Some Important Definition:

 Marginal Cost: Marginal Cost is the additional cost incurred for increase in
one additional unit of output. Marginal cost is nothing but the variable cost.
 Marginal Costing: Marginal Costing is the method of ascertaining marginal
cost and it evaluates the effect of fixed and variables costs on profit due to
change in volume of production.
 Distinguish features of Marginal Costing are:
(a) Only variable costs are charged to the cost unit. Fixed costs are recovered
from contribution;
(b) All costs including semi variable costs are divided into two parts, fixed and
variable;
(c) Closing inventories are valued at variable cost only;
(d) Break-even Analysis and Cost-volume-profit Analysis are integral parts of
this costing technique.
 Marginal Costing technique is having many advantages, such as:
(a) It provides useful data for managerial decision-making;
(b) It is a very effective tool of profit planning;
(c) Itsfacilitiescontrolovervariablecostsbyavoidanceofarbitraryapportionment
or allocation of fixed costs;
(d) Problems on computation of accurate fixed factory overhead rate can be
avoided as fixed overheads are charged against contribution;
 (e) It provides the management with many useful techniques for decision –
making like Break – even Analysis, etc.
 Limitations of Marginal Costing are:
(a) It assumes the semi-variables costs can be segregated into two parts,
fixed and variable elements. In practice, however, such segregation of
semi- variable costs is very difficult;
(b) It excludes fixed cost for decision–making, which sometimes may lead to
wrong conclusion;
(c) Itfailstoreflecttheimpactofincreasedfixedcostsduetodevelopmentof
technology on production costs;
(d) Variable cost technique cannot be successfully applied in “Cost plus
contract”.
 Cost-volume-profit (CVP) Analysis examines the relationship of costs and
profit to the volume of production to maximize profit of the firm. The
method of studying the relationship between the cost, volume of production,
sales and their impact on profit is called as ‘Cost-volume-profit Analysis’.
CVP Analysis is a logical extension of marginal costing and is used as a
very powerful tool by the management in the process of budgeting and profit
planning.
 Objectives of CVP Analysis are:
(a) It helps to forecast profit fairly and accurately;
(b) It acts as an effective tool of profit planning to the management;
(c) It helps in ascertaining break-even point of the product produced and sold.
(d) It is very much useful in setting up flexible budget;
(e) It assists the management in the process of performance evaluation for
the purpose of control;
 (f) It helps in formulating price policies by projecting the effect of different
price structures on costs and profits.
 Underlying assumption of CVP Analysis are:
(a) Total cost consists of two components –fixed cost and variable cost;
(b) Selling price per unit remains constant at different volume of sales;
(c) Only one product is sold by the concern or if it sells multiple product, the
sales mix remains constant at different volume of sales;
(d) Volume of production is equal to the sales volume.
 ElementsofCVPAnalysisare:
 MarginalCostEquation;
 Contribution;
 Profit–VolumeRatio;
 Break-evenPoint;
 MarginofSafety
 MarginalCost Equation exhibits the relationship between the contribution,
fixed cost and profit. It explains that the excess of sales over variable cost is
the contribution towards fixed cost and profit, i.e. S – V = F + P.
 Contribution is the excess of sales over variable cost, i.e. C = S – V. This
contribution is available towards fixed cost and profit, i.e. C = F + P.
 Profit–VolumeRatio(P/VRatio)istheratioofcontributionandsales.Itis
generally expressed in percentage. It exhibits % of contribution included in
sales, i.e. P/V Ratio = C/S x 100. It indicates the effect on profit for a given
change in sales.
 Break-evenPoint(BEP)is that level of sales where there is no profit or no
loss.At break–evenpoint,total sales revenue is equal to total cost. Any sales
above this BEP, a concern earns profit,whereas any sales below this BEP,the
concern suffers loss. At BEP,total fixed cost and variable cost upto that level
of sales have been recovered from sales. Generally, at any other
pointofsales, contribution from sales is available towards fixed cost and
profit. But as there is no profit or loss at BEP, Contribution from sales at
BEP is available towards fixed cost only, i.e. at BEP, C = F.
 Margin of Safety (MS) is the level of sales made above the break – even
point.In other words, Margin of Safety is the excess of actual sales over BEP
sales. Generally, at any point of sales, contribution from sales is available
towards fixed cost and profit. But as the total fixed cost has already been
recovered at break–evenpoint, contribution from sales at margin of safety is
available towards profit only, i.e. at MS, C = P.
 CVP Analysis is popularly known as Break – even Analysis, although there
exists a narrow difference between these two terms. CVP Analysis refers to
the study of the effect on profit due to changes in cost and volume of output,
whereas BE Analysis refers to the study of determination of that level of
activity where total sales is equal to the total cost and also the study of
determination of profit at any level of activity. However, the technique of
BE Analysis is so popular for studying CVP Analysis that these two terms
are generally used synonymously.
IncomeStatementunderMarginalCosting:

Rs.

Sales xxxx

Less:VariableCost xxx

Contribution xxxxx

Less:FixedCost(Operating) xxx

Profit (EBIT) xxxxx

Formula:

1. Contribution(C)=Sales–VariableCost=FixedCost+Profit
2. Profit–VolumeRatio(P/VRatio)=Contribution/Sales*100
={(Changeinprofit)/(Changeinsales)}* 100
3. BEPSales(invalue)=FixedCost/(P/VRatio)

BEPSales(inunits)=FixedCost/Contributionperunit

4. MarginofSafety(MOS)=ActualSales–BEP sales
=Profit/(P/Vratio)
5. RequiredSales(invalue)=(FixedCost+Profit)/Contributionperunit
Required Sales (in units) = (Fixed Cost + Profit) / (P/V Ratio).
 Model Problems:

Q1.X Ltd. Made sales during a certain period for Rs. 100,000. The net profit
for the same period was Rs. 10,000 and the fixed overheads were Rs. 15,000.

Find out:

(i) P/V Ratio.

(ii) Required sales to earn a profit of Rs.15,000.
(iii) NetProfitfromsalesofRs.1,50,000.
(iv) Break–even point sales.

Q2.DBLtdfurnishedthefollowinginformation:

2004-2005 2005-2006
Particulars
₹ ₹
Sales(₹10/unit) 2,00,000 2,50,000
Profit 30,000 50,000
You are required to compute:

(a) P/V Ratio.

(b) Break-even point.
(c) Total variable cost for 2004-2005 & 2005-2006.
(d) Sales required to earn a profit of ₹60,000.
(e) Profit/Loss when sales are ₹100,000.
(f) Margin of Safety when Profit is ₹80,000.
(g) During2006-2007,due to increase in c`ost, variable cost is expected to rise to
₹7/unit and fixed cost to ₹55,000. If selling price can not be increased, what will be the amount
of sales to maintain the profit of 2005-2006?
3. Rainbow Ltd. Sold goods for ₹ 30,00,000 in a year. In that year, the variable
cost is 60% of sales and profit is ₹ 8,00,000.
Findout:(i)P/VRatio,(ii)FixedCost,(iii)Break-evensales,(iv)Break-evensales if
selling price was reduced by 10% and fixed costs were increased by ₹
1,00,000.

4. The sales and profit of J.K.Ltd. During two years were as given below:

Year Total Sales(₹) Total Cost(₹)

2010 3,00,000 2,60,000
2011 3,40,000 2,90,000
You are required to compute:

(i)P/VRatio;(ii)Break-evenPoint;(iii)Salesrequiredtoreachaprofitof₹40,000;
(iv) Profit made when sales amount is ₹ 2,50,000; (v) Margin of Safety when
sales are ₹ 2,50,000.

5. Fill in the blanks of each of the following independent situation:

Products
Particulars
X Y Z
No. of units sold ? (i) 10,000 5,000
Selling price per unit(₹) 20 ? (ii) 30
Variable cost of sales(%) 75 75 ? (iii)
Contribution(₹) ? (iv) 25,000 50,000
Fixed Cost(₹) 1,20,000 10,000 ? (v)
Profit/Loss (₹) 30,000 ? (vi) 15,000