40  Cost Sheet, Marginal Costing and CVP Analysis

40.1 What is Cost Accounting?

Cost Accounting is the process of ascertaining, controlling and reporting the costs of products, services and activities. It originated in the late 19th-century industrial era, but the modern discipline was systematised by the Institute of Cost and Management Accountants (CIMA, UK 1919) and the Institute of Cost Accountants of India (ICAI-CMA, formerly ICWAI, 1944).

TipWorking definitions

Author / body	Definition
CIMA	“The technique and process of ascertaining cost, beginning with the recording of expenditure and ending with the preparation of statistical data.”
Charles T. Horngren	“Cost accounting measures and reports financial and non-financial information related to the organisation’s acquisition or consumption of resources.”
W.W. Bigg	“The provision of such analysis and classification of expenditure as will enable the total cost of any particular unit of production to be ascertained with reasonable accuracy.”
ICAI-CMA	“The process of accounting from the point at which expenditure is incurred or committed to the establishment of its ultimate relationship with cost centres and cost units.”

40.2 Cost — Concept and Elements

40.2.1 Elements of Cost

TipThree elements of cost

Element	Direct	Indirect (Overhead)
Material	Direct material (DM)	Indirect material — lubricants, stores
Labour	Direct labour (DL)	Indirect labour — supervisors, security
Expenses	Direct expenses (royalty, hire)	Indirect expenses — rent, depreciation

40.2.2 Cost Aggregates

TipCost aggregates

Aggregate	Components
Prime Cost	Direct Material + Direct Labour + Direct Expenses
Factory / Works Cost	Prime Cost + Factory Overhead
Cost of Production	Factory Cost + Office & Administration Overhead
Cost of Goods Sold (COGS)	Cost of Production + Opening FG − Closing FG
Cost of Sales / Total Cost	COGS + Selling & Distribution Overhead
Sales	Total Cost + Profit

flowchart TB
  DM[Direct Material] --> PC[Prime Cost]
  DL[Direct Labour] --> PC
  DE[Direct Expenses] --> PC
  PC --> FC[Factory Cost]
  FOH[Factory Overhead] --> FC
  FC --> CP[Cost of Production]
  AOH[Admin Overhead] --> CP
  CP --> COS[Cost of Sales]
  SDOH[Selling & Distribution OH] --> COS
  COS --> S[Sales]
  P[Profit] --> S
    classDef default fill:#003366,color:#ffffff,stroke:#ffcc00,stroke-width:3px,rx:10px,ry:10px;

40.3 Classification of Costs

40.3.1 By Behaviour (Most-tested)

TipThree behavioural classes of costs

Class	Behaviour	Examples
Fixed	Constant in total; varies inversely per unit	Rent, salaries, depreciation
Variable	Varies in proportion to output; constant per unit	Raw material, direct labour
Semi-variable / Mixed	Partly fixed + partly variable	Electricity, telephone
Step costs	Fixed within ranges; jumps at threshold	Supervisor pay for each shift

40.3.2 By Function

Production · Administration · Selling · Distribution · R&D · Pre-production · Conversion.

40.3.3 By Identifiability

TipDirect vs Indirect

• Direct costs — traceable to a specific cost object (product, job, contract).
• Indirect costs (Overheads) — common to multiple cost objects; need allocation/apportionment.

40.3.4 By Controllability

TipControllable vs Uncontrollable

• Controllable — can be influenced by a manager at a given level.
• Uncontrollable — beyond the manager’s control (rent, top-down fees).

40.3.5 By Decision-Relevance

TipDecision-relevant cost concepts

• Relevant cost — future cost that differs across alternatives.
• Irrelevant cost — does not differ across alternatives.
• Sunk cost — past, irreversible cost; irrelevant.
• Opportunity cost — value of the best foregone alternative.
• Differential / Incremental cost — change in cost between alternatives.
• Marginal cost — change in total cost per additional unit (variable cost in the short run).
• Out-of-pocket cost — actual cash outflow.
• Imputed cost — notional cost (interest on own capital).
• Conversion cost — Direct Labour + Factory Overhead.
• Joint costs — shared by two or more joint products.
• Replacement cost — current cost of replacing an asset.
• Shutdown cost — cost incurred even if operations cease.

40.4 Costing Methods

TipCosting methods by production setup

Method	When used	Examples
Job costing	Job-specific production	Printing, repairs, construction
Batch costing	Production in batches	Pharma, biscuits
Contract costing	Long-duration single contracts	Civil construction
Process costing	Continuous processes	Chemicals, steel, cement
Operation costing	Sequential operations	Toys, automobile components
Service / Operating costing	Service organisations	Transport, hotels, hospitals
Unit / Output costing	Single homogeneous product	Bricks, cement
Composite costing	Multiple methods together	Automobile manufacturing

40.5 Costing Techniques

TipCosting techniques

Technique	Idea
Standard Costing	Pre-set standards; variance analysis (Topic 40)
Marginal Costing	Distinguish fixed vs variable; charge only variable to product
Absorption / Total Costing	All fixed + variable charged to product
Activity-Based Costing (ABC)	Costs allocated via activities and drivers
Target Costing	Reverse: price − required margin = allowable cost
Life-Cycle Costing	Costs over the full product life
Throughput Costing	Only DM charged to product (TOC)
Kaizen Costing	Continuous improvement, small cost reductions

40.6 Cost Sheet — Format

A Cost Sheet is a statement showing the various components of total cost for a product or service, classified element-wise and stage-wise. Standard format follows the aggregate sequence:

TipCost Sheet — standard format

Particulars	₹
Direct Material consumed	XXX
Add: Direct Labour	XXX
Add: Direct Expenses	XXX
Prime Cost	XXX
Add: Factory / Works Overhead	XXX
Add: Opening WIP − Closing WIP	XXX
Factory / Works Cost	XXX
Add: Office & Administration Overhead	XXX
Cost of Production	XXX
Add: Opening FG − Closing FG	XXX
Cost of Goods Sold	XXX
Add: Selling & Distribution Overhead	XXX
Cost of Sales / Total Cost	XXX
Add: Profit	XXX
Sales	XXX

40.7 Marginal Costing

Marginal Costing is the technique where only variable costs are charged to the product, while fixed costs are treated as period costs and written off against contribution. Developed in the early 20th century (Jonathan Harris, 1936; W.B. Lawrence in the UK) and consolidated by CIMA. Also called Direct Costing or Variable Costing in the US.

40.7.1 Key Equation — Marginal Costing

\[\boxed{\text{Sales} - \text{Variable Cost} = \text{Contribution} = \text{Fixed Cost} + \text{Profit}}\]

TipMarginal Costing terminology

• Marginal Cost = Variable cost per unit (DM + DL + Variable OH).
• Contribution = Sales − Variable Cost = Fixed Cost + Profit.
• P/V Ratio (Profit-Volume Ratio) = (Contribution / Sales) × 100.
• Break-Even Point = Fixed Cost / Contribution per unit (units) = Fixed Cost / P/V Ratio (₹).
• Margin of Safety = Actual Sales − BEP Sales = Profit / P/V Ratio.

40.7.2 Absorption vs Marginal Costing

TipAbsorption vs Marginal Costing

Dimension	Absorption Costing	Marginal Costing
Treatment of fixed cost	Product cost (apportioned)	Period cost (written off)
Inventory valuation	Includes fixed OH	Excludes fixed OH
Profit	Affected by stock levels	Independent of stock
Use	External reporting (Ind AS 2 — requires absorption)	Internal decision-making
Profit measure	Net Profit	Contribution
Pricing decisions	Less suitable	Suitable for short-term

NoteInd AS 2 — absorption mandatory for external reporting

Ind AS 2 / IAS 2 requires inventory to be valued at the lower of cost or NRV, with cost including fixed production overhead (absorption costing). Marginal costing is permitted only for internal/management decisions.

40.8 CVP Analysis — Cost-Volume-Profit

CVP analysis studies the relationship between costs, volume of output, and profit. Pioneered by Walter Rautenstrauch in the 1930s. Key uses: break-even, margin of safety, profit planning, product-mix decisions.

40.8.1 Break-Even Point (BEP)

Break-Even Point (BEP) = the level of sales at which total revenue = total cost; i.e., no profit, no loss.

TipBEP formulas

• BEP (units) = Fixed Cost / Contribution per unit
• BEP (₹) = Fixed Cost / P/V Ratio = BEP units × Selling Price per unit
• Target Profit (units) = (Fixed Cost + Desired Profit) / Contribution per unit
• Margin of Safety (₹) = Actual Sales − BEP Sales
• Margin of Safety (%) = (MOS / Actual Sales) × 100 = Profit / Contribution × 100

40.8.2 Break-Even Chart

flowchart LR
  X[Output Volume<br/>X-axis] --> Y[Revenue & Cost<br/>Y-axis]
  Y --> TR[Total Revenue line]
  Y --> TC[Total Cost line]
  Y --> FC[Fixed Cost line]
  TR -.crosses.- TC
  TC -.crosses.- BEP[Break-Even Point]
    classDef default fill:#003366,color:#ffffff,stroke:#ffcc00,stroke-width:3px,rx:10px,ry:10px;

40.8.3 Assumptions of CVP / BEP

TipAssumptions of CVP/BEP analysis

• All costs are classifiable into fixed and variable.
• Total fixed cost is constant.
• Variable cost per unit is constant.
• Selling price per unit is constant.
• Volume is the only factor affecting cost and revenue.
• Production = Sales (no inventory change).
• Single product OR constant sales mix.
• Efficiency and productivity remain unchanged.

40.8.4 Limitations of CVP

TipLimitations of CVP analysis

• Costs not always neatly classifiable.
• Linearity assumption may not hold at extremes.
• Sales price often varies (volume discounts).
• Multi-product complicates the model.
• Ignores risk and time value of money.
• Inventory build-ups distort profit picture.

40.8.5 Composite / Weighted BEP — Multi-product

For multiple products, BEP is computed at the weighted P/V ratio based on sales mix:

\[\text{Composite BEP} = \frac{\text{Total Fixed Cost}}{\text{Weighted P/V Ratio}}\]

40.9 Make-or-Buy Decisions

TipMake-or-buy — decision rule

• Compare marginal cost of making vs buying price.
• Make if MC of making < Buying price (and capacity available).
• Buy if MC > Buying price, or if outsourcing frees scarce capacity.
• Consider qualitative factors — quality, IP, supplier dependence, strategic importance.

40.10 Other Marginal-Costing Decisions

TipDecisions where marginal costing is most useful

• Make-or-buy (above).
• Acceptance of a special / export order at below-normal price.
• Adding or dropping a product / segment / customer.
• Optimal product mix under constraints (linear programming).
• Sell-or-process-further decisions in joint products.
• Shutdown vs continued operations decisions.
• Pricing — minimum acceptable price = variable cost.
• Plant-replacement evaluation.

NoteLimiting / Key factor analysis

When a resource (raw material, labour hours, machine hours) is limited, products should be ranked by Contribution per unit of limiting factor rather than absolute contribution.

40.11 Activity-Based Costing (ABC)

Activity-Based Costing (ABC) — pioneered by Robin Cooper and Robert Kaplan in the late 1980s (HBR, 1988) — allocates overhead by activities and cost drivers rather than blanket bases like machine hours.

TipABC — five-step process

• Identify activities.
• Group activities into cost pools.
• Identify cost drivers for each pool.
• Compute cost-driver rate.
• Apply costs to products.

40.11.1 ABC vs Traditional Costing

TipABC vs Traditional

Dimension	Traditional	ABC
Allocation base	Volume measures (DL hours, machine hours)	Multiple drivers (transactions, setups)
Suited for	Mass production, similar products	Diverse products, high overhead
Cost pools	Few (departments)	Many (activities)
Accuracy	Low for complex environments	High

40.11.2 Time-Driven ABC (TDABC)

Kaplan & Anderson (2004) — simplification using only two estimates: cost per time unit + time per transaction.

40.12 Target Costing

Target Costing — Japanese (Toyota 1960s) — reverses the cost-plus-price logic:

\[\text{Target Cost} = \text{Target Selling Price} - \text{Required Profit Margin}\]

The product must be designed to meet that cost. Tools: Value Engineering, Kaizen Costing, Cross-functional design teams.

40.13 Life-Cycle Costing (LCC)

Life-Cycle Costing captures all costs of a product from R&D, design, manufacturing, marketing, distribution, customer service, and disposal. Particularly important for software, drugs, defence equipment. Includes the “committed cost” insight — ~80 % of life-cycle cost is locked-in at design phase.

40.14 Modern Trends in Cost Accounting

TipTwelve modern trends in cost accounting

• ABC and TDABC for service firms and overhead-heavy industries.
• Target Costing + Kaizen in lean manufacturing.
• Lean accounting — value-stream costing (Cunningham, Maskell).
• Throughput Accounting (TOC) — Goldratt’s The Goal.
• Strategic cost management — Shank-Govindarajan (1993).
• Cost analytics dashboards.
• Quality cost reporting — Prevention, Appraisal, Internal failure, External failure.
• Environmental / Green Cost Accounting.
• CAS — Cost Accounting Standards (CASB / ICAI-CMA).
• Big data + AI in cost prediction.
• Blockchain costing of supply chains.
• Cost-of-AI computations — power, GPU hours.

40.15 Practice Questions

Q 01 Prime Cost Easy

Prime Cost is the sum of:

• ADM + DL + DE
• BDM + Factory OH
• CDL + Admin OH
• DDM + DL + Admin OH

View solution

Correct Option: A

Prime Cost = DM + DL + Direct Expenses.

Q 02 Conversion Cost Medium

Conversion Cost equals:

• ADM + DL
• BDL + Factory Overhead
• CDM + Factory Overhead
• DTotal Cost − Sales

View solution

Correct Option: B

Conversion Cost = DL + Factory Overhead.

Q 03 Sunk cost Easy

Sunk costs are:

• AFuture costs
• BIrrelevant for decisions
• CRelevant for decisions
• DOpportunity costs

View solution

Correct Option: B

Sunk costs are past and irreversible — irrelevant for decisions.

Q 04 Contribution Easy

Contribution equals:

• ASales − Total Cost
• BSales − Variable Cost
• CSales − Fixed Cost
• DFixed Cost − Variable Cost

View solution

Correct Option: B

Contribution = Sales − Variable Cost = Fixed Cost + Profit.

Q 05 PV ratio Medium

P/V Ratio is:

• AProfit / Sales × 100
• BContribution / Sales × 100
• CFixed Cost / Profit × 100
• DVariable Cost / Sales × 100

View solution

Correct Option: B

P/V Ratio = Contribution / Sales × 100.

Q 06 BEP Medium

BEP in units equals:

• AFixed Cost / Sales
• BFixed Cost / Contribution per unit
• CSales / Fixed Cost
• DVariable Cost / Contribution

View solution

Correct Option: B

BEP units = Fixed Cost / Contribution per unit; BEP ₹ = FC / P/V Ratio.

Q 07 MOS Medium

Margin of Safety (₹) equals:

• AActual Sales − BEP Sales
• BBEP Sales − Actual Sales
• CFixed Cost / Variable Cost
• DContribution / Sales

View solution

Correct Option: A

MOS = Actual Sales − BEP Sales. Also = Profit / P/V Ratio.

Q 08 Process costing Medium

Process costing is most appropriate for:

• ACustom printing job
• BCement and chemicals
• CCivil construction
• DHotel services

View solution

Correct Option: B

Process costing — continuous processes (cement, chemicals, steel, sugar).

Q 09 ABC origin Hard

Activity-Based Costing (ABC) was popularised in the late 1980s by:

• ACooper & Kaplan
• BGoldratt
• CDrucker
• DStern Stewart

View solution

Correct Option: A

Robin Cooper and Robert Kaplan, HBR (1988).

Q 10 Target costing Medium

Target Costing reverses the equation to:

• ACost + Profit = Price
• BPrice − Profit = Target Cost
• CCost × Markup = Price
• DCost + Tax = Price

View solution

Correct Option: B

Target Cost = Price − Required Profit Margin. Toyota 1960s.

Q 11 Absorption Medium

Ind AS 2 requires inventory to be valued using:

• AMarginal costing
• BAbsorption costing
• CThroughput costing
• DDirect costing

View solution

Correct Option: B

Ind AS 2 requires absorption costing for external financial reporting.

Q 12 Limiting factor Hard

When a resource is scarce, products should be ranked by:

• ATotal contribution
• BContribution per unit
• CContribution per unit of limiting factor
• DProfit per unit

View solution

Correct Option: C

Contribution per unit of limiting factor — key/limiting-factor analysis.

Q 13 Step cost Medium

Costs that remain fixed within ranges but jump at thresholds are:

• AVariable costs
• BStep costs
• CSunk costs
• DOpportunity costs

View solution

Correct Option: B

Step costs — supervisors, leased machines per shift.

Q 14 CVP assumption Hard

A key assumption of CVP analysis is that:

• ASelling price changes with volume
• BVariable cost per unit is constant
• CFixed cost varies with volume
• DProductivity is unstable

View solution

Correct Option: B

CVP assumes constant variable cost per unit and constant selling price per unit.

Q 15 Throughput Hard

Throughput Accounting — only direct material is treated as variable — was popularised by:

• AEli Goldratt
• BRobert Kaplan
• CDrucker
• DMaskell

View solution

Correct Option: A

Eliyahu Goldratt, *The Goal* (1984) — Theory of Constraints.

Q 16 Composite BEP Hard

For a multi-product firm, BEP is computed using:

• AAverage selling price
• BWeighted P/V Ratio
• CMaximum P/V Ratio
• DMinimum P/V Ratio

View solution

Correct Option: B

Composite BEP = Total Fixed Cost / Weighted P/V Ratio.

Q 17 Marginal Cost Easy

Marginal Cost is the change in total cost when output increases by:

• AOne batch
• BOne unit
• COne year
• D10 %

View solution

Correct Option: B

Marginal Cost = change in total cost per additional unit; effectively variable cost in the short run.

Q 18 ICAI-CMA Hard

The Indian institute that issues Cost Accounting Standards is:

• AICAI (Chartered Accountants)
• BICAI-CMA (Cost Accountants)
• CICSI (Company Secretaries)
• DSEBI

View solution

Correct Option: B

ICAI-CMA (formerly ICWAI) — via the Cost Accounting Standards Board (CASB).

Q 19 BEP at zero profit Easy

At BEP:

• AContribution = Variable Cost
• BContribution = Fixed Cost
• CSales = Variable Cost
• DSales = Fixed Cost

View solution

Correct Option: B

At BEP, Contribution = Fixed Cost (profit is zero).

Q 20 Match methods Hard

Match the costing method with the typical industry:

(i)	Job costing	(a)	Chemicals
(ii)	Contract costing	(b)	Transport
(iii)	Process costing	(c)	Civil construction
(iv)	Operating costing	(d)	Printing

• A(i)-(d), (ii)-(c), (iii)-(a), (iv)-(b)
• B(i)-(a), (ii)-(b), (iii)-(c), (iv)-(d)
• C(i)-(c), (ii)-(d), (iii)-(b), (iv)-(a)
• D(i)-(b), (ii)-(a), (iii)-(d), (iv)-(c)

View solution

Correct Option: A

Job — Printing; Contract — Construction; Process — Chemicals; Operating — Transport.

40.15.1 Advanced Format Questions

AR 1Assertion-ReasonHard

A: Marginal costing treats fixed costs as period costs.
R: Contribution = Sales − Variable cost.

• ABoth true; R explains A
• BBoth true; R does not explain A
• CA true, R false
• DA false, R true

View solution

Correct Option: B

S 1Statement-basedMedium

Cost sheet elements: (i) Prime cost. (ii) Works cost. (iii) Cost of production. (iv) Cost of sales.

• AAll four (cumulative)
• B(i) and (ii) only
• C(iii) and (iv) only
• D(i), (ii), (iii) only

View solution

Correct Option: A

N 1NumericalMedium

FC ₹2 L; SP ₹100/unit; VC ₹60/unit. BEP in units:

• A5,000
• B2,000
• C10,000
• D3,333

View solution

Correct Option: A

BEP = FC/(SP−VC) = 2,00,000/40 = 5,000.

N 2NumericalHard

Sales ₹10 L; VC ₹6 L. P/V Ratio is:

• A40 %
• B60 %
• C25 %
• D50 %

View solution

Correct Option: A

Contribution/Sales = (10−6)/10 = 40%.

40.16 Quick Recall

ImportantQuick recall

• CIMA (UK 1919) · ICAI-CMA / ICWAI (India 1944) · CASB issues Cost Accounting Standards.
• Elements of cost: Direct Material · Direct Labour · Direct Expenses · Indirect (Overheads).
• Cost aggregates: Prime Cost = DM + DL + DE → Factory Cost → Cost of Production → COGS → Cost of Sales → Sales.
• Conversion Cost = DL + Factory OH.
• Behaviour classes: Fixed · Variable · Semi-variable · Step.
• Decision costs: Relevant · Sunk · Opportunity · Differential · Marginal · Out-of-pocket · Imputed · Joint · Replacement · Shutdown.
• Methods: Job · Batch · Contract · Process · Operation · Service/Operating · Unit · Composite.
• Techniques: Standard · Marginal · Absorption · ABC · Target · Life-cycle · Throughput · Kaizen.
• Cost Sheet flow: DM → +DL → +DE → Prime Cost → +Factory OH → Factory Cost → +Admin OH → CoP → +Opening FG − Closing FG → COGS → +S&D OH → Cost of Sales → +Profit → Sales.
• Marginal Costing (Harris 1936, Lawrence, CIMA): Sales − VC = Contribution = FC + Profit.
• P/V Ratio = Contribution / Sales × 100.
• BEP units = FC / Contribution p.u.; BEP ₹ = FC / P/V Ratio.
• Target Profit units = (FC + Desired Profit) / Contribution p.u.
• MOS = Actual Sales − BEP Sales = Profit / P/V Ratio.
• At BEP, Contribution = Fixed Cost.
• Absorption vs Marginal: external (Ind AS 2) vs internal decisions.
• Composite BEP = Total FC / Weighted P/V Ratio.
• Limiting factor: rank by Contribution per unit of limiting factor.
• ABC (Cooper-Kaplan, HBR 1988): cost pools + drivers; TDABC (Kaplan-Anderson 2004).
• Target Costing (Toyota 1960s): Target Cost = Price − Required Margin.
• Life-Cycle Costing: ~80 % of cost locked at design phase.
• Throughput Accounting (Goldratt 1984): only DM is variable; TOC.
• Modern trends: ABC/TDABC · Lean accounting (Maskell) · Strategic cost mgmt (Shank-Govindarajan 1993) · Quality cost reporting (PAF) · Green cost accounting · CAS · AI cost prediction · cost-of-AI compute.