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Page 1 m arginal c osting

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Page 2 JOIN KHALID AZIZ ACCOUNTING(FINANACIAL & COST) OF ICMAP STAGE 1,2,3,4 (NEW CLASSES) CA..MODULE B,C,D PIPFA (FOUNDATION,INTERMEDIATE,FINAL) ACCA-F1,F2,F3 BBA,MBA B.COM(FRESH),M.COM MA-ECONOMICS..O/A LEVELS KHALID AZIZ…..0322-3385752

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Page 3 Why do we study Marginal Costing?

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Page 4 What do we study in Marginal Costing? Marginal Cost Marginal Costing Direct Costing Absorption Costing Contribution Profit Volume Analysis Limiting Factor/key factor Break Even Analysis Profit Volume Chart

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Page 5 What do we study in Marginal Costing? and Why do we Study MC? Marginal Cost Marginal Costing Direct Costing Absorption Costing Contribution Profit Volume Analysis Limiting Factor/key factor Break Even Analysis Profit Volume Chart Management Decision Making

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Page 6 Marginal Cost “Marginal cost is amount at any given volume of out put by which aggregate costs are changed….. if volume of output is increased or decreased by one unit”

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Page 7 Marginal Cost “ Marginal cost is amount at any given volume of out put by which aggregate costs are changed if volume of output is increased or decreased by one unit” 1 Manufacture 100 radio Variable costs Rs150 p u Fixed cost Rs 5000 2 If Manufacture 101 radios Marginal Cost 100 x150= 15000 Fixed Cost = 5000 total 20000 Marginal cost 150 x101=15150 Fixed Cost = 5000 TOTAL 20150 1 2 additional Cost=Rs 150

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Page 8 Marginal Costing marginal costing is ascertainment of “ marginal costing is ascertainment of marginal cost by differentiating between fixed and variable costs and of the effect of changes in volume or type of output ”

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Page 9 Marginal Costing What Could be effects of Changes In volume In volume or or Type of output

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Page 10 Marginal Costing What Could be effects of Changes In volume In volume or or Type of output 1 lakh units To 2 lakh units

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Page 11 Marginal Costing What Could be effects of Changes In volume In volume or or Type of output From One Model of Car to Another From One Size of product to another

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Page 12 Marginal Costing ---Characteristics Fixed & Variable Costs MC Costs as Products Costs Fixed Costs as Period Costs Inventory Valuation Contribution Pricing Marginal Costing & Profit

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Page 13 Marginal Costing ---Characteristics Segregation Fixed & Variable Costs Semi-variable costs are segregated into fixed & variable Semi-variable costs are segregated into fixed & variable

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Page 14 Marginal Costing ---Characteristics Marginal Costs as Products Costs Only Variable costs are charged to products Only Variable costs are charged to products

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Page 15 Marginal Costing ---Characteristics Fixed Costs as Period Costs Fixed costs treated Period costs Charged to costing P & L Account Fixed costs treated Period costs Charged to costing P & L Account

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Page 16 Marginal Costing ---Characteristics Inventory Valuation WIP & F goods are Valued at Marginal Cost WIP & F goods are Valued at Marginal Cost

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Page 17 Marginal Costing ---Characteristics Contribution S-V=C Profitability judged on Contribution made S-V=C Profitability judged on Contribution made

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Page 18 Marginal Costing ---Characteristics Pricing Pricing is based on Contribution & Marginal Costs Pricing is based on Contribution & Marginal Costs

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Page 19 Marginal Costing ---Characteristics Marginal Costing & Profit A B C Total Sales - - - ---- Less VC - - - ---- Contribution - - - ---- Fixed Cost ---- Profit -----

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Page 20 Marginal Costing --- Marginal Costing Profit Sales of A Marginal cost Of A Contribution of A Total Contribution of A,B& C Total Fixed Cost Sales of B Marginal cost Of B Contribution of B Sales of C Marginal cost Of C Contribution of C less = == = Profit/loss

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Page 21 Absorption Costing Absorption cost is a total cost technique “ Absorption cost is a total cost technique Under which total cost i.e. fixed & variable is charged to production. Inventory is also valued at total cost.

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Page 22 Absorption-Marginal Costing--differences Fixed & Variable Costs Measurement Of Profitability Valuation Of stock

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Page 23 Absorption-Marginal Costing--differences Fixed & Variable Costs Marginal Costing Only variable cost FC charged to P/L Absorption Costing Both F & V Costs Are charged

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Page 24 Absorption-Marginal Costing--differences Valuation Of stock WIP & FS at Marginal Cost Total Cost

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Page 25 Absorption-Marginal Costing--differences Measurement Of Profitability C=S-VP=S-V-F

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Page 26 Marginal Costing Months 1 2 3 Total Rs Rs Rs Rs Absorption Costing Months 1 2 3 Total Rs Rs Rs Rs (A) Sales 2,00,000 1,65,000 2,35,000 6,00,000 2,00,000 1,65,000 2,35,000 6,00,000 Opening Stock 84,000 84,000 1,05,000 2,73,000 1,08,000 1,08,500 1,35,625 3,52,625 Add V Cost 1,20,000 1,20,000 1,20,000 3,60,000 1,20,000 1,20,000 120,000 3,60,000 F Cost _ _ _ _ 35,000 35,000 35,000 1,05,000 Total Cost 2,04,000 2,04,000 2,25,000 6,33,000 2,63,000 2,63,000 2,90,625 8,17,625 Less C Stock 84,000 1,05,000 84,000 2,73,000 1,08,000 1,35,625 1,08,500 3,52,625 (B) COGS 1,20,000 99,000 1,41,000 3,60,000 1,55,000 1,27,875 1,82,125 4,65,000 Contribution (A-B) c 80,000 66,000 94,000 2,40,000 _ _ _ _ ( D) F Cost 35000 35,000 35,000 1,05,000 _ _ _ _ Profit (C-D) 45,000 31,000 59,000 1,35,000 (A-B) 45,000 37,125 52,875 1,35000 Comparative Cost Statement

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Page 27 Marginal Costing Months 1 2 3 Total Rs Rs Rs Rs Absorption Costing Months 1 2 3 Total Rs Rs Rs Rs (A)Sales 2,00,000 1,65,000 2,35,000 6,00,000 2,00,000 1,65,000 2,35,000 6,00,000 Opening Stock 84,000 84,000 1,05,000 2,73,000 1,08,000 1,08,500 1,35,625 3,52,625 Add V Cost 1,20,000 1,20,000 1,20,000 3,60,000 1,20,000 1,20,000 120,000 3,60,000 F Cost _ _ _ _ 35,000 35,000 35,000 1,05,000 Total Cost 2,04,000 2,04,000 2,25,000 6,33,000 2,63,000 2,63,000 2,90,625 8,17,625 Less C Stock 84,000 1,05,000 84,000 2,73,000 1,08,000 1,35,625 1,08,500 3,52,625 (B) COGS 1,20,000 99,000 1,41,000 3,60,000 1,55,000 1,27,875 1,82,125 4,65,000 Contribution (A-B) c 80,000 66,000 94,000 2,40,000 _ _ _ _ ( D) F Cost 35000 35,000 35,000 1,05,000 _ _ _ _ Profit (C-D) 45,000 31,000 59,000 1,35,000 (A-B) 45,000 37,125 52,875 1,35000 Comparative Cost Statement

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Page 28 Marginal Costing Months 1 2 3 Total Rs Rs Rs Rs Absorption Costing Months 1 2 3 Total Rs Rs Rs Rs (A)Sales 2,00,000 1,65,000 2,35,000 6,00,000 2,00,000 1,65,000 2,35,000 6,00,000 Opening Stock 84,000 84,000 1,05,000 2,73,000 1,08,000 1,08,500 1,35,625 3,52,625 Add V Cost 1,20,000 1,20,000 1,20,000 3,60,000 1,20,000 1,20,000 120,000 3,60,000 F Cost _ _ _ _ 35,000 35,000 35,000 1,05,000 Total Cost 2,04,000 2,04,000 2,25,000 6,33,000 2,63,000 2,63,000 2,90,625 8,17,625 Less C Stock 84,000 1,05,000 84,000 2,73,000 1,08,000 1,35,625 1,08,500 3,52,625 (B) COGS 1,20,000 99,000 1,41,000 3,60,000 1,55,000 1,27,875 1,82,125 4,65,000 Contribution (A-B) c 80,000 66,000 94,000 2,40,000 _ _ _ _ ( D) F Cost 35000 35,000 35,000 1,05,000 _ _ _ _ Profit (C-D) 45,000 31,000 59,000 1,35,000 (A-B) 45,000 37,125 52,875 1,35000 Comparative Cost Statement

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Page 29 Concept Of Contribution

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Page 30 Contribution is the difference between sales And the marginal (Variable) cost Contribution =sales-variable cost C= S-V Contribution = Fixed Cost+ Profit C= F+P Therefore S-V = F+P

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Page 31 Contribution is the difference between sales And the marginal (Variable) cost S-V=F+P If any 3 factors in the equation are known The 4 th could be found out P=S-V-F P=C-F F=C-P S=F+P+V V=S-C……….

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Page 32 Sales =Rs 12,000 V Cost=RS 7,000 F Cost=Rs 4,000 C=S-V =12,000-7000=5000 P=C-F =5,000-4000 =Rs 1,000 PROFIT ? S=C+V =5,000+7,000 =Rs 12,000 SALES?

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Page 33 Sales =Rs 12,000 V Cost=RS 7,000 F Cost=Rs 4,000 F=C-P =5,000-1,000 =Rs 4,000 F COST? V=S-C =12,000-5000 =Rs 7,000 V Cost?

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Page 34 Profit –Volume Ratio (PV Ratio) (Expresses the relation of Contribution to sales) P/V Ratio =Contribution = C/S =S-V/S Sales C = S XP/V Ratio C S = -------- P/V Ratio Sales= Rs 10,000 V Cost=Rs 8,000 P/V Ratio=c/s =S-V/S =10,000-8000/10,000 =20%

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Page 35 Profit –Volume Ratio (PV Ratio) When PV Ratio is Given C= SXPV Ratio C= 10000X20% =Rs 20,000

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Page 36 Profit –Volume Ratio (PV Ratio) Another Method Change in Contribution P/V Ratio = --------------------------------- Change in Sales Change in profit = ----------------------- Change in Sales 1600-1000 =-------------------x 100 22000-20000 600 = -----------x100=30% 2,0000 Year sales net profit 2005 20,000 1000 2006 22,000 1600

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Page 37 What Could be the Uses of PV Ratio? Break Even Point Profit at Given Sales Vol required to earn given Profit

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Page 38 How Improvement in PV Ratio Could be Achieved? Increasing Selling Price Reducing Variable Cost Changing Sales Mix

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Page 39 Limiting Or Key Factor a factor in short supply

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Page 40 Limiting Or Key Factor a factor in the activities of an undertaking which at a point of time or over a period will limit the volume of out put

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Page 41 Limiting Or Key Factor What Could be the Limiting Factors ? Labour Materials Power Sales Capacity Machines ………….

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Page 42 Cost- Volume- Profit Analysis

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Page 43 Cost- Volume- Profit Analysis Cost Of Production Selling Prices Volume Produced /Sold

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Page 44 Cost- Volume- Profit Analysis Break Even Analysis Profit Volume Chart

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Page 45 Cost- Volume- Profit Analysis Break Even Analysis A point of no profit no loss A point where revenue equals cost

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Page 46 What are BEP---assumptions All costs are fixed or variable VC remains Constant Total FC remains Constant Selling Price don’t change With Volume Synchronisation of Prod & Sales No Change in Productivity per workers

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Page 47 Cost- Volume- Profit Analysis Break Even Analysis Methods Algebraic Method Graphic Method

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Page 48 Cost- Volume- Profit Analysis ALGEBRAIC METHOD Fixed Cost BEP (Units) = --------------- = F Contribution PU S-V Fixed Cost BEP (Rs ) = ----------------- x Sales Contribution Fixed Cost BEP (Rs) = ------------------ P/V Ratio

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Page 49 Cost- Volume- Profit Analysis ALGEBRAIC METHOD Fixed Cost BEP (Units) = --------------- = F Contribution PU S-V Fixed Cost BEP (Rs ) = ----------------- x Sales Contribution Fixed Cost BEP (Rs) = ------------------ P/V Ratio F Cost=Rs 12000 S Price=Rs12 pu V Cost =Rs 9 pu Find BEP

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Page 50 Cost- Volume- Profit Analysis Other Uses Profit at diff. Sales Vol. Sales at Desired Profit F Cost=Rs 12000 S Price=Rs12 pu V Cost =Rs 9 pu Profit when sales are a)Rs 60,000 b)Rs 1,00,000

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Page 51 Cost- Volume- Profit Analysis Profit at diff. Sales Vol. C P/V Ratio= ----- = 3/12=25% S WHEN SALES=Rs 60,000 contribution=salesxp/vratio =60000x25% =Rs 15000 Profit =contribution-fixed cost =15000-12000 =Rs3000 F Cost=Rs 12000 S Price=Rs12 pu V Cost =Rs 9 pu Profit when sales are a)Rs 60,000 b)Rs 1,00,000

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Page 52 Cost- Volume- Profit Analysis Other Uses Sales at Desired Profit F Cost +Desired Profit Sales= ------------------------------- P/V Ratio F Cost=Rs 12000 S Price=Rs12 pu V Cost =Rs 9 pu Sales if desired profit a)Rs 6000 b)Rs 15,000

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Page 53 Cost- Volume- Profit Analysis Sales at Desired Profit F Cost +Desired Profit Sales= ------------------------------- P/V Ratio 12,000+6000 a)Sales= --------------- 25% =Rs 72,000 F Cost=Rs 12000 S Price=Rs12 pu V Cost =Rs 9 pu Sales if desired profit a)Rs 6000 b)Rs 15,000

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Page 54 CVP Analysis -question P ltd has earned a profit of Rs 1.80 lakh on sales of Rs 30 lakhs and V Cost of Rs 21 lakhs. work out a)BEP b)BEP When V Cost decreases by5% c)BEP at present level when selling price reduced by5%

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Page 55 CVP Analysis - S-V P/V Ratio=-------- S 3000000-2100000 = ------------------------ 3000000 =30% Sales =VC+FC+P 3000000=2100000+FC+180000 FC =Rs 720000 7,20,000 BEP= ------------- 30% =Rs 2400000

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Page 56 CVP Analysis -question b) When V Cost increases by 5% New Variable Cost=2100000+5% =22,05,000 PV Ratio 3000000-2205000 3000000 =26.5% BEP =7,20,000/ 26.5% =Rs 27,16,981

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Page 57 CVP Analysis -question c)When Selling Price reduced by 5% New SP=3000000—5% =Rs 28,50,000 Contribution=28,50,000-21,00,000 =Rs7,50,000 PV Ratio =7500000/2850000 =26.32% FC+PROFIT Desired Sales= ------------------ = 720000+1800000 PV Ratio 26.32% =Rs 34,19,453( appx)

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Page 58 BEP Graphical Presentation

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Page 59 Break-Even Analysis Costs/Revenue Output/Sales Initially a firm will incur fixed costs, these do not depend on output or sales. FC Q1

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Page 60 Break-Even Analysis Costs/Revenue Output/Sales Initially a firm will incur fixed costs, these do not depend on output or sales. FC As output is generated, the firm will incur variable costs – these vary directly with the amount produced VC The total costs therefore (assuming accurate forecasts!) is the sum of FC+VC TC Total revenue is determined by the price charged and the quantity sold – again this will be determined by expected forecast sales initially. TR The lower the price, the less steep the total revenue curve. TR Q1 The Break-even point occurs where total revenue equals total costs – the firm, in this example would have to sell Q1 to generate sufficient revenue to cover its costs.

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Page 61 Break-Even Analysis Costs/Revenue Output/Sales FC VC TC TR Q1 If the firm chose to set price higher than Rs2 (say Rs3) the TR curve would be steeper – they would not have to sell as many units to break even TR Q2

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Page 62 Break-Even Analysis Costs/Revenue Output/Sales FC VC TC TR Q1 If the firm chose to set prices lower it would need to sell more units before covering its costs TR) Q3

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Page 63 Break-Even Analysis Costs/Revenue Output/Sales FC VC TC TR Q1 Loss Profit

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Page 64 Break-Even Analysis Costs/Revenue Output/Sales FC VC TC TR Q1 Q2 Assume current sales at Q2 Margin of Safety Margin of safety shows how far sales can fall before losses made. If Q1 = 1000 and Q2 = 1800, sales could fall by 800 units before a loss would be made TR Q3 A higher price would lower the break even point and the margin of safety would widen

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Page 65 Costs/Revenue Output/Sales FC VC TR High initial FC. Interest on debt rises each year – FC rise therefore FC 1 Losses get bigger!

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Page 66 Break-Even Analysis Remember: A higher price or lower price does not mean that break even will never be reached! The BE point depends on the sales needed to generate revenue to cover costs

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Page 67 Break-Even Analysis Importance of Price Elasticity of Demand: Higher prices might mean fewer sales to break- even Lower prices might encourage more customers but higher volume needed before sufficient revenue generated to break-even

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Page 68 Break-Even Analysis Links of BE to pricing strategies and elasticity Penetration pricing – ‘high’ volume, ‘low’ price – more sales to break even

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Page 69 Break-Even Analysis Links of BE to pricing strategies and elasticity Market Skimming – ‘high’ price ‘low’ volumes – fewer sales to break even

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Page 70 Break-Even Analysis Links of BE to pricing strategies and elasticity Elasticity – what is likely to happen to sales when prices are increased or decreased?

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Page 71 Marginal Costing Cost Volume Chart

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Page 72 Construction Of PV Chart 1 select a scale on Horizontal axis---sales 2 Select a scale on Vertical axis- FC & Profit 3 Plot FC & Profit 4 Diagonal line crosses sales line at BEP

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Page 73 PV Chart Information Fixed Cost =Rs 5000 Sales =Rs 20000(pu RS 20) V Cost= Rs 10000(pu Rs10) Find PV Ratio, BEP, Profit?

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Page 74 Construction Of PV Chart 0 5000 10000 15000 20000 Sales Rs Fixed Cost Rs 2000 4000 5000 6000 8000 6000 5000 4000 2000 Profit Rs BEP

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Page 75 Construction Of PV Chart 0 5000 10000 15000 20000 Sales Rs Fixed Cost Rs 2000 4000 5000 6000 8000 6000 5000 4000 2000 Profit Rs BEP Loss Area Profit Area -------------------------- Margin of Safety

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Page 76 Effect Of Change in Profit- 20% decrease in fixed Cost New F Cost= 5000- 20%=Rs4000 Fixed Cost New BEP = PV Ratio = 4000/50% =Rs 8000 New Profit=S-F-V =20000-4000-10000 =Rs 6000

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Page 77 Effect of Change in profit- 20% decrease in FC 0 5000 10000 15000 20000 Sales Rs Fixed Cost Rs 2000 4000 5000 6000 8000 Profit Rs BEP Loss Area Profit Area 8000 6000 5000 4000 2000

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Page 78 Effect Of Change in Profit- 10% decrease in V Cost New V Cost= 10000- 10%=Rs9000 New PV Ratio=20000-9000 20000 Fixed Cost New BEP = PV Ratio = 5000/55% =Rs 9090 Appx New Profit=S-F-V =20000-5000-9000 =Rs 6000 =55%

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Page 79 Construction Of PV Chart 0 5000 10000 15000 20000 Sales Rs Fixed Cost Rs 2000 4000 5000 6000 8000 6000 5000 4000 2000 Profit Rs New BEP Loss Area Profit Area

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Page 80 Effect Of 5% Decrease in Selling Price 0 5000 10000 15000 20000 Sales Rs Fixed Cost Rs 2000 4000 5000 6000 8000 6000 5000 4000 2000 Profit Rs New BEP Loss Area Profit Area

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Page 81 ATTENTION COMMERCE STUDENTS ACCOUNTING(FINANACIAL & COST) OF ICMAP STAGE 1,2,3,4 (NEW CLASSES) CA..MODULE B,C,D PIPFA (FOUNDATION,INTERMEDIATE,FINAL) ACCA-F1,F2,F3 BBA,MBA B.COM(FRESH),M.COM MA-ECONOMICS..O/A LEVELS KHALID AZIZ…..0322-3385752

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