, costs are greater than income. At point of intersection P, costs are exactly

equal to income, and hence neither profit nor loss is made.

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Definition of fixed costs

Costs that do not change when production or sales levels do change, such as rent, property tax,

insurance, or interest expenses. The fixed costs are summarized for a specific time period

(generally one month).

Explanation of fixed costs with example:

Fixed costs are those business costs that are not directly related to the level of production or

output. In other words, even if the business has a zero output or high output the level of fixed

output the level of fixed costs will remain broadly the same. In the long term fixed costs can alter

– perhaps as a result of investment in production capacity (e.g. adding new factory unit) or

through the growth in overheads required to support a larger, more complex business.

Example of Fixed cost:

Rent and taxes

Depreciation

Research and development

Marketing (non- revenue related )

Administration costs

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Definition of Variable cost (per units cost)

Variable costs are costs that change in proportion to the good or service that a business

produces. Variable costs are also the sum of marginal costs over all units produced. They can

also be considered normal costs. Fixed costs and variable costs make up the two components of

total cost.

Direct costs, however, are costs that can easily be associated with a particular cost object.

However, not all variable costs are direct costs. For example, variable manufacturing overhead

costs are variable costs that are indirect costs, not direct costs. Variable costs are sometimes

called unit-level costs as they vary with the number of units produced.

Direct labor and overhead are often called conversion cost, while direct material and direct labor

are often referred to as prime cost.

In marketing, it is necessary to know how costs divide between variable and fixed. This

distinction is crucial in forecasting the earnings generated by various changes in unit sales and

thus the financial impact of proposed marketing campaigns. In a survey of nearly 200 senior

marketing managers, 60 percent responded that they found the "variable and fixed costs" metric

very useful

Explanation of variable cost with example:

Variable costs are those costs which vary directly with the level of output. They represent

payments output-related inputs such as raw materials, direct labor, fuel and revenue- related

costs such as commission.

For example, a firm pays for raw materials. When activity is decreased, less raw material is used,

and so the spending for raw materials falls. When activity is increased, more raw material is

used, and spending therefore rises. Note that the changes in expenses happen with little or no

need for managerial intervention. These costs are variable costs.

A company will pay for line rental and maintenance fees each period regardless of how much

power gets used. And some electrical equipment (air conditioning or lighting) may be kept

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running even in periods of low activity. These expenses can be regarded as fixed. But beyond

this, the company will use electricity to run plant and machinery as required. The busier the

company, the more the plant will be run, and so the more electricity gets used. This extra

spending can therefore be regarded as variable.

In retail the cost of goods is almost entirely a variable cost; this is not true of manufacturing

where many fixed costs, such as depreciation, are included in the cost of goods.

Although taxation usually varies with profit, which in turn varies with sales volume, it is not

normally considered a variable cost.

For some employees, salary is paid on monthly rates, independent of how many hours the

employees work. This is a fixed cost. On the other hand, the hours of hourly employees can often

be varied, so this type of labour cost is a variable cost. The cost of material is a variable cost

Definition of selling price (per unit price)

The price that a unit is sold for sales tax is not included the selling price and a sales tax paid is

not included as a cost. The selling price times the number of units sold equals the total sales.

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Definition of semi-variable cost:

Semi-variable cost is an expense which contains both a fixed-cost component and a variable-

cost component. The fixed cost element shall be a part of the cost that needs to be paid

irrespective of the level of activity achieved by the entity. On the other hand the variable

component of the cost is payable proportionate to the level of activity.

Explanation of semi-variable cost;

It shows similarities to telephone bills. One must pay line rental and on top of that a price that

depends on how heavy one is using the service. So it changes with output. Another example is

satellite television. A price for the box must be paid monthly and to get additional movies, more

money has to be given.

Cost of energy, such as electricity, is a good example as it is integral to production of goods and

services. This component straddles both the fixed and variable universe because electrical power

is essential for the basic operation of the business in lighting and heating – this portion is a sunk

cost that is foregone regardless of production. As demand ramps up, more energy is required to

ramp up the production process in the use of machinery or large banks of computers for instance.

Cost of electrical energy will then rise accordingly as production activities increase. Therefore,

the cost of electricity can be viewed as semi-variable.

Take the highest output and costs. Take the lowest output and costs. Take one from the other =

movement in cost per unit Calculate variable cost per unit Put back into highest total cost and

rework variable cost to the output, leaving fixed cost.

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Assumption Of Break Even Analysis:

The Break even Analysis Depends On three Key Assumption:

1. Average per-unit sales prices (per-unit revenue):

This is the price that you receive per unit of sales. Take into account sales discount and

special offers. Get this numbers from sales forecast. For non-unit based businesses, make the

per- unit revenue Rs. 1 and enter your costs as a percent of a rupees. The most common

questions about this inputs relate to averaging many different products into a single

estimates. The analysis requires a single number and if you build your sales forecast first,

then you will have this number. You are not alone in this the vast majority of businesses sell

more than one item, and have to average for their Break even Analysis.

2. Average Per-unit Cost:

This is incremental cost, or variable cost, of each unit sales. If you buy goods for resale, this

is what you paid, on average, for the goods you sell. If you sell a services, this is what it

costs you, per dollar of revenue or unit of services delivered, to deliver that services. If you

are using a units-based Sales Forecast table (for manufacturing and mixed business types),

you can projects unit costs from the sales forecast table. If you are using the basic sales

Forecast table for retail, services and distribution businesses, use a percentage estimate, e.g.

a retail store running a 50% margin would have a per-unit cost of .5, and a per-unit revenue

of 1.

3. Monthly Fixed Cost:

Technically, a break even analysis defines fixed cost as costs that would continue even if

you want broke. Instead, we recommend that you use your regular running costs, including

payroll and normal expenses (total monthly Operating Expenses). This will give you a better

insight on financial realities. If averaging and estimating is difficult, use your Profit and

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Loss table to calculate a working fixed cost estimate – it will be a rough estimate, but it will

provide a useful input for a conservative Break even Analysis.

Limitation OF Break Even Analysis:

It is best suited to the analysis of one product at a time. It may be difficult to classify a cost

as all variable or all fixed; and there may be a tendency to continue to use a break even

analysis the cost income function have changed.

It is important to understand what the result of your Break even analysis are telling you.

If, for example, the calculation reports that you would break even when you sold your 500th

unit, decide whether this seems feasible. If you don’t think you can sell 500 units within a

reasonable period of time (dedicated by your financial situation, patience and personal

expectations), then this may not be the right business for you to go into. If you think 500 unit

is possible but would take while, try lowering your price and calculated and analyzing the

new breakeven point.

Alternatively, take a look at your costs – both fixed and variable – and identify areas

where you might be able to make cuts.

Lastly, understand that breakeven analysis is not a predictor of demand, so if you go

into market with the wrong product or the wrong price, it may be tough to ever hit the break

even point.

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Break even point:

The sales volume (express as units sold) at which the company breaks even. Profits are Rs.0 at

the break even point. The break even point is calculated by the following formula:

Break Even Point (BEP) = Fixed cost / contribution (selling price- variable cost)

Time period:

The fixed costs are summarized for a specific time period.

The per unit variable cost is not dependant on a specific period of time.

The per unit selling price is not dependant on a specific period of time.

The Break even Point is expressed the number of units, over a specific time period, that

must be sold to obtain a Net Profit Rs.0. the time period the units must be sold is always

the same as the time period of fixed costs.

Typically the period is monthly, however it could be Yearly or even Hourly. For

example, a farmer seeking the break even on an annual corn crop would choose a yearly

time period. The farmer would add up the fixed costs for the whole year and the break

even sales volume would be expressed as yearly sales volume.

The text that is written in the time period field is copied to the title of the break even Graph and

Break Even Report. If you leave the field blank then nothing will be copied.

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BREAK EVEN POINT:

Assume the following:

Fixed Cost:

Monthly Rent: 100Rs.

Insurance (600Rs. P.A. 600/12 months) 50Rs.

Total Monthly Fixed Costs 150Rs.

Variable Cost:

Materials 3Rs.

Labor 6Rs.

Total Variable Cost 7Rs.

Selling price: 10Rs.

Break Even Point Calculation

Break Even Point = Fixed costs / (selling price – Variable Costs)

= 150 / (10 – 7)

= 150 / 3

Break Even Point = 50

To break even the company must sell 50 units per month.

If the company just broke even, then its Profits and Loss statements would look like the

followings:

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Monthly Profits and Loss Statements

Sales

Goss sales (10Rs. Per units 50 units) 500Rs.

Les COGS (7Rs. Per Units Units) 350Rs.

Nets Sales 150Rs.

Expenses

Rent 100Rs.

Insurance 50RS.

Total Expenses 150Rs.

Net Profit 0 RS.

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Definition Of Break Even Point:

Break-even point is the level of sales at which profit is zero. According to this definition, at

break-even point sales are equal to fixed cost plus variable cost. This concepts is further

explained by the following equation:

[Break-even sales= fixed cost + variable cost]

The break-even point can be calculated using either the equation method or margin method.

These two method are equivalent:

Equation method:

The equation method center on the contribution approach to the income statement.

The format of this statement can be expressed is equation form as follow:

Profit = (Sales – Variable expenses) – Fixed Expenses

Rearranging this equation slightly yields the following equation, which is widely used in cost

volume profit (CVP) analysis:

Sales = Variable expenses + Fixed Expenses + Profit

According to the definition of break-even point, break-even point is the level of sales where

profits are zero. Therefore the break-even point can be computed by finding that point where

sales just equal the total of the variable expenses plus fixed expenses and profit is zero.

Example:

For example we can use the following data to calculate break-even point.

1. Sales prices per units = 250 Rs.

2. Variable cost per unit = 150Rs.

3. Total fixed expenses = 35000Rs.

Calculate break even point.

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Calculation:

Sales = Variable Expenses + Fixed Expenses + Profits

Rs.250Q* = Rs.150Q + Rs.35000 + Rs. 0**

Rs.100Q = Rs.35000

Q = 35000 / 100

Q = 350 units

[Q* = numbers of units sold]

**The break-even point can be computed by finding that point where profits is zero.

The break even point in sales Rupees can be computed by multiplying the break even level of

units sales by the selling price per units.

350 units x 250Rs. per units = Rs. 87500

Contribution Margin Method:

The contribution Margin method is actually just a short cut conversion of the equation method

already described. The approach center on the idea discussed earlier that each unit sold provides

a certain amount of contribution margin that goes toward covering fixed cost. To find out how

many units must sold to break even, divide the total fixed cost by the unit contribution margin

be.

Break even Point In Units = Fixed Expenses / Unit contribution Margin

35000Rs. / Rs.100* per unit

350 units

*Rs. 250 (sales) – Rs. 150 (variable Exp.)

A variation of this method uses the Contribution Margin Ration (CM ratio) instead of the unit

Contribution margin. The result is the break even in total sales dollars rather than in total units

sold.

Break even point in total sales dollars = Fixed Expenses / CM Ratio

= Rs. 35000 / 0.40

= Rs. 87500

This approach is particularly suitable in situation where a company has multiple product lines

and wishes to compute a single break even point for the company as a whole.

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The following formula is also used to calculate break even point

Break even point in Rupees = [Fixed cost / 1 – (variable cost – Sales)]

This formula can produce the same answer:

Break even point = [Rs. 35000 / 1 – (150/250)]

= Rs. 35000 / 1 – 0.6

= Rs. 35000 / 0.4

= Rs. 87500

Break-even Point In Units

The break-even point in units for Oil Change Co. is the number of cars it needs to service in

order to cover the company's fixed and variable expenses. The break-even point formula is to

divide the total amount of fixed costs by the contribution margin per car:

It's always a good idea to check your calculations. The following schedule confirms that the

break-even point is 160 cars per week:

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Desired Profit In Units

Let's say that the owner of Oil Change Co. needs to earn a profit of $1,200 per week rather than

merely breaking even. You can consider the owner's required profit of $1,200 per week as

another fixed expense. In other words the fixed expenses will now be $3,600 per week (the

$2,400 listed earlier plus the required $1,200 for the owner). The new point needed to earn

$1,200 per week is shown by the following break-even formula:

Always check your calculations:

The above schedule confirms that servicing 240 cars during a week will result in the required

$1,200 profit for the week.

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Break-even Point In Sales Dollars

One can determine the break-even point in sales dollars (instead of units) by dividing the

company's total fixed expenses by the contribution margin ratio.

The contribution margin ratio is the contribution margin divided by sales (revenues)

The ratio can be calculated using company totals or per unit amounts. We will compute the

contribution margin ratio for the Oil Change Co. by using its per unit amounts:

The break-even point in sales dollars for Oil Change Co. is:

The break-even point of $3,840 of sales per week can be verified by referring back to the break-

even point in units. Recall there were 160 units necessary to break-even. At $24 per unit the

necessary sales in dollars would be $3,840.

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Desired Profit In Sales Dollars

Let's assume a company needs to cover $2,400 of fixed expenses each week plus earn $1,200 of

profit each week. In essence the company needs to cover the equivalent of $3,600 of fixed

expenses each week.

Presently the company has annual sales of $100,000 and its variable expenses amount to $37,500

per year. These two facts result in a contribution margin ratio of 62.5%:

The amount of sales necessary to give the owner a profit of $1,200 per week is determined by

this break-even point formula:

To verify that this answer is reasonable, we prepared the following schedule:

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As you can see, for the owner to have a profit of $1,200 per week or $62,400 per year, the

company's annual sales must triple. Presently the annual sales are $100,000 but the sales need to

be $299,520 per year in order for the annual profit to be $62,400.

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BIBILOGRAPHY

1. Icai Costing Book (Marginal Cost)

2. Break even Analysis Document By Emmanuel (Scribd)

3. M.com Part- 1 Advanced Cost Accounting Book By Ainapure