Unit -3

RAS - 501

Computation of Material Variance

Q: What is the Definition of direct materials price variance?

A: The actual cost less the actual quantity at standard price equals the
direct materials price variance. The difference between the actual quantity at standard price and
the standard cost is the direct materials quantity variance. The total of both variances equals the
total direct materials variance.
Q: What is the Definition of materials variance?

A: Material variance has two definitions, one relating to direct materials and the other to the
size of a variance. They are: Related to materials. This is the difference between the actual cost
incurred for direct materials and the expected (or standard) cost of those materials.
Q: What is material price variance?

A: In variance analysis (accounting) direct material price variance is the difference

between the standard cost and the actual cost for the actual quantity of material purchased. It
is one of the two components (the other is direct material usage variance) of
direct material total variance.

Q: Explain direct material cost. What are the steps to estimate the direct material cost?

A: Direct materials cost: The cost of direct materials which can be easily identified with
the unit of production. For example, the cost of glass is a direct materials cost in light bulb
manufacturing.
The manufacture of products or goods required material as the prime element. In general, these
materials are divided into two categories. These categories are direct materials and indirect materials.
Direct materials are also called productive materials, raw materials, raw stock, stores and only
materials without any descriptive title.

Steps to estimate the direct material costs:-

1. Find the total amount to be produced. This is usually noted as the order size.
2. Calculate the total amount of raw materials required to produce the order size.
3. Multiply that amount by the cost associated with the raw materials.
4. If there is a waste or scrap, its cost should be added to the costs in step 3.
5. If the waste or scrap can be sold at salvage value, this value should be subtracted from the
costs in step 4.
Computation of Material Variance/Break Even Analysis
1: Break even point as unit volume. In business, break even point usually means the unit
volume that balances total costs with total gains. For the analyst, break even is the quantity Q for
which cash outflows equal cash inflows, exactly. At the break even quantity, therefore, net cash
flow equals zero.
Formula of Break even point:

Q: How do you calculate the breakeven quantity?

A: Revenue is the unit quantity sold multiplied by the selling price per unit. To figure total
costs you first multiply the unit quantity sold by the variable costs per unit, then you add the fixed
costs. So it looks like this: You then reorder the equation to solve for BEQ.

Break-even Point Analysis

Contents:

1. Definition and Explanation

2. Calculation by equation method
3. Calculation by contribution margin method
4. Advantages
5. Limitations

Definition and Explanation:

Break-even point is the level of sales at which profit is zero. At break even point total sales
are equal to total cost (variable + fixed).
If a firm cannot manage sales to cover variable as well as fixed costs it will have to bear
losses. The following is the further explanation of this concept:

There are two methods for the calculation of break-even point. These are:

1. Equation method
2. Contribution margin method

Equation Method:

We can use the following equation to calculate break-even point:

Profit = Sales - (Variable expenses + Fixed expenses)

or

Sales = Variable expenses + Fixed expenses + Profit

When break-even point is calculated using above equation profit is taken as zero because
break-even is that level of sales where sales are equal to total cost (variable + fixed) and
profit is zero.

Example:

We can use the following data to calculate break-even point.

 Sales price per unit = $500

 variable cost per unit = $300
 Total fixed expenses = $70,000

Required: Calculate break-even point using equation method.

Solution:

Sales = Variable expenses + Fixed expenses + Profit

$500Q* = $300Q* + $70,000 + $0**

$200Q = $70,000

Q = $70,000/$200

Q = 350 Units

Q* = Number (Quantity) of units sold.

**The break even point can be computed by finding that point where profit is zero

Graphical Representation (Break-even Chart - CVP Graph):

The break even point in sales dollars can be computed by multiplying the break even level of
unit sales by the selling price per unit.

350 Units × $500 Per unit = $175,000

Contribution Margin Method:

Under this method total fixed cost is divided by unit contribution margin. The resulting figure
is number of units to be sold to break-even (no profit, no loss).
Example:
We can use the following data to calculate break-even point.
 Sales price per unit = $500
 variable cost per unit = $300
 Total fixed expenses = $70,000
Required: Calculate break-even point using contribution margin method.
Solution:
Break-even point in units = Fixed expenses / Unit contribution margin
$70,000 / $200*
350 Units
*$500 (Sales) − $300 (Variable exp.)
Break even point in sales:
350 Units × $500 Per unit
= $175,000
Equation method and contribution margin methods are equivalent. Contribution margin
method is actually a shortcut conversion of equation method.

The following formula is also extensively used to calculate break even point:
Break-even Sales in Dollars = [Fixed Cost / 1 – (Variable Cost / Sales)]
This formula produces the same answer:
Break Even Point = [$70,000 / 1 – (300 / 500)]
= $70,000 / 1 – 0.6
= $70,000 / 0.4
= $175,000
Number of units to be sold to break even:
$175,000 / $500
= 350 units

Advantages:
Following are some of the main advantages of break even analysis:
1. It explains the relationship between cost, production, volume and returns.
2. It can be extended to show how changes in fixed cost, variable cost, commodity prices,
and revenues will effect profit levels and break even points. Break even analysis is
most useful when used with partial budgeting, capital budgeting techniques.
3. The major benefits to use break even analysis is that it indicates the lowest amount
of business activity necessary to prevent losses.

Limitations:
Break even analysis is best suited to the analysis of one product at a time. It may be difficult
to classify a cost as all variable or all fixed; and there may be a tendency to continue to use
a break even analysis after the cost and income functions have changed.