Marginal Costing - Management Accounting | CMA Inter Syllabus
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In cost accounting, cost of production per unit of the goods produced or services provided is calculated with the help of the various methods such as Unit Costing (Job Costing, Batch Costing, Contract Costing) or Process Costing. Marginal costing is not a method of calculating the cost of production as per the mentioned methods, but it is a technique applicable to the existing methods to find out the effect on profits if changes are made either in the volume of output or in the type of output. Thus, marginal costing is a technique which helps the management in taking various routine and special or crucial decisions for running the organizational activities like:
a. To continue with a product or not,
b. To change the selling price as per the market conditions,
c. To change the method of production,
d. To make or buy decision,
e. To decide about sales mix.
Marginal Costing
Marginal Costing is the practice of charging all marginal costs to operations processes or products and deducting all fixed costs against the profits for a particular period in which they arise.
Marginal Costing may be defined as “the ascertainment by differentiating between fixed cost and variable cost, of marginal cost and of the effect on profit of changes in volume or type of output.” With marginal costing procedure costs are separated into fixed and variable cost.
According to J. Batty, Marginal costing is “a technique of cost accounting pays special attention to the behaviour of costs with changes in the volume of output.” This definition lays emphasis on the ascertainment of marginal costs and also the effect of changes in volume or type of output on the company’s profit.
In other words, Marginal costing may be defined as the technique of presenting cost data wherein variable costs and fixed costs are shown separately for managerial decision-making. It should be clearly understood that marginal costing is not a method of costing like process costing or job costing. Rather it is simply a method or technique of the analysis of cost information for the guidance of management.
Marginal Cost
The term ‘marginal cost’ is defined as the amount at any given volume of output by which aggregate costs are changed, if the volume of output is increased or decreased by one unit. It is a variable cost of one unit of a product or a service i.e., a cost which would be avoided if that unit was not produced or provided.
| Marginal Cost = Variable Cost = Direct Labour + Direct Material + Direct Expenses + Variable Overheads |
The term Marginal Cost refers to the amount at any given volume of output by which the aggregate costs are charged if the volume of output is changed by one unit. Accordingly, it means that the added or additional cost of an extra unit of output.
Marginal cost may also be defined as the “cost of producing one additional unit of product.” Thus, the concept marginal cost indicates wherever there is a change in the volume of output; certainly there will be some change in the total cost. It is concerned with the changes in variable costs. Fixed cost is treated as a period cost and is transferred to Profit and Loss Account.
Marginal Costs can be presented as under:
| Particulars | ₹ |
| Raw Material Cost | x |
| Direct Labour Cost | x |
| Direct Expenses | x |
| Variable Manufacturing Expenses | x |
| Variable portions of Administration Expenses | x |
| Variable portions of Selling and Distribution Expenses | x |
| Total Marginal Costs/ Variable Costs | xxxx |
Marginal costing principles can be understood with help of the following example:
XYZ Co. makes a product, the Goldy, which has a variable production cost of ₹6 per unit and a sales price of ₹10 per unit. At the beginning of September 2021, there were no opening inventories and production during the month was 20,000 units. Fixed costs for the month were ₹ 45,000 (production, administration, sales and distribution). There were no variable marketing costs.
Calculate the contribution and profit for September 2021, using marginal costing principles, if sales were as follows:
(a) 10,000 Goldies (b) 15,000 Goldies (c) 20,000 Goldies
Features of marginal costing are as follows:
a. Marginal costing is used to know the impact of variable cost on the volume of production or output.
b. Break-even analysis is an integral and important part of marginal costing.
c. Contribution of each product or department is a foundation to know the profitability of the product or department.
d. Addition of variable cost and profit to contribution is equal to selling price.
e. Marginal costing is the base of valuation of stock of finished product and work in progress.
f. Fixed cost is recovered from contribution and variable cost is charged to production.
g. Costs are classified on the basis of fixed and variable costs only. Semi-fixed costs are also divided into fixed cost and variable cost.
The technique of marginal costing is based upon the following assumptions:
a. All elements of cost-production, administration and selling and distribution can be segregated into fixed and variable components.
b. Variable cost remains constant per unit of output irrespective of the level of output and thus fluctuates directly in proportion to changes in the volume of output.
c. The selling price per unit remains unchanged or constant at all levels of activity.
d. Fixed costs remain unchanged or constant for the entire volume of production.
e. The volume of production or output is the only factor which influences the costs.
The following are the important advantages of marginal costing:
a. The Technique of marginal costing is very simple to operate and easy to understand. Since, fixed costs are kept outside the unit cost; the cost statements prepared on the basis of marginal cost are much less complicated.
b. By not charging fixed overhead to cost of production, the effect of varying charges per unit is avoided.
c. It does away with the need for allocation, apportionment and absorption of fixed overheads and hence removes the complexities of under-absorption of overheads.
d. Marginal cost remains the same per unit of output irrespective of the level of activity. It is constant in nature and helps the management in production planning.
e. Marginal costing is essentially useful to management as a technique in cost analysis and cost presentation. It enables the presentation of data in a manner useful to different levels of management for the purpose of controlling costs. Therefore, it is an important technique in cost control.
f. It prevents the carry forward of current year’s fixed overheads through valuation of closing stocks. Since fixed costs are not considered in valuation of closing stocks, there is no possibility of factitious profits by over-valuing stocks.
g. It facilitates the calculation of various important factors, break – even point expectations of profits at different levels of production, sales necessary to earn a predetermined target of profit, effect on profit, effect on profit
due to changes of raw materials prices, increased wages, change in sales mixture, etc.
h. It is a valuable aid to management for decision – making and fixation of selling prices, selection of a profitable product/sales mix, make or buy decision, problem of key or limiting factor, determination of the optimum level of activity, close or shut down decisions, evaluation of performance and capital investment decisions, etc.
i. It facilitates the study of relative profitability of different product lines, departments, production facilities, sales divisions, etc.
j. It is complimentary to standard costing and budgetary control and can be used along with them to yield better results.
k. Since fixed costs are not controllable and it is only variable or marginal cost that is controllable, marginal costing, by dividing costs into controllable and non-controllable, help in cost control.
l. When there are different products, the determination of number of units of each product, called Optimum Product Mix, is made with the help of marginal costing.
m. Similarly, optimum sales mix i.e., sales of each and every product to get maximum profit can also be determined with the help of marginal costing.
n. It helps the management in profit planning by making a study of relationship between cost, volume and profits. Further, break-even charts and profit graphs make the whole problem easily understandable even to a layman.
o. It is very useful in management reporting marginal costing facilitates ‘Management by exception’ by focusing attention of the management towards more important areas than to waste time on problems which do not require urgent attention of the higher managements.
p. It helps in short-term profit planning by breakeven and profitability analysis, both in terms of quantity and graphs. Comparative profitability and performance between two or more products and divisions can easily be assessed and brought to the notice of management for decision making.
q. Apart from the above, numerous managerial decisions can be taken with the help of marginal costing, some of which, may be as follows:-
In spite of so many advantages, the technique of marginal costing suffers from the following limitations:
a. The technique of marginal costing is based upon a number of assumptions which may not hold good under all circumstances.
b. The separation of costs into fixed and variable is difficult and sometimes gives misleading results.
c. Normal costing systems also apply overhead under normal operating volume and this shows that no advantage is gained by marginal costing.
d. All costs are not divisible into fixed and variable. There are certain costs which are semi – variable in nature. It is very difficult and arbitrary to classify these costs into fixed and variable elements.
e. Variable costs do not always remain constant and do not always vary in direct proportion to volume of output because of the laws of diminishing and increasing returns.
f. Selling prices do not remain constant forever and for all levels of output due to competition, discounts for bulk orders, changes in the general price level, etc.
g. Fixed costs do not remain constant after a certain level of activity. Further, marginal costing ignores the fact that fixed costs are also controllable.
h. Application of fixed overhead depends on estimates and not on the actuals and as such there may be under or over absorption of the same.
i. Under marginal costing, stocks and work in progress are understated. The exclusion of fixed costs from inventories affect profit and true and fair view of financial affairs of an organisation may not be clearly transparent.
j. The exclusion of fixed costs from the stocks of finished goods and work-in-progress is illogical since fixed costs are also incurred on the manufacture of products. Stocks valued on marginal costing are undervalued and the profit and loss account cannot reveal true profits. Similarly, as the stocks are undervalued, the balance sheet does not give a true picture.
k. Although the technique of marginal costing overcomes the problem of under or over absorption of fixed overheads, the problem still exists in regard to under or over absorption of variable overheads.
l. Marginal costing completely ignores the ‘time factor’. Thus, if two jobs give equal contribution but one takes longer time to complete, the one which takes longer time should be regarded as costlier than the other. But this fact is ignored altogether under marginal costing.
m. The technique of marginal costing cannot be applied in contract or ship building industry because in such cases, normally the value of work-in-progress is very high and the exclusion of fixed overheads may result into losses every year and huge profit in the year of completion of the job.
n. Cost control be better being achieved with the help of other techniques, viz., standard costing and budgetary control than by marginal costing technique.
o. Fixation of selling price in the long run cannot be done without considering fixed costs. Thus, pricing decisions cannot be based on marginal cost alone.
p. In the present days of automation, the proportion of fixed costs in relation to variable costs is very high and hence managerial decisions based upon only the marginal cost ignoring equally important element of fixed cost may not be correct.
q. Volume variance in standard costing also discloses the effect of fluctuating output on fixed overhead. Marginal cost data becomes unrealistic in case of highly fluctuating levels of production, e.g., in case of seasonal factories.
r. Control affected by means of budgetary control is also accepted by many. In order to know the net profit, we should not be satisfied with contribution and hence, fixed overhead is also a valuable item. A system which ignores fixed costs is less effective since a major portion of fixed cost is not taken care of under marginal costing.
s. In practice, sales price, fixed cost and variable cost per unit may vary. Thus, the assumptions underlying the theory of marginal costing sometimes becomes unrealistic. For long term profit planning, absorption costing is the only answer.
1. Contribution
In common parlance, contribution is the reward for the efforts of the entrepreneur or owner of a business concern. From this, one can get in his mind that contribution means profit. But it is not so. Technically or in Costing terminology, contribution means not only profit but also fixed cost. That is why; it is defined as the amount recovered towards fixed cost and profit.
Contribution can be computed by subtracting variable cost from sales or by adding fixed costs and profit
Contribution can be computed by subtracting variable cost from sales or by adding fixed costs and profit.
Symbolically, C = S - V (1)
Where C = Contribution*
S = Selling Price*
V = Variable Cost*
Also C = F + P (2)
Where F = Fixed Cost#
P = Profit
*These can be found out both product wise and total
#Fixed cost can be found out only for total
From (1) and (2) above, we may deduce the following equation called Fundamental Equation of MarginalCosting i.e.
S-V = F + P (3) (can be found out only for total)
Contribution is helpful in determination of profitability of the products and/or priorities for profitabilities of the products. When there are two or more products, the product having more contribution is more profitable.
For example: The following are the three products with selling price and cost details:
| Particulars | A | B | c |
| Selling Price( | 100 | 150 | 200 |
| Variable Cost () | 50 | 70 | 100 |
| Contribution() | 50 | 80 | 100 |
In the above example, one can say that the product ‘C’ is more profitable because, it has more contribution. This proposition of product having more contribution is more profitable is valid, as long as, there are no limitations on any factor of production. In this context, factors of production means, the factors that are responsible for producing the products such as material, labour, machine hours, demand for sales etc.
Measure of profitability when there is a Limiting Factor (or) Key Factor:
In the above example, we find that product having more contribution is more profitable. However, when there is a limitation on any input factor, the profitability of the product cannot simply be determined by finding out the contribution of the unit, but it can be found out by ascertaining the contribution per unit of that factor of production which is limited in the given situation. Such factor of production which is limited in the question is called key factor or limiting factor.
Continuing the above example, it may be explained as follows:
The three products take same raw material. A takes 1 kg, B requires 2 kgs, C requires 5 kgs and the raw material is not abundant.
Then profitability of the above products is determined as follows:
Profitability = (Contribution per unit)/ Key Factor
| A | B | C |
| 50 / 1 = ` 50 | 80 / 2 = ` 40 | 100 / 5 = ` 20 |
Now, product A is more profitable because it has more contribution per kg of material.
The key factor can also be called as scarce factor or Governing factor or Limiting factor or Constraining factor etc., whatever may be the name, it indicates the limitation on the particular factor of production.
From the above, it is essentially understandable that contribution is helpful in determination of profitability of the products, priorities for profitability of the products and in particular, profitabilities when there are limitation on any factor.
2. Profit Volume Ratio (P/V Ratio) or Contribution Ratio
A ratio is a statistical or mathematical tool with the help of which a relationship can be established between the variables of the same kind. Further, it may be expressed in different forms such as fractional form, quotient, percentage, decimal form, and proportional form.
For example:
Gross profit ratio: It may be expressed as follows:
Symbolicaly, P/V ratio = ( Contribution per unit) / Key Factor ) × 100 → (1)
P/V ratio = ( Contribution / Sales* × 100)
Contribution = Sales × P/V ratio → (2)
Sales = ( Contribution / P/V Ratio) → (3)
When cost accounting data is given for two periods, then:
P/V ratio = ( Change in Contribution / Change in Sales × 100)
or, P/V ratio = (Change in Profit / Change in Sales × 100)
It is to be noted that the above two formulas are valid as long as there are no changes in prices, means input prices and selling prices.
Usually, Sales = Cost + Profit
i.e. it can also be written as Sales = Variable Cost + Fixed Cost + Profit and this is called general sales equation.
Since Sales consists of variable costs and contribution, given the variable cost ratio, P/V ratio can be found out. Similarly, given the P/V ratio, variable cost ratio can be found out.
For example, P/V ratio is 40%, then variable cost ratio is 60%, given variable cost ratio is 70%, then P/V ratio is 30%. Such a relationship is called complementary relationship. Thus, P/V ratio and variable cost ratios are said to be complements of each other.
P/V ratio is also useful like contribution for determination of profitabilities of the products as well as the priorities for profitabilities of the products. In particular, it is useful in determination of profitabilities of the products in the following two situations:
(i) When sales potential in value is limited.
(ii) When there is a greater demand for the products.
3. Break Even Point
When someone asks a layman about his business he may reply that it is alright, but a technical man may reply that it is break even. So, Break Even means the volume of production or sales where there is no profit or loss. In other words, Break Even Point is the volume of production or sales where total costs are equal to revenue. It helps in finding out the relationship of costs and revenues to output. In understanding the breakeven point, cost, volume and profit are always used. The break even analysis is used to answer many questions of the management in day to day business.
Break-even Chart is a graphical representation of the Break- Even Analysis, i.e. Cost-Volume- Profit relationship. It indicates the point of production at which there is neither profit nor loss. It also indicates the estimated profit or loss at different levels of production.
The formal break even chart is as follows:
When no. of units are expressed on X-axis and costs and revenues are expressed on Y-axis, three lines are drawn i.e., fixed cost line, total cost line and total sales line. In the above graph we find there is an intersection point of the total sales line and total cost line and from that intersection point if a perpendicular is drawn to X-axis, we find break even units. Similarly, from the same intersection point a parallel line is drawn to X-axis so that it cuts Y-axis, where we find Break Even point in terms of value. This is how, the formal pictorial representation of the Break Even chart.
At the intersection point of the total cost line and total sales line, an angle is formed called Angle of Incidence.
From the breakeven charts breakeven point and profits at a glance can be found out. Besides, management makes profit planning with the help of breakeven charts. It can clearly be understood by way of charts to know the changes in profit due to changes in costs and output. Such profit planning is made with the variables mainly cost, profit and volume, such an analysis is called breakeven analysis. Throughout the charts relationship is established among the cost, volume and profit, it is also called Cost-Volume-Profit Analysis (CVP analysis). The analysis is further explained in Module 3.3.
Break Even Point in value = F × S / S - V .......... (1)
= F × S / C .......... (2)
= F × S / F + P .......... (3)
= F / P.V. Ratio .......... (4)
or = F / C/S
or = F / S-V / S
or = F / 1 - (V/S) .........(5)
Break Even Point (in units) = Fixed Cost / Contribution per unit
Proof for basic breakeven:
Let, V be the variable cost per unit Where,
U be the volume of output i.e., No. of units F = Fixed Cost
P be the Profit V = Variable Cost per unit
F be the Fixed Cost S = Sales
S be the Selling Price P = Profit
C = Contribution
By substituting the notations in general sales equation:
Sales = Fixed cost + Variable cost + Profit
SU = F + VU + P
At Break Even, SU = F +VU (Since P = 0)
or, SU – VU = F
or, U(S – V) = F
or, U = F / S-V
or, No. of Units = Fixed Cost / Contribution per Unit
Break even sales:
SU (Sales) = F × S / S - V
4. Margin of Safety
It is the sales point beyond the breakeven point. Margin of safety can be obtained by subtracting break even sales from actual sales. It is useful to determine financial soundness of business enterprise. If margin of safety is high, then the financial position of the enterprise is sound.
Margin of Safety = Total Sales – Break Even Sales -->(1)
Total Sales = Break Even Sales + Margin of Safety Sales -->(2)
A relative measure to the margin of safety is its ratio to total sales.
Sales value to earn desired profit = Fixed Cost + desired Profit / P/V Ratio and
Required units to earn desired profit = Fixed Cost + desired Profit / Contribution per unit
Fixed cost = (Sales x P/V ratio) – Profit
Total sales = Break even sales + Margin of safety sales
or, Break even sales = Total sales – Margin of safety sales
or, Margin of safety sales = Total sales – Break even sales
Fixed cost = Break even sales × P/V ratio
Shut down sales = Fixed Cost - Shut Down Costs / P/V Ratio
Shut down Units = Fixed Cost - Shut Down Costs / Contribution per unit
The level at which profits are same or the level at which costs are same for two methods or two alternatives
i.e., Indifference Point = Difference in Fixed Cost / Difference in variable costs per unit
Cost-volume-profit (CVP)/break-even analysis is the study of the interrelationships between costs, volume and profit at various levels of activity.
The management of an organisation usually wishes to know the profit likely to be made if the target for production and sales for the year are achieved. Management may also be interested to know the following:
a. The break-even point, at which is the activity level at which there is neither profit nor loss.
b. The amount by which actual sales can fall below anticipated sales, without a loss being incurred.
A company’s net income is a measure of management’s success in attaining its goals. In planning, management must anticipate how selling prices, costs, expenses, and profits will react to changes in activity when the activity s measured in terms of capacity or volume. When the degree of variability in costs is known, the effect of volume changes can be predicted.
Cost-volume-profit (CVP) analysis is a technique that uses the degrees of cost variability to measure the effect of changes in volume on resulting profits. Such analysis assumes that the fixed costs of the firm will remain the same in total within a wide range of production volume within which the firm expects to operate, known as the relevant range.
Cost-volume-profit analysis considers the relationship between costs (fixed and variable), sales volume and levels of profit. The techniques of CVP analysis are used in breakeven calculations, contribution/ sales ratio analysis and can be applied to indicate the level of sales necessary to make a desired profit (target profit) or the amount by which sales can fall before the product is loss making (margin of safety).
Break-even analysis can be used to help management select an action when several alternatives exist. This analysis is based on the conditions that variable costs will vary in constant proportion to the sales volume and that fixed costs will be fixed over a prescribed or relevant range of activity.
Therefore, if management wishes to test new proposals that will change the percentage of variable costs to sales volume, or the total amount of fixed costs, or a combination of these changes, then it can use the basic breakeven equation to calculate the results.
Break-even point represents the minimum level of sales (revenue or volume) needed to cover total costs (fixed and variable). At breakeven point, profit is equal to zero because our total sales income is equal to total expenditure.
The formula is for breakeven volume is below:
Contribution per unit = unit selling price – unit variable costs
It is an analysis of three variables, viz. cost, volume and profit, which gives the relationship amongst costs, revenue (sales), activity levels (quantity) and the resulting profit. Cost-Volume-Profit (CVP) Analysis is also known as
Break–Even Analysis. Every business organisation works to maximize its profits. With the help of CVP analysis, the management studies the co-relation of profit and the level of production.
CVP analysis is concerned with the level of activity where total sales equal the total cost and it is called as the break-even point. In other words, we study the sales value, cost and profit at different levels of production. CVP analysis highlights the relationship between the cost, the sales value, and the profit.
If only we could look into a crystal ball and find out exactly how many customers were going to buy our product, we would be able to make perfect business decisions and maximize profits. While management accountinginformation can’t really help much with the crystal ball, it can be of use in providing the answers to questions about the consequences of different courses of action. One of the most important decisions that need to be made before any business even starts is ‘how much do we need to sell in order to break-even?’ By ‘break-even’ we mean simply covering all our costs without making a profit. This type of analysis is known as ‘cost-volume-profit analysis’ (CVP analysis) Cost-volume profit analysis is an essential tool used to guide managerial, financial and investment decisions.
As quantity increases, variable cost increases but fixed costs remains same, so total cost also increases. Since quantity increases value of sale also increases. Initially when company sells small quantity of units total cost is greater than sales, then it incurs loss. As it sells more & more quantity, sales exceeds total cost, it makes profit. Level at which there is no profit no loss is called as B.E.P. (Break Even Point). Such analysis between quantity (volume), cost, sales & profit is called as CVP analysis. The cost-volume-profit analysis is an extension of marginal costing. It makes use of the principles of marginal costing. It is an important tool of short term planning and is more relevant where the proposed changes in the level of activity are relatively small. It is useful in making short-run decisions.
CVP analysis looks at the effect of sales volume variations on costs and operating profit. The analysis is based on the classification of expenses as variable (expenses that vary in direct proportion to sales volume) or fixed (expenses that remain unchanged over the long term, irrespective of the sales volume). Accordingly, operating income is defined as follows:
Operating Income = Sales – Variable Costs – Fixed Costs
CVP analysis looks primarily at the effects of differing levels of activity on the financial results of a business. The reason for the particular focus on sales volume is because, in the short-run, sales price, and the cost of materials and labour, are usually known with a degree of accuracy. Sales volume, however, is not usually so predictable and therefore, in the short-run, profitability often hinges upon it. For example, Company A may know that the sales price for product X in a particular year is going to be in the region of ₹500 and its variable costs are approximately ₹300. It can, therefore, say with some degree of certainty that the contribution per unit (sales price less variable costs) is ₹200. Company A may also have fixed costs of ₹2,00,000 per annum, which again, are fairly easy to predict. However, when we ask the question, ‘Will the company make a profit in that year?’ the answer is ‘We don’t know’. We don’t know because we don’t know the sales volume for the year. However, we can work out how many sales the business needs to achieve in order to make a profit and this is where CVP analysis begins.
(i) All elements of cost, i.e., production, administration and selling and distribution can be segregated into fixed and variable components.
(ii) Variable cost remains constant per unit of output irrespective of the level of output and thus fluctuates directly in proportion to changes in the volume of output.
(iii) Fixed cost remains constant at all volumes of output.
(iv) Selling price per unit remains unchanged or constant at all levels of output.
(v) Volume of production is the only factor that influences cost.
(vi) There will be no change in the general price-level.
(vii)There is only one product or in case of multi-products, the sales mix remains unchanged.
(viii)There is synchronization between production and sales.
a. All other variables remain constant
It has been assumed that all variables other than the particular one under consideration have remained constant throughout the analysis. In other words, it is assumed that volume is the only factor that will cause costs and revenues to change. However, changes in other variables such as production efficiency, sales mix and price levels can have an important influence on sales revenue and costs. If significant changes in these other variablesoccur the CVP analysis presentation will be incorrect.
b. Single product or constant sales mix
CVP analysis assumes that either a single product is sold or, if a range of products is sold, that sales will be in accordance with a predetermined sales mix. When a predetermined sales mix is used, it can be depicted in the CVP analysis by measuring sales volume using standard batch sizes based on a planned sales mix. As we have discussed, any CVP analysis must be interpreted carefully if the initial product mix assumptions do not hold.
c. Total costs and total revenue are linear functions of output
The analysis assumes that unit variable cost and selling price are constant. This assumption is only likely to bevalid within the relevant range of production.
d. Profits are calculated on a variable costing basis
The analysis assumes that the fixed costs incurred during the period are charged as an expense for that period.Therefore, variable-costing profit calculations are assumed. If absorption-costing profit calculations are used,it is necessary to assume that production is equal to sales for the analysis to predict absorption costing profits.
e. Costs can be accurately divided into their fixed and variable elements
CVP analysis assumes that costs can be accurately analyzed into their fixed and variable elements. In practice,the separation of semi-variable costs into their fixed and variable elements is extremely difficult. Nevertheless, areasonably accurate analysis is necessary if CVP analysis is to provide relevant information for decision-making.
f. Analysis applies only to the relevant range
CVP analysis is appropriate only for decisions taken within the relevant production range, and that it is incorrect to project cost and revenue figures beyond the relevant range.
g. Analysis applies only to a short-term time horizon
CVP analysis is based on the relationship between volume and sales revenue, costs and profit in the short run, typically a period of one year, in which the output of a firm is likely to be restricted to that available from the current operating capacity. During this period significant changes cannot be made to selling prices and fixed and variable costs. CVP analysis thus examines the effects of changes in sales volume on the level of profits in the short run. It is inappropriate to extend the analysis to long-term decision-making.
a. It is assumed that fixed costs are the same in total and variable costs are the same per unit at all levels of output. This assumption is a great simplification. The following are two inevitable cases-
(i) Fixed costs will change if output falls or increases substantially (most fixed costs are step costs).
(ii) The variable cost per unit will decrease where economies of scale are made at higher output volumes, but the variable cost per unit will also eventually rise when diseconomies of scale begin to appear at even higher volumes of output (for example the extra cost of labour in overtime working).
The assumption is only correct within a normal range or relevant range of output. It is generally assumed that both the budgeted output and the breakeven point lie within this relevant range.
b. It is assumed that sales prices will be constant at all levels of activity. This may not be true, especially at higher volumes of output, where the price may have to be reduced to win the extra sales.
c. Production and sales are assumed to be the same, so that the consequences of any increase in inventory levels or of ‘de-stocking’ are ignored.
d. Uncertainty in the estimates of fixed costs and unit variable costs is often ignored.
Break-Even means the volume of production or sales where there is no profit or loss. In other words, Break-Even Point is the volume of production or sales where total costs are equal to revenue. It helps in finding out the relationship of costs and revenues to output. In understanding the breakeven point, cost, volume and profit are always used. The break even analysis is used to answer many questions of the management in day to day business.
Break-even Chart is a graphical representation of the Break- Even Analysis, i.e. Cost-Volume- Profit relationship. It indicates the point of production at which there is neither profit nor loss. It also indicates the estimated profit or loss at different levels of production.
A break-even chart is a chart which indicates approximate profit or loss at different levels of sales volume within a limited range. A very serious limitation of breakeven charts is that they can show the costs, revenues, profits and margins of safety for a single product only, or at best for a single ‘sales mix’ of products. Break-even charts for multiple products can be drawn if a constant product sales mix is assumed.
While constructing the chart, the following assumption is normally considered:
a. Costs are classified into fixed and variable costs.
b. Fixed costs shall remain fixed during the relevant volume range of graph.
c. Variable cost per unit will remain constant during the relevant volume range of graph.
d. Selling price per unit will remain constant.
e. Sales mix remains constant.
f. Production and sales volume are equal.
g. There exists a linear relationship between costs and revenue.
h. Linear relationship is indicated by way of straight line
For example suppose that FA sells three products, X, Y and Z which have variable unit costs of ₹3, ₹4 and ₹5 respectively. The sales price of X is ₹8, the price of Y is ₹6 and the price of Z is ₹6. Fixed costs per annum are ₹10,000. A break-even chart cannot be drawn, because we do not know the proportions of X, Y and Z in the sales mix.
The formal Break-Even Chart is as follows:
On the X-axis of the graph is plotted the number of units produced, sold and on the Y-axis are shown costs and sales revenues. The fixed cost line is drawn parallel to X-axis. This line indicates that fixed expenses remain the same with any volume of production. The variable costs for different levels of activity are plotted over the fixed cost line. The variable cost line is joined to fixed cost line at zero volume of production. This line can also be regarded as the total cost line because it starts from the point where fixed cost has been incurred and variable cost is zero. Sales values at various levels of output are plotted joined and the resultant line is the sales line. The sales line will cut the total cost line at a point where the total costs are equal to total revenues and this point of intersection lines is known as breakeven point—the point of no profit no loss.
The number of units to be produced at the breakeven point is determined by drawing a perpendicular to the X-axis from the point of intersection and measuring the horizontal distance from the zero point to the point at which the perpendicular is drawn.
The sales value at breakeven point is determined by drawing a perpendicular to the Y-axis from the point of intersection and measuring the vertical distance from the zero point to the point at which the perpendicular is drawn.
Loss and profit are as have been shown in the charts which show that if production is less than the breakeven point, the business shall be running at a loss and if the production is more than the breakeven level, profit shall result.
Angle of Incidence
Angle of Incidence is an angle formed at the intersection point of total sales line and total cost line in a formal break even chart. If the angle is larger, the rate of growth of profit is higher and if the angle is lower, the rate of growth of profit is lower. So, growth of profit or profitability rate is depicted by Angle of Incidence.
Break Even Analysis (or) Cost-Volume-Profit Analysis (CVP analysis):
From the breakeven charts breakeven point and profits at a glance can be found out. Besides, management makes profit planning with the help of breakeven charts. It can clearly be understood by way of charts to know the changes in profit due to changes in costs and output. Such profit planning is made with the variables mainly cost, profit and volume, such an analysis is called breakeven analysis. Throughout the charts relationship is established among the cost, volume and profit, it is also called Cost-Volume-Profit Analysis (CVP analysis). That is why it is popularly said by S.C. Kuchal in his book “Financial Management - An Analytical and Conceptual Approach”, that Costvolume-profit analysis, break even analysis and profit graphs are interchangeable words. The analysis is further explained as follows:
The change in profit can be studied through Break even charts under different conditions in the following manner:
(i) Increase in No. of Units:
‘……’ line indicates increase in total cost and total sales.
In the above chart, if we clearly observe we find that there is no change in BEP even if there is increase or decrease in No. of units.
(ii) Increase in Sales due to increase in selling price:
NTS = New Total Sales line
‘……’ line indicates changes in break even point and changes in sales.
From the above chart, we observe that profit is increased by increasing the selling price and also, if there is change in selling price, BEP also changes. If selling price is increased then BEP decreases. If selling price is decreased then BEP increases. Thus, we say that there is an inverse relationship between selling price and BEP.
(iii) Decrease in variable cost:
‘……’ line indicates decrease in total cost and decrease in B.E.P
From the above chart, we observe that when variable costs are decreased, no doubt, profit is increased. If there is change in variable cost then BEP also changes. If variable cost is decreased then BEP also decreases. If variable cost is increased then BEP also increases. Thus there is direct relationship between variable cost and BEP.
(iv) Change in fixed cost:
‘……’ line indicates decrease in fixed cost and total cost and also decrease in BEP.
NTC = New Total Cost Line
NFC = New Fixed Cost Line
From the above chart also we find that there is increase in profit due to decrease in fixed cost. If fixed cost is increased then BEP also increases. If fixed cost is decreased then BEP also decreases. Thus, there is a direct relationship between fixed cost and BEP.
Non linear Break-Even Chart:
In some cases on account of non-linear behaviour of cost and sales there may be two or more break even points. In such a case the optimum profit is earned where the difference between the sales and the total costs is the largest. It is obvious that the business should produce only upto this level. This is being illustrated in the above chart.
When break-even point is calculated only with those fixed costs which are payable in cash, such a break-even point is known as cash break-even point. This means that depreciation and other non-cash fixed costs are excluded from the fixed costs in computing cash break-even point. Its formula is
Cash break-even point = Cash fixed costs / Contribution per unit.
a. Graphical representation of cost and revenue data (break-even charts) can be more easily understood by non-financial managers.
b. A breakeven model enables profit or loss at any level of activity within the range for which the model is valid to be determined, and the C/S ratio can indicate the relative profitability of different products.
Profit-volume chart prominently exhibits the relationship between profit and sales volume. The normal break-even charts suffer from one limitation. Profit cannot be read directly from the chart. It is essential to deduct total cost from sale to know the profit figure. The profit graph overcomes the difficulty by plotting profit directly against an activity. These charts are easy to understand and their preparation involves drawing sales curve and profit curve. The point at which profit line cuts the sales line is called break-even point. Taking the methods and objects under consideration, the profit-volume chat can be further divided into following categories i.e.:
a. Simple Profit-Volume Chart:
Its preparation involves the following steps:
(i) Finding out profit at any two levels of activity.
(ii) Drawing sales line.
(iii) Drawing profit line.
Simple Profit-Volume chart is shown below:
Profit volume chart showing different breakeven point at different price levels is shown below:
b. Sequential Profit Graph:
Sometimes, a company manufactures more than one product of varying profitability. A change in the profitability of one product will lead to a change in the profitability as a whole. Profit-volume chart can be prepared for a group also. This chart shows relative profitability of different products. It is also called profit-volume graph for a group of products, sequential profit graph or profit path chart. Its main advantage is that it exhibits the relative profitability of different products at a glance. This graph is also useful to show average slope and marginal slope.
Methods of drawing ‘Profit Path’:
In sequential profit graph or profit graph for a group of products, a line “profit plan” is drawn in order to draw total profit line. For drawing profit path, a statement is prepared showing cumulative sale and cumulative profit. The line ‘Profit path’ is drawn with the aid of columns for cumulative same and cumulative profit.
Steps in drawing Profit volume graph (or) sequential profit graph:
Neither the break-even nor the contribution graphs highlight the profit or loss at different volume levels. To ascertain the profit or loss figures from a break-even graph, it is necessary to determine the difference between the total cost and total revenue lines. The profit–volume graph is a more convenient method of showing the impact of changes in volume on profit.
Prepare a P/V graph from the following data:
Units produced 60,000; Selling price per unit ₹15; Variable cost per unit ₹10; Fixed costs ₹1,50,000. Show the expected sales on the graph when the profit to be earned is ₹87,500.
Organisations typically produce and sell a variety of products and services. To perform breakeven analysis in a multi-product organization, however, a constant product sales mix must be assumed. In other words, it is to be assumed that whenever x units of product A are sold, y units of product B and z units of product C are also sold. Such an assumption allows us to calculate a weighted average contribution per mix, the weighting being on the basis of the quantities of each product in the constant mix. This means that the unit contribution of the product that makes up the largest proportion of the mix has the greatest impact on the average contribution per mix.
The only situation when the mix of products does not affect the analysis is when all of the products have the same ratio of contribution to sales (C/S ratio).
Most firms produce and sell many products or services. Here, we shall consider how we can adapt CVP analysis to a multi-product setting. It can be explained with the help of the following example:
The ABC Company sells two types of products – A and B. The CMA has prepared the following information based on the sales forecast for the period:
| Product Sales Units (Volume) |
A 1200 |
B 600 |
Total |
| Unit selling price | 300 | 200 | |
| Unit variable cost | 150 | 110 | |
| Unit contribution | 150 | 90 | |
| Total sales revenues | 3,60,000 | 1,20,000 | 4,80,000 |
| Less: Total variable cost | 1,80,000 | 66,000 | 2,46,000 |
| Contribution to direct and common fixed costs | 1,80,000 | 54,000 | 2,34,000 |
| Less: Direct Avoidable fixed costs | 90,000 | 27,000 | 1,17,000 |
| Contribution to common fixed costs | 90,000 | 27,000 | 1,17,000 |
| Less: Common fixed costs | 39,000 | ||
| Profit | 78,000 |
Differential Cost is the change in the costs which results from the adoption of an alternative course of action. The alternative actions may arise due to change in sales volume, price, product mix (by increasing, reducing or stopping the production of certain items), or methods of production, sales, or sales promotion, or they may be due to ‘make or buy’ or ‘take or refuse’ decisions. When the change in costs occurs due to change in the activity from one level to another, differential cost is referred to as incremental cost or decremental cost, if a decrease in output is being considered, i.e. total increase in cost divided by the total increase in output. However, accountants generally do not distinguish between differential cost and incremental cost and the two terms are used to mean one and the same thing.
The computation of differential cost provides an useful method of analysis for the management for anticipating the results of any contemplated changes in the level or nature of activity. When policy decisions have to be taken, differential costs worked out on the basis of alternative proposals are of great assistance.
The determination of differential cost is simple. Differential cost represents the algebraic difference between the relevant costs for the alternatives being considered. Thus, when two levels of activities are being considered, the differential cost is obtained by subtracting the cost at one level from the cost of another level.
For example, difference in costs may arise because of replacement of labour by machinery and difference in costs of two alternative courses of action will be the differential cost.
It is important to note that differential cost may be an increase or a decrease in costs. Suppose, present cost is ₹2,50,000, when the work is done by labour and the expected cost ₹2,25,000 when the work is done by machinery.
In this case, differential cost will be decrease in costs ₹25,000 (i.e., ₹2,50,000 - ₹2,25,000) and the decision of replacement of labour by machinery should be implemented by the firm because differential cost of ₹25,000 (decrease in cost) will increase the profits of the firm by ₹25,000.
If change in cost occurs due to change in level of activity, differential cost is referred to as incremental cost in case of increase in output and decremental cost in case of decrease in output. However, in practice, no distinction is made between differential cost and incremental or decremental cost and two terms are used to mean the same thing.
However, if the alternate course of action does not involve any additional fixed costs change in variable costs will become differential costs and there will be no difference between marginal costs and differential costs.
A management of any type of business organisation is confronted with the problem of making appropriate decisions. “Behaviour of cost” plays a vital and crucial role in decision-making areas. Although the historical costs serve as an effective tool for predicting future costs, they are not suitable to decision-making process. We are of the view that variable costs are affected by a decision and fixed costs are not affected, but in reality, it is not so; particularly in the long run, no type of cost is fixed. Costs tend to vary due to variations in volume of production, method of production, product mix and the like. Such increase or decrease in the total costs at a particular level of activity has to be analyzed. At this juncture, the concept of differential cost arises.
a. In order to ascertain the differential costs, only total cost is needed and not cost per unit.
b. Existing level is taken to be the base for comparison with some future or forecasted level.
c. Differential cost is the economist’s concept of marginal cost.
d. It may be referred to as incremental cost when the difference in cost is due to increase in the level of production and decremental costs when difference in cost is due to decrease in the level of production.
e. It does not form part of the accounting records, but may be incorporated in budgets.
f. It is not necessary to adopt marginal cost technique for differential cost analysis because it can be worked out on the method of absorption costing or standing costing.
g. What is said of the differential cost above, applies to differential revenue also.
h. Variable costs are the differential costs when the additional output does not involve the additional fixed costs. It is used for planning and decision-making only and not incorporated in the accounting records. It is intended for the comparison of the expected changes in costs and revenues. It is applied only to the existing business and not suitable for new business set-up. Differential costs are future costs.
i. Differential cost analysis is carried on using only relevant costs.
Differential Costing is used for various policy decisions, some of which are stated below:
a. The introduction of a new plant.
b. Make or buy decisions.
c. Lease or buy decisions.
d. Discontinuing a product, suspending or closing down a segment of the business.
e. The profitability of a change in product mix.
f. Acceptance of an offer at a lower selling price.
g. Change in the methods of production.
h. The determination of the most profitable levels of production and price.
i. Submitting tenders.
j. The determination of price at which raw materials can be purchased.
k. Equipment replacement decisions.
l. The profitability or otherwise of further processing.
m. The opening of a new sales area or territory.
n. Determination of most profitable levels of production and price.
o. Acceptance of offer at a lower price or offering a quotation at lower selling price in order to increase capacity.
p. It is used to decide whether it will be more profitable to sell a product as it is or to process it further into a different product to be sold at an increased price.
q. Determining the suitable price at which raw material may be purchased.
r. Decision of adding a new product or business segment.
s. Discontinuing a product or business segment in order to avoid or reduce the present loss or increase profit.
Differential costs are also known as incremental costs, although technically an incremental cost should refer only to an increase in cost from one alternative to another; decrease in cost should be referred to as decremental cost. Differential cost is a broader term, encompassing both cost increases (incremental costs) and cost decreases (decremental costs) between alternatives.
The concept of differential costing is vital in planning and decision-making. It is an important tool in evaluating the profitability of alternative choice decisions and helping management in choosing the best alternative. The differential cost analysis can assist management in knowing the additional profit that would be earned if idle or unused capacity is used for extra production or if some additional investments are made by the firm.
Marginal cost represents the increase or decrease in total cost which occurs with a small change in output say, a unit of output. In Cost Accounting variable costs represent marginal cost.
Differential cost is the change (increase or decrease) in the total cost (variable as well as fixed) due to change in the level of activity, technology or production process or method of production. In other words, it can be defined as the cost of one unit of product or service which would be avoided if that unit was not produced or provided.
(a) Both the techniques of cost analysis and cost presentation.
(b) Both are made use of by the management in decision making and in formulating policies.
(c) The concepts of differential costs and marginal costs mainly arise out of the difference in the behaviour of fixed and variable costs.
(d) Differential costs compare favourably with the economist’s definition of marginal cost, viz. that marginal cost is the amount which at any given volume of output is changed if output is increased or decreased by one unit.
(a) Differential cost analysis can be made in the case of both absorption costing as well as marginal costing.
(b) While marginal costing excludes the entire fixed costs, some of the fixed costs may be taken into account as being relevant for the purpose of differential cost analysis.
(c) Marginal costs may be embodied in the accounting system whereas differential costs are worked out separately as analysis statements.
(d) In marginal costing, margin of contribution and contribution ratio are the main yardsticks for performance evaluation and for decision making. In differential cost analysis, differential costs are compared with the incremental or decremental revenues, as the case may be.
The main point which distinguishes marginal cost and differential cost is that change in fixed cost when volume of production increases or decreases by a unit of production. In the case of differential cost variable as well as fixed cost i.e. both costs change due to change in the level of activity, whereas under marginal costing only variable cost changes due to change in the level of activity.
A company is at present working at 90 per cent of its capacity and producing 13,500 units per annum. It operates a flexible budgetary control system. The following figures are obtained from its budget.
| Particulars | 90% | 100% |
| Sales (`) | 15,00,000 | 16,00,000 |
| Fixed expenses (`) | 3,00,500 | 3,00,600 |
| Semi-fixed expenses (`) | 97,500 | 1,00,500 |
| Variable expenses (`) | 1,45,000 | 1,49,500 |
| Units made | 13,500 | 15,000 |
Labour and material costs per unit are constant under present conditions. Profit margin is 10 per cent.
a. You are required to determine the differential cost of producing 1,500 units by increasing capacity to 100%
b. What would you recommend for an export price for these 1,500 units taking into account that overseas prices are much lower than indigenous prices?
Absorption Costing and Marginal Costing
The cost of a product or process can be ascertained using different elements of cost using any of the following two techniques viz.,
1. Absorption Costing
2. Marginal Costing
Under this method, the cost of the product is determined after considering the total cost i.e., both fixed and variable costs. Thus this technique is also called traditional or total costing. The variable costs are directly charged to the products where as the fixed costs are apportioned over different products on a suitable basis, manufactured during a period. Thus under absorption costing, all costs are identified with the manufactured products.
Marginal costing is “the ascertainment of marginal costs and of the effect on profit of changes in volume or type of output by differentiating between fixed costs and variable costs.” Several other terms in use like direct costing, contributory costing, variable costing, comparative costing, differential costing and incremental costing are used more or less synonymously with marginal costing.
It is a process whereby costs are classified into fixed and variable and with such a division so many managerial decisions are taken. The essential feature of marginal costing is division of total costs into fixed and variable, without which this could not have existed. Variable costs vary with volume of production or output, whereas fixed costs remains unchanged irrespective of changes in the volume of output. It is to be understood that unit variable cost remains same at different levels of output and total variable cost changes in direct proportion with the number of units. On the other hand, total fixed cost remains same disregard of changes in units, while there is inverse relationship between the fixed cost per unit and the number of units.
Marginal Costing and Absorption Costing will report different profit figures if there is any change in the volume ofinventory during the period. If closing inventory is greater than opening inventory, absorption costing will report a higher profit than marginal costing. If opening inventory is greater than closing inventory (i.e. inventory levels decrease), then absorption costing will report a lower profit than marginal costing.
There are two differences between the way that variances are calculated in a marginal costing system and in an absorption costing system:
Here only variable costs are charged to product, processes or operations. Fixed costs are charged as period costs to the profit statement of the same period in which they are incurred. The cost of production under this method does not include fixed factory overheads and therefore, the value of closing stock comprises of only variable costs. No part of the fixed expenses in included in the value of closing stock and carried over to the next period. Since fixed overheads are not included in the cost of production, therefore the question of their under/ over recovery does not arise. Here decisions are made on the basis of contribution i.e. excess of sales price over variable costs. This basis of decision making results in optimum profitability.
Fixed production overheads are charged to the product to be subsequently released as a part of goods sold i.e., it is included in cost per unit.
Profit is the difference between sales and cost of goods sold.
Costs are seldom classified into variable and fixed. Although such a classification is possible, it fails to establish a cost-volume profit relationship.
If inventories increase during a period, this method will reveal more profit than marginal costing. When inventories decrease, fewer profits are reported because under this method closing stock is valued at higher figures. Since inventories are valued at total cost, a portion of fixed overheads are also included in inventories.
Arbitrary apportionment of fixed costs may result in under or over recovery of overheads.
Differences between Absorption Costing and Marginal Costing:
| NO. | Absorption Costing | Marginal Costing |
| 1. | Both fixed and variable costs are considered for product costing and inventory valuation. | Only variable costs are considered for product costing and inventory valuation. |
| 2. | Fixed costs are charged to the cost of production. Each product bears a reasonable share of fixed cost and thus the profitability of a product is influenced by the apportionment of fixed costs. | Fixed costs are regarded as period costs. The profitability of different products is judged by their P/V ratio. |
| 3. | Cost data are presented in conventional pattern. Net profit of each product is determined after subtracting fixed cost along with their variable cost. | Cost data are presented to highlight the total contribution of each product. |
| 4. | The difference in the magnitude of opening stock and closing stock affects the unit cost of production due to the impact of related fixed cost. |
The difference in the magnitude of opening stock and closing stock does not affect the unit cost of production. |
| 5. | In case of absorption costing the cost per unit reduces, as the production increases as it is fixed cost which reduces, whereas, the variable cost remains the same per unit. | In case of marginal costing the cost per unit remains the same, irrespective of the production as it is valued at variable cost. |
Difference in profit under Marginal and Absorption Costing:
(i) No opening and closing stock: In this case, profit/loss under absorption and marginal costing will be equal.
(ii) When opening stock is equal to closing stock: In this case, profit/loss under two approaches will be equal provided the fixed cost element in both the stocks is same amount.
(iii) When closing stock is more than opening stock: In other words, when production during a period is more than sales, then profit as per absorption approach will be more than that by marginal approach. The reason behind this difference is that a part of fixed overhead included in closing stock value is carried forward to next accounting period.
(iv) When opening stock is more than the closing stock: In other words when production is less than the sales, profit shown by marginal costing will be more than that shown by absorption costing. This is because a part of fixed cost from the preceding period is added to the current year’s cost of goods sold in the form of opening stock.
XYZ Ltd.
Operating Income Statement under Marginal Costing
For the year ended……
| Particulars | ₹ | ₹ |
| Sales | xxxxx | |
| Total variable cost: | ||
| Direct material consumed | xxxx | |
| Direct labour cost | xxxx | |
| Variable manufacturing overhead | xxxx | |
| Variable cost of goods produced | xxxx | |
| Add: Op. stock of finished goods (valued at Total Var. Cost of previous year) | xxxx | |
| Less: Cl. stock of finished goods (valued at Total Var. Cost of current year) | xxxx | |
| Variable Cost of Goods Sold | ||
| Add: Variable administration, selling and distribution overhead | xxxx | |
| Total variable cost | xxxx | |
| Contribution Margin (Sales - Total variable cost) | xxxx | |
| Less: Fixed operating costs (Production, administration, selling and distribution) | xxxx | |
| Operating Income | xxxx |
XYZ Ltd.
Operating Income Statement under Absorption Costing
For the year ended…….
| Particulars | ₹ | ₹ |
| Sales | xxxx | |
| Cost of Goods Sold: | ||
| Direct material consumed | xxxx | |
| Direct labour cost | xxxx | |
| Variable manufacturing overhead | xxxx | |
| Fixed manufacturing overhead | xxxx | |
| Manufacturing Cost incurred during the year (Gross Factory Cost) | xxxx | |
| Add: Opening Work-in-Progress | xxxx | |
| Less: Closing Work-in-Progress | xxxx | |
| Total cost of goods manufactured | xxxx | |
| Add: Op. stock of finished goods (valued at total cost of previous year) | xxxx | |
| Less: Cl. stock of finished goods (valued at total cost of current year) | xxxx | |
| Gross profit/Margin (i.e. Sales - Cost of goods sold) | xxxx | |
| Less: Operating Costs: | ||
| Administration costs, etc. (Both Fixed & Variable) | xxxx | |
| Selling and distribution costs (Both Fixed & Variable) | xxxx | |
| Operating Income | xxxx |
ABC Limited has production capacity of 5,00,000 units per annum at its full capacity.
| Company’s Cost structure is as under: | |
| Variable production cost per unit | ₹32.00 |
| Variable selling expenses per unit | ₹ 9.60 |
| Fixed production cost per annum | ₹30,00,000 |
| Fixed selling expenses per annum | ₹20,00,000 |
During the year ended 31st March, 2022, the company worked at 80 percent of its capacity
The operating data for the year are as follows:
| Production | 4,00,000 Units |
| Sales | ₹ 64 per Unit; 3,87,500 Units |
| Opening stock of finished goods | 50,000 Units |
Fixed production expenses are absorbed on the basis of capacity and fixed selling expenses are recovered on the basis of period.
You are required to prepare statements of Cost and Profit for the year ending 31st March, 2022:
a. On the basis of marginal costing
b. On the basis of absorption costing.
You are given the following information for the coming year of a factory:
| Particulars | Amount |
| Fixed expenses | ₹4,00,000 |
| Selling price per unit | ₹20 |
| Variable expenses per unit | ₹10 |
| Budgeted output | 80,000 units |
Calculate Break-even Point in Rupees and Margin of Safety in Rupees.
From the following information, calculate the amount of profit using marginal cost technique:
Fixed cost ₹3,00,000
Variable cost per unit ₹5
Selling price per unit ₹10
Output level 1,00,000 units
From the following particulars find out break-even point:
Fixed Expenses ₹1,00,000
Selling price Per unit ₹20
Variable cost per unit ₹15
From the following information calculate:
(1) P/V Ratio
(2) Break-Even Point
(3) If the selling price is reduced to ₹ 80, calculate New Break-Even Point:
₹
Total sales 5,00,000
Selling price per unit 100
Variable cost per unit 60
Fixed cost 1,20,000
Sales ₹ 2,00,000
Profit ₹ 20,000
Variable Cost 60%
You are required to calculate:
(1) P/V Ratio
(2) Fixed Cost
(3) Sales volume to earn a profit of ₹ 50,000
From the following particulars, calculate:
(a) P/V Ratio
(b) Profit when sales are ₹ 40,000, and
(c) New break-even point if selling price is reduced by 10%
Fixed cost = ₹ 8,000
Break-even point = ₹ 20,000
Variable cost = ₹ 60 per unit
From the following particulars, calculate Margin of safety:
Fixed cost ₹ 1,00,000
Variable cost ₹ 1,50,000
Total Sales ₹ 3,00,000
From the following information calculate the Cash Break-Even Point:
| Particulars | ₹ |
| Selling price per unit | 60 |
| Variable cost per unit | 40 |
| Fixed cost | 2,00,000 |
| Depreciation included in fixed cost | 50,000 |
For the coming year, a manufacturing company has budgeted as under:
Contribution/Sales (C/S) Ratio = 45%
Margin of Safety Ratio = 33 1/2%
Fixed Costs = ₹ 5,85,000
Required: Determine Total Sales-volume for the coming year and Profit thereon.
When sales of a company declines from ₹ 9,00,000 to ₹ 7,00,000, its profit of ₹ 50,000 is converted into a loss of ₹ 50,000.
Determine contribution margin ratio.
An exporter of garments is earning a profit of ₹ 1,00,000 on a sale of ₹ 12,00,000. Selling price is ₹ 40 per garment and variable cost is ₹30 per garment. The exporter incurs an additional fixed cost of ₹3,00,000 on product improvement which also enables him to economise ₹5 in per garment variable cost.
As per trade agreements, the sale of his garments is restricted to the old value of ₹ 12,00,000. What should be the selling price per garment so that the exporter earns the same profit at the same sales value?
On investigation it was found that variable cost in XYZ Ltd is 80 per cent of the selling price. If the fixed expenses are ₹ 10,000, calculate the break-even sales of the company.
Another firm, MN Company Ltd, having the same amount of fixed expenses, has its break-even point at a lower figure than that of XYZ Ltd. Comment on the causes.
ABC Ltd manufactures and sells four types of products under the brand names of A, B, C and D. The sales-mix in value comprises 33.33, 41.67, 16.67 and 8.33 per cents for products A, B, C and D respectively. The total budgeted sales (100 per cent) are ₹ 60,000 per month. Operating costs are:
Variable costs as per cent of selling price: Product A 60, B 68, C 80, and D 40. Fixed costs, ₹ 14,700 per month.
Calculate the break-even point for the products on an over-all basis.
From the cost records of a company for a specific period, for product X, the information given in the first column can be ignored since it is only one of the several projections of an assistant accountant, but it may be useful to you.
| Particular | This Period Actual (₹) | One of The Future Projections (₹) |
| Sales (Units) | 10,000 | 20,000 |
| Profit (Loss) | (10,000) | 10,000 |
| Fixed Costs | 30,000 | 30,000 |
| Variable Cost Per Unit | 8 | 8,000 |
On the basis of the first column, determine
1. What increased sales volume is required to cover an additional attractive packaging cost of ₹ 0.50 per unit, to increase the sales, at the existing sales price, to yield zero profit?
2. What increased sales volume in required at the present sale price, to cover an additional publicity expense of ₹5,000 for that period, while yielding a profit of ₹5,000.
3. What increased sale volume is required to reach a profit of ₹4,000 while reducing the selling price by 3 per cent per unit?
1. To obtain the break-even point in rupee sales value, total fixed costs are divided by:
A. Variable cost per unit;
B. Contribution margin per unit;
C. Fixed cost per unit;
D. Profit/volume ratio.
Answer:- D. Profit/volume ratio.
2. The break-even point is the point at which:
A. There is no profit, no loss;
B. Contribution margin is equal to total fixed cost;
C. Total revenue is equal to total cost;
D. All of the above.
Answer:- A. There is no profit, no loss;
3. The primary difference between a fixed budget and a variable (flexible) budget is that a fixed budget:
A. includes only fixed costs, while a variable budget includes only variable costs.
B. is concerned with only further acquisitions of fixed costs, while a variable budget is concerned with expenses which vary with sales.
C. cannot be changed after the period begins, while a variable budget can be changed after the period begins.
D. is a plan for a single level of sales (or other measure of activity), while a variable budget consists of several plans, one for each of several levels of sales (or other measures of activity).
Answer:- D. is a plan for a single level of sales (or other measure of activity), while a variable budget consists of several plans, one for each of several levels of sales (or other measures of activity).
4. Margin of safety is referred to as:
A. Excess of actual sales over fixed expenses;
B. Excess of actual sales over variable expenses;
C. Excess of actual sales over break-even sales;
D. Excess of budgeted sales over fixed costs.
Answer:- C. Excess of actual sales over break-even sales;
5. Contribution margin is known as
A. Marginal income
B. Gross profit
C. Net income
D. Net profit
Answer:- A. Marginal income
6. Fixed cost per unit decrease when
A. Production volume increases
B. Production volume decreases
C. Variable costs per unit decreases
D. Prime costs per unit decreases
Answer:- A. Production volume increases
7. Within a relevant range, the amount of variable costs per unit
A. Differs at each production level
B. Remains constant at each production level
C. Increases as production increases
D. Decreases as production increases
Answer:- B. Remains constant at each production level
8. Margin of safety is referred to as
A. Excess of budgeted or actual sales over the variable expenses and fixed expense, at break-even.
B. Excess of budgeted or actual sales revenue over the fixed expenses.
C. Excess of actual sales over budgeted sales.
D. Excess of sales revenue over the variable expenses.
Answer:- C. Excess of actual sales over budgeted sales.
9. Under marginal costing system, the contribution margin discloses the excess of
A. Revenue over fixed costs
B. Projected revenues over the break-even point
C. Revenues over variable costs
D. Variable costs over fixed costs
Answer:- C. Revenues over variable costs
10. A decrease in sales price
A. does not affect the break-even point
B. lowers the fixed cost
C. Increases the break-even point
D. lowers the break-even point
Answer:- C. Increases the break-even point
1. Marginal costing and absorption costing will report different profit figures if there is any change in the volume of inventory during the period. Answer:- True
2. Another term for marginal costing is variable costing. Answer:- True
3. For the marginal cost, the stock will be calculated on total cost. Answer:- False
4. The P/V ratio will be equal to the profits by the sale ratio Answer:- False
5. BEP in marginal costing is Break entity profit Answer:- False
6. The kind of cost which will not differ due to the volume of the production is called Fixed cost Answer:- True
7. Under High and Low Point method, the output at two different levels is compared with the amount of total costs incurred at these two points. Answer:- True
8. In Analytical method of calculating marginal costing, it is determined on the basis of past records. Answer:- False
9. Margin of safety will be ₹ 37,500 if Profit is ₹ 15,000 and P/V ratio is 40%. Answer:- True
10. Differential cost is the economist’s concept of marginal cost. Answer:- True
11. Marginal Costing is the practice of charging all marginal costs to operations processes or products and deducting all fixed costs against the profits for a particular period in which they arise. Answer:- True
12. Marginal cost may also be defined as the “cost of producing one additional unit of product.” Answer:- True
13. Addition of variable cost and profit to contribution is equal to selling price. Answer:- True
14. Fixed costs remain unchanged or constant for the entire volume of production. Answer:- True
15. Marginal cost remains the same per unit of output irrespective of the level of activity. Answer:- True
16. Marginal cost per unit is not constant in nature and helps the management in production planning. Answer:- False
17. Selling prices do not remain constant forever and for all levels of output due to competition, discounts for bulk orders, changes in the general price level, etc. Answer:- True
18. Fixation of selling price in the long run can be done without considering fixed costs. Answer:- False
19. Break-even analysis can be used to help management select an action when several alternatives exist. Answer:- True
20. CVP analysis looks at the effect of sales volume variations on costs and operating profit. Answer:- True
1. If the total cost of 1000 units is ₹ 60,000 and that of 1001 units is ₹ 60,400, then the increase of ₹ 400 in the total cost is Marginal cost
2. The costing method where fixed factory overheads are added to inventory is called Absorption costing
3. The marginal cost of change in the total cost when the quantity of product is increased by one unit
4. Contribution margin in marginal costing is also known as Marginal income
5. Fixed cost is also referred to as Period cost in the marginal costing technique.
6. An increase in the variable cost Improves margin of safety
7. Under marginal costing, the stock is valued at Variable Cost
8. Marginal cost is equal to Prime cost plus variable overheads
9. While computing contribution in marginal costing, The total marginal cost gets deducted from total sales revenue
10. The marginal cost will be equal to Prime cost plus all the variables overhead
11. Break-even Chart is a graphical representation of the Break- Even Analysis
12. Graphical representation of cost and revenue data (breakeven charts) can be more easily understood by nonfinancial managers.
13. Differential cost is the result of an alternative course of action.
14. A management of any type of business organization is confronted with the problem of making appropriate Decisions
15. Differential cost analysis is carried on using only Relevant costs
16. The main point which distinguishes Marginal cost and differential as that change in fixed cost when volume of production increases or decreases by a unit of production.
17. Fixed production overheads under Absorption costing are charged to the product to be subsequently releasedas a part of goods sold.
18. The Price to be charged for a product or service is often one of the most important decisions made by managers.
19. When the conditions prevailed both internally and externally are Favourable to the companies, they usually plan to earn some planned profit
20. The decision about whether to produce parts and components in-house, or to sub-contract work to external suppliers, is referred to as the Make-or-buy decision
1. What do you mean by marginal costing? Discuss its usefulness and limitations.
Answer:-
2. Distinguish between absorption costing and variable costing.
Answer:-
3. Discuss the role of contribution in marginal costing in decisions relating to fixation of selling price.
Answer:-
4. What are the limitations of break-even analysis?
Answer:-
5. Define break-even point. How can the break-even point be computed?
Answer:-
1. What do you understand by the term margin of safety with reference to volume of production?
Answer:-
2. What do you understand by the term break-even analysis”? Enumerate its uses.
Answer:-
3. Discuss the uses of CVP analysis and its significance to management.
Answer:-
4. Mention the basic assumption made for ‘Break-even Analysis’ and also state how far they are valid.
Answer:-
5. Mention some possible courses of action to improve profit-volume ratio.
Answer:-
1. Determine Margin of safety if Profit is ₹15,000 and P/V ratio is 40%.
A. ₹37,500
B. ₹33,000
C. ₹38,000
D. None of the above
Answer:- A. ₹37,500
2. What is Margin of Safety if Sales is 20,000 units and B.E.P is 15,000 units?
A. 15000 units
B. 5000 units
C. 10000 units
D. 20000 units
Answer:- B. 5000 units
3. Calculate margin of safety if sales is ₹3,00,000 and B.E.P is ₹ 4,50,000.
A. ₹1,00,000
B. ₹1,50,000
C. Amount of sales < B.E.P, therefore no margin of safety
D. None of the above
Answer:- A. ₹1,00,000
4. Determine sales in rupees for desired profit if fixed cost is ₹10,000, Variable cost is ₹30,000, Sales is ₹50,000 and desired profit is ₹5,000.
A. ₹73,500
B. ₹75,000
C. ₹5,000
D. ₹37,500
Answer:- D. ₹37,500
5. What will be sales in rupees for desired profit if fixed cost is ₹30,000, desired profit is ₹15,000 and P/V ratio is 30%?
A. ₹1,50,000
B. ₹1,00,000
C. ₹2,00,000
D. None of the above
Answer:- A. ₹1,50,000
6. Calculate sales in rupees for desired profit if fixed cost is ₹10,000, selling price is ₹20 per unit, Variable cost is ₹15 per unit and desired profit is ₹1 per unit.
A. ₹20,000
B. ₹50,000
C. ₹70,000
D. ₹10,000
Answer:- B. ₹50,000
7. Determine sales in units for desired profit if Fixed cost is ₹15,000, desired profit is ₹5,000 Selling price per unit is ₹20 and Variable cost per unit is ₹16.
A. ₹5,000 units
B. ₹5,000
C. ₹10,000
D. ₹10,000 units
Answer:- A. ₹5,000 units
8. What will be sales in units if fixed cost is ₹50,000 Contribution per unit is ₹60 and desired profit per unit is ₹10.
A. ₹6,000 units
B. ₹1,000
C. ₹1,000 units
D. ₹6,000
Answer:- C. ₹1,000 units
9. Determine B.E.P in units and amount if Units produced if ₹10,000, Fixed cost is ₹40,000, Selling price is ₹50 per unit and Variable cost us ₹30 per unit.
A. ₹40 per unit, ₹2,00,000
B. ₹50 per unit, ₹10,00,000
C. ₹20 per unit, ₹1,00,000
D. None of the above
Answer:- C. ₹20 per unit, ₹1,00,000
10. Determine B.E.P if Sales is ₹1,00,000, Variable cost is ₹50,000 and Profit is ₹20,000.
A. ₹60,000
B. ₹40,000
C. ₹80,000
D. None of the above
Answer:- A. ₹60,000
1. A company having annual sales of ₹10 crores is earning 12% profit before charging interest and depreciation. Interest and depreciation amount to ₹60 lakhs and ₹100 lakhs respectively. If the contribution/sales ratio of the company is 0.4, calculate its break-even sales.
2. In a purely competitive market 10,000 units of a product can be manufactured and sold and certain amount of profit is generated. It is estimated that 2,000 units of that product need to be manufactured and sold in a monopoly market to earn the same profit.
Profit under both the market conditions is targeted at ₹2,00,000. The variable cost per unit is ₹100 and the total fixed cost is ₹37,000.
You are required to determine the selling prices under both monopoly and competitive conditions.
3. A company has a fixed cost of ₹ 20,000. It sells two products A and B, in the ratio of 2 units of A and 1 unit of B. Contribution is ₹1 per unit of A and ₹2 per unit of B. How many units of A and B would be sold at break-even point?
4. ABC Ltd. manufactures three products, P, Q and R. The unit selling prices of these products are ₹100, ₹80 and ₹50 respectively. The corresponding unit variable costs are ₹ 50, ₹40 and ₹20. The proportions (quantity-wise) in which these products are manufactured and sold are 20%, 30% and 50% respectively.The total fixed costs are ₹14,80,000.Given the above information, you are required to work out the overall break-even quantity and the product wise break-up of such quantity.
5. A producer of Ladies purses is earning a monthly post tax profit of ₹ 60,000 when income tax rate is 40%. Selling price of a purse is ₹50 and per unit variable cost is ₹30. How many more purses he should sell to earn same monthly post tax profit, if the tax rate goes up to 50%?
6. Calculate break-even for a train journey between Delhi- Bangalore where cost of an Engine is ₹ 1,00,000 and of a bogie ₹20,000. Capacity of a bogie is 80 passengers and each ticket for the journey is ₹600. There is no variable cost per passenger.
7. W Ltd. is a single product producer with P/V ratio of 40% for the product during the current year.
Due to increasing competition it is believed that the price will have to be reduced by 10% in the next year. By what percentage sales value and sales quantity should increase so that W Ltd. earns same profit in the next year also?
8. A company has a contribution/sales ratio of 40%. It maintains a margin of safety of 20%. If its annual fixed cost amount to ₹ 24 lakhs, calculate its
A. Break-even sales,
B. Margin of safety,
C. Total sales,
D. Total variable costs and
E. Profit
9. A company sells its product at ₹15 per unit. In a period, if it produces and sells 8000 units, it incurs a loss of ₹5 per unit. If the volume is raised to 20000 units, it earns a profit of ₹ 4 per unit.
Calculate break-even point in terms of rupees as well as in units.
10. A Company manufactures radios, which are sold at ₹ 1,600 per unit. The total cost is composed of 30% for direct materials, 40% for direct wages and 30% for overheads. An increase in material price by 30% and in wage rates by 10% is expected in the forthcoming year, as a result of which the profit at current selling price may decrease by 40% of the present profit per unit. You are required to prepare a statement showing current and future profit at present Selling Price.
How much Selling Price should be increased to maintain the present rate of profit?
1. Prepare a profit and loss statement under
(i) Absorption costing and
(ii) Marginal costing from the following data:
Total units produced 5000 units
Total units sold 4000 units
Selling price per unit ₹10
Total fixed overheads ₹15,000
Cost structure:
| Particulars | (Per unit) |
| Direct material | ₹ 2 |
| Direct wages | ₹ 2 |
| Variable overhead | ₹ 2 |
| Fixed overhead | ₹ 3 |
2. You are required to ascertain profit t and loss under (i) marginal-costing- and (ii) absorption-costing method from the following data:
Basic production data:
Normal volume of production = 20,000 units per period.
Sales price = ₹5 per unit.
Variable cost = ₹3 per unit.
Fixed cost = ₹1 per unit.
Total fixed cost = ₹20,000 (20,000 × ₹1).
Selling and distribution costs (not available).
The opening and closing stocks consist of both finished goods as well as equivalent units of WIP.
3. A company produces a variety of products each having a number of component parts. Product B takes 10 hours to process on a machine working to its full capacity. B has a selling price of ₹100 and a marginal cost of ₹50.
‘AA’ – a component part (used for product A), could be made on the same machine in 2 hours for a marginal cost of ₹15. The suppliers’ price is ₹20. Should one make or buy the component ‘AA’? Assume that themachine hour is the limiting factor.
4. A company has a capacity of producing 50,000 units of a certain product in a month. The sales department reports that the following schedule of sale prices is possible:
| Volume of Production | Selling Price per unit (₹) |
| 60% | 0.95 |
| 70% | 0.90 |
| 80% | 0.85 |
| 90% | 0.75 |
| 100% | 0.60 |
The variable cost of manufacture between these levels is ₹0.20 per unit and the fixed cost is ₹15,000. At which volume of production will the profit be the maximum?
5. The following date relates to a manufacturing company:
Plant capacity: 2,00,000 units per annum
Present utilization = 50%
Actuals for the year are:
Selling price ₹40 per unit
Materials cost ₹15 per unit
Variable manufacturing costs ₹9 per unit
Fixed costs ₹18 lakhs
In order to improve the capacity utilization, the following proposals are being considered:
(i) Reduce the selling price by 15%.
(ii) Spend additionally ₹2,00,000 on sales promotion
How many units should be made and sold in order to earn a profit t of ₹5,00,000 per year?
Key Terms
Marginal cost- Marginal cost is the aggregate of variable costs.
Marginal costing- Marginal costing is a technique which is concerned with the changes in costs and profits result from changes in volume of output.
Absorption Costing- Absorption costing is the total cost technique. It is the practice of charging all costs, both variable and fixed, to operations, processes or products.
Higher contribution- Higher contribution means more profit
Break-even Analysis- In CVP analysis, an attempt is made to measure variations of costs and profit with volume of production.
Break-even point- Break-even point may be as the point of sales volume at which total revenue equals total costs.
Angle of Incidence: Angle of Incidence is the angle between sales and total cost line. This angle is an indicator of profit earning capacity of the firm over the break-even point sales.
Break-even Analysis: Break-even Analysis is a method for examining the relationship between sales revenue, variable costs and fixed costs to determine the minimum value of production necessary to break-even.
Break-even Chart: Break-even Chart is the chart which shows the profitability or otherwise of a firm at various levels of activity. It indicates the point at which neither profit nor loss is made.
Contribution or Gross Margin: Contribution or Gross Margin is the difference between sales value and the variable cost. In other words, Contribution or Gross Margin is defined as the amount recovered towards fixed cost and profit. patel visahw navinbhai
Differential Cost: Differential Cost is the change in the costs which results from the adoption of an alternative course of action.
Margin of Safety: Margin of Safety is represented by excess sales over and above the break-even point sales.
Profit Volume Ratio (P/V Ratio) or Contribution Ratio: Profit Volume Ratio (P/V Ratio) or Contribution Ratio is the ratio of Contribution to Sales.
P/V Ratio = (Contribution/Sales) × 100 or
= [(Sales – Variable cost)/Sales] × 100 or
= (Change in Contribution/Change in Sales) × 100 or
= (Change in Profit/Change in Sales) × 100
Marginal cost plus prices are based on the marginal cost of production or the marginal cost of sales, plus a profit margin.
Desired Profit: It is a profit level desired by the fi rm to earn at the given level of sales volume.
Key Factor: Factor of influence on the component of contribution.
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