How to approach it
- Recover this year's units per product from sales and prices (watch whether quantities are per product or combined).
- Recover per-unit costs, separating common and special materials, and fixed from variable overheads.
- Project product by product: new volume × new price; each cost with its own inflation and efficiency factor.
- Total contribution, C/S ratio, then break-even = projected fixed costs ÷ C/S ratio; margin of safety on next year's sales.
Key rules to apply
- Variable overheads that follow labour hours change with both volume and hours per unit.
- Variable operating expenses that follow revenue change with projected revenue.
- Inflation applies to fixed costs; volume does not.
Common mistakes
Drawn from the examiners' comments for this sitting (summarised in our words) and from typical errors on this topic.
- Growing prices but not volumes, or applying both growth rates to total sales (examiners' point).
- Applying both material inflation rates to total material cost.
- Using this year's sales in the margin of safety.
Similar question with worked solution
Written by us with our own numbers; it tests the same skills as Q8 without copying it.
Original practice question
Two-variant forecast
This year: 500 Basic at Rs 100,000 and 500 Deluxe at Rs 150,000. Per unit: general material Rs 40,000 (both); Deluxe also uses a special part of Rs 10,000; labour Rs 10,000; variable overhead Rs 6,000 (follows labour hours). Fixed factory costs Rs 18m; fixed operating costs Rs 15m.
Next year: volumes +4% (Basic) and +10% (Deluxe); prices +8%; general material +5%; special part +20%; wage rate +15% but hours per unit −5%; overhead inflation +10%; fixed factory +10%; fixed operating +8%.
Required: Calculate break-even sales and margin of safety.
Worked solution
| Working | Rs m |
|---|---|
| Sales: 520 × 108,000 + 550 × 162,000 | 145.26 |
| General material: 1,070 × 42,000 | (44.94) |
| Special part: 550 × 12,000 | (6.60) |
| Labour: 1,070 × 10,000 × 1.15 × 0.95 | (11.69) |
| Variable overhead: 1,070 × 6,000 × 1.10 × 0.95 | (6.71) |
| Contribution | 75.32 |
| Fixed costs: 19.8 + 16.2 | 36.00 |
C/S ratio = 75.32 ÷ 145.26 = 51.85%. Break-even = 36.00 ÷ 0.5185 = Rs 69.43m.
Answer: Break-even ≈ Rs 69.4m; margin of safety ≈ 52.2% of forecast sales.