MANAGEMENT

ACCOUNTING
TOPIC COVERED
(MODULE 2)
 Marginal Cost
• Uses
• Applications
• Advantages
• Limitations
 Important Terms
• Fixed V/S Variable Cost
• Contribution
• Profit-Volume Ratio
• Break-Even Point
• Margin of Safety
• Cost-Volume Analysis
 Marginal Cost
Marginal Cost Definition: Marginal cost is the
additional cost incurred when producing one more
unit of a good or service.

Relation to Variable Cost: It arises from variable

costs, as fixed costs remain unchanged regardless of
the output level.

No Extra Fixed Costs: Since fixed costs don't change

with production, no additional fixed cost is involved
in producing an extra unit once production starts.
 Marginal Cost
Demo Table.

Particular Rupees ₹
Direct Material XX

Direct Labour XX

Direct Expenses XX

Prime Cost XX

(+) Total Variable Overhead XX

Marginal Cost Per Unit XXXX -/-

Marginal Costing & Uses
Marginal Costing : Marginal costing is a technique
where only variable costs are assigned to units of
production, while fixed costs are written off against
the total contribution.

Purpose: It helps in determining costs and measuring

how profit is affected by changes in output volume or
type.

Usefulness: Marginal costing is highly useful for

decision-making, as it separates costs into fixed and
variable categories.
 Marginal Costing Applications
Profit Planning and Forecasting:
 Highlights the contribution margin, helping managers assess profitability.
 It aids in profit forecasting by analyzing the relationship between costs, sales, and profits.

Pricing Decisions :
 Set minimum prices by focusing on variable costs, useful in competitive markets.
 Useful for special pricing decisions, ensuring short-term orders cover variable costs.

Make or Buy Decisions:

 Compares the variable production costs with outsourcing prices to decide cost-effectiveness.
 Helps in identifying avoidable fixed costs that could make outsourcing a better option.

Product Mix and Optimization:

 Guides product elimination by analyzing contribution margin and overall profitability.
 Helps prioritize products with the highest contribution margin for optimal resource allocation.
 Marginal Costing Applications
Key Financial Decisions:
 Assists in deciding whether to shut down or continue operations based on variable cost
coverage.
 Evaluates profitability of expansion by forecasting how additional production impacts profit.

Sales and Production Planning:

 Supports flexible budgeting to evaluate performance at various production levels.
 It in inventory valuation prevents overproduction driven by fixed cost allocations.

Cost-Volume-Profit (CVP) Analysis:

 CVP analysis assesses how changes in costs, sales, and prices impact profitability.
 Useful for sensitivity analysis and exploring different business scenarios.

Decision-Making in Uncertainty:
 Helps managers assess less risky options by focusing on how changes affect contribution.
 Marginal costing provides clarity on short-term decisions during fluctuating demand.
 Marginal Costing Applications
Special Markets and Customers:
 Special Markets: Orders can be accepted at prices below total cost (but above marginal
cost), especially in foreign markets. This increases profit as only variable costs increase
while fixed costs remain unchanged. However, selling at lower prices in regular markets can
lead to an overall price drop.

 Special Customers: Similar price concessions may be offered to specific customers, like the
Government, but these cannot be extended to all customers.

10
Cost Control:
 Marginal costing provides variable costs and fixed costs separately. Cost information is
reported periodically and regularly to the management for decision-making and controlling
the costs
 1
Ease of Understanding
This system is simple to understand and
operate, aiding in the evaluation of

Advantages
performance across departments, divisions,
products, and sales teams.

2
Effective Cost Control

of
By focusing on variable costs, it
helps in controlling costs, as fixed
costs are generally non-controllable
in the short term.

Marginal 3
Useful Management Technique
It equips management with valuable
tools like break-even analysis and P/V
ratio to better understand financial

Costing
performance.

4
Profit Planning Support
The system provides guidance on
profitability at different production and
sales levels, making it a crucial tool for
profit planning.
 Difficulty in Cost Classification

Limitations
1 Classifying total costs into fixed and
variable components can be
challenging, making accurate cost
assessment difficult.

2
Impact on Profitability

of
Eliminating fixed costs in inventory
valuation can negatively impact
profitability, leading to skewed
financial results.

Marginal 3
Limitations of Historical Data
Marginal costing relies on historical
data, which may not be relevant for
future-oriented management

Costing
decisions.

4
Short-Term Pricing and Profit
Pricing and profitability assessments
based on marginal cost are effective only
in the short term, limiting their long-term
applicability..
 FIXED COST VARIABLE COST
Increase and Decrease in
Known as "Period Cost" or "Time proportion to sales and output.
Cost". Called as "Product Cost" or
"Marginal Cost“.
Does not depend on volume of
production and sales. Fixed cost Vary in direct proportion to output
remain constant Fixed cost are
fixed in unite. Variable cost vary in total but they
remain constant per unit.
Examples:- Salary, rent, manager's
Salary etc. known as fixed Example:- Direct Material, Direct
overheads. Wages etc.
 CONTRIBUTION

 Contribution is the difference between sales and variable cost.

 Contribution is also known as "Contribution Margin" or "Gross Margin".

Contribution = Sales - Variable Cost

Contribution = Fixed Expenses + Profit

Profit = Profit Contribution - Fixed cost

FORMULAE
Sales = Contribution + Variable Cost

Sales - Variable cost = Fixed Cost + Profit/ Loss

 PROFIT VOLUME RATIO
 Relationship between contribution and sales and is usually expressed in percentage.

 High P/V ratio indicate high profitability

 Low P/V ratio indicate low profitability

𝐶𝑂𝑁𝑇𝑅𝐼𝐵𝑈𝑇𝐼𝑂𝑁
× 100
𝑆𝐴𝐿𝐸𝑆

𝑆𝐴𝐿𝐸𝑆 − 𝑉𝐴𝑅𝐼𝐴𝐵𝐿𝐸 𝐶𝑂𝑆𝑇

× 100
P/V RATIO = 𝑆𝐴𝐿𝐸𝑆

𝐹𝐼𝑋𝐸𝐷 𝐸𝑋𝑃𝐸𝑁𝑆𝐸𝑆 + 𝑃𝑅𝑂𝐹𝐼𝑇 FORMULAE

× 100
𝑆𝐴𝐿𝐸𝑆

𝐶𝐻𝐴𝑁𝐺𝐸 𝐼𝑁 𝑃𝑅𝑂𝐹𝐼𝑇 𝑂𝑅 𝐶𝑂𝑁𝑇𝑅𝐼𝐵𝑈𝑇𝐼𝑂𝑁

× 100
𝐶𝐻𝐴𝑁𝐺𝐸 𝐼𝑁 𝑆𝐴𝐿𝐸𝑆
 BREAK EVEN POINT
 The break-even point can be defined as a point where total costs (expenses) and total sales
(revenue) are equal.

 Break-even point can be described as a point where there is no net profit or loss.

 Total Sales Revenue = Total Cost incurred

BREAK EVEN POINTS 𝐹𝐼𝑋𝐸𝐷 𝐶𝑂𝑆𝑇

=
(UNITS) 𝐶𝑂𝑁𝑇𝑅𝐼𝐵𝑈𝑇𝐼𝑂𝑁 (𝑝𝑒𝑟 𝑢𝑛𝑖𝑡)

𝐹𝐼𝑋𝐸𝐷 𝐶𝑂𝑆𝑇𝑆
FORMULAE
BREAK EVEN POINTS =
(RS. ₹) 𝑃. 𝑉 𝑅𝐴𝑇𝐼𝑂

BEP UNIT x SELLING PRICE

 BREAK EVEN POINT

Comparison Cash Cost

The sales level at which a The sales level at which total
Definition business generates enough revenue equals total costs,
cash revenue to cover its cash including both fixed and
expenses. variable costs.

Covers only cash operating Covers all costs, including both

Focus expenses, ensuring that the cash costs and non-cash costs like
company does not run out of cash. depreciation.

Assessing liquidity and short-term Understanding overall profitability

Used For solvency by ensuring cash flow can by considering the full cost
cover cash outflows. structure of the business.
GRAPH ANALYSIS

The horizontal axis represents sales in units, and the

vertical axis shows monetary value in dollars.

The light blue dashed line indicates cash costs, while

the blue solid line represents revenue.

The vertical dashed line at 100 units marks the cash

break-even point, where cash costs equal revenue.

The red dashed line shows total costs, including both

cash and non-cash expenses.

The vertical dashed line at 125 units marks the cost

break-even point, where total costs equal revenue,
indicating overall profitability.
 MARGIN OF SAFETY
 The Margin of Safety (MOS) represents the buffer between actual or budgeted sales and the
breakeven point.

 It shows how much sales can drop before the company reaches a no-profit, no-loss situation.

 A higher MOS indicates a lower risk of loss, while a lower MOS suggests a more vulnerable
financial position.

MARGIN OF SAFETY = ACTUAL SALES – BREAKEVEN SALES

𝑃𝑅𝑂𝐹𝐼𝑇 FORMULAE
MARGIN OF SAFETY =
𝑃. 𝑉𝑅𝐴𝑇𝐼𝑂
 COST VOLUME PROFIT

 Cost-volume-profit analysis, or CVP, is something companies use to figure out how

changes in costs and volume affect their operating expenses and net income.

 CVP works by comparing different relationships, such as the cost of operating and
producing goods, the amount of goods sold, and profits generated from the sale of those
goods.

 CVP analysis gives companies strong insight into the profitability of their products or
services.

 Cost-volume-price analysis is a way to find out how changes in variable and fixed costs
affect a firm's profit.

 Companies can use the formula result to see how many units they need to sell to break
even (cover all costs) or reach a certain minimum profit margin.
 CVP FORMULA ANALYSIS

 The CVP formula can be used to calculate the sales volume needed to cover costs and
break even, in the CVP breakeven sales volume formula, as follows:

𝐹𝐶 FIXED COST
𝐵𝑅𝐸𝐴𝐾𝐸𝑉𝐸𝑁 𝑆𝐴𝐿𝐸𝑆 𝑉𝑂𝐿𝑈𝑀𝐸 =
𝐶𝑀 CONTRIBUTION MARGIN :
SALES – VARIABLE COSTS

To use the above formula to find a Company's

target sales volume, simply add a target profit
amount per unit to the fixed-cost component of the
formula. This allows you to solve for the target
volume based on the assumptions used in the
model.
 USES OF CVP

A) Informed
Decision-Making
CVP analysis helps managers assess how
changes in costs, sales, and pricing affect
profitability, aiding in strategic decision-
making.

B) Cost Control and

Efficiency:
C) Profit Planning:
It helps identify fixed and
variable costs, allowing CVP analysis aids in determining
managers to reduce expenses break-even points and setting
and enhance operational profit goals, guiding future
efficiency. business planning.
 ELEMENTS OF CVP

VOLUME
The number of units
COST produced in the case of a PROFIT
physical product, or the The difference between the
The expenses involved in amount of service sold.
producing or selling a selling price of a product or
product or service. service minus the cost to
produce or provide it.
 ASSUMPTIONS USED

All costs can The selling Changes in Changes in

be accurately price per unit is activity are activity are
identified as constant & All the only the only
either fixed units produced factors that factors that
or variable. are sold affect costs. affect costs.
 PRACTICAL PROBLEMS

Ques. Vibhava Ltd. produces two products called "Super and Delier. From the following
information show which product is more profitable, time being the kay factor.

Per Unit of (Super) Per Unit of(delux)

Material 15 15
Labour (₹ 3 per hour) 12 9
Fixed Overhead 12 9
Variable (₹ 3 per hour) 12 9
Total Cost 48 42
Profit 7 6
Selling Price 55 48
 PRACTICAL PROBLEMS
Solution: Vibhava Ltd. Marginal Cost Statement
SUPER DELUX
₹ ₹ ₹ ₹
Sales 55.00 48
Less: Variable Cost : Material 15 15
Labour 12 9
Overhead 12 39.00 9 33
Contribution Per unit 16.00 15

₹12 ₹9
= 4 hours = 3 hours
Standard Time to produce ₹3 ₹3

Contibution Per hour ₹16 ₹15 =

= ₹4 ₹5
4 hr 3 hrs

Product Delux is more profitable as it gives more contribution per hour.

 PRACTICAL PROBLEMS
Ques. In a factory producing two different kinds of articles, the limiting factor is the availability of labour. From
the following information show which product is more profitable. Product
Cost Per Unit of (Blue) Cost Per Unit of(Red)
Material 5 5
Labour (6 hours @₹ 5 per hour) 30
(3 hours @₹ 5 per hour) 15
Fixed Overhead – 50% Labour 15 7
Variable Overhead 15 15
Total Cost 65 42.50

95 65.00
Selling Price 30 22.50
Profit
Total Product (units) 500 600
 PRACTICAL PROBLEMS
Solution:
BLUE RED

Selling Price Per Unit 95 65

Less: Marginal Cost : Material 5 5
Labour 30 15
Overhead 15 50 15 35
Contribution Per unit 45 30

45 30
Contribution Per hour = 7.50 = 10.00
6 3

Therefore product RED is more profitable as the contribution per unit of limiting factor is more.
 PRACTICAL PROBLEMS
Ques: The following figures are available from the records of Venus Enterprises as at 31st March

Calculate:
(a) The P/V ratio and total fixe expenses.
(b) The break-even level of sales.
(c) Sales required to earn a profit of Rs. 90 lakhs.
(d) Profit or loss that would arise if the sales were Rs. 280 lakhs. d
Solution:

(a) P/V ratio = Change in Profit/Change in Sales × 100 = 20 lakhs/50 lakhs × 100 = 40%
Fixed Expense = Contribution – Profit
= (S × P/V ratio) – P = (200 lakhs × 40%) – 50 lakhs = 80 lakhs – 50 lakhs = Rs. 30 lakhs (in 1989)
F = (150 × 40%) – 30 = 60 – 30 = Rs. 30 lakhs (in 1988)
(b) B.E.P. = F/P.V. ratio = 30 Lakhs/40% = Rs. 75 lakhs.
(c) Sales = F + P/P.V. ratio = 30 lakhs + 90 lakhs/40% = 120 lakhs/40% = Rs. 300 lakhs sales required to earn a Profit of Rs. 90 lakhs.
(d) Desired Profit = (S x P/V ratio) – F
(280 lakhs × 40%) – 30 lakhs = 112 lakhs – 30 lakhs = Rs. 82 lakhs.
 PRACTICAL PROBLEMS
Ques: Calculate P/V ratio in each of the following independent situations.
(i) Variable cost ₹60, Contribution ₹40
(ii) Sales ₹20, variable cost ₹15
(iii) Ratio of variable cost to sales 84%
(iv) Profit ₹5,000; Sales ₹25,000; Fixed Cost ₹8,000
(v) Year I Sales ₹50,000, Total cost ₹40,000.
Year II Sales ₹60,000, Total cost ₹ 45,000

Solution: (i)P/V ratio = Contribution/Sales = Contribution / Variable cost + Contribution = 40/60+40 = 40/100 = 40%

(ii) P/V ratio = Contribution/Sales = S-V/S = 20-15/20 = 5/20 = 25%

(iii) P/V ratio = 100 - Variable cost to sales ratio = 100-84% = 16%.

(iv) P/V ratio = Contribution/Sales = F+P/S = 5,000+8,000/25000 = 13,000/25,000 = 13/25.

(v) P/V ratio = Change in profit/Change in sales = 15,000-10000 / 60,000 - 50,000 = 5000/10,000 = 50%.

Profit is the difference between sales and total cost.

Ques: Following data is given:
Total fixed cost = ₹12000
Selling price = ₹12 per unit
Variable cost = ₹9 per unit

Solution: Contribution = Sales-Variable cost = 12-9 = ₹3 per unit

P/V ratio = Contribution / Sales ×100 = 3/2 ×100 = 25%

Break-even point (in units) = Fixed cost / Contribution per unit = 12,000 / 3 = 4,000 units.

Break-even point (in ₹ ) = Total fixed cost / Contribution × Sales = 12,000/3 × 12 = ₹ 48000

Also, Break-even point (in ₹) = Total Fixed cost / P/V ratio = ₹12000/25% = ₹48000

Verification Break-even point may be verified as follows:

Total cost = Fixed cost + Variable cost
= ₹12,000+ (4,000 units × ₹9) = ₹48,000
The sales value and total cost at break-even point are exactly equal.
 PRACTICAL PROBLEMS
Ques: following data is given:
Fixed cost = ₹12,000 (total)
Selling price =₹12 per unit
Variable cost = ₹9 Per unit
Calculation of Profit at different Sales Volumes
What will be the profit when sales are (a) ₹ 60,000 (b) ₹1,00,000 ?

Solution: P/V ratio = Contribution/Sales = 3/12 = 25%

(a) When sales Contribution Profit = ₹60,000
= Sales x P/V ratio = 60,000 × 25% = 15,000
Profit = Contribution - Fixed cost
= ₹15,000 - ₹12,000 = ₹3,000

(b) When sales contribution = ₹1,00,000

= 1,00,000 × 25% = 25,000
Profit = ₹25,000 - ₹12,000 = ₹13,000.
 PRACTICAL PROBLEMS
Ques: The following information is given :
Sales = ₹2,00,000
Variable cost = ₹1,20,000
Fixed cost = 30,000
Calculate :
(a) Break-even point
(b) New break-even point if selling price is reduced by 10%
(c) New break-even point if variable cost increases by 10%
(d) New break-even point if fixed cost increases by 10%

Solution: P/V ratio = Sales-Variable cost/Sales = 2,00,000-1,20,000 / 2,00,000 = 80,000 / 2,00,000 × 100 = 40%

(a) Break-even point = Fixed cost/P/Vratio = 30,000/40% = ₹75,000

(b) When selling price in reduced by 10%, new sales = 2,00,000 - 10% = ₹ 1,80,000
 PRACTICAL PROBLEMS
Solution: New P/V ratio = 1,80,000-1,20,000/1,80,000 = 60,000/1,80,000 = 1/3

New Break-even point = Fixed cost / P/V ratio = 30,000 / 1/3 = ₹ 90,000

(c) When variable cost increases by 10%, new variable cost

= 1,20,000 + 10% = 1,32,000
New P/V ratio = 2,00,000-1,32,000 = 68,000 / 2,00,000 × 100 = 34%

New Break-even point = Fixed cost/ P/V ratio = 30,000 / 34% = ₹ 88,235 (approx.)

(d) If fixed cost increases by 10%, new fixed cost = 30,000 + 10% = 33,000

P/V ratio remains unaffected at 40%

New Break-even point = 33,000/40% = ₹ 82,500.