A to Z Costing Knowledge Glossary — Letter V
Investopedia-style costing concepts explained with formulas, practical examples, comparisons, and exam-focused teaching tips.
1 Value Added Cost
| Category | Activity-Based Management / Lean |
|---|---|
| Best Used In | Identifying beneficial activities in production |
| Key Formula | Value Added Cost = Cost of activities that add value to the customer |
| Exam Importance | Low |
Value Added Cost is the cost of activities that directly increase the value of a product or service from the customer’s perspective, such as machining, assembly, or customization.
It contrasts with non-value-added costs (waste). In lean accounting, the goal is to maximize value-added activities and eliminate or minimize non-value-added ones.
- Identifying waste in processes
- Activity-based management
- Improving cost efficiency
A manufacturer identifies machining and assembly as value-added activities, while inspection and storage are non-value-added. By focusing on improving value-added activities and reducing non-value-added, total cost decreases without affecting product quality.
Total cost ₹10,00,000. Value-added activities cost ₹7,00,000 (machining, assembly). Non-value-added cost ₹3,00,000 (rework, storage). Lean initiative reduces non-value-added to ₹1,00,000, saving ₹2,00,000.
- Identify all activities in the production or service process.
- Classify each as value-added or non-value-added from customer’s perspective.
- Sum the costs of value-added activities.
- Compare with total cost to identify waste.
- Aim to reduce non-value-added costs without reducing value-added.
| Value Added vs. Non-Value Added Cost | Non-value-added costs are waste; value-added costs are necessary and beneficial to customer. |
|---|---|
| Value Added Cost vs. Total Cost | Total cost includes both value-added and non-value-added. |
2 Value Analysis
| Category | Cost Reduction Technique |
|---|---|
| Best Used In | Reducing cost without affecting functionality |
| Key Formula | Value = Function / Cost |
| Exam Importance | Low |
Value Analysis is a systematic approach to improve the value of a product by analyzing its functions and reducing unnecessary costs while maintaining quality and performance.
It focuses on the function of a product and seeks to achieve that function at the lowest possible cost, thereby improving the value ratio (Function/Cost).
- Cost reduction in product design
- Improving product value
- Eliminating redundant features
A company analyzes a product and finds a component over-engineered; by using a cheaper material that still meets requirements, cost is reduced without reducing function, increasing value.
Product function requires supporting 10 kg. Current component supports 20 kg and costs ₹100. Redesign to support 12 kg costs ₹70. Value increases because same function (or adequate) at lower cost.
- Identify the primary and secondary functions of the product.
- Determine the cost of each function.
- Brainstorm alternative ways to achieve same function at lower cost.
- Evaluate alternatives for performance and cost.
- Implement the best alternative to improve value.
| Value Analysis vs. Value Engineering | Value analysis is applied to existing products; value engineering is applied during design phase. |
|---|---|
| Value Analysis vs. Cost Reduction | Cost reduction may sacrifice quality; value analysis maintains function. |
3 Value Chain
| Category | Strategic Cost Management |
|---|---|
| Best Used In | Analyzing competitive advantage, cost drivers |
| Key Formula | No formula; framework of activities from raw material to customer |
| Exam Importance | Low |
Value Chain is the sequence of activities that a company performs to design, produce, market, deliver, and support its products, from raw material acquisition to final customer.
It provides a framework for identifying cost drivers and sources of competitive advantage, enabling strategic cost management and differentiation.
- Strategic cost analysis
- Identifying cost reduction opportunities
- Competitive benchmarking
A company analyzes its value chain from procurement, production, marketing, distribution, to after-sales service, identifying that distribution costs are higher than competitors; it then renegotiates logistics or changes distribution strategy.
Value chain activities: inbound logistics ₹10, operations ₹20, outbound logistics ₹15, marketing ₹10, service ₹5. Total cost ₹60; each activity analyzed for cost drivers and value added.
- Identify primary activities: inbound logistics, operations, outbound logistics, marketing, service.
- Identify support activities: procurement, technology development, HR, infrastructure.
- Analyze cost and value generated by each activity.
- Identify linkages and cost drivers.
- Develop strategies to improve cost or differentiation.
| Value Chain vs. Supply Chain | Supply chain focuses on physical flow; value chain includes all value-adding activities, internal and external. |
|---|---|
| Value Chain vs. Life Cycle | Life cycle is stages of product’s life; value chain is activities within the organization. |
4 Value Engineering
| Category | Cost Reduction / Product Design |
|---|---|
| Best Used In | New product development, design optimization |
| Key Formula | Value = Function / Cost |
| Exam Importance | Low |
Value Engineering is the application of value analysis during the design and development stage of a product, to ensure that the product delivers required functions at the lowest possible cost.
It proactively integrates cost reduction into the design process, avoiding over-engineering and unnecessary features from the start.
- New product development
- Design-to-cost programs
- Competitive product design
During the design of a new appliance, engineers use value engineering to select materials and components that meet specifications at minimum cost, reducing overall product cost without sacrificing performance.
A car manufacturer designs a seat using cheaper but equally durable fabric, saving ₹500 per seat. Across 1,00,000 cars, savings ₹5 crore, with no loss in function.
- Identify required functions and performance criteria for new product.
- Generate alternative designs meeting criteria.
- Estimate cost of each alternative.
- Select the design with best value (function per unit of cost).
- Incorporate into final product design.
| Value Engineering vs. Value Analysis | Value engineering is during design phase; value analysis is after product exists. |
|---|---|
| Value Engineering vs. Target Costing | Target costing sets cost goal; value engineering helps achieve that goal. |
5 Variance
| Category | Standard Costing / Budgetary Control |
|---|---|
| Best Used In | Performance measurement |
| Key Formula | Variance = Standard/Budgeted − Actual (or Actual − Standard depending on context) |
| Exam Importance | Very High |
Variance is the difference between a standard or budgeted amount and the actual amount, used to measure performance and identify areas needing attention.
Variances can be favorable (actual better than standard) or adverse (actual worse). They are fundamental to standard costing and budgetary control systems.
- Variance analysis for cost control
- Performance evaluation of managers
- Identifying inefficiencies and corrective actions
A company sets standard material cost at ₹50 per unit. Actual cost is ₹55. Variance = ₹5 adverse per unit, triggering investigation into price or quantity differences.
Budgeted sales ₹10,00,000; actual sales ₹9,50,000. Variance = ₹50,000 adverse (assuming lower sales is unfavorable). If actual sales ₹10,50,000, variance = ₹50,000 favorable.
For revenues: Variance = Actual Revenue − Budgeted Revenue (favorable if positive)
- Determine standard/budgeted amount.
- Determine actual amount.
- Compute difference using appropriate formula.
- Classify as favorable or adverse.
- Analyze causes and take corrective action.
| Variance vs. Variance Analysis | Variance is the difference; variance analysis is the process of investigating variances. |
|---|---|
| Favorable vs. Adverse Variance | Favorable improves profit; adverse reduces profit. |
6 Variance Analysis
| Category | Standard Costing / Management Control |
|---|---|
| Best Used In | Investigating and interpreting variances |
| Key Formula | Variance = (Standard Price × Standard Quantity) − (Actual Price × Actual Quantity) |
| Exam Importance | Very High |
Variance Analysis is the systematic process of computing variances, identifying their causes, and taking corrective action to control costs and improve performance.
It involves breaking down total variances into sub-variances (price, quantity, mix, yield, etc.) to pinpoint exactly what drove the difference.
- Cost control in standard costing systems
- Management by exception
- Performance evaluation
A company finds total material cost variance ₹10,000 adverse. It further breaks into material price variance ₹4,000 adverse and material usage variance ₹6,000 adverse, leading to specific corrective actions (supplier negotiation, waste reduction).
Standard material cost = 500 kg × ₹10 = ₹5,000; actual = 520 kg × ₹12 = ₹6,240. Total variance = 1,240 adverse. Price variance = (10-12)×520 = ₹1,040 adverse; usage variance = (500-520)×10 = ₹200 adverse. Combined = ₹1,240.
- Compute total variance for each cost element.
- Break into price/rate and quantity/efficiency variances.
- If applicable, further analyze into mix and yield variances.
- Investigate causes of significant variances.
- Take corrective actions and adjust standards if necessary.
| Variance Analysis vs. Budgetary Control | Budgetary control compares actual vs budget; variance analysis often uses standard costs per unit. |
|---|---|
| Price Variance vs. Quantity Variance | Price is rate effect; quantity is usage effect. |
7 Variable Cost
| Category | Cost Behaviour |
|---|---|
| Best Used In | Contribution margin, CVP analysis |
| Key Formula | Total Variable Cost = Variable Cost per Unit × Number of Units |
| Exam Importance | Very High |
Variable Cost is a cost that changes in total in direct proportion to changes in activity level or volume, while remaining constant per unit.
Examples include direct materials, direct labour (if hourly), and variable overheads. It is the foundation of marginal costing and CVP analysis.
- Contribution and break-even analysis
- Flexible budgeting
- Make-or-buy and special order decisions
A product has variable cost of ₹30 per unit. If 1,000 units produced, total variable cost = ₹30,000. If 2,000 units, total = ₹60,000. Variable cost per unit remains ₹30.
Direct material ₹10/unit, direct labour ₹8/unit, variable overhead ₹5/unit. Total variable cost per unit = ₹23. For 5,000 units, total variable cost = ₹1,15,000.
- Identify all costs that vary with output.
- Determine variable cost per unit for each.
- Sum to get total variable cost per unit.
- Multiply by activity level to get total variable cost.
- Use in contribution margin and break-even calculations.
| Variable Cost vs. Fixed Cost | Fixed cost remains constant in total; variable cost changes with activity. |
|---|---|
| Variable Cost vs. Semi-variable Cost | Semi-variable has both fixed and variable components. |
8 Variable Costing (Marginal Costing)
| Category | Costing Methodology |
|---|---|
| Best Used In | Short-term decision making, CVP |
| Key Formula | Contribution = Sales − Variable Cost |
| Exam Importance | Very High |
Variable Costing, also known as Marginal Costing, is a costing method where only variable production costs are treated as product costs; fixed manufacturing overheads are treated as period costs and expensed in full.
It emphasizes contribution margin as the key measure for decision making, as fixed costs are considered irrelevant for short-term decisions.
- Break-even and target profit analysis
- Make-or-buy and special order decisions
- Profit planning and product mix decisions
A company evaluates a special order at ₹40 per unit when variable cost is ₹35. Under variable costing, the order contributes ₹5 per unit to fixed costs and is accepted if fixed costs are already covered or if it increases overall profit.
Selling price ₹100, variable cost ₹60, fixed cost ₹50,000. Contribution per unit = ₹40. Break-even = 50,000/40 = 1,250 units. Under absorption costing, product cost includes fixed overhead, leading to different profit when inventory changes.
Profit = Contribution − Fixed Cost
- Separate costs into fixed and variable.
- Compute variable cost per unit.
- Compute contribution per unit = selling price − variable cost.
- Deduct total fixed costs to get profit.
- Use for break-even and target profit calculations.
| Variable Costing vs. Absorption Costing | Absorption includes fixed production overhead in product cost; variable costing treats it as period cost. |
|---|---|
| Variable Costing vs. Throughput Accounting | Throughput accounting treats only direct material as variable; variable costing includes all variable costs. |
9 Variable Cost per Unit
| Category | Cost Behaviour |
|---|---|
| Best Used In | Contribution, break-even, budgeting |
| Key Formula | Variable Cost per Unit = Total Variable Cost / Number of Units |
| Exam Importance | High |
Variable Cost per Unit is the cost directly attributable to producing one additional unit, which remains constant over the relevant range.
It includes direct materials, direct labour (if variable), and variable overheads per unit. It is used to calculate contribution margin and break-even point.
- Contribution margin calculation
- Break-even and CVP analysis
- Flexible budgeting
If total variable cost for 5,000 units is ₹1,25,000, then variable cost per unit = 1,25,000 / 5,000 = ₹25. This ₹25 is used to compute contribution per unit (selling price − 25).
Direct material ₹10, direct labour ₹5, variable overhead ₹3. Total variable cost per unit = ₹18. Selling price ₹30, contribution per unit = ₹12.
- Identify all variable cost elements.
- Sum total variable cost for a given activity level.
- Divide by number of units to get variable cost per unit.
- Use in contribution and break-even formulas.
- Verify that per-unit cost remains constant over relevant range.
| Variable Cost per Unit vs. Total Variable Cost | Per unit constant; total changes with volume. |
|---|---|
| Variable Cost per Unit vs. Average Cost | Average cost includes fixed cost per unit; variable cost per unit excludes fixed. |
10 Variable Cost Ratio
| Category | Marginal Costing / CVP |
|---|---|
| Best Used In | Profitability and break-even analysis |
| Key Formula | Variable Cost Ratio = (Variable Cost / Sales) × 100 |
| Exam Importance | Medium |
Variable Cost Ratio expresses total variable cost as a percentage of sales revenue, indicating the proportion of each sales rupee consumed by variable costs.
It is the complement of the P/V ratio (P/V ratio = 1 − Variable cost ratio). It helps in understanding cost structure and break-even sales value.
- Break-even analysis in value terms
- Comparing cost structures
- Profit planning
Sales ₹1,00,000, variable cost ₹60,000. Variable cost ratio = 60%. P/V ratio = 40%. Break-even sales = Fixed costs / 0.40.
Sales ₹5,00,000, variable costs ₹3,50,000. Variable cost ratio = (3,50,000/5,00,000)×100 = 70%. P/V ratio = 30%. If fixed costs ₹90,000, break-even sales = 90,000/0.30 = ₹3,00,000.
- Determine total variable cost and total sales for a period.
- Divide variable cost by sales.
- Multiply by 100 to express as percentage.
- Compute P/V ratio = 100% − variable cost ratio.
- Use in break-even and target profit formulas.
| Variable Cost Ratio vs. P/V Ratio | P/V Ratio = 1 − Variable Cost Ratio; they are complements. |
|---|---|
| Variable Cost Ratio vs. Contribution Margin Ratio | Contribution margin ratio = (Sales − Variable Cost) / Sales; same as P/V ratio. |
11 Variable Overhead
| Category | Overhead Classification |
|---|---|
| Best Used In | Product costing, variance analysis |
| Key Formula | Variable Overhead = Overheads that vary with production volume |
| Exam Importance | Medium |
Variable Overhead is the indirect manufacturing cost that changes in total with the level of production, such as power, indirect materials, and variable maintenance.
Unlike fixed overhead, variable overhead varies with activity but is not directly traceable to units; it is allocated using a rate per unit of activity.
- Product costing under marginal or absorption costing
- Flexible budgeting
- Variance analysis for overheads
A factory has variable overhead of ₹5 per machine hour for power and consumables. If a job uses 100 machine hours, variable overhead allocated = ₹500.
Total variable overhead ₹1,00,000 for 20,000 machine hours = ₹5 per machine hour. A product using 10 machine hours absorbs ₹50 variable overhead.
- Identify variable overhead items.
- Determine total variable overhead for the period.
- Select an activity base (e.g., machine hours).
- Compute variable overhead rate.
- Apply to products based on their actual usage of the base.
| Variable Overhead vs. Fixed Overhead | Fixed overhead remains constant; variable overhead changes with volume. |
|---|---|
| Variable Overhead vs. Direct Material | Direct material is traceable; variable overhead is indirect but variable. |
12 Variable Overhead Expenditure Variance
| Category | Standard Costing / Variance Analysis |
|---|---|
| Best Used In | Controlling variable overhead spending |
| Key Formula | (Standard Variable OH Rate − Actual Variable OH Rate) × Actual Hours |
| Exam Importance | Medium |
Variable Overhead Expenditure Variance (also called spending variance) is the difference between the actual variable overhead incurred and the standard variable overhead allowed for actual hours worked.
It isolates the effect of paying more or less per unit of activity for variable overhead items, independent of efficiency.
- Variable overhead cost control
- Identifying price changes in indirect materials, power
- Performance evaluation of cost centres
Standard variable overhead rate ₹5/machine hour; actual variable overhead ₹5.50/machine hour; actual hours 2,000. Expenditure variance = (5-5.50)×2,000 = ₹1,000 adverse.
Standard variable OH rate ₹8 per labour hour; actual rate ₹7.5 per labour hour; actual hours 4,000. Expenditure variance = (8-7.5)×4,000 = ₹2,000 favourable.
- Determine standard variable overhead rate per activity unit.
- Compute actual variable overhead rate per activity unit.
- Record actual activity (hours) for the period.
- Compute variance using formula.
- Analyze causes (price changes, waste in variable overhead).
| Expenditure Variance vs. Efficiency Variance | Expenditure is spending rate; efficiency is usage of activity base. |
|---|---|
| Variable OH Expenditure vs. Fixed OH Expenditure | Both measure spending differences but variable relates to actual hours, fixed relates to period total. |
13 Variable Overhead Efficiency Variance
| Category | Standard Costing / Variance Analysis |
|---|---|
| Best Used In | Measuring efficiency of activity base usage |
| Key Formula | (Standard Hours for Actual Output − Actual Hours) × Standard Variable OH Rate |
| Exam Importance | Medium |
Variable Overhead Efficiency Variance is the difference between the standard hours allowed for actual production and the actual hours worked, multiplied by the standard variable overhead rate.
It measures the impact of labour efficiency (or whichever activity base is used) on variable overhead absorption; if workers are efficient, less variable overhead is consumed.
- Labour efficiency analysis related to overheads
- Overhead cost control
- Sub-variance analysis for variable overhead total variance
Standard hours for actual output 1,000; actual hours 900; standard variable OH rate ₹6/hour. Efficiency variance = (1,000−900)×6 = ₹600 favourable (less hours used than standard).
Standard hours 2,000; actual hours 2,100; variable OH rate ₹4/hour. Efficiency variance = (2,000−2,100)×4 = ₹400 adverse (extra hours caused more variable overhead).
- Compute standard hours allowed for actual output.
- Record actual hours worked.
- Find difference.
- Multiply by standard variable overhead rate.
- Interpret favorable if standard hours > actual hours.
| Variable OH Efficiency vs. Labour Efficiency Variance | Same hours difference but multiplied by variable OH rate instead of labour rate. |
|---|---|
| Variable OH Efficiency vs. Fixed OH Efficiency Variance | Both use hours difference but different rates; fixed OH rate is predetermined. |
14 Variable Overhead Total Variance
| Category | Standard Costing / Variance Analysis |
|---|---|
| Best Used In | Overall variable overhead control |
| Key Formula | Variable OH Total Variance = Standard Variable OH for Actual Output − Actual Variable OH |
| Exam Importance | Medium |
Variable Overhead Total Variance is the difference between the standard variable overhead allowed for actual production and the actual variable overhead incurred.
It is the sum of variable overhead expenditure and efficiency variances, indicating overall performance in managing variable overheads.
- Overhead cost control
- Performance evaluation
- Reconciling budgeted and actual variable overheads
Standard variable overhead for actual output = ₹5,000; actual variable overhead = ₹5,400. Total variance = ₹400 adverse, split into expenditure and efficiency components.
Standard hours for actual output 800; standard rate ₹10/hr → standard variable OH ₹8,000. Actual variable OH ₹8,200. Total variance = 8,000 − 8,200 = ₹200 adverse.
- Determine standard variable overhead rate and standard hours for actual output.
- Compute standard variable overhead allowed.
- Determine actual variable overhead incurred.
- Subtract actual from standard to get total variance.
- Analyze by splitting into expenditure and efficiency variances.
| Variable OH Total Variance vs. Expenditure + Efficiency | Total = Expenditure Variance + Efficiency Variance. |
|---|---|
| Variable OH Total vs. Fixed OH Total Variance | Fixed OH total variance = absorbed − actual; variable OH total = standard for actual output − actual. |
15 Variable Production Overhead
| Category | Overhead Classification |
|---|---|
| Best Used In | Product costing, marginal costing |
| Key Formula | Variable Production Overhead = Indirect variable costs incurred in production |
| Exam Importance | Medium |
Variable Production Overhead refers to the variable portion of manufacturing overhead, such as power, indirect materials, and variable maintenance, that changes with production volume.
These costs are part of product cost under both absorption and marginal costing (as variable cost), and they are allocated using a predetermined rate.
- Product costing and inventory valuation
- Variable costing and contribution analysis
- Flexible budgeting
Variable production overhead includes consumable lubricants, electricity for machines, and variable maintenance. A rate per machine hour is used to assign these costs to products.
Total variable production overhead ₹80,000 for 8,000 machine hours → rate ₹10/machine hour. Product using 50 hours absorbs ₹500.
- Identify variable production overhead items.
- Estimate total for the period.
- Choose activity base (machine hours, labour hours).
- Compute rate.
- Apply to products.
| Variable Production Overhead vs. Fixed Production Overhead | Fixed remains constant; variable changes with volume. |
|---|---|
| Variable Production Overhead vs. Direct Material | Direct material is traceable; variable production overhead is indirect. |
16 Volume Variance
| Category | Standard Costing / Overhead Variance |
|---|---|
| Best Used In | Measuring impact of production volume on fixed overhead |
| Key Formula | Volume Variance = Absorbed Fixed Overhead − Budgeted Fixed Overhead |
| Exam Importance | High |
Volume Variance is the difference between the fixed overhead absorbed into production (based on standard hours for actual output) and the budgeted fixed overhead for the period, arising due to difference in production volume.
It indicates whether fixed overheads were over- or under-absorbed due to producing more or less than budgeted volume, not due to cost changes.
- Capacity utilization analysis
- Inventory valuation under absorption costing
- Performance evaluation of production volume
Budgeted fixed overhead ₹2,00,000 for 10,000 hours; absorption rate ₹20/hour. Actual production used 8,000 standard hours. Absorbed fixed overhead = 8,000×20 = ₹1,60,000. Volume variance = 1,60,000 − 2,00,000 = ₹40,000 adverse (under-absorbed).
Budgeted fixed OH ₹1,50,000; budgeted hours 7,500; standard hours for actual output 8,000; rate ₹20/hr. Absorbed = ₹1,60,000. Volume variance = 1,60,000 − 1,50,000 = ₹10,000 favourable.
- Determine budgeted fixed overhead and budgeted activity.
- Compute absorption rate.
- Determine standard hours for actual output.
- Multiply by rate to get absorbed fixed overhead.
- Subtract budgeted from absorbed to get volume variance.
| Volume Variance vs. Capacity Variance | Capacity variance = (Actual Hours − Budgeted Hours) × Rate; volume includes efficiency effect. |
|---|---|
| Volume Variance vs. Efficiency Variance | Volume = Capacity + Efficiency variances (for fixed overhead). |
17 Volume Ratio
| Category | Performance Measurement |
|---|---|
| Best Used In | Measuring capacity utilization |
| Key Formula | Volume Ratio = (Standard Hours for Actual Output / Budgeted Hours) × 100 |
| Exam Importance | Low |
Volume Ratio compares the standard hours allowed for actual production with the budgeted hours, indicating the level of activity achieved relative to budget.
It is one of the three ratios used in labour efficiency and capacity analysis (efficiency ratio, capacity ratio, volume ratio). A ratio below 100% indicates under-achievement of planned volume.
- Capacity utilization measurement
- Performance evaluation of production volume
- Inter-period comparison
Budgeted hours 10,000; standard hours for actual output 9,000. Volume ratio = 90%, indicating production was 90% of planned volume.
Budgeted hours 8,000; standard hours for actual output 8,400. Volume ratio = (8,400/8,000)×100 = 105%, indicating production exceeded budget.
- Determine budgeted hours for the period.
- Compute standard hours allowed for actual output.
- Divide standard hours by budgeted hours.
- Multiply by 100 to get ratio.
- Interpret: 100% = on budget; >100% above; <100% below.
| Volume Ratio vs. Capacity Ratio | Capacity ratio = Actual Hours / Budgeted Hours; Volume ratio uses standard hours, not actual. |
|---|---|
| Volume Ratio vs. Efficiency Ratio | Efficiency ratio = Standard Hours / Actual Hours; Volume ratio = Standard Hours / Budgeted Hours. |
18 Vertical Analysis
| Category | Financial Statement Analysis |
|---|---|
| Best Used In | Evaluating cost structure, common-size statements |
| Key Formula | Vertical analysis % = (Line Item / Total Base) × 100 |
| Exam Importance | Low |
Vertical Analysis is a method of financial statement analysis where each line item is expressed as a percentage of a base amount (e.g., total sales for income statement, total assets for balance sheet), facilitating comparison across companies and periods.
It produces common-size statements that reveal cost structure and financial position proportions, helping in benchmarking and trend analysis.
- Comparing cost structures between companies
- Analyzing expense ratios
- Identifying significant cost components
In an income statement, cost of goods sold is expressed as % of sales. If sales ₹10,00,000 and COGS ₹6,00,000, COGS is 60%. This is compared across years or with competitors.
Income statement: Sales ₹5,00,000; COGS ₹3,00,000; operating expenses ₹1,00,000; net profit ₹1,00,000. Vertical analysis: COGS 60%, operating 20%, net profit 20%.
- Select the financial statement and base item (sales for P&L, total assets for balance sheet).
- For each line item, divide by base amount.
- Multiply by 100 to get percentage.
- Present as common-size statement.
- Analyze changes over time or compare with industry.
| Vertical Analysis vs. Horizontal Analysis | Horizontal analysis compares year-over-year changes; vertical compares line items to a base within same period. |
|---|---|
| Vertical Analysis vs. Ratio Analysis | Vertical is a form of ratio analysis; ratios are more specific. |
19 Variable Selling and Distribution Overhead
| Category | Overhead Classification |
|---|---|
| Best Used In | Marginal costing, cost sheet |
| Key Formula | Variable Selling & Distribution Overhead = Indirect variable costs of selling and delivering goods |
| Exam Importance | Low |
Variable Selling and Distribution Overhead refers to the variable portion of selling and distribution costs, such as sales commissions, freight outward, and packaging that vary with sales volume.
These costs are included in total variable cost for contribution analysis and are part of marginal costing, unlike fixed selling overheads which are period costs.
- Contribution margin calculation
- Product profitability analysis
- Flexible budgeting for selling costs
A company pays 5% sales commission and freight of ₹2 per unit. These are variable selling and distribution overheads, deducted from sales along with production variable costs to determine contribution.
Sales price ₹100; variable production cost ₹50; variable selling overhead ₹5 (commission + freight). Total variable cost ₹55; contribution ₹45.
- Identify variable selling and distribution expenses.
- Estimate per-unit amount.
- Add to other variable costs to get total variable cost per unit.
- Deduct from selling price to get contribution.
- Use in break-even and profitability analysis.
| Variable Selling vs. Fixed Selling Overhead | Fixed selling overhead (e.g., advertising) is period cost; variable changes with sales. |
|---|---|
| Variable Selling vs. Distribution Overhead | Distribution is a subset of selling; both can be variable or fixed. |
20 Value-Based Pricing
| Category | Pricing Strategy |
|---|---|
| Best Used In | Setting prices based on customer perceived value |
| Key Formula | Price = Perceived Value to Customer (not cost-based) |
| Exam Importance | Low |
Value-Based Pricing is a pricing strategy where the selling price is set primarily on the customer’s perceived value of the product, rather than on the cost of producing it.
It requires understanding customer needs, preferences, and willingness to pay, often used for differentiated products, luxury goods, and services with unique value propositions.
- Premium and luxury products
- Innovative products with little competition
- Services where value perception drives price
A pharmaceutical company prices a life-saving drug based on the value it provides to patients (e.g., extended life) rather than the cost of manufacturing, allowing high margins that fund R&D.
A software company offers a tool that saves customers ₹1,00,000 per year. It prices the software at ₹20,000 per year, less than the value delivered, ensuring high perceived value and adoption.
- Assess customer’s perceived value of the product benefits.
- Determine willingness to pay through market research.
- Set price within value range, above cost floor, and competitive constraints.
- Communicate value effectively to justify price.
- Monitor demand and adjust based on feedback.
| Value-Based vs. Cost-Plus Pricing | Cost-plus ignores customer value; value-based ignores cost (to a degree). |
|---|---|
| Value-Based vs. Target Costing | Target costing starts with market price and subtracts margin; value-based starts with perceived value. |
