2.
Marginal Costing
II Marginal Costing
• Meaning and Concepts – Fixed Cost, Variable
Cost Contribution, Profit Volume Ratio, Break
Even Point, Margin of Safety. Cost Volume
Profit Analysis – Assumptions and Limitations.
Simple practical problems.
Marginal costing
Marginal costing is an approach where variable
costs are charged to cost units, but the fixed cost
for the relevant period is written off in full against
the total contribution for that period.
The fixed cost is not shared or apportioned to any
cost centre or cost unit.
Its main use is in providing relevant information
for planning and decision-making.
Marginal Costing Method:
Product A Product B Product C Total
Raw Material 10 20 15 45
Labour 20 30 25 75
Overheads 10 20 10 40
Total Variable 40 70 50 160
cost
Sales 70 100 80 250
(-) Total 40 70 50 160
variable cost
Contribution 30 30 30 90
Less-fixed cost ---- ---- ------ 30
Net Profit 60
Marginal Costing is a variable costs
Marginal costing is useful to calculate product cost
It is used to find the relationship between profit & volume
Variable costs varies as per volume but fixed cost remains
same
In marginal costing costs are classified into variable cost
& fixed costs
Only variable costs are charged to the product
Means fixed costs are not charged to the product.
Fixed costs are absorbed through total profit Of The
Company
Contribution
• Contribution is a key term in marginal costing.
It is simply the difference between total sales
and total variable cost.
Marginal v absorption costing
Advantages of marginal costing
The marginal costing approach is preferable for
decision-making
Separating fixed and variable costs can help in
short-term pricing decisions.
As fixed costs will remain constatnt by fluctuations
in activity, management can focus on variable costs
and contribution.
It gives a more accurate picture of how an
organisation’s cash flows and profits are affected by
sales and volume.
In manufacturing organisations, it avoids the
manipulation of profits through increased
production volumes.
Break-Even point :
• The break-even point is the point at which
total cost and total revenue are equal.
• There is no loss or gain for your small
business.
• Company is reached such a level of
production at which the costs of production
equals the revenues for a product
Break-even point
• The break-even point is the point at which
neither a profit or a loss is incurred. Break-
even occurs where total contribution is exactly
equal to fixed cost and hence sales revenue is
exactly equal to variable cost plus fixed cost.
BREAK- EVEN-POINT
Profit Area Sale
Loss Area Total Cost
Cost BEP
Fixed Cost
Volume(Units)
Break Even Point
• No profit no loss
• Contribution = Fixed cost
• BEP( in units) = Fixed cost / contribution per
unit
• BEP( in amount) = Fixed cost / PV ratio
• Contribution beyond BEP is profit
Margin of Safety
• Indicates soundness of business
• High margin of safety – BEP is much below the actual
sales
• Margin of safety = Sales – BEP sales
• Margin of safety = Sales – fixed cost/ PV ratio
• Margin of safety = Profit / PV ratio
Profit Volume Ratio (P/V)
• Indicates contribution earned with respect to one rupee of
sales
• Properties of PV ratio:
It remains constant at all the levels of activities provided per
unit sales price & variable cost remains constant
High PV ratio indicates high profitability
Low PV ratio indicates low profitability
Overall profitability can be increased by concentrating more
on product having high PV ratio
Cost-Volume-Profit (CVP) Analysis
• It is used to find out how changes in variable and fixed
costs impact a firm's profit.
• Companies can use CVP analysis to see how many units
they need to sell to break even (cover all costs) or,
alternatively, how many units they need to sell to reach a
certain minimum profit margin.
• CVP analysis considers the interaction between sales
revenue, total costs and the volume of activity, which
between them make up profit.
• Using the CVP model, profit can be predicted for given
situations.
CVP & profit statement
Basic equations
• Profit = Sales – Total cost
• Profit = Sales – (Variable cost + Fixed cost)
• Profit = Sales – Variable cost – Fixed cost
• Profit + Fixed cost = Sales – Variable cost
• Sales – Variable cost = Contribution = Fixed cost + profit
• Contribution – Fixed cost = Profit
• PV ratio = contribution / sales * 100
• PV ratio = change in profit / change in sales * 100
Means
• Sales * PV ratio = Contribution
• Contribution / PV ratio = Sales
Margin of safety
• The margin of safety is the
amount of sales the business
can afford to lose and still
not make a loss.
• It is the difference between
the budgeted sales volume
(or revenue) and the
budgeted break-even
volume (or revenue).
• It can be expressed in units /
products or sales or as a
percentage.
Margin of Safety
• Indicates soundness of business
• High margin of safety – BEP is much below the actual
sales
• Margin of safety = Sales – BEP sales
• Margin of safety = Sales – fixed cost/ PV ratio
• Margin of safety = Sales * PV ratio – Fixed cost / PV
ratio
• Margin of safety = Contribution – Fixed cost/ PV ratio
• Margin of safety = Profit / PV ratio
