Marginal Costing PDF

CHAPTER-3
Marginal Costing and

Cost-Profit-Volume Analysis
Introduction and Marginal Costing

Applications of Marginal Cost Technique
Principles of Marginal Costing
Main Features of Marginal Costing
Advantages and Disadvantages of Marginal Costing
Determination of Marginal Costing
Break Even Analysis
Management Tools
Limitations of Break Even Point
Problem Limitations and Uses of Break Even Charts
Marginal Costing
Comparative Analysis of Cost Management
Profit Margin Analysis
· Operating Profit Ratio
· Gross Profit Ratio
· Net Profit Ratio
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INTRODUCTION OF MARGINAL COSTING
Marginal Costing is the process of identification, measurement,

accumulation analysis, preparation, interpretation and communication of
information used by management to plan, evaluate and control within an
entity and to assure appropriate use of and accountability for its
resources. Management accounting also comprises the Preparation of
financial report for non management groups such as share holders,
creditors, regulatory agencies and tax authorities.
Marginal costing is not a separate method of costing like contract

costing, process costing or operating costing rather it is a specific
technique of costing where variable cost for different levels of sales is
presented in such a manner that manager can take day to day decisions.
Marginal cost means change in cost which will be observed when

Production is increased or decreased by one unit up to a certain level of
Production. As fixed cost is fixed, change in cost will be equal to
variable cost per unit. Thus from practical point of view, marginal cost is
just equal to overall variable cost per unit. Where overall variable cost
per unit is sum total of the followings1:-
(1) Prime cost per unit.
(2) Variable overhead per unit
(3) Variable Part of semi-variable overhead.
1. Cooper R. (2010), “Cost classifications in unit-based and activity based manufacturing cost
systems”, Journal of Cost Management, Fall, pp.4-14.
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The marginal cost is the cost to produce one additional unit. This
cost would include the raw materials used to make the item, the average
labour cost of the item, the average machine or hardware cost associated
with creating the item. Marginal costs are sometimes very difficult to
assess. First, we must determine the useful life of our machinery, that
can be a very subjective determination. Typically, the raw material is
easy to assess, although not always, determining Marginal cost is much
easier in a manufacturing setting that it is in a service oriented area.
Marginal costing what is it? Marginal cost is a term used to

describe the change in total cost of production resulting from the
addition of one item. It can also be seen as the avoidable cost of not
producing an additional item. It is usual to look at short term marginal
cost, which is an additional cost when only some of the cost of
production can be varied in long term or more commonly known as long
run marginal cost is the change in cost when all input cost can be varied.
It is closely related to marginal cost pricing, in which prices are set at an
amount equal to the Marginal Cost.
Marginal Costing is that technique of costing in which cost and

profit are ascertained on the basis of marginal cost per unit. It can be
defined as follows :-
“Marginal Costing is the ascertainment of marginal cost and of the

effect on profit due to changes in volume or type of output by
differenting between fixed cost and variable cost.”2
2. Green F.B. and Amenkhienan F.E. (1992), “Accounting innovations: A cross sectional survey of
manufacturing firms”, Journal of Cost Management for the Manufacturing Industry, Spring
58–64.
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Definition of Marginal Costing

In the words of J. Batty, “Marginal Costing is a technique of cost
accounting which pays special attention to the behavior of cost, with
changes in the volume of output.” According to ICMA, England,
“Marginal cost in the amount at any given volume of output, by which
aggregate cost are changed, if the volume of output in increased or
decreased by one unit.”
Applications of Marginal Cost Technique

Marginal costing is the most powerful and popular technique in aid
of managerial decision making, As already seen, It reveals the cost,
volume profit relationship in all its ramifications which is useful in profit
planning, selling price determination, selection of optimum volume of
production etc.3
Marginal costing, with its focus on variability of costs and

avoidance of overhead apportionment, is so versatile that it is applied in
varied circumstances and to tackle diverge problems by those in charge
of such situations. The following are some of the more popular areas of
application of marginal costing.4
1. Fixation of Selling Price

Price is one of the most significant factor that determines the
market for the products as well as the volume of profit for the
3. Drucker P.F. (1994), “Cost control and management”, in Management Controls: New Directions
in Basic Research (eds C.P. Bonini, R. Jaedicke and H. Wagner), McGraw-Hill, p.174.
4. Kaplan R.S. and Cooper R. (1998), “Cost and Effect: Using Integrated Systems to Drive
Profitability and Performance, Harvard Business School Press, p.251-55.
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organization. Under, normal circumstances, the price of a product must

cover the total costs of the product plus a margin of profit.
However, under certain special circumstances, price has to be fixed

even below the total cost. For instance, when there is a general trade
depression (or) exploring new markets (or) accepting additional orders,
the producer has to cut the price even below the total costs of the
concerned product.
Under these special circumstances, the concept of marginal cost is

usefully applied to fit the prices.
2. Accepting Bulk Orders (or) Foreign Market Orders
Some bulk orders may be received from local dealers (or) foreign
dealers asking for a price which is below the market price. This calls for
a decision to accept (or) reject the order.
The order from a local dealer should not be accepted at a price

below the market price because it will affect the normal market and
goodwill of the company on the other hand, the order from the foreign
dealer should be accepted because it will give additional contribution, as
the fixed costs have already been met.
3. Make (or) Buy Decision
In a make (or) buy decision, the price quoted by the outside

suppliers should be compared with the marginal cost of producing the
component parts. If the outside price of the component is lower than the
marginal cost of producing it, it is worth buying. On the other hand, if
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the outside price is higher than the marginal cost, making the component
in the factory may be preferred.
4. Selection of Suitable Product Mix
When a factory manufacturers more than one product, a problem is

faced by the management as to which product will give maximum
profits. The solution is the products which give the maximum
contribution are to be retained and their production should be increased.
5. Key Factor
It is also known as limiting factor (or) governing factor or scarce
factor. A key factor is one which restricts production and profit of a
business. It may arise due to the shortage of material, labour, capital
plant capacity (or) sales.
Normally, when there is no limiting factor, the selection of the

product will be on the basis of the highest P/V ratio. But, when there are
limiting factors, selection of the product will be on the basis of the
highest contribution per unit of the key factor.
6. Maintaining a Desired Level of Profit

Management may be interested in maintaining a desired level of
profits. The sales required to earn a desired level of profits can be
ascertained by the marginal costing techniques.
7. Alternative methods of Production

Marginal costing is helpful in comparing the alternative methods of
production i.e., machine work (or) hand work. The method which gives
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maximum contribution is to be adopted keeping in mind the limiting

factor.
8. Determination of Optimum Level of Activity

The technique of marginal costing helps the management in
determination the optimum level of activity. To make such a decision,
contribution at different levels of activity can be found. The level of
activity which gives the highest contribution will be the optimum level.
The level of production can be raised till the marginal cost does not
exceed the selling price.
9. Evaluation of Performance
Evaluation of performance efficiency of various departments or
product lines can be made with the help of marginal costing. The
management has to discontinue the production of non-profitable
products or department so as to maximize the profits. In such cases,
decision to discontinue will be on the basis of the lowest contribution or
P/V Ratio.
10. Cost Control

The two types of costs-variable and fixed are controllable and
non-controllable respectively. The variable cost is controlled by
production department and the fixed cost is controlled by the
management.
11. Closure of a Department or Discontinuing a Product

Marginal costing technique shows the contribution of each product
to fixed costs and profit. If a department or a product contributes the
least amount, then the department can be closed (or) its production can
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be discountinued. It means the product which gives a higher amount of

contribution may be chosen and the rest should be discontinued.
12. Profit Planning
Profit planning is a plan for future operation (or) or planning

budget to attain the given objective or to attain the maximum profit. The
volume of sale required to maintain a desired profit can be ascertained.
13. Introduction of a New Product
A production firm may add additional products with the available

facility. The new product is sold in the market at a reasonable price, in
order to sell it in large quantities. It may become popular. If favourable,
the sales can be increased. Thus, the total cost comes down and
contributes some amount towards fixed costs and profits.
14. Choice of Technique
Every management wishes to manufacture the products at the most

economical way. For this, the marginal costing is a good guide as to the
products at different stages of production, that is to say whether the
management has to adopt hand operated system (or) semi-automatic
system or complete automatic system. When operations are done
manually, fixed cost will be lower than the fixed cost incurred by
machines and in complete automatic system, fixed costs are more than
variable cost.
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15. Decision Making
Price must not be less than total cost under normal conditions,
Marginal costing acts as a price fixer and a high margin will contribute
to the fixed cost and profit. But this principle cannot be followed every
time. Price should be equal to marginal cost plus a reasonable amount,
which depends upon demand and supply, competition, policy of pricing
etc.
If the price is equal to marginal cost, then there is a loss equal to

fixed costs. Sometimes, the businessman has to face loss when
(a) there is cut-threat competition
(b) there is the fear of future market
(c) that goods are of perishable nature d) the employees cannot

be removed
(e) a new product is introduced in the market
(f) competitors cannot be driven out etc.
16. Introduction of New Product (or) Product Line
The technique to assess the profitability of a line extension product

is the incremental contribution estimates. The same technique of
contribution analysis would be followed in assessing the profitability of
a new product line sales forecast would result from a market survey and
market research.
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PRINCIPLES OF MARGINAL COSTING
The principles of marginal costing are as follows5:-
1. For any given period of time, fixed costs will be the same, for
any volume of sales and production provided that the level of
activity is within the relevant range. Therefore, by selling
extra item of product or service the following will happen: (1)
Revenue will increase by the sales value of the item sold. (2)
Cost will increase by the variable cost per unit. (3) Profit will
increase by the amount of contribution earned from the extra
item.
2. Similarly, if the volume of sales falls by one item, the profit

will fall by the amount of contribution earned from the item.
3. Profit measurement should therefore be based on an analysis

of total contribution. Since fixed costs relate to a period of
time, and do not change with increases or decreases in sales
volume, it is misleading to charge units of sales with a share
of fixed costs.
4. When a unit of product is made, the extra costs incurred in its

manufacture are the variable production costs. Fixed costs are
unaffected, and no extra fixed costs are incurred when output
in increased.
MAIN FEATURES OF MARGINAL COSTING

(i) Marginal Costing is a technique of decision making.
5. Berliner C. and Brimson J.A. (1998), “Cost Management for Today’s Advanced
Manufacturing”, Harvard Business School Press, p.217.
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(ii) The total cost is classified into fixed and variable cost.
(iii) Fixed cost are ascertained separately and excluded from cost
of production. The fixed costs are charged to Profit and loss
account.
(iv) The stock of work in Progress and finished goods are valued
at variable cost. Fixed cost will not be included in valuation
of the stock.
(v) Contribution is ascertained by reducing the variable cost from

the selling price.
(vi) The profitability of products or process is determined on the

basis of contribution.
(vii) Profit is ascertained by reducing the fixed cost from the

contribution of all the products or departments or process or
division etc.
(viii) The profitability of various levels of activity is ascertained by

calculating cost volume profit relationship.6
ADVANTAGES AND DISADVANTAGES OF MARGINAL

COSTING
Advantages
1. Marginal costing is simple to understand.
2. By not charging fixed overhead to cost of production, the

effect of varying charges per unit is avoided.
6. Merchant K.A. (2008), “Modern Management Control Systems: Text and Cases”, Prentice-Hall,
New Jersey, p.85.
101
3. It prevents the illogical carry forward in stock valuation of

some proportion of current year’s fixed overhead.
4. The effects of alternative sales or production policies can be

more readily available and assessed, and decisions taken
would yield the maximum return to business.
5. It eliminates large balance left in overhead control accounts

which indicates the difficulty of ascertaining an accurate
overhead recovery rate.
6. Practical cost control is greatly facilitated avoiding arbitrary

allocation of fixed overhead, efforts can be concentrated on
maintaining a uniform and consistent marginal cost. It is
useful to various levels of management.
7. It helps in short-term profit planning by breakeven graphs and

profitability analysis. Comparative profitability, performance
between two or more products and divisions can easily be
assessed and brought to the notice of management for
decision making.
Disadvantages
1. The separation of costs into fixed and variable is difficult and

sometimes gives misleading results.
2. Normal costing systems also apply overhead under normal

operating volume and this shows that no advantage is gained
by marginal costing.
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DETERMINATION OF MARGINAL COSTING

Marginal costing is ascertainment of the marginal cost which varies
directly with the volume of production by differentiating between fixed
costs and variable costs and finally ascertaining its effect on profit.
Marginal costing is an accounting system where only variable cost or
direct labour will be charged to the cost of units. This costing technique
is also known as direct costing. Fixed costs are never charged to
production. They are written off to the profit and loss account. Marginal
costing focuses on the relationship between cost, price and volume. This
method concentrates on the controllable aspects of business by
separating fixed and variable costs. Marginal Costing helps in Pricing
decisions, showing the true profit of the period, preparing break-even
analysis and also Business Decision making like, Fixation of selling
price, Key or limiting factor, Make or buy decisions, Selection of a
suitable product mix, Effect of change in price, closing down or
suspending activities, Maintaining a desired level of profit. Marginal
cost is the cost management technique for the analysis of cost and
revenue information and for the guidance of management. Absorption
costing and marginal costing are two different techniques of cost
accounting. Absorption costing is widely used for cost control purpose
whereas marginal costing is used for managerial decision-making and
control.7
7. Cooper R. (2010), op.cit., p.10.

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Estimation of Units Produced
The Gems and Jewellery industry is associated with differentiated

products and the estimation of the amount of quantity produced and cost
of the item will vary greatly, depending on the types of gems and
precious-stones used in the jewellery. In addition, the accurate cost
estimation of the product cost is not possible because jewellery is
manufactured using different metal alloys, different gem stones, and
different precious-stones. In order to estimate the quantity of items
manufactured during a particular financial year we estimate the material
equivalent gold used in production by dividing the cost of material
consumed with the average price of gold during the corresponding
financial year. Further, we assume that the company is manufacturing
homogenous product and each product weights 100 grams. Using this
method we can estimate the number of units manufactured during a
given financial year.8
Costing Pattern at Surana Jewellers Corporation Ltd
The results in Table 3.1 summarize the cost pattern at Surana

Jewellers Corporation Limited during the last five financial years. It can
be observed that material cost is the main cost for this company followed
by administrative expenses and personnel expenses.
8. Kaplan R.S. and Cooper R. (1998), op.cit., p.259.

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Table 3.1
Cost associated with Gems and Jewellery Manufacturing at Surana
Jewellers Corporation Ltd
(From 2009-10 to 2013-14)
(Rs. in lacs)
Particulars 2009-10 2010-11 2011-12 2012-13 2013-14

Material Consumed 1,58,527 2,20,631 3,93,861 5,18,424 8,50,190
Personnel Expenses 158 253 280 357 374
Manufacturing Expenses 58 25 43 36 139
Selling Expenses 19 4 11 17 -
Administrative Expenses 441 224 337 337 1,254
Cost of Sales 1,59,202 2,21,137 3,94,531 5,19,171 8,51,957
Average Gold Price 12.23 15.23 18.24 24.87 29.71
Material Equivalent Gold 12965 14484 21589 20848 28614
(in kg)
Number of Units 129653 144843 215891 208477 286137
Produced (1Unit = 100 gms)
Source: Annual Reports and Accounts of the Company from 2009-10 to 2013-14.
Table 3.1 shows that cost of material consumed had an increasing

trend throughout the period under study. It was Rs. 158527 lacs in
2009-10 which increased continuously as Rs. 220,631 lacs in 2010-11,
Rs. 393,861 lacs in 2011-12, Rs. 518,424 lacs in 2012-13 and reached up
to Rs. 850,190 lacs in the final year 2013-14.
Personnel Expenses also have continuously increased trend.

Initially, in the year 2009-10, these expenses amounted Rs. 158 lacs
which reached to Rs. 253 lacs in 2010-11, Rs. 280 lacs in 2011-12,
Rs. 357 lacs in 2012-13 and up to Rs. 374 lacs in 2013-14.
Manufacturing expenses for Surana Jewellers showed a fluctuating

trend during the study period. In 2009-10, the amount of manufacturing
105
expenses was Rs. 58 lacs which came down sharply to Rs. 25 lacs in
2010-11, then increased to Rs. 43 lacs in 2011-12 but again decreased to
Rs. 36 lacs in 2012-13. Finally, it increased and climbed up to Rs. 139
lacs in the year 2013-14. From this analysis, it seems that manufacturing
was not consistent during the period under study.
Selling and administrative expenses also showed a fluctuating trend

but cost of sales increased continuously. It was Rs. 159,202 lacs in
2009-10 which increased to Rs. 221,137 lacs in 2010-11, Rs. 394,531
lacs in 2011-12, Rs. 519,171 lacs in 2012-13 and reached to Rs. 851,957
lacs in 2013-14.
Number of units produced by the firm also had an increasing trend

except in the year 2012-13. In the year 2009-10, 129653 units were
produced. This number increased to 144843 in 2010-11and reached to
215891 in 2011-12. It 2012-13, it came down slightly to 208477 but
increased up to 286137 in the final year 2013-14.
Now, different ratios e.g., material to prime cost, direct labour to

prime cost, direct exp. to prime cost and profit to sale, have been
calculated and given in Table 3.2.
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Table 3.2
Different Ratios of Surana Jewellers Corporation Ltd
(Ratio in Percent)
Year Direct Material Direct Labour to Direct Exp. to Profit to

to Prime Cost Prime Cost Prime Cost Sale
2009-10 99.86 0.036 0.099 4.01
2010-11 99.87 0.011 0.110 1.51
2011-12 99.91 0.071 0.011 2.80
2012-13 99.93 0.007 0.053 2.33
2013-14 99.94 0.043 0.016 1.72
Average 99.90 0.034 0.058 2.47
S.D. 0.036 0.026 0.046 0.99
C.V. 0.000 0.775 0.792 0.403
Source: Annual Reports and Accounts of the Company for the period from 2009-10 to 2013-14.
Table 3.2 shows that among the ratios calculated and presented,
material to prime cost ratio was always highest (more than 99.8 percent)
which is obvious as material (gold) is most precious in gems and
jewellery business and other costs and expenses are very low in
comparison to its cost. Direct Material to prime cost was almost
consistent but had an increasing trend as the ratio was 99.86 percent in
2009-10 which increased slightly to 99.87 percent in 2010-11, 99.91
percent in 2011-12, 99.93 percent in 2012-13 and reached to 99.94
percent in 2013-14.
For Surana Jewellers, direct labour to prime cost and direct

expenses to prime cost ratios have low values with fluctuating trend.
Profit to sale ratio had a decreasing trend for the period under study
except in the year 2011-12. In 2009-10, the ratio was 4.01 percent
(highest) which decreased sharply to 1.51 percent (lowest) in 2010-11
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but increased to 2.80 percent in 2011-12. After that it came down to 2.33
percent in 2012-13 and declined up to 1.72 percent in the final year
2013-14. The average ratio was 2.47 percent which is very low, high
values of standard deviation and coefficient of variation indicate
fluctuating trend which should be controlled and the ratio should be
improved in future.
Costing Pattern at Classic Diamonds (India) Ltd

Table 3.3 summarizes the cost pattern at Classic Diamonds (India)
Limited during the last five financial years.
Table 3.3
Cost associated with Gems and Jewellery Manufacturing at Classic
Diamonds (India) Ltd
(From 2009-10 to 2013-14)
(Rs. in lacs)
Particulars 2009-10 2010-11 2011-12 2012-13 2013-14

Material Consumed 56382 54489 58070 44335 20793
Selling Expenses 297 93 72 - -
Administrative Expenses 750 491 480 509 289
Cost of Sales 64169 58236 60695 45970 21540
(in kg)
Number of Units 46101 35777 31837 17827 6999
Table 3.3 shows that cost of material consumed had a decreasing

trend throughout the period under study except in the year 2011-12. It
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was Rs. 56382 lacs in 2009-10 which decreased to Rs. 54489 lacs in
2010-11 but increased to Rs. 58070 lacs in 2011-12. Then it came down
to Rs. 44335 lacs in 2012-13 and declined up to Rs. 20793 lacs in the
final year 2013-14.
Personnel Expenses also had decreasing trend except in the year

2011-12. Initially, in the year 2009-10, these expenses amounted
Rs. 2871 lacs (maximum) which decreased to Rs. 1789 lacs in 2010-11
but increased to Rs. 1853 lacs in 2011-12. Then it decreased sharply to
Rs. 1025 lacs in 2012-13 and came down further to Rs. 423 lacs
(minimum) in 2013-14.
Manufacturing expenses for Classic Diamonds showed a sharp

decreasing trend during the study period. In 2009-10, the amount of
manufacturing expenses was Rs. 3870 lacs (maximum) which came
down sharply to Rs. 1374 lacs in 2010-11, Rs. 219 lacs in 2011-12,
Rs. 101 lacs in 2012-13. Finally, it decreased up to Rs. 35 lacs
(minimum) in the year 2013-14. From this analysis, it seems that
manufacturing was decreasing continuously which indicate the
decrement in business.
Selling and administrative expenses also shows decreasing trend as

well as cost of sales decreased continuously except in the year 2011-12.
It was Rs. 64169 lacs in 2009-10 which decreased to Rs. 58236 lacs in
2010-11, then increased to Rs. 60695 lacs in 2011-12, but again
decreased to Rs. 45970 lacs in 2012-13 and came down to Rs. 21540
lacs in 2013-14. It was because of decreased production. It is suggested
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that the management of the firm should try to increase the sales but
increasing additional expenses on adjusting and marketing.
Number of units produced by the firm also had a decreasing trend.

In the year 2009-10, 46101 units (highest) were produced. This number
decreased to 35777 in 2010-11, 31837 in 2011-12, 17827 in 2012-13,
and came down to 6999 units (lowest) in the year 2013-14.
Different ratios have been calculated for Classic Diamonds and

given in Table 3.4.
Table 3.4
Ratio Analysis of Classic Diamonds (India) Ltd
(Ratio in Percent)

2009-10 89.32 4.54 6.13 4.16
2010-11 94.51 3.10 2.38 4.24
2011-12 96.55 3.08 0.36 13.42
2012-13 97.52 2.25 0.22 8.35
2013-14 97.84 1.99 0.16 6.58
Average 95.15 2.99 1.85 7.35
S.D. 3.51 0.99 2.57 3.82
C.V. 0.037 0.333 1.387 0.519
Table 3.4 shows that material to prime cost ratio had an increasing
trend. The ratio was 89.32 percent (lowest) in 2009-10 which increased
to 94.51 percent in 2010-11, 96.55 percent in 2011-12, 97.52 percent in
2012-13 and reached to 97.84 percent in 2013-14.
110
For Classic Diamonds, direct labour to prime cost and direct

expenses to prime cost ratios have low values with decreasing trend.
Profit to sale ratio had an increasing cum decreasing trend for the period
under study. In 2009-10, the ratio was 4.16 percent (lowest) which
increased to 4.24 percent in 2010-11 and reached up to 13.42 percent
(highest) in 2011-12. After that it came down to 8.35 percent in 2012-13
and declined up to 6.58 percent in the final year 2013-14. The average
ratio was 7.35 percent which is moderate. It is suggested that the firm
should improve the ratio keeping fluctuations in control.
Costing Pattern at Gitanjali Gems Limited

The results in Table 3.5 summarizes the cost pattern at Gitanjali
Gems Limited. It can be observed that material cost is the main cost for
this company followed by manufacturing expenses and administrative
expenses.
Table 3.5
Cost associated with Gems and Jewelry Manufacturing at
Gitanjali Gems Ltd
(From 2009-10 to 2013-14) (Rs. in lacs)
Particulars 2009-10 2010-11 2011-12 2012-13 2013-14
Personnel Expenses 1,163 1,580 1,505 2,480 2,651
Manufacturing Expenses 8,134 5,408 6,961 13,805 17,618
Selling Expenses 1,695 1,492 1,385 2,092 -
Administrative Expenses 2,076 2,467 3,111 2,981 15,582
Cost of Sales 2,47,610 2,48,625 3,12,500 4,76,887 7,34,959
(in kg)
Number of Units 191776 156060 164220 183164 235310
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Table 3.5 shows that cost of material consumed had a continuously

increasing trend throughout the period under study. It was Rs. 234,542
lacs in 2009-10 which increased to Rs. 237,679 lacs in 2010-11,
Rs. 299,537 lacs in 2011-12, Rs. 455,529 lacs in 2012-13 and rose up to
Rs. 699,107 lacs in the final year 2013-14.
Personnel and manufacturing expenses had increasing trend during

almost entire period which indicate that manufacturing was increasing
which indicate the improvement in business.
Selling and administrative expenses show some fluctuating trend

but cost of sales had an increasing trend continuously. It was Rs.
247,610 lacs in 2009-10 which increased to Rs. 248,625 lacs in 2010-11,
Rs. 312,500 lacs in 2011-12, Rs. 476,887 lacs in 2012-13 and reached
up to Rs. 734,959 lacs in 2013-14.
Number of units produced by the firm also had an increasing trend

produced. This number decreased to 156060 units (lowest) in 2010-11,
which then increased to 164220 units in 2011-12, 183164 units in
2012-13 and finally reached to 235310 units (highest) in the year
2013-14.
Different ratios have been calculated for Gitanjali Gems and given
in Table 3.6.
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Table 3.6
Ratio Analysis of Gitanjali Gems Ltd
(Ratio in Percent)

2009-10 96.18 0.48 3.33 3.36
2010-11 97.14 0.65 2.21 5.90
2011-12 97.25 0.49 2.26 4.64
2012-13 96.54 0.53 2.92 4.32
2013-14 97.18 0.37 2.45 3.08
Average 96.86 0.50 2.63 4.26
S.D. 0.47 0.10 0.48 1.12
C.V. 0.005 0.200 0.182 0.263
trend except in the year 2012-13. The ratio was 96.18 percent in 2009-10
which increased to 97.14 percent in 2010-11 and reached to 97.25
percent in 2011-12. Then it decreased to 96.54 percent in 2012-13 but
increased and finally reached to 97.18 percent in 2013-14.
For Gitanjali Gems, direct labour to prime cost and direct expenses
to prime cost ratios have low values with fluctuating trend. Profit to sale
ratio had a decreasing trend for the period under study except in the year
2010-11. In 2009-10, the ratio was 3.36 percent which increased to 5.90
percent (highest) in 2010-11 but after that decreased to 4.64 percent in
2011-12, 4.32 percent in 2012-13 and declined up to 3.08 percent
(lowest) in the final year 2013-14. The average ratio was 4.26 percent
which is not satisfactory and should be improved. It is suggested that the
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management of the firm should try to increase the percentage of profit

by controlling the cost.
Costing Pattern at Vaibhav Gems Limited
Table 3.7 showed cost associated with Gems and Jewellery

manufacturing at Vaibhav Gems Ltd for the period from 2009-10 to
2013-14.
Table 3.7
Cost associated with Gems and Jewelry Manufacturing at Vaibhav
Gems Ltd
(From 2009-10 to 2013-14)
(Rs. in lacs)
Particulars 2009-10 2010-11 2011-12 2012-13 2013-14

Material Consumed 25399 6138 9464 10457 13075
Selling Expenses 138 110 146 205
Expenses Capitalized -37
Cost of Sales 28813 31443 11391 13058 16087
(in kg)
Number of Units 20768 10596 5189 4205 4401
The results in Table 3.7 summarize the cost pattern at Vaibhav

Gems Limited. It can be observed that material cost is the main cost for
this company followed by personnel expenses, manufacturing and
administrative expenses.
114
Table 3.7 shows that material consumed had a continuously

increasing trend throughout the period under study except in the year
2010-11. It was Rs. 25399 lacs in 2009-10 (highest) which decreased
sharply to Rs. 6138 lacs in 2010-11, but increased to Rs. 9464 lacs in
2011-12, Rs. 10457 lacs in 2012-13 and reached up to Rs. 13075 lacs in
the final year 2013-14.
Personnel expenses had a decreasing cum increasing trend. These

amount was Rs. 1882 lacs in 2009-10 which decreased to Rs. 1323 lacs
in 2010-11 and further cae down to Rs. 1132 lacs in 2011-12. Then it
increased to Rs. 1434 lacs in 2012-13 and inclined up to Rs. 1625 lacs in
the final year 2013-14.
Manufacturing expenses also showed exactly similar trend during

the study period. The amount for manufacturing expenses was Rs. 788
lacs in 2009-10 which decreased to Rs. 485 lacs in 2010-11 and declined
to Rs. 414 lacs in 2011-12. Afterwards, it increased to Rs. 602 lacs in
2012-13 and reached up to Rs. 811 lacs in the year 2013-14.
Selling and administrative expenses showed some fluctuating trend

but cost of sales had an increasing trend except in the year 2011-12. It
was Rs. 28813 lacs in 2009-10 which increased to Rs. 31443 lacs in
2010-11, but came down sharply to Rs. 11391 lacs in 2011-12, which
then increased again to Rs. 13058 lacs in 2012-13 and rose up to
Rs. 16087 lacs in 2013-14.
Number of units produced by the firm had a decreasing trend

except in the year 2013-14. In the year 2009-10, 20768 units (maximum)
were produced. This number decreased rapidly to 10596 units in
115
2010-11, 5189 units in 2011-12 and declined to 4205 units (minimum) in

2012-13. Finally, the number increased somewhat and reached to 4401
units in the year 2013-14. It is suggested that the management of the
firm should try to increase the sale by arranging and participating in the
exhibitions.
Table 3.8 showed different ratios of Vaibhav Gems Ltd for the
period from 2009-10 to 2013-14.
Table 3.8
Different Ratios of Vaibhav Gems Ltd
(Ratio in Percent)

2009-10 90.49 6.70 2.81 3.69
2010-11 77.25 16.65 6.10 3.06
2011-12 85.95 10.28 3.76 2.78
2012-13 83.70 11.48 4.82 6.12
2013-14 84.29 10.47 5.22 4.25
Average 84.34 11.12 4.54 3.98
S.D. 4.77 3.58 1.28 1.32
C.V. 0.057 0.322 0.282 0.333
Table 3.8 shows that material to prime cost ratio had a fluctuating
trend. It was 90.49 percent (highest) in 2009-10 which decreased to
77.25 percent in 2010-11, then increased to 85.95 percent in 2011-12 but
declined again to 83.70 percent in 2012-13. Finally, it increased slightly
to 84.29 percent in 2013-14.
For Vaibhav Gems, direct labour to prime cost and direct expenses
to prime cost ratios have low values with fluctuating trend. Profit to sale
116
ratio had a fluctuating trend for the period under study. In 2009-10, the
ratio was 3.69 percent which decreased to 3.06 percent in 2010-11 and
came down to 2.78 percent (lowest) in 2011-12 but after that it increased
sharply to 6.12 percent in 2012-13 and lastly, the ratio declined and
came down to 4.25 percent in the final year 2013-14. The average ratio
was 3.98 percent which is not satisfactory and should be improved in the
future. It is suggested that the firm should increase this ratio by
increasing sales and controlling the cost.
Costing Pattern at Rajesh Exports Ltd

The results in Table 3.9 summarize the cost pattern at Rajesh
Exports Limited. It can be observed that material cost is the main cost
for this company followed by administrative expenses and personnel
expenses.
Table 3.9
Cost Associated with Gems and Jewellery Manufacturing at Rajesh
Exports Limited
(From 2009-10 to 2013-14)
(Rs. in lacs)
Particulars 2009-10 2010-11 2011-12 2012-13 2013-14

Selling Expenses 256 321 308 1012
Cost of Sales 8,14,170 11,90,584 18,21,489 20,42,692 25,04,703
(in kg)
Number of Units 661465 778832 996681 817267 841622
117
Table 3.9 shows that material consumed had a continuously

increasing trend throughout the period under study. It was Rs. 808972
lacs in 2009-10 (lowest) which increased to Rs. 1186161 lacs in
2010-11, Rs. 1817947 lacs in 2011-12, Rs. 2032542 lacs in 2012-13 and
reached up to Rs. 2500460 lacs in the final year 2013-14.
Personnel expenses had an increasing trend except in the year

2010-11. Their amount was Rs. 492 lacs in 2009-10 which decreased to
Rs. 430 lacs in 2010-11 but increased to Rs. 513 lacs in 2011-12,
Rs. 565 lacs in 2012-13 and inclined up to Rs. 1891 lacs in the final
year 2013-14.
Manufacturing expenses showed increasing trend except in the yaer

2010-11. The amount for manufacturing expenses was Rs. 34 lacs in
2009-10 which decreased to Rs. 31 lacs in 2010-11 but increased to
Rs. 33 lacs in 2011-12. Afterwards, it increased to Rs. 51 lacs in
2012-13 and reached up to Rs. 190 lacs in the year 2013-14.
Selling and administrative expenses shows some fluctuating trend

but cost of sales had an increasing trend. It was Rs. 814170 lacs in
2009-10 which increased to Rs. 1190584 lacs in 2010-11, Rs. 1821489
lacs in 2011-12, Rs. 2042692 lacs in 2012-13 and rose up to
Rs. 2504703 lacs in the final year 2013-14.
Number of units produced by the firm had an increasing trend

produced. This number increased rapidly to 778832 units in 2010-11 and
reached to 996681 units in 2011-12. Then, it declined to 817267 units in
118
2012-13. Finally, the number increased somewhat and reached to

841622 units in the year 2013-14. It is suggested that the management of
the firm shuld control the decreasing trend.
Table 3.10 showed different ratios of Rajesh Exports Ltd for the
period from 2009-10 to 2013-14.
Table 3.10
Ratio Analysis of Rajesh Exports Ltd
(Ratio in Percent)

2009-10 99.94 0.060 0.004 0.73
2010-11 99.96 0.036 0.004 4.71
2011-12 99.97 0.028 0.002 1.53
2012-13 99.98 0.018 0.002 (-)2.01
2013-14 99.92 0.075 0.005 2.43
Average 99.95 0.04 0.003 1.48
S.D. 0.02 0.02 0.001 2.45
C.V. 0.000 0.542 0.395 1.659
trend except in the year 2013-14. It was 99.94 percent in 2009-10 which
increased to 99.96 percent in 2010-11, then increased slightly to 99.97
percent in 2011-12 and 99.98 percent in 2012-13. Finally, it decreased
and came down to 99.92 percent in 2013-14.
For Rajesh Exports, direct labour to prime cost and direct expenses
to prime cost ratios have low values with downward trend. Profit to sale
ratio had a fluctuating trend for the period under study. In 2009-10, the
119
ratio was 0.73 percent which increased to 4.71 percent in 2010-11 but
came down to 1.53 percent in 2011-12 and became negative to -2.01
percent in 2012-13 and lastly, the ratio inclined and reached to 2.43
percent in the final year 2013-14. The average ratio was 1.48 percent
which is not satisfactory and should be improved by increasing sales and
controlling the cost.
TEST OF SIGNIFICANCE (Two Way Analysis of Variance)
Test of significance has been applied by using two way analysis of

variance as follows:
1. Direct Material to Prime Cost
Following hypotheses have been set and tested-
(a) Null Hypothesis: There is no significant difference in the ratio of

direct material to prime cost between the companies under study.
(b) Null Hypothesis: The year wise difference in the ratio of direct
material to prime cost within the companies under study is not significant.
F-Ratio between the Companies (Inter Company)

Computed Value of F= 27.01
Critical Value of F at 5 percent level of significance (V1=4 and

V2=16) =3.01
The null hypothesis is rejected because the computed value of F is

more than the table value, hence it is concluded that the difference in the
ratio of direct material to prime cost between the companies under study
is significant.
120
F-Ratio within the Companies (Intra Company)
Critical Value of F at 5 percent level of significance (V1=16 &

V2=4) is 5.84
The null hypothesis is accepted as the computed value of F is less

than the critical value of F. It is therefore, concluded that the intra
company difference in the ratio of direct material to prime cost is not
significant.
2. Direct Labour to Prime Cost

(c) Null Hypothesis: There is no significant difference in the ratio of

direct labour to prime cost between the companies under study.
(d) Null Hypothesis: The year wise difference in the ratio of direct labour
to prime cost within the companies under study is not significant.
F Ratio between the Companies (Inter Company)

V2=16) =3.01
The null hypothesis is rejected because the computed value of F is

more than the table value, hence it is concluded that the difference in the
ratio of direct labour to prime cost between the companies under study is
significant.
121
F Ratio within the Companies (Intra Company)

V2=4) is 5.84

company difference in the ratio of direct labour to prime cost is not
significant.
3. Direct Expenses to Prime Cost
(e) Null Hypothesis: There is no significant difference in the ratio of

direct expenses to prime cost between the companies under study.
(f) Null Hypothesis: The year wise difference in the ratio of direct
expenses to prime cost within the companies under study is not significant.
F Ratio between the Companies (Inter Company)

V2=16) =3.01
The null hypothesis is rejected because the computed value of F

(10.06) is more than the table value (3.01), hence it is concluded that the
difference in the ratio of direct expenses to prime cost between the
companies under study is significant.
122

V2=4) is 5.84

company difference in the ratio of direct expenses to prime cost is not
significant.
4. Profit to Sales
(g) Null Hypothesis: There is no significant difference in the ratio

of profit to sales between the companies under study.
(h) Null Hypothesis: The year wise difference in the ratio of profit
to sales within the companies under study is not significant.
F-Ratio between the Companies (Inter Company)

V2=16) =3.01
Since the computed value of F is more than the critical value of F at

5 percent level of significance, hence the null hypothesis is rejected and
it is concluded that the difference in the ratio of profit to sales between
the companies under study is significant.
123

V2=4) is 5.84

company difference in the ratio of profit to sales is not significant.
Marginal Cost of Production for the Sampled Companies
Marginal cost is defined as the increase or decrease in the total cost

of production for making one additional unit of an item. It is computed
in situations where the break-even point has been reached: the fixed
costs have already been absorbed by the already produced items and
only the direct labours have to be accounted for. Marginal costs are
variable costs consisting of labour and material costs, plus estimated
portion of fixed costs (such as administration overheads and selling
expenses). In this research, marginal cost has been estimated by dividing
the difference between the average costs of sales during the period from
2009-10 to 2013-14, by the average quantities produced by each firm
during the corresponding time period.
124
Table 3.11
Marginal Cost Estimation of the Sampled Companies
Company Cost Cost Qty (Period1) Qty (Period2) Marginal
(Period1) (Period2) Cost
(in Lacs)
Surana 4,96,699 3,23,510 2,13,854 1,74,718 4.43
Classic 46,610 57,268 23,110 32,886 1.09
Gitanjali 4,43,243 3,21,406 1,84,688 1,73,805 11.19
Vaibhav 17,995 21,176 6,098 10,189 0.78
Rajesh 18,89,867 14,67,234 8,58,601 8,13,561 9.38
Source: Annual Reports and Accounts of the Companies under study from 2009-10 to 2013-14.
From Table 3.11, it can be observed that marginal cost was

minimum for Vaibhav Gems that was Rs. 0.78 lacs, then Rs. 1.09 lacs
for Classic Diamonds, Rs. 4.43 lacs for Surana Jewellers, Rs. 9.38 lacs
for Rajesh Exports and maximum Rs. 11.19 lacs for Gitanjali Gems. The
large difference in marginal costs of the firms under study clearly
indicate that there is a huge difference between selling and expenses
among them.
BREAK EVEN ANALYSIS
Break Even Point
Break Even Point is the point at which total revenue is equal to

total cost. It is the point of no profit; no loss. In its broad sense; it means
a system of analysis that can be used to determine the probable point at
any level of Production.
Break even analysis is the analysis of three variables i.e., cost,

volume and profit. This analysis measurers variation of cost and
125
volumes and their impact on profit. Profit is affected by several internal

and external factors which influence sales revenue and cost.
Break even analysis helps the management in profit planning. Profit

of a concern can be increased by increasing the output and sales or
reducing cost. If a concern produces to the maximum capacity and sell,
contribution is also increased to the maximum level.
Heiser puts it in the following words, “The most significant single

factor in planning of the average business is the relationship between the
volume of business, its cost and profit.”9 Thus cost, volume and profit
analysis is an attempt to measure the effect of changes in volume, cost,
price and product mix on profits with the increase in volume unit cost of
production decrease and vice versa, because the fixed cost and constant
with the decrease in fixed cost per unit profit will be more. Break even
analysis is made with the objective of ascertaining the following:
1. The cost for various levels of production.
2. The desirable volume of production.
3. The profit at various levels of production.
4. The difference between sales revenue and variable cost.
IMPORTANCE OF BREAKEVEN ANALYSIS

We all known that the break even point in a business is when it’s
not making a profit or losing money. Most business owners either don’t
know it or think they know it, with neither exactly knowing. Break even
can be expressed as a rupee amount or unit sales, and once determined,
9. Berliner C. and Brimson J.A. (1998), op.cit., p.279.
126
one has a target to reach through carefully though out of Business

Plan.10
It is very important to understand that increased sales do not always

translate into increased profits. Many companies have gone out of
business by ignoring the importance of Breakeven Analysis, thinking
increased sales will lead to certain profitability. Unfortunately, more
often than not, the company’s variable costs, or those directly derived
from sales levels, get exponentially larger as sales volume grows. Not
knowing the variable costs is a silent killer for many companies.
When calculating the Breakeven Point, one has to make certain

assumptions and estimates error on the side of conservation numbers by
using more pessimistic sales and margin thresholds, while overstating
the projected costs. Business firms want the Breakeven Point to be in the
safe zone - a worst case threshold.
The Importance of Breaking Even in Business Finance

Breaking even is extremely important for all business. A business
breaks even when it earns enough sales revenues to pay for all expense.
In other words, all costs have been paid, though the business did not
suffer a loss or make a profit. The break-even point usually is calculated
on a monthly or annual basis. If the business is not at least breaking
even, then firm must revaluate the business strategy and make
appropriate changes.11
10. Lauderman M. and Schaeberle F.W. (2003), “The cost accounting practices of firms using
standard costs”, Cost and Management (Canada), July/August, 31–5.
11. Berliner C. and Brimson J.A. (1988), “Cost Management for Today’s Advanced
Manufacturing”, Harvard Business School Press, p.221.
127
Basics : To accurately gauge the break-even point, the firms need to

evaluate several factors. First calculate fixed costs, meaning all of the
expenses needed to one product. If the firm has a furniture business, then
calculate the total cost (e.g. labour, materials, shipping) of obtaining one
piece of furniture. Next, calculate variable costs, which increase or
decrease as the firm produce more products. Examples of overhead
expenses include - retail or warehouse space, utilities, insurance and
office staff, such as an accountant, receptionist or security personal.
Considerations : Do not be overwhelmed with expenses simply

because the business has a lot of them. One must understand how much
the business is spending, as the business can succeed instead of barely
surviving or even failing. Consider working with a certified public
accountant to ensure that you calculate all costs.
Price : After realizing how much the product or service costs the
business, assess the unit price. For example, if the business own a
computer repair business, one should know whether the business is
changing clients enough so that the firm at least break even. The break
even point (number of units one must sell) equals the fixed cost divided
by the difference between the unit price and variable unit cost. Use break
even point to establish the pricing structure as well as target sales goals
(e.g., need X number of clients each week).
Benefits : Make sure that management renegotiate long-term

expenses by contacting the suppliers and asking for better deals. For
instance, if the business operates a spa that is not breaking even, call the
supplier of shampoos and conditioners. Ask for different terms, such as
128
getting a 15 percent discount by ordering an extra box of create. If the

supplier is not interested, then research other ways one can get similar
materials. One should never rely on just one supplier, distributor or
manufacturer.
Potential : For the expansion of business, use break-even analysis

to estimate potential profit and calculate necessary sales. In fact, many
investors want businesses to include break-even analysis within their
business plans so investors can gauge possible returns on their
investments. There are many other calculations that can be prepared to
strengthen operations.
The break-even analysis depends on three key assumptions12 :
1. Average Per-Unit Sales Price (Per Unit Revenue):- This is the

price that business receive per unit of sales. Take into account
sales discounts and special offers. Get this number from the
sales forecast. For non-unit based businesses, make the
per-unit revenue rupee one, and enter costs as a percent of a
rupee. The most common questions about this input relate to
averaging many different products into a single estimate. The
analysis requires a single number, and if the firm builds its
sales forecast first, then it will have this number. 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 the incremental cost, or

variable cost, of each unit of sales. If business buy goods for
12. Brealey J.A. (2006), “The calculation of product costs and their use in decision-making in the
British Manufacturing Industry”, Ph.D. dissertation, University of Huddersfield.
129
resale, this is what it paid, on average, for the goods from sell.
If firm sells a service, this is what it costs, per rupee of
revenue or unit of service delivered, to deliver that service. If
business is using a Units-Based Sales Forecast table (for
manufacturing and mixed business types), one can project
unit costs from the sales forecast table. If business is using the
basic sales forecast table for retail, service and distribution
business, use a percentage estimate, e.g., retail store running a
50% margin would have a per-unit cost of Rs.5, and a per unit
revenue of rupee 1.
3. Monthly Fixed Costs: Technically, a break even analysis

defines fixed costs as costs that would continue. Instead, we
recommend that one uses his regular running fixed costs,
including payroll and normal expenses (total monthly
Operating Expenses). This will give the business a better
insight on financial realities. If averaging and estimating is
difficult, use profit and 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.
MANAGEMENT TOOLS
A breakeven chart is a strategic tool used to plot the financial
revenue of a business unit against time or sales to determine to point
when sales output is equal to revenue generated. This is recognized as
the breakeven point. The information used to determine and analysis the
breakeven and point includes fixed, variable and total costs and the
associated sales revenues. They are defined as:
130
The Breakeven Chart

· Fixed Costs: costs that do not vary in relation to the level of
sales output, for example rent.
· Variable Costs: Costs that very in proportion to the level of sales
output, for example materials.
· Total Costs: The sum of all costs, including fixed and variable.
· Associated Sales Revenues: The total revenue made by the

company from sales. It can be derived by multiplying price by
output.
The analysis of a breakeven chart considers whether a venture runs

at a profit or a loss. Sales above the breakeven point indicates continued
and profitable growth. The principle of break-even theory is that during
the early stages of a business venture, total costs, both fixed and variable
exceed sales. As output increases, sales begin to rise faster than costs
131
and, eventually, they become equal (breakeven point). If sales continue

to rise and exceed total costs, the business achieves profitability.13
The tool assumes that all the goods which are produced will be sold
and that costs, namely the price, will remain constant. Likewise, it also
relies on the capacity in terms of output to remain unchanged.
LIMITATIONS OF BREAK EVEN POINT
Like all methods of estimating breakeven, this approach has its

limitations. The cost of goods sold method, like other methods, depends
on having accurate historical information. It is retrospective in its
perspective. Using this approach to look to the future to estimate the
breakeven point depends having on its assumption. If we are using
assumptions based on recent past history, one must assume future
consumer behavior will continue relatively unchanged into the
immediate future (into the next relevant short term period of the for
which break even needs to be estimated) This method calculates
breakeven in terms of rupees of gross revenue but not the number of unit
sold (customer served) to break even, but such an estimate will have a
margin of error that is unacceptable in a highly price competitive market
where customers are more price sensitive.
For every business that sells more than one product or service, the
issue of sale mix or product mix affects the break even point. The broad
approach does not attempt to take into account the sale mix. For some
business, the fixation of sale mix from day to day or week to week can
13. Sizer J. (1999), “An Insight into Management Accounting”, Penguin, Chs 11, 12.
132
be great. This variation has a direct impact on the variability of the

breakeven point. The greater the variability of the breakeven point, the
greater the rise that managers will not have the information needed to
make timely decisions as conditions change.14
By itself, the cost of good sold approach does not tell us the
breakeven point change with volume of sales or as the scale.
BREAK-EVEN POINT ANALYSIS

The break-even point is, in general, the point at which the gains
equal the losses. A break-even point defines when an investment will
generate a positive return. The point where sales or revenues equal
expenses. Or also the point where total costs equal total revenues. There
is no profit made or loss incurred at the break-even point. This is
important for anyone that manages a business, since the break-even
point is the lower limit of profit when prices are set and margins are
determined. The change in total cost that comes from making or
producing one additional item. The purpose of analyzing marginal cost is
to determine at what point an organization can achieve economies of
scale.
The calculation is most often used among manufacturers as a means

of isolating an optimum production level. A company’s breakeven point
is the point at which its sales exactly cover its expenses. The company
sells enough units of its product to cover its expenses without making a
profit or taking a loss. If it sells more, then it makes a profit. On the
14. Ibid.
133
other hand, if it sells less, it makes a loss. To compute a company’s

breakeven point in sales volume, one needs to know the values of those
variables. Those three variables are fixed costs, variable costs, and the
price of the product. Fixed costs are those which do not change with the
level of sales, such as overhead. Variable costs are those which do
change with the level of sales, such as cost of goods sold. The price of
the product has been set by the company through looking at the
wholesale cost of the product, or the cost of manufacturing the product,
and marking it up. The estimation of the break-even point for the firms
during different financial years is presented in Table 3.12.
134
Table 3.12
Break-even Point Analysis
PARAMETER COMPANY 2009-10 2010-11 2011-12 2012-13 2013-14
Surana Jewellers 158527 220631 393861 518424 850190
Classic Diamonds 56382 54489 58070 44335 20793
Total Variable
Cost Gitanjali Gems 234542 237679 299537 455529 699107
(in Lakhs)
Vaibhav Gems 25399 16138 9464 10457 13075
Rajesh Exports 808972 1186161 1817947 2032542 2500460

Total Fixed Cost
Gitanjali Gems 13068 10946 12963 21358 35852
(in Lakhs)
Vaibhav Gems 3414 15305 1927 2601 3012
Rajesh Exports 5198 4423 3542 10150 4243


Number of Units
Gitanjali Gems 191776 156060 164220 183164 235310
Produced
Vaibhav Gems 20768 10596 5189 4205 4401
Rajesh Exports 661465 778832 996681 817267 841622
Surana Jewellers 1.28 1.55 1.88 2.55 3.03

Classic Diamonds 1.54 1.74 2.21 2.82 3.30
Per Unit Selling
Price Gitanjali Gems 1.38 1.73 2.04 2.80 3.30
(in Lakhs)
Vaibhav Gems 1.50 1.62 2.34 3.46 4.01
Rajesh Exports 1.24 1.46 1.80 2.45 3.05

Break-Even Point
Gitanjali Gems 81094 53848 59181 68921 110366
(Units)
Vaibhav Gems 12335 157758 3749 2676 2885
Rajesh Exports 351205 -* -* -* 55002
*Company was in loss

Source: Annual Reports and Accounts of Companies under study for 2011-12 to 2013-14.
Surana Jewellers : Table 3.12 shows that total variable cost for
Surana Jewellers had an increasing trend throughout the period under
135
study. Initially in 2009-10, it was Rs. 158527 lacs which increased and
finally reached up to Rs. 850190 lacs in 2013-14. Total fixed cost
showed an increasing trend also except in the year 2010-11. Initially in
2009-10, it was Rs. 675 lacs which finally reached up to Rs. 1767 lacs in
2013-14. Number of units produced had an increasing trend except in the
year 2012-13. Starting from 129653 units in 2009-10, Surana Jewellers
produced 286137 units in the final year 2013-14, that is more than
double in numbers. Per unit selling price increased continuously for
Surana Jewellers. In 2009-10, it was Rs. 1.28 lacs which reached up to
Rs. 3.03 lacs in 2013-14.
Break-even point for Surana Jewellers had a fluctuating trend for

the period under study. In 2009-10, it was equal to 12544 units which
increased sharply to 21836 units in 2010-11 but decreased more rapidly
to 11725 units in 2011-12 and further came down slightly to 11488 units
in 2012-13. Finally, it increased and reached up to 30814 units in
2013-14 which was the highest break-even point for the firm.
Classic Diamonds : The total variable cost for Classic Diamonds

had a decreasing trend throughout the period under study except in the
year 2011-12. Initially in 2009-10, it was Rs. 56382 lacs which
decreased and finally came down to Rs. 20793 lacs in 2013-14. Total
fixed cost showed a continuously decreasing trend. Initially in 2009-10,
it was Rs. 7787 lacs which declined and finally came to Rs. 747 lacs in
2013-14. Number of units produced also had a decreasing trend. Starting
from 46101 units in 2009-10, Classic Diamonds produced only 6999
units in the final year 2013-14, that is less than one-fifth of initial units
136
in numbers. On the other hand, per unit selling price increased

continuously for Classic Diamonds. In 2009-10, it was lowest at
Rs. 1.54 lacs which reached up to Rs. 3.30 lacs in 2013-14.
Break-even point for Classic Diamonds had a decreasing trend for

the period under study. In 2009-10, it was equal to 24876 units which
decreased sharply to 17264 units in 2010-11, 6819 units in 2011-12,
4943 units in 2012-13. Finally, it decreased and further came down to
2293 units in 2013-14 which was the lowest break-even point for the
firm.
Gitanjali Gems : Table 3.12 shows that total variable cost for
Gitanjali Gems had an increasing trend throughout the period under
study. Initially in 2009-10, it was Rs. 234542 lacs which increased and
finally reached up to Rs. 699107 lacs in 2013-14. Total fixed cost
showed an increasing trend also except in the year 2010-11. Initially in
2009-10, it was Rs. 13068 lacs which finally reached up to Rs. 35852
lacs in 2013-14. Number of units produced had an increasing trend
except in the year 2010-11. Starting from 191776 units in 2009-10,
Gitanjali Gems produced 235310 units in the final year 2013-14. Per
unit selling price increased continuously for Gitanjali Gems. In 2009-10,
it was Rs. 1.38 lacs which reached up to Rs. 3.30 lacs in 2013-14.
Break-even point for Gitanjali Gems had an increasing trend for the
period under study except in the year 2010-11. In 2009-10, it was equal
to 81094 units which decreased sharply to 53848 units in 2010-11 but
after that increased to 59181 units in 2011-12, 68921 units in 2012-13.
137
Finally, it increased and reached up to 110366 units in 2013-14 which

was the highest break-even point for the firm.
Vaibhav Gems : The total variable cost for Vaibhav Gems had a
fluctuating trend. Initially in 2009-10, it was Rs. 25399 lacs which
fluctuate and finally came down to Rs. 13075 lacs in 2013-14. Total
fixed cost showed an increasing trend except in the year 2011-12.
Initially in 2009-10, it was Rs. 3414 lacs which declined and finally
came to Rs. 3012 lacs in 2013-14. Number of units produced also had a
decreasing trend except in the year 2013-14. Starting from 20768 units
in 2009-10, Vaibhav Gems produced only 4401 units in the final year
2013-14, that is less than one-fourth of initial units in numbers. On the
other hand, per unit selling price increased continuously for Vaibhav
Gems. In 2009-10, it was lowest at Rs. 1.50 lacs which reached up to
Rs. 4.01 lacs in 2013-14.
Break-even point for Vaibhav Gems had a decreasing trend for the
period under study except in the years 2010-11 and 2013-14. In 2009-10,
it was equal to 12335 units which increased sharply to 157758 units in
2010-11, but declined rapidly to 3749 units in 2011-12 and came down
to 2676 units in 2012-13. Finally, it increased and reached to 2885 units
in 2013-14.
Rajesh Exports : It can be seen from Table 3.12 that for Rajesh
Exports, total variable cost had an increasing trend throughout the period
under study. Initially in 2009-10, it was Rs. 808972 lacs which increased
and finally reached up to Rs. 2500460 lacs in 2013-14. Total fixed cost
showed a decreasing trend except in the year 2012-13. Initially in
138
2009-10, it was Rs. 5198 lacs which finally came to Rs. 4243 lacs in
2013-14. Number of units produced had an increasing trend except in the
year 2012-13. Starting from 661465 units in 2009-10, Rajesh Exports
produced 841622 units in the final year 2013-14. Per unit selling price
increased continuously for Rajesh Exports. In 2009-10, it was Rs. 1.24
lacs which reached up to Rs. 3.05 lacs in 2013-14.
In 2009-10, break-even point for Rajesh Exports was 351205 units

which came down to 55002 units in 2013-14.
MARGINAL COSTING
Meaning of Cost Volume Profit
Cost-volume-profit (CVP) analysis is used to determine how

changes in costs and volume affect a company’s operating income and
net income. Key calculations when using CVP analysis are the
contribution margin and the contribution margin ratio. The contribution
margin represents the amount of income or profit the company made
before deducting its fixed costs. Said another way, it is the amount of
sales rupees available to cover (or contribute to) fixed costs. When
calculated as a ratio, it is the percent of sales dollars available to cover
fixed costs. Once fixed costs are covered, the next rupee of sales results
in the company having income. CVP analysis provides managers with
the advantage of being able to answer specific pragmatic questions
needed in business analysis. Questions such as what the company’s
breakeven point is help managers project how future spending and
139
production will contribute to the success or failure of the company. For

instance, when a manager knows the breakeven point, he can decide for
spending and increase production efforts to increase profitability.
Because CVP analysis is based on statistical models, decisions can be
broken down into probabilities that help with the decision-making
process.
Another major benefit of CVP analysis is that it provides a detailed

snapshot of company activity. This includes everything from the costs
needed to produce a product to the amount of the product produced. This
helps managers determine, very specifically, what the future will hold if
variables are altered. For instance, transportation expenses and costs for
materials can change. These variable costs can affect the bottom line.
CVP analysis allows the manager to plug in variable costs to establish an
idea of future performance, within a range of possibilities. This,
however, can be a disadvantage to managers who are not detail-oriented
and precise with the data they record. Projections based on cost
estimates, rather than precise numbers, can result in inaccurate
projections.
Even though CVP analysis is based on specific data and requires

tremendous attention to detail, the best that it can do is provide
approximate answers to questions, rather than ones that are exact. It
answers hypothetical questions better than it provides actual answers for
solving problems. It leaves the business manager to decide how to act on
the CVP analysis data he has at hand. For this reason, the manager has to
exercise extreme caution when making decisions about changes to
140
business operations and finance. Judgments have to be made after

careful investigation and deliberation — and not just be based solely on
statistics. Investigation may involve, for instance, interviewing
employees and carefully observing their daily activities, as opposed to
simply treating them as part of a statistical model. In performing this
analysis, there are several assumptions made, including:
· Sales price per unit is constant.
· Variable costs per unit are constant.
· Total fixed costs are constant.
· Everything produced is sold.
· Costs are only affected because activity changes.
· If a company sells more than one product, they are sold in the
same mix.15
Cost-Volume Profit (CVP) Analysis

Profits of business firms are the result of many factors such as:
(i) selling prices, (ii) volume of sales (iii) unit variable costs (iv) total
fixed costs, (v) combinations in which the various product lines are sold,
etc. To do an effective planning, management must analyse how profits
will be affected by a change in any one of these factors. A cost volume
profit (CVP) analysis is useful to management in knowing how profit is
influenced by sales volume, sales price, variable expenses and fixed
expense. Broadly, CVP analysis uses the techniques of (i) Break-even
analysis and (ii) Profit-Volume (P/V) analysis.
15. Drury C. (2008), “Management and Cost Accounting”, Cengage Learning EMEA, pp.150-53.
141
It was observed that in marginal costing, marginal cost varies

directly with the volume of production or output. On the other had, fixed
cost remains unaltered regardless of the volume of output within the
scale of production already fixed by management. In case if cost
behavior is related to sales income, it shows cost-volume profit
relationship. In net effect, if volume is changed, variable cost varies as
per the change in volume. In this case, selling price remains fixed, fixed
remains fixed and then there is a change in profit.
Being a manager, one constantly strive to relate these elements in

order to achieve the maximum profit. A part from profit projection, the
concept of Cost-Volume-Profit (CVP) is relevant to virtually all decision
making areas, particularly in the short run.
The relationship among cost, revenue and profit at different levels

may be expressed in graphs such as breakeven charts, profit volume
graphs, or in various statement forms.
Profit depends on a large number of factors, most important of

which are the cost of manufacturing and the volume of sales. Both these
factors are interdependent. Volume of sales depends upon the volume of
production and market forces which in turn is related to costs.
Management has no control over market. In order to achieve certain
level of profitability, it has to exercise control and management of costs,
mainly variable cost. This is because fixed cost is a non-controllable
cost. But then, cost is based on the following factors:
· Volume of production
142
· Product mix
· Internal efficiency and the productivity of the factors of

production
· Methods of production and technology
· Size of batches
· Size of Plant
Thus, one can say that cost-volume-profit analysis furnishes the

complete picture of the profit structure. This enables management to
distinguish among the effect of sales, fluctuations in volume and the
results of changes in price of product/services.16
Limitations of CVP Analysis
CVP analysis is a useful planning and control device, usually in the

form of a chart, showing how revenue, costs, and profit fluctuate with
volume. The CPV technique is useful to management in areas of
budgeting, cost control and decision making. Inspite of CVP being a
useful technique, it suffers from some limitations. Firstly, because of the
many assumptions, CVP is only an approximation at best. If prices, unit
costs, sales-mix, operating efficiency, or other relevant factors change,
then the overall CVP analysis and relationship also must be modified.
Because of these assumptions, cost data are of limited significance.
In a multi-product situation, different products typically yield

different contribution margins and are produced in various volumes with
16. Lauderman M. and Schaeberle F.W. (2003), op.cit., p.29.

143
differing costs. As a result neither the revenue curve nor the cost curve is
necessarily straight and the break-even point in difficult to find.
Therefore, while preparing or interpreting cost-volume profit

analysis, all assumptions and limitations should be carefully considered.
A series of CVP analysis based on different sets of assumptions and
circumstances may be prepared to reflect situations prevailing in
different business enterprises. When circumstances change, CVP
analysis should also be revised to reflect the changing situations. It is
also necessary to have up-to-date analysis so that it can act as a useful
device in profit forecast, budgeting. Cost control and managerial
decision making.
The CVP analysis is generally made under certain limitations and

with certain assumed conditions, some of which may not occur in
practice. Following are the main limitations and assumptions in the cost-
volume profit analysis:
1. It is assumed that the production facilities anticipated for the

purpose of cost-volume profit analysis do not undergo any
change. Such analysis gives misleading results if expansion
or reduction of capacity takes place.
2. In case where a variety of products with varying margins of

profit are manufactured, it is difficult to forecast with
reasonable accuracy the volume of sales mix which would
optimize the profit.
144
3. The analysis will be correct only if input price and selling

price remain fairly constant which in reality is difficulty to
find. Thus, if a cost reduction program is undertaken or
selling price is changed, the relationship between cost and
profit will not be accurately depicted.
4. In cost-volume profit analysis, it is assumed that variable

costs are perfectly and completely variable at all levels of
activity and fixed cost remains constant throughout the range
of volume being considered. However, such situations may
not arise in practical situations.
5. It is assumed that the changes in opening and closing

inventories are not significant, though sometimes they may be
significant.
6. Inventories are valued at variable cost and fixed cost is

treated as period cost. Therefore, closing stock carried over to
the next financial year does not contain any component of
fixed cost. Inventory should be valued full cost in reality.
Objectives of Cost-Volume-Profit Analysis
1. In order to forecast profits accurately, it is essential to

ascertain the relationship between cost and profit on one hand
and volume on the other.
2. Cost-volume-profit analysis is helpful in setting up flexible

budget which indicates cost at various levels of activities.
3. Cost-volume-profit analysis assist in evaluation performance

for the purpose of control.
145
4. Such analysis may assist management in formulating pricing

policies by projecting the effect of different price structures
on cost and profit.
Assumptions and Terminology
Following are the assumptions on which the theory of CVP is

based:
1. The changes in the level of various revenue and costs arise only
because of the changes in the number of product (or service) units
produced and sold. The number of output (units) of be sold is the only
revenue and cost driver. Just as a cost driver is any factor that affects
costs, a revenue driver is any factor that affects revenue.
2. Total costs can be divided into a fixed component and a

component that is variable with respect to the level of output. Variable
costs include the following:
a. Direct materials
b. Direct labour
c. Direct chargeable expenses
Variable overheads include the following:
a. Variable part of factory overheads
b. Administration overheads
c. Selling and distribution overheads
3. There is linear relationship between revenue and cost.

146
4. When put in a graph the behavior of total revenue and cost is

linear (straight line) i.e. Y = mx+C holds good which is the equation of a
straight line.
5. The unit selling price, unit variable costs and fixed costs are
constant.
6. The theory of CVP is based upon the production of a single

product. However of late, management accountants are functioning to
give a theoretical and a practical approach to multi- product CVP
analysis.
7. The analysis either covers a single product or assumes that the

sales mix sold in case of multiple products will remain constant as the
level of total units sold changes.
8. All revenue and cost can be added and compared without taking
into account the time value of money.
9. The theory of CVP is based on the technology that remains

constant.
10. The theory of price elasticity is not taken into considerations.17
COMPARATIVE ANALYSIS OF COST MANAGEMENT
Direct Material Cost
Direct material cost is the cost of the raw materials and components
used to create a product. The materials must be easily identifiable with
17. Drucker P.F. (1994), op.cit., p.217.

147
the resulting product (otherwise they are considered to be joint costs).

The direct material cost is one of the few variable costs involved in the
production process; as such, it is used in the derivation of throughput
from production processes. Throughput is sales minus all totally variable
expenses. Examples of direct materials are: (i) The gold used
(ii) Precious/semi-precious stones used.
The results in Table 3.13 summarizes the direct materials cost, as a

percentage total cost, incurred by the firms analysed in this research
study for the last five financial years.
Table 3.13
Direct Material Cost to Cost of Sales Ratio of Firms under Study
(From 2009-10 to 2013-14)
(Ratio in Percent)
Year Surana Classic Gitanjali Vaibhav Rajesh

Jewellers Diamonds Gems Gems Exports
2009-10 99.58 87.86 94.72 88.15 99.36
2010-11 99.77 93.57 95.60 51.32 99.63
2011-12 99.83 95.68 95.85 83.08 99.81
2012-13 99.86 96.44 95.52 80.08 99.50
2013-14 99.79 96.53 95.12 81.28 99.83
Average 99.77 94.02 95.36 76.78 99.63
S.D. 0.11 3.64 0.44 14.56 0.20
C.V. 0.001 0.039 0.005 0.190 0.002
Table 3.13 showed that direct material cost to sales ratio had an
increasing trend except in the year 2013-14 for Surana Jewellers,
although the increase was negligible which is confirmed by standard
148
deviation 0.11 and coefficient of variation 0.001. For Classic Diamonds

the trend was continuously increasing as the ratio was 87.86 percent in
2009-10 which continuously increased and finally reached to 96.53
percent in 2013-14.
For Gitanjali Gems and Rajesh Exports, the ratio showed

fluctuating trend but fluctuations were very low whereas, in case of
Vaibhav Gems, the ratio had highly fluctuating trend that should be
controlled.
It can be observed that all the firms spent a significant proportion of

its total cost in purchase of raw materials. It is observed that among the
five firms analyzed in this research, Surana Jewellers (99.77%) spends
highest proportion of its total cost on purchase of raw materials,
followed by Rajesh Exports (99.63%), Gitanjali Gems (95.36%), Classic
Diamonds (94.02%), and Vaibhav Gems (76.78%).
Test of Significance
Following hypotheses have been set and tested by applying two

way analysis of variance of F-test:
(i) Null Hypothesis (Ho) : There is no significant difference in the

ratio of material cost to sales between the companies under study.
(ii) Null Hypothesis (Ho): There is no significant difference is the

year-wise ratio of material cost to sales of the companies under study.
149
Table 3.14
ANOVA TALE
Source Sum Degree of Variance F-Ratio
Freedom (Sum/d.f)
(d.f.)
Between 1781.25 (c-1)=(5-1)=4 445.31 F = 9.49
Companies (SSC) (Between
Companies)
Within 166.87 (r-1)=(5-1)=4 41.72 F = 1.25
Companies (SSR) (Within
Error 750.55 (c-1)(r-1)=16 46.91 Companies)
(i) F-Test Between the Companies (Inter Companies)

HigherVariance 445.31
F = = = 9.49
SmallerVariance 46.91
Critical value of F at 5 percent level of significance (For V1 = 4 and

V2 = 16) is 3.01.
Decision: Since the calculated value of F (9.49) is more than the

critical value of F at 5 percent level of significance (3.01) therefore, the
null hypothesis is rejected and it can be concluded that the difference in
the ratio of direct material cost to sales of the companies under study is
significant.
(ii) F-Test Within the Companies (Intra Companies)

F = = = 112
.
Critical value of F at 5 percent level of significance (V1 = 16 and

V2 = 4) is 5.84.
150
Decision: Since the calculated value of F is less than the critical

value of F at 5 percent level of significance, hence there is no evidence
of rejecting the null hypothesis. The null hypothesis is accepted and it
can be concluded that the intra company difference in the direct material
cost to sales ratio is not significant.
Direct Labour Cost

Direct labour cost is a part of wage-bill or payroll that can be
specifically and consistently assigned to or associated with the
manufacture of a product, a particular work order, or provision of a
service. In other words, it is the cost of the work done by those workers
who actually make the product on the production line. The direct labour
cost is generally incurred in every process.
The direct labour cost to sales ratio of the firms under study has
been shown in the following Table 3.15.
Table 3.15
Direct Labour Cost to Cost of Sales Ratio of Firms under Study
(From 2009-10 to 2013-14) (Ratio in Percent)
2009-10 0.10 4.47 0.47 6.53 0.06
2010-11 0.11 3.07 0.64 4.21 0.04
2011-12 0.07 3.05 0.48 9.94 0.03
2012-13 0.07 2.23 0.52 10.98 0.03
2013-14 0.04 1.96 0.36 10.10 0.08
Average 0.08 2.96 0.49 8.35 0.05
S.D. 0.03 0.98 0.10 2.87 0.02
C.V. 0.356 0.331 0.204 0.344 0.452
151
The results in Table 3.15 summarize the direct labour cost, as a

percentage of sales, incurred by the firms analysed in this research study
for the last five financial years. It can be observed that most of the firms
spend a very small proportion of its total cost as direct labour cost. It is
observed that among the five firms analyzed in this research, Vaibhav
Gems (8.35%) spends highest proportion of its total cost as direct labour
cost, followed by Classic Diamonds (2.96%), Gitanjali Gems (0.49%),
Surana Jewellers (0.08%), and Rajesh Exports (0.05%). Further, it can
be observed that the proportion of total sales cost spent as direct labour
cost during the last five financial years had decreased for Surana
Jewellers, Classic Diamonds and Rajesh Exports whereas Gitanjali
Gems and Vaibhav Gems had a fluctuating trend.


ratio of Direct Labour Cost to sales between the companies under study.

year-wise ratio of Direct Labour Cost to sales of the companies under
study.
152
Table 3.16
ANOVA TALE
Freedom (Sum/d.f)
(d.f.)
Between 251.45 (c-1)=(5-1)=4 62.86 F = 30.97
Companies)
Within 4.33 (r-1)=(5-1)=4 1.08 F = 1.88

F = = = 30.97

V2 = 16) is 3.01.
Decision: Since the calculated value of F is more than the critical

value of F at 5 percent level of significance therefore, the null hypothesis
is rejected and it can be concluded that the difference in the ratio of
direct labour cost to sales of the companies under study is significant.

HigherVariance 2.03
F = = = 188
.

V2 = 4) is 5.84.
Decision: Since the calculated value of F(1.88) is less than the

critical value of F(5.84) at 5 percent level of significance, hence there is
153
no evidence of rejecting the null hypothesis. The null hypothesis is

accepted and it can be concluded that the intra company difference in the
direct labour cost to sales ratio is not significant.
Direct Expenses
Direct expenses are the expenses in addition to direct material and
labour cost which can be directly attributed to a particular process. It is
that portion of expense that is directly expended in providing a product
or service for sale and is included in calculation of cost of goods sold,
e.g. labour and inventory. All expenses which are incurred for
production or purchasing are called direct expenses.
Table 3.17
Direct Expenses to Cost of Sales Ratio of the Firms under Study
(From 2009-10 to 2013-14)
(Ratio in Percent)

2009-10 0.036 6.031 3.285 2.735 0.004
2010-11 0.011 2.359 2.175 1.542 0.003
2011-12 0.011 0.361 2.228 3.634 0.002
2012-13 0.007 0.220 2.895 4.610 0.002
2013-14 0.016 0.162 2.397 5.041 0.008
Average 0.016 1.827 2.596 3.512 0.004
S.D. 0.011 2.523 0.479 1.418 0.003
C.V. 0.711 1.381 0.184 0.404 0.655
The results in Table 3.17 summarizes direct expenses, as a

percentage of total cost, incurred by the firms analyzed in this research
154
study for the last five financial years. It can be observed that most of the
firms spend 1-3% of its total cost as direct expenses. Among the five
firms analyzed in this research, Vaibhav Gems (3.512%) spends highest
proportion of its total cost as direct expenses, followed by Gitanjali
Gems (2.596%), Classic Diamonds (1.827%), Surana Jewellers
(0.016%), and Rajesh Exports (0.004%). Further, it can be observed that
the proportion of total sales cost spent as direct expenses during the last
five financial years had decreased for Surana Jewellers, Classic
Diamonds, and Gitanjali Gems. In contrast, the proportion of total sales
cost spent as direct expenses for Vaibhav Gems and Rajesh Exports had
increased during the last five financial years. Classic Diamonds has
experienced maximum decrease and Vaibhav Gems has experience
maximum increase in their proportion of total cost spent as direct
expenses.


ratio of Direct Expenses to cost of sales between the companies under
study.

year-wise ratio of Direct Expenses to cost of sales of the companies
under study.
155
Table 3.18
ANOVA TALE
Freedom (Sum/d.f)
(d.f.)
Between 48.78 (c-1)=(5-1)=4 12.20 F = 6.32
Companies)
Within 3.54 (r-1)=(5-1)=4 0.89 F = 2.17

F = = = 6.32
V2 = 16) is 3.01.
Decision: Since the calculated value of F (6.32) is more than the
null hypothesis is rejected and it can be concluded that the difference in
the ratio of direct expenses to cost of sales of the companies under study
is significant.

HigherVariance 1.93
F = = = 2.17

V2 = 4) is 5.84.

value of F at 5 percent level of significance, hence the null hypothesis is
156
direct expenses to cost of sales ratio is not significant.
Production Overheads
Production overheads are indirect expenses associated with
processes used to produce a good or service. It includes expenses such as
stationery, utilities, support staff salaries, and rent and other facilities
costs. The overhead expenses are generally expended over all the
processes involved in production process. These are to be apportioned
over the various processes in an amicable manner. In order to improve
the efficiency and profitability of production process the production
overheads needs to be reduced.
The production overheads to cost of sales ratio of the firms under

study has been shown in the following Table 3.19.
Table 3.19
Production Overheads to Cost of Sales Ratio of the Firms under Study
(From 2009-10 to 2013-14)
(Ratio in Percent)

2009-10 0.29 1.63 1.52 2.58 0.57
2010-11 0.10 1.00 1.59 2.93 0.33
2011-12 0.09 0.91 1.44 3.34 0.16
2012-13 0.07 1.11 1.06 4.33 0.47
2013-14 0.15 1.34 2.12 3.58 0.09
Average 0.14 1.20 1.55 3.35 0.32
S.D. 0.09 0.29 0.38 0.67 0.20
C.V. 0.635 0.242 0.246 0.199 0.624
157
The results in Table 3.19 summarize production overheads, as a

percentage of total cost of sales, incurred by the firms analyzed in this
research study for the last five financial years. It can be observed that
most of the firms have to spend around 1% of their total cost as
production overheads. It is observed that among the five firms analyzed
in this research Vaibhav Gems (3.35%) spends highest proportion of its
total cost as production overheads, followed by Gitanjali Gems (1.55%),
Classic Diamonds (1.20%), Rajesh Exports (0.32%), and Surana
Jewellers (0.14%). Further, it can be observed that the proportion of total
sales cost spent as production overhead during the last five financial
years has fluctuating trend for all the firms. According to coefficient of
variation, Surana Jewellers and Rajesh Exports have higher fluctuations
whereas Classic Diamonds and Gitanjali Gems have moderate
fluctuations and Vaibhav Gems has minimum fluctuations.

(i) Null Hypothesis (Ho): There is no significant difference in the

ratio of Production Overheads to cost of sales between the companies
under study

year-wise ratio of Production Overheads to cost of sales of the
companies under study.
158
Table 3.20
ANOVA TALE
Freedom (Sum/d.f)
(d.f.)
Between 452.10 (c-1)=(5-1)=4 113.02 F = 1.80
Companies)
Within 246.83 (r-1)=(5-1)=4 61.71 F = 1.01

F = = = 180
.

V2 = 16) is 3.01.
Decision: Since the calculated value of F (1.80) is less than the

null hypothesis is accepted and it can be concluded that the difference in
the ratio of production overheads to cost of sales of the companies under
study is not significant.

F = = = 1.01

V2 = 4) is 5.84.
159

production overheads to cost of sales ratio is not significant.
PROFIT MARGIN ANALYSIS
Operating Profit Ratio

Operating profit is the amount of profit a company makes after
paying for variable costs of production such as wages, raw materials, etc.
It is the profit resulting from standard operation and it does not include
unique or one-time transactions. Operating profit margin is generally
expressed as a percentage of sales and shows the efficiency of a
company in controlling the cost and expenses associated with business
operations. In simple terms, operating profit margin measures a
company’s revenue that is left over after deducting direct labours and
overheads, but before taxes and interests and other indirect costs are
deducted. The other terms used to describe operating profit margin ratios
include operating margin, operating income margin, operating profit
margin or return on sales (ROS).
Operating profit margin is an important indicator to measure

company’s pricing strategy and operational efficiency. It also shows
whether the fixed costs are too high for the production or sales volume.
Operating profit margin gives an idea of how much a company makes
(before interest and taxes) on each rupee of sales. A high or increasing
operating margin is preferred because if the operating margin is
160
increasing, the company is earning more per rupee of sales. Operating

margin can be used to compare a company with its competitors and with
its past performance. It is best to analyze the changes of operating
margin over time and to compare company’s figure to those of its
competitors. Operating margin shows the profitability of sales resulting
from regular business. Operating income results from ordinary business
operations and excludes other revenue or losses, extraordinary items,
interest on long term liabilities and income taxes.
Operating Income
Operating Profit Margin = ´ 100
Net Sales
The comparison of operating profit margin across different firms

over the last five years is summarized in Table 3.21.
Table 3.21
Operating Profit Ratio of Firms under Study
(From 2009-10 to 2013-14)
(in Percentage)

2009-10 3.80 9.38 6.71 7.49 0.56
2010-11 1.27 6.45 7.71 -83.17 -4.64
2011-12 2.87 13.69 6.85 6.09 -1.78
2012-13 2.40 8.48 6.91 10.21 -1.90
2013-14 1.68 6.64 5.23 8.95 2.36
Average 2.40 8.93 6.68 -10.08 -1.08
S.D. 0.99 2.93 0.90 40.88 2.66
C.V. 0.415 0.329 0.135 -4.053 -2.465
Source: Annual Reports and Accounts of the firms for the period from 2009-10 to 2013-14.
161
Table 3.21 shows that Surana Jewellers had a decreasing trend of

operating profit ratio except in the year 2011-12 during the period under
study. The ratio was 3.80 percent (highest) in 2009-10 which sharply
decreased to 1.27 percent (lowest) in 2010-11. Then it increased to 2.87
percent in 2011-12 but declined to 2.40 percent in 2012-13 and came
down further to 1.68 percent in the final year 2013-14. It is suggested
that the decreasing trend should be controlled by reducing the
operating cost.
Classic Diamonds also had a decreasing trend of operating profit

ratio except in the year 2011-12. The ratio was 9.38 percent in 2009-10
which sharply decreased to 6.45 percent (lowest) in 2010-11. Then, it
increased and climbed up to 13.69 percent (highest) in 2011-12 but
declined to 8.48 percent in 2012-13 and further decreased to 6.64
percent in the final year 2013-14. It is further suggested that the firms
should increase the ratio by reducing and controlling the operating cost.
Table 3.21 shows that for Gitanjali Gems, operating profit ratio had
a fluctuating trend during the period under study. Initially, the ratio was
6.71 percent in 2009-10 which increased to 7.71 percent (highest) in
2010-11. Then it decreased to 6.85 percent in 2011-12 but inclined up to
6.91 percent in 2012-13. Finally, it decreased again and came down to
5.23 percent in the year 2013-14. It is suggested that the firms should try
to maintain consistency in the ratio and control the decreasing trend.
For Vaibhav Gems, operating profit ratio also had a fluctuating

trend during the period under study. Initially, in 2009-10, the ratio was
7.49 percent in 2009-10 which decreased sharply to -83.17 percent
162
(lowest) in 2010-11 because in this year there was a sudden increase in

direct labour cost. Then, it increased to 6.09 percent in 2011-12 and
inclined up to 10.21 percent in 2012-13. Finally, it decreased and came
down to 8.95 percent in the year 2013-14. It is suggested that the firms
should control the operating cost through making an optimum use of
available sources and increase the profitability.
Table 3.21 shows that for Rajesh Exports, operating profit ratio had
a fluctuating trend during the period under study. The ratio was 0.56
percent in 2009-10 which decreased to -4.64 percent (lowest) in
2010-11. Then it increased slightly to -1.78 percent in 2011-12 but
declined up to -1.90 percent in 2012-13. Finally, it increased and reached
to 2.36 percent in the year 2013-14. The operating profit position of the
firms can not be regarded satisfactory and the management of the firms
should try to control it.
The average operating profit ratio was maximum 8.93 percent for
Classic Diamonds followed by 6.68 percent of Gitanjali Gems and 2.40
percent of Surana Jewellers. Then Rajesh Exports (-1.08 percent) and
Vaibhav Gems (-10.08 percent) had average loss during the period under
study. Standard deviation was highest for Vaibhav Gems that should be
kept in control by the management whereas other firms showed
satisfactory and in-control standard deviation. Coefficient of variation
was highest negatively for Vaibhav Gems indicating loss with high
fluctuations followed by Rajesh Exports, Surana Jewellers, Classic
Diamonds and Gitanjali Gems. The first two firms should improve their
163
operating profit with serious efforts and others kept fluctuations in

control.

operating profit ratio between the companies under study.

year-wise operating profit ratio of the companies under study.
Table 3.22
ANOVA TALE
Freedom (Sum/d.f)
(d.f.)
Between 1497.37 (c-1)=(5-1)=4 374.34 F = 1.21
Companies)
Within 1480.05 (r-1)=(5-1)=4 370.01 F = 1.20

F = = = 1.21

V2 = 16) is 3.01.
164

the operating profit ratio between the companies under study is not
significant.

F = = = 1.20
Critical value of F at 5 percent level of significance (V1 = 4 and V2

= 16) is 3.01.

operating profit ratio of the companies under study is not significant.
Gross Profit Ratio

Gross profit margin measures manufacturing and distribution
efficiency of a company during the production process. It tells an
investor the percentage of revenue/sales left after subtracting the cost of
goods sold. A company that shows a higher gross profit margin than its
competitors and industry, is more efficient. Investors tend to pay more
for businesses that have higher efficiency ratings than their competitors,
as these businesses should be able to make a decent profit as long as
overhead costs are controlled (overhead refers to rent, utilities, etc.).
165
Gross profit margin is calculated by subtracting cost of goods sold

(COGS) from total revenue and dividing that value by total revenue.
Gross profit margin is a key measure of profitability by which

investors and analysts compare similar companies and companies to
their overall industry. The metric is an indication of the financial
success and viability of a particular product or service. The higher the
percentage, the more the company retains on each rupee of sales to
service its other costs and obligations. The gross profit margin ratio is
used as one indicator of a business’s financial health. It shows how
efficiently a business is using its materials and labour in the production
process and gives an indication of the pricing, cost structure, and
production efficiency of your business. The higher the percentage, the
more the business retains of each rupee of sales, which means more
money is left over for other operating expenses and net profit. A low
gross profit margin ratio means that the business generates a low level of
revenue to pay for operating expenses and net profit. It indicates that
either the business is unable to control production or inventory costs or
that prices are set too low. The gross profit margin ratio can be
calculated as follows.
Revenue - Cost of Goods Sold
Gross Profit Ratio = ´ 100
Revenue
The comparison of gross profit margin across different firms over

the last five years is summarized in Table 3.23.
166
Table 3.23
Gross Profit Ratio of Firms under Study
(From 2009-10 to 2013-14)
(in Percentage)

2009-10 3.60 8.44 6.59 6.92 0.54
2010-11 1.13 5.53 7.55 -84.04 -4.66
2011-12 2.78 12.94 6.74 5.10 -1.79
2012-13 2.18 7.64 6.84 9.38 -1.91
2013-14 1.40 5.07 5.18 8.08 2.35
Average 2.22 7.92 6.58 -10.91 -1.09
S.D. 1.01 3.14 0.86 40.91 2.66
C.V. 0.455 0.396 0.131 -3.749 -2.435
Table 3.23 shows that Surana Jewellers had a decreasing trend of

gross profit ratio except in the year 2011-12 during the period under
study. The ratio was 3.60 percent (highest) in 2009-10 which sharply
decreased to 1.13 percent (lowest) in 2010-11. Then, it increased to 2.78
percent in 2011-12 but declined to 2.18 percent in 2012-13 and came
down further to 1.40 percent in the final year 2013-14. The decreasing
trend is not regarded favourable as it shows that the firm could not
control the cost of goods sold. It is suggested that the cost of goods sold
should be kept under control.
Classic Diamonds also had a decreasing trend of gross profit ratio

except in the year 2011-12. The ratio was 8.44 percent in 2009-10 which
sharply decreased to 5.53 percent in 2010-11. Then, it increased up to
12.94 percent (highest) in 2011-12 but declined to 7.64 percent in
167
2012-13 and further decreased to 5.07 (lowest) percent in the final year
2013-14. The decreasing trend was because of increasing cost of goods
sold. It is suggested that the management of the firms should try to
control the cost of goods sold effectively and control the decreasing
trend.
For Gitanjali Gems, gross profit ratio had a fluctuating trend during
the period under study. Initially, in 2009-10, the ratio was 6.59 percent
which increased to 7.55 percent (highest) in 2010-11. Then it decreased
to 6.74 percent in 2011-12 but inclined slightly to 6.84 percent in
2012-13. Finally, it decreased again and came down to 5.18 percent in
the year 2013-14. It is suggested that the firm should control the
decreasing trend by effectively controlling the cost of goods sold.
Table 3.23 showed that gross profit ratio for Vaibhav Gems had a
fluctuating trend during the period under study. Initially, in 2009-10, the
ratio was 6.92 percent in 2009-10 which decreased sharply to -84.04
percent (lowest) in 2010-11. In this year, the cost of goods sold abruptly
increased due to labour cost. Then, it increased to 5.10 percent in
2011-12 and reached up to 9.38 percent in 2012-13. Finally, the ratio
decreased and came down to 8.08 percent in 2013-14. The gross profit
should be increased by increasing sales and controlling the cost of goods
sold.
The gross profit ratio had a fluctuating trend for Rajesh Exports.
The ratio was 0.54 percent in 2009-10 which decreased to -4.66 percent
(lowest) in 2010-11. Then, it increased to -1.79 percent in 2011-12 and
came down to -1.91 percent in 2012-13. Finally, it increased and reached
168
to 2.35 percent in the year 2013-14. The gross profit ratio of Rajesh
Exports was very poor in comparison toother firms which should be
improved.
The average gross profit ratio was maximum 7.92 percent for
Classic Diamonds followed by 6.58 percent of Gitanjali Gems and 2.22
percent of Surana Jewellers. Then Rajesh Exports (-1.09 percent) and
study. Standard deviation was highest for Vaibhav Gems that should be
kept in control whereas other firms showed controlled standard
deviation. Coefficient of variation was highest negatively for Vaibhav
Gems indicating loss with high fluctuations followed by Rajesh Exports,
Surana Jewellers, Classic Diamonds and Gitanjali Gems. The first two
firms should improve their gross profit with serious efforts and others
kept fluctuations in control.

gross profit ratio between the companies under study.

year-wise gross profit ratio of the companies under study.
169
Table 3.24
ANOVA TALE
Freedom (Sum/d.f)
(d.f.)
Between 1134.13 (c-1)=(5-1)=4 283.53 F = 1.15
Companies)
Within 1570.40 (r-1)=(5-1)=4 392.60 F = 1.20

F = = = 115
.
Critical value of F at 5 percent level of significance (For V1 = 16

and V2 = 4) is 5.84.
the gross profit ratio between the companies under study is not
significant.

F = = = 1.20
Critical value of F at 5 percent level of significance (V1 = 4 and V2

= 16) is 3.01.
170

gross profit ratio of the companies under study is not significant.
Net Profit Ratio
The net profit margin tells you how much profit a company makes
for every rupee it generates in revenue or sales. Net profit margins vary
by industry, but all else being equal, the higher a company’s net profit
margin compared to its competitors, the better. To calculate net profit
margin, several financial books, sites, and resources tell an investor to
take the after-tax net profit divided by sales. All companies must be
compared on the same basis. Net profit margin is one of the most closely
followed numbers in finance. Shareholders look at net profit margin
closely because it shows how good a company is at converting revenue
into profits available for shareholders or owners. One of the most
important concepts to understand is that net profit is not a measure of
how much cash a company earned during a given period. This is because
the income statement includes a lot of non-cash expenses such as
depreciation and amortization. Net Profit Margin is the percentage of
revenue remaining after all operating expenses, interest, taxes and
preferred stock dividends (but not common stock dividends) have been
deducted from a company’s total revenue.
Total Revenue - Total Expenses
Net Profit Ratio =
Total Revenue
171
The comparison of net profit margin across different firms over the
last five years is summarized in Table 3.25.
Table 3.25
Net Profit Ratio of Firms under Study
(From 2009-10 to 2013-14)
(in Percentage)

2009-10 1.26 4.36 5.20 4.80 2.38
2010-11 1.00 0.57 4.70 -147.54 0.70
2011-12 0.99 2.43 4.23 1.76 1.04
2012-13 1.09 1.19 4.38 2.08 1.20
2013-14 0.78 -13.11 3.28 7.45 1.59
Average 1.02 -0.91 4.36 -26.29 1.38
S.D. 0.17 6.97 0.71 67.82 0.64
C.V. 0.170 -7.643 0.162 -2.579 0.465
Table 3.25 depicts that Surana Jewellers had a decreasing trend of

net profit ratio except in the year 2012-13 during the period under study.
The ratio was 1.26 percent (highest) in 2009-10 which sharply decreased
to 1.00 percent in 2010-11 and came down to 0.99 percent in 2011-12.
Then, it increased to 1.09 percent in 2012-13 but declined to 0.78
percent (lowest) in the final year 2013-14. The decreasing trend shows
that the firm had no control over the indirect cost. It is suggested that to
increase the net profit ratio, the firm should try to reduce and control the
indirect cost.
172
Classic Diamonds had a decreasing trend of net profit ratio except

in the year 2011-12. The ratio was 4.36 percent (highest) in 2009-10
which sharply decreased to 0.57 percent in 2010-11. Then, it increased
up to 2.43 percent in 2011-12 but declined to 1.19 percent in 2012-13
and further came down to -13.11 (lowest) percent in the final year
2013-14. The decreasing trend shows inefficiency of the management of
the firm towards controlling the indirect expenses. The management of
the firm should follow a strict policy to control the indirect expenses and
increase the net profit ratio.
For Gitanjali Gems, net profit ratio had a decreasing trend during
the period under study except in the year 2012-13. Initially, in 2009-10,
the ratio was 5.20 percent (highest) which decreased to 4.70 percent in
2010-11 and came down to 4.23 percent in 2011-12. Then it increased to
4.38 percent in 2012-13 but finally, decreased again and came down to
3.28 percent in the year 2013-14. It is suggested that the firm should
control the decreasing trend of net profit ratio by increasing the net
profit and controlling the indirect expenses.
Table 3.25 showed that net profit ratio for Vaibhav Gems had a
fluctuating trend during the period under study. Initially, in 2009-10, the
ratio was 4.80 percent in 2009-10 which decreased sharply to -147.54
percent (lowest) in 2010-11 because of abnormal increase in cost of
goods sold. Then, it increased to 1.76 percent in 2011-12, 2.08 percent in
2012-13 and reached up to 7.45 percent in 2013-14. It is suggested that
173
the management of the firm should continue the increasing trend of net
profit ratio.
The net profit ratio had an increasing trend for Rajesh Exports
during the period under study except in the year 2010-11. The ratio was
2.38 percent (highest) in 2009-10 which decreased to 0.70 percent
(lowest) in 2010-11. Then, it increased to 1.04 percent in 2011-12,
1.20 percent in 2012-13 and finally reached up to 1.59 percent in the
year 2013-14. It is suggested that increasing trend should be maintained
in future also.
The average net profit ratio was maximum 4.36 percent for
Gitanjali Gems followed by 1.38 percent of Rajesh Exports and 1.02
percent of Surana Jewellers. Then Classic Diamonds (-0.91 percent) and
study. Standard deviation was highest for Vaibhav Gems and higher for
Classic Diamonds that should be kept in control whereas other firms
showed satisfactory standard deviation. Coefficient of variation was
highest negatively for Classic Diamonds and Vaibhav Gems indicating
loss with high fluctuations followed by Rajesh Exports, Surana Jewellers
and Gitanjali Gems. The first two firms should improve their net profit
with serious efforts and others should keep fluctuations in control.

174

net profit ratio between the companies under study.

year-wise net profit ratio of the companies under study.
Table 3.26
ANOVA TALE
Freedom (Sum/d.f)
(d.f.)
Between 3152.02 (c-1)=(5-1)=4 788.01 F = 1.19
Companies)
Within 3640.68 (r-1)=(5-1)=4 910.17 F = 1.03

F = = = 119
.
Critical value of F at 5 percent level of significance (For V1 = 16

and V2 = 4) is 5.84.

the net profit ratio between the companies under study is not significant.
175
(ii) F-Test Between the Companies (Intra Companies)

F = = = 1.03

V2 = 4) is 5.84.

net profit ratio of the companies under study is not significant.
*****

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CHAPTER-3

Marginal Costing and

Introduction and Marginal Costing

INTRODUCTION OF MARGINAL COSTING

Marginal Costing is the process of identification, measurement,

Marginal costing is not a separate method of costing like contract

Marginal cost means change in cost which will be observed when

(1) Prime cost per unit.

(2) Variable overhead per unit

(3) Variable Part of semi-variable overhead.

Marginal costing what is it? Marginal cost is a term used to

Marginal Costing is that technique of costing in which cost and

“Marginal Costing is the ascertainment of marginal cost and of the

Definition of Marginal Costing

Applications of Marginal Cost Technique

Marginal costing, with its focus on variability of costs and

1. Fixation of Selling Price

organization. Under, normal circumstances, the price of a product must

However, under certain special circumstances, price has to be fixed

Under these special circumstances, the concept of marginal cost is

2. Accepting Bulk Orders (or) Foreign Market Orders

The order from a local dealer should not be accepted at a price

3. Make (or) Buy Decision

In a make (or) buy decision, the price quoted by the outside

4. Selection of Suitable Product Mix

When a factory manufacturers more than one product, a problem is

Normally, when there is no limiting factor, the selection of the

6. Maintaining a Desired Level of Profit

7. Alternative methods of Production

maximum contribution is to be adopted keeping in mind the limiting

8. Determination of Optimum Level of Activity

10. Cost Control

11. Closure of a Department or Discontinuing a Product

be discountinued. It means the product which gives a higher amount of

12. Profit Planning

Profit planning is a plan for future operation (or) or planning

13. Introduction of a New Product

A production firm may add additional products with the available

14. Choice of Technique

Every management wishes to manufacture the products at the most

15. Decision Making

If the price is equal to marginal cost, then there is a loss equal to

(a) there is cut-threat competition

(b) there is the fear of future market

(c) that goods are of perishable nature d) the employees cannot

(e) a new product is introduced in the market

(f) competitors cannot be driven out etc.

16. Introduction of New Product (or) Product Line

The technique to assess the profitability of a line extension product

PRINCIPLES OF MARGINAL COSTING

The principles of marginal costing are as follows5:-

2. Similarly, if the volume of sales falls by one item, the profit

3. Profit measurement should therefore be based on an analysis

4. When a unit of product is made, the extra costs incurred in its

MAIN FEATURES OF MARGINAL COSTING

(v) Contribution is ascertained by reducing the variable cost from

(vi) The profitability of products or process is determined on the

(vii) Profit is ascertained by reducing the fixed cost from the

(viii) The profitability of various levels of activity is ascertained by

ADVANTAGES AND DISADVANTAGES OF MARGINAL

2. By not charging fixed overhead to cost of production, the

3. It prevents the illogical carry forward in stock valuation of

4. The effects of alternative sales or production policies can be