Cost and Revenue Analysis
Domain focus
Cost and revenue analysis examines how costs and revenues respond to activity. Exam tasks include high-low separation, contribution statements, break-even, margin of safety, target profit, operating leverage and the marginal versus absorption profit difference.
Core rules
- Contribution = sales - variable costs. Profit = contribution - fixed costs.
- BEP units = fixed costs / contribution per unit; BEP revenue = fixed costs / PV ratio.
- Margin of safety = budgeted sales - break-even sales; it measures the cushion before loss.
- High-low: variable cost per unit = change in cost / change in activity, using the highest and lowest activity levels, not the highest and lowest costs.
- Marginal costing values inventory at variable production cost; absorption costing includes fixed production overhead. Profit difference = change in inventory × fixed overhead absorption rate.
Worked example
Selling price is ₹100, variable cost ₹60 and fixed cost ₹80,000. Contribution per unit is ₹40, so BEP = 80,000/40 = 2,000 units. For target profit of ₹40,000, required units = (80,000 + 40,000)/40 = 3,000. At budgeted sales of 3,500 units, margin of safety is 1,500 units. Operating leverage = contribution/profit = 140,000/60,000 = 2.33; a 10% sales rise, with fixed costs unchanged, raises profit by about 23.3%.
Traps
Using the highest cost rather than the highest activity in high-low; treating fixed cost per unit as constant; mixing PV ratio with contribution per unit; forgetting closing inventory in absorption profit; ignoring the relevant range and stepped costs.