Key Factor
A key factor is also called as a limiting factor or principal budget factor or scarce factor. It is
factor of production which is scarce and because of want of which the production may stop.
Generally, sales volume, plant capacity, material, labour etc may be limiting factors. When there
is a key factor profit is calculated by using the formula
Example
The following particulars are extracted from the records of a company.
Direct wages per hour is Rs.5. Comment on the profitability of each product
(both use the same raw materials) when:
(i) Total sales potential in units is limited.
(ii) Production capacity (in terms of machine hours) is the limiting factor.
(iii) Material is in short supply.
(iv) Sales potential in value is limited.
Solution:
Total variable cost = Rs. 45 (10+15+5+15)
Contribution = For A Rs. 100 – Rs. 45 = Rs. 55 per unit
Calculate similarly for Product B.
Point wise answer
a) When total sales potential in units is limited, product B will be more profitable compared
to A as its Contribution per unit is more by Rs.14 (69 – 55).
b) When production capacity in terms of machine hours is the limiting factor, product B is
more profitable as its „contribution per hour‟ is more by Rs.16.17 (34.5 – 18.33)
c) When raw material is in short supply product A is more profitable as its contribution per
kg‟ is higher by Rs.4.5 (27.5 – 23)
d) When sales potential in value is the limiting factor product „B‟ is better as its P/V Ratio
is higher than that of product A
Note: Contribution per unit can be divided with any given “Key Factor” or “Limiting factor” to
obtain “Key-factor contribution‟ (K.F.C.). The Product which gives higher contribution in terms
of key-factor is decided to be better and more profitable.
Opportunity Cost Analysis
Opportunity cost refers to the profit lost when one alternative is selected over another. For
example, Apple has Rs. 1,000,000 and choose to invest it in producing iPhones that will generate
a return of 5%. It could have spent the money on a different investment of producing MacBook
that would have generated a return of 4%, then the 4% is the opportunity cost of producing
iPhone.
Opportunity cost may be explicit or implicit. Implicit opportunity cost is not a direct cost, but
rather the lost opportunity to generate income through those recourses. For example, if you leave
your house empty instead of renting it out then rent is the foregone income and hence the
opportunity cost.
Outlay Costs Analysis
Outlay cost is any expenditure made for acquiring a product or for carrying out an activity. For
example, the outlay cost for a research project may include wages, lab supplies and test services.
Or, the outlay costs for a production run includes direct materials, indirect supplies, and direct
labor.
Outlay costs include the actual expenditure of funds on factors like material, rent, wages, etc.
These are the actual expenditures and are recorded in the books of accounts. These costs are used
for measuring the profitability of the weaving operations.
Differential Costing & Analysis
The concept of differential cost is a relevant cost concept in those decision situations which
involve alternative choices. It is the difference in the total costs of two alternatives. This helps in
decision making. It can be determined by subtracting the cost of one alternative from the cost of
another alternative.
Differential costing is the change in the total cost which results from the adoption of an
alternative course of action. The alternative may arise on account of sales, volume, price change
in sales mix, etc decisions. Differential cost analysis leads to more correct decisions than more
marginal costing analysis. Inthis technique the total costs are considered and not the cost per
unit.
Differential costs do not form part of the accounting system while marginal costing can be
adapted to the routine accounting itself. However, when decisions involve huge amount of
money differential cost analysis proves to be useful.
Example:
Differential cost is generally confused with marginal cost. Of course, these two techniques are
similar in some aspects but these also differ in certain other respects.
Similarities
(i) Both the differential cost analysis and marginal cost analysis are based on the classification of
cost into fixed and variable. When fixed costs do not change, both differential and marginal costs
are same.
(ii) Both are the techniques of cost analysis and presentation and are used by the management in
formulating policies and decision making.
Dissimilarities
(i) Marginal cost may be incorporated in the accounting system where as differential cost are
worked out for reporting to the management for taking certain decisions.
(ii) Entire fixed cost are excluded from costing where as some of the relevant fixed costs may be
included in the differential cost analysis.
(iii) In marginal costing, contribution and p/v ratio are the main yardstick for evaluating
performance and decision making. In differential cost analysis emphasis is made between
differential cost and incremental or decremental revenue for making policy decisions.
(iv) Differential cost analysis may be used in absorption costing and marginal costing.