Indifference Point
The indifference point in costing is the level of production or sales where two different cost structures result in the same total cost. This concept helps businesses decide between two options, such as choosing between two suppliers or production methods. For example, if a company has the option to produce a product using either a fixed-cost system or a variable-cost system, the indifference point is where the total costs for both systems are equal. Understanding this point allows businesses to make informed decisions based on their production needs and cost management.
Let’s say Company A has a fixed cost of Rs.10,000 for producing a gadget, regardless of how many they make. They also have a variable cost of Rs.5 per gadget. Company B, on the other hand, has no fixed costs but charges Rs.10 per gadget. To find the indifference point, we set the total costs equal to each other. If Company A produces 1,000 gadgets, their total cost would be Rs.10,000 + (Rs.5 × 1,000) = Rs.15,000. For Company B to match this, they would need to produce 1,500 gadgets (Rs.10 × 1,500 = Rs.15,000). Therefore, at the indifference point of 1,500 gadgets, both companies have the same total cost, helping them make the best choice for their production strategy. In case the activity level is greater than 1500 it would be advantageous to give order to Company A and if the order size is lesser than 1500 it would be advantageous to give order to Company B.
By CA L.Muralidharan and CPA L.Mukundan
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