Introduction

As discussed in the first chapter ‘Introduction to Cost and Management

Accounting’, the cost and management accounting system, by provision of
information, enables management to take various decisions. Marginal
Costing is a technique of cost and management accounting which is used
to analyse relationship between cost, volume and profit.
In order to appreciate the concept of marginal costing, it is necessary to
study the definition of marginal costing and certain other terms
associated with this technique. The important terms have been defined
as follows:
1. Marginal Cost: Marginal cost as understood in economics is the
incremental cost of production which arises due to one-unit increase
in the production quantity. As we understood, variable costs have direct
relationship with volume of output and fixed costs remains constant
irrespective of volume of production. Hence, marginal cost is measured
by the total variable cost attributable to one unit. For example, the total
cost of producing 10 units and 11 units of a product is
`10,000 and `10,500 respectively. The marginal cost for 11th unit i.e. 1
unit extra from 10 units is `500.
 MARGINAL COSTING

Marginal cost can precisely be the sum of prime cost and variable overhead.
Example 1: Arnav Ltd. produces 10,000 units of product Z by incurring a
total cost of `3,50,000. Break-up of costs are as follows:
(i) Direct Material @ `10 per unit, `1,00,000,
(ii) Direct employee (labour) cost @ `8 per unit, `80,000
(iii) Variable overheads @ `2 per unit, `20,000
(iv) Fixed overheads `1,50,000 (upto a volume of 50,000 units)
In this example, if Arnav Ltd. wants to know marginal cost of producing
one extra unit from the current production i.e. 10,001 st unit. The marginal
cost would be the change in the total cost due production of this 10,001 st
extra unit. The extra cost would be `20, as calculated below:
10,000 10,001 Change in
units units Cost
(A) (B (c) = (B) -
) (A)
(i) Direct Material @ `10 1,00,000 1,00,010 10
per unit

(ii) Direct employee 80,000 80,008 8

(labour) cost @ `8 per
unit
(iii) Variable overheads 20,000 20,002 2
@ `2 per unit

(iv) Fixed overheads 1,50,000 1,50,000 0

Total Cost 3,50,000 3,50,020 20

2. Marginal Costing: It is a costing system where products or

services and inventories are valued at variable costs only. It does
not take consideration of fixed costs. This system of costing is also
known as direct costing as only direct costs forms the part of product
and inventory cost. Costs are classified on the basis of behavior of cost
(i.e. fixed and variable) rather functions as done in absorption costing
method.
3. Direct Costing: Direct costing and Marginal Costing is used
synonymously at various places and it is so also. But the relation of costs
with respect to activity level must be understood. Some costs are
variable at batch level but fixed for unit level and likewise variable at
production line level but fixed for batches and units.
 COST AND MANAGEMENT ACCOUNTING

Example 2: Arnav Ltd. produces 10,000 units of product Z by incurring

a total cost of `4,80,000. Break-up of costs are as follows:
(i) Direct Material @ `10 per unit, `1,00,000,
(ii) Direct employee (labour) cost @ `8 per unit, `80,000
(iii) Variable overheads @ `2 per unit, `20,000
(iv) Machine set up cost @ `1,200 for a production run (100 units can
be manufactured in a run)
(v) Depreciation of a machine specifically used for production of Z `10,000
(iv) Apportioned fixed overheads `1,50,000.
Analysis of the costs:
10,000 10,001 Change in Direct Cost
units units Cost
(A (B (c) = (B) -
) ) (A)
(i) Direct 1,00,000 1,00,010 10 Unit level Direct
Cost.
Material @
`10 per unit
(ii) Direct 80,000 80,008 8 Unit level Direct
employee Cost.
(labour) cost
@
`8 per unit
(iii) Variable 20,000 20,002 2 Unit level Direct
overheads @ Cost.
`2 per unit
(iv) Machine set 1,20,000 1,21,200 1,200 Batch level
up cost Direct Cost
(v) Depreciation 10,000 10,000 0 Product level
of a machine Direct Cost.
(iv) Apportioned 1,50,000 1,50,000 0 Department level
fixed Direct Cost
overheads
Total Cost 4,80,000 4,81,220 1,220
In the example, the direct cost of producing 10,001 st unit is 1,220 but it is
not the marginal cost of producing one extra unit rather marginal cost of
running one extra production run (batch).
4. Differential and Incremental Cost: Differential cost is
difference between the costs of two different production
levels. It is a relative representation of
 MARGINAL COSTING

costs for two different levels either increase or decrease in cost.

Incremental cost, on the other hand, is the increase in the costs due
change in the volume or process of production activities. Incremental
costs are sometime compared with marginal cost but in reality there is
a thin line difference between the two. Marginal cost is the change in
the total cost due to production of one extra unit while incremental cost
can be both for increase in one unit or in total volume. In the Example 2
above,
`1,220 is the incremental cost of producing one extra unit but not
marginal cost for producing one extra unit.
The technique of marginal costing is based on the distinction
between product costs and period costs. Only the variables costs are
regarded as the costs of the products while the fixed costs are treated as
period costs which will be incurred during the period regardless of the
volume of output. The main characteristics of marginal costing are as
follows:
1. All elements of cost are classified into fixed and variable
components. Semi-variable costs are also analyzed into fixed and
variable elements.
2. The marginal or variable costs (as direct material, direct labour and
variable factory overheads) are treated as the cost of product.
3. Under marginal costing, the value of finished goods and work–
in–progress is also comprised only of marginal costs. Variable
selling and distribution are excluded for valuing these inventories.
Fixed costs are not considered for valuation of closing stock of
finished goods and closing WIP.
4. Fixed costs are treated as period costs and are charged to profit
and loss account for the period for which they are incurred.
5. Prices are determined with reference to marginal costs and
contribution margin.
6. Profitability of departments and products is determined with reference
to their contribution margin.
 COST AND MANAGEMENT ACCOUNTING

Some of the facts about marginal costing are depicted below:

Not a distinct method: Marginal costing is not a distinct method of
costing like job costing, process costing, operating costing, etc., but a
special technique used for managerial decision making. Marginal costing
is used to provide a basis for the interpretation of cost data to measure
the profitability of different products, processes and cost centres in the
course of decision making. It can, therefore, be used in conjunction with
the different methods of costing such as job costing, process costing, etc.,
or even with other techniques such as standard costing or budgetary
control.
Cost Ascertainment: In marginal costing, cost ascertainment is made
on the basis of the nature of cost. It gives consideration to behaviour of
costs. In other words, the technique has developed from a particular
conception and expression of the nature and behaviour of costs and their
effect upon the profitability of an undertaking.
Decision Making: In the orthodox or total cost method, as opposed to
marginal costing, the classification of costs is based on functional basis.
Under this method the total cost is the sum total of the cost of direct
material, direct labour, direct expenses, manufacturing overheads,
administration overheads, selling and distribution overheads. In this
system, other things being equal, the total cost per unit will remain
constant only when the level of output or mixture is the same from period
to period. Since these factors are continually fluctuating, the actual total
cost will vary from one period to another. Thus, it is possible for the
costing department to say one day that an item costs `20 and the next
day it costs `18. This situation arises because of changes in volume of
output and the peculiar 6ehavior of fixed expenses included in the total
cost. Such fluctuating manufacturing activity, and consequently the
variations in the total cost from period to period or even from day to
day, poses a serious problem to the management in taking sound
decisions. Hence, the application of marginal costing has been given wide
recognition in the field of decision making.

For the determination of cost of a product or service under marginal

costing, costs are classified into variable and fixed. All the variable costs
are part of product and
 MARGINAL COSTING

services while fixed costs are charged against contribution margin.

Cost and Profit Statement under Marginal Costing
Amount Amount
(`) (`)

Revenue (A) xxx

Product Cost:
- Direct Materials xx
- Direct employee (labour) x
- Direct expenses xx
- Variable manufacturing overheads
x
Product (Inventoriable) Costs: xxx
xx
x
(B) Product Contribution Margin {A – B}
xx
- Variable Administration overheads
x
- Variable Selling & Distribution overheads
Contribution Margin: (C) xx

Period Cost: (D) x

xxx
Fixed Manufacturing expenses
Fixed non-manufacturing xx
expenses x xxx

Profit/ (loss) {C – D} xx
x
xxx

xx
x xxx

xx
x
xxx

(i) Product (Inventoriable) Costs: These are the costs which are
associated with the purchase and sale of goods (in the case of
merchandise inventory). In the production scenario, such costs are
associated with the acquisition and conversion of materials and
all other manufacturing inputs into finished product for sale.
Hence, under marginal costing, variable manufacturing costs constitute
inventoriable or product costs.
Finished goods are measured at product cost. Work-in-process (WIP)
inventories are also measured at product cost on the basis of percentage
of completion (Please refer Process & Operation costing chapter)
 COST AND MANAGEMENT ACCOUNTING

(ii) Contribution: Contribution or contribution margin is the difference

between sales revenue and total variable costs irrespective of
manufacturing or non- manufacturing.

Contribution (C) = Sales Revenue (S) – Total Variable Cost (V)

It is obtained by subtracting variable costs from sales revenue. It can

also be defined as excess of sales revenue over the variable costs. The
contribution concept is based on the theory that the profit and fixed
expenses of a business is a ‘joint cost’ which cannot be equitably
apportioned to different segments of the business. In view of this
difficulty the contribution serves as a measure of efficiency of operations
of various segments of the business. The contribution forms a fund for
fixed expenses and profit as illustrated below:
Example:
Variable Cost = `50,000, Fixed Cost = `
20,000, Selling Price = ` 80,000
Contribution = Selling Price – Variable Cost
= ` 80,000 – ` 50,000 = ` 30,000
Profit = Contribution – Fixed Cost
= ` 30,000 – ` 20,000 = `10,000
Since, contribution exceeds fixed cost; the profit is of the magnitude of `
10,000. Suppose the fixed cost is ` 40,000 then the position shall be:
Contribution – Fixed cost = Profit or,
= ` 30,000 – ` 40,000 = - ` 10,000
The amount of `10,000 represent extent of loss since the fixed costs are
more than the contribution. At the level of fixed cost of `30,000, there
shall be no profit and no loss.
(iii)Period Cost: These are the costs, which are not assigned to
the products but are charged as expenses against the revenue
of the period in which they are incurred. All fixed costs either
manufacturing or non-manufacturing are recognised as period costs in
marginal costing.
 MARGINAL COSTING

The distinctions in these two techniques are illustrated by the

following di
agra

Fig. 14.1. Absorption Costing Approach

Fig. 14.2. Marginal Costing Approach

14.5.1 The main points of distinction between marginal
costing and absorption costing are as below:
Marginal costing Absorption costing
1. Only variable costs are Both fixed and variable costs are
considered for product considered for product costing and
costing and inventory inventory valuation.
valuation.
 COST AND MANAGEMENT ACCOUNTING

2. Fixed costs are regarded as Fixed costs are charged to the cost
period costs. The Profitability of production. Each product bears a
of different products is reasonable share of fixed cost and
judged by their P/V ratio. thus the profitability of a product is
influenced by the apportionment of
fixed costs.
3. Cost data presented Cost data are presented in
highlight the total conventional pattern. Net profit of
contribution of each product. each product is determined after
subtracting fixed cost along with
their variable costs.
4. The difference in the The difference in the magnitude of
magnitude of opening stock opening stock and closing stock
and closing stock does not affects the unit cost of production
affect the unit cost of due to the impact of related fixed
production. cost.
5. In case of marginal costing In case of absorption costing the
the cost per unit remains the cost per unit reduces, as the
same, irrespective of the production increases as it is fixed
production as it is valued at cost which reduces, whereas, the
variable cost variable cost remains the same per
unit.
14.5.2 Difference in profit under Marginal and Absorption costing
The above two approaches will compute the different profit because of
the difference in the stock valuation. This difference is explained as
follows in different circumstances.
1. No opening and closing stock: In this case, profit / loss under
absorption and marginal costing will be equal.
2. 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.
3. 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.
4. 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
 MARGINAL COSTING

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.
14.5.3 Absorption Costing
 In absorption costing the classification of expenses is based on
functional basis whereas in marginal costing it is based on the
nature of expenses.
 In absorption costing, the fixed expenses are distributed over
products on absorption costing basis that is, based on a pre-
determined level of output. Since fixed expenses are constant, such a
method of recovery will lead to over or under-recovery of expenses
depending on the actual output being greater or lesser than the
estimate used for recovery. This difficulty will not arise in marginal
costing because the contribution is used as a fund for meeting fixed
expenses.
The presentation of information to management under the two costing
techniques is as under:
Income Statement (Absorption costing)
( `)
Sales XXXXX
Production Costs:
Direct material XXXX
consumed Direct X
labour cost XXXX
Variable manufacturing X
overhead Fixed XXXX
manufacturing overhead Cost X
of Production XXXX
Add: Opening stock of finished goods X
(Value at cost of previous period’s production) XXXX
X
XXXX
X
XXXXX
Less: Closing stock of finished goods XXXXX
(Value at production cost of current
period) Cost of Goods Sold
Add: (or less) Under (or over) absorption of fixed .
XXXX
Manufacturing overhead X

XXXXX
 COST AND MANAGEMENT ACCOUNTING

Add: Administration costs XXXXX

Selling and distribution costs XXXXX XXXXX
Total Cost XXXXX
Profit (Sales – Total cost) XXXXX

Income Statement (Marginal costing)

(`)
Sale XXXXX
s
Variable manufacturing costs:
– Direct material consumed XXXXX
– Direct labour XXXXX
– Variable manufacturing overhead XXXXX
Cost of Goods Produced XXXXX
Add: Opening stock of finished goods XXXXX
(Value at cost of previous period)
Less Closing stock of finished goods (Value at current
: variable cost)
Cost of Goods Sold XXXXX
Add: Variable administration, selling and dist. overhead XXXXX
Total Variable Cost XXXXX
Add: Selling and distribution costs
Contribution (Sales – Total variable costs) XXXXX
Less Fixed costs (Production, admin., selling and dist.) XXXXX
:
Net Profit XXXXX

It is evident from the above that under marginal costing technique the
contributions of various products are pooled together and the fixed
overheads are met out of such total contribution. The total contribution is
also known as gross margin. The contribution minus fixed expenses yields
net profit. In absorption costing technique cost includes fixed overheads
as well.
 MARGINAL COSTING

ILLUSTRATION 1:
Wonder Ltd. manufactures a single product, ZEST. The following figures
relate to ZEST for a one-year period:
Activity Level 50% 100%
Sales and production (units) 400 800
(`) (`)
Sales 8,00,000 16,00,000
Production costs:
- Variable 3,20,000 6,40,000
- Fixed 1,60,000 1,60,000
Selling and distribution costs:
- Variable 1,60,000 3,20,000
- Fixed 2,40,000 2,40,000

The normal level of activity for the year is 800 units. Fixed costs are
incurred evenly throughout the year, and actual fixed costs are the same
as budgeted. There were no stocks of ZEST at the beginning of the year.
In the first quarter, 220 units were produced and 160 units
were sold. Required:
(a) COMPUTE the fixed production costs absorbed by ZEST if
absorption costing is used?
(b) CALCULATE the under/over-recovery of overheads during the period?
(c) CALCULATE the profit using absorption costing?
(d) CALCULATE the profit using marginal costing?
SOLUTION
(a) Fixed production costs absorbed:
( `)
Budgeted fixed production costs

1,60,000 Budgeted output (normal level of activity 800 units)

Therefore, the absorption rate: 1,60,000/800 = ` 200 per
unit During the first quarter, the fixed production
cost absorbed by ZEST would be (220 units × ` 200) 44,000
 COST AND MANAGEMENT ACCOUNTING

(b) Under /over-recovery of overheads during the (`)

period:
40,000
Actual fixed production overhead
(1/4 of ` 1,60,000)
Absorbed fixed production overhead 44,000
Over-recovery of overheads 4,000
(c) Profit for the Quarter (Absorption Costing)

(`) (`)
Sales revenue (160 units × ` 2,000): (A) 3,20,000
Less: Production costs:
- Variable cost (220 units × ` 800) 1,76,000
- Fixed overheads absorbed (220 units × ` 44,000 2,20,000
200)
Add: Opening stock --
 `2,20,000 (60,000)
Less: Closing Stock

 ×60units
220units
 
Cost of Goods sold 1,60,000
Less: Adjustment for over-absorption of fixed (4,000)
production overheads
Add: Selling & Distribution Overheads:
- Variable (160 units × `400) 64,000
- Fixed (1/4th of ` 2,40,000) 60,000 1,24,000
Cost of Sales (B) 2,80,000
Profit {(A) – (B)} 40,000

(d) Profit for the Quarter (Marginal Costing)

(`) (`)
Sales revenue (160 units × ` 2,000): (A) 3,20,000
Less: Production costs:
- Variable cost (220 units × ` 800) 1,76,000
Add: Opening stock --
 MARGINAL COSTING

 `1,76,000 (48,000)
Less: Closing Stock

 ×60units 
220units
  1,28,000
Variable cost of goods sold
Add: Selling & Distribution Overheads: 64,000
- Variable (160 units ×
1,92,000
`400) Cost of Sales (B)
1,28,000
Contribution {(C) = (A) –
(B)} Less: Fixed Costs:
- Production cost (40,000)

- Selling & distribution (60,000) (1,00,000)

cost Profit 28,000

ADVANTAGES
1. Simplified Pricing Policy: The marginal cost remains constant per
unit of output whereas the fixed cost remains constant in total.
Since marginal cost per unit is constant from period to period within a
short span of time, firm decisions on pricing policy can be taken. If
fixed cost is included, the unit cost will change from day to day
depending upon the volume of output. This will make decision making
task difficult.
2. Proper recovery of Overheads: Overheads are recovered in
costing on the basis of pre-determined rates. If fixed overheads are
included on the basis of pre-determined rates, there will be under-
recovery of overheads if production is less or if overheads are more.
There will be over- recovery of overheads if production is more than
the budget or actual expenses are less than the estimate. This
creates the problem of treatment of such under or over-recovery of
overheads. Marginal costing avoids such under or over recovery of
overheads.
3. Shows Realistic Profit: Advocates of marginal costing argues that
under the marginal costing technique, the stock of finished goods
and work-in-progress are carried on marginal cost basis and the fixed
expenses are written off to profit and loss account as period cost.
This shows the true profit of the period.
 COST AND MANAGEMENT ACCOUNTING

4. How much to produce: Marginal costing helps in the preparation of

break- even analysis which shows the effect of increasing or
decreasing production activity on the profitability of the company.
5. More control over expenditure: Segregation of expenses as
fixed and variable helps the management to exercise control over
expenditure. The management can compare the actual variable
expenses with the budgeted variable expenses and take corrective
action through analysis of variances.
6. Helps in Decision Making: Marginal costing helps the
management in taking a number of business decisions like make or
buy, discontinuance of a particular product, replacement of
machines, etc.
7. Short term profit planning: It helps in short term profit planning
by B.E.P charts.
LIMITATIONS
1. Difficulty in classifying fixed and variable elements: It is difficult
to classify exactly the expenses into fixed and variable category. Most
of the expenses are neither totally variable nor wholly fixed. For
example, various amenities provided to workers may have no
relation either to volume of production or time factor.
2. Dependence on key factors: Contribution of a product itself is
not a guide for optimum profitability unless it is linked with the key
factor.
3. Scope for Low Profitability: Sales staff may mistake marginal cost
for total cost and sell at a price; which will result in loss or low
profits. Hence, sales staff should be cautioned while giving marginal
cost.
4. Faulty valuation: Overheads of fixed nature cannot altogether be
excluded particularly in large contracts, while valuing the work-in-
progress. In order to show the correct position fixed overheads have
to be included in work-in- progress.
5. Unpredictable nature of Cost: Some of the assumptions regarding
the behaviour of various costs are not necessarily true in a realistic
situation. For example, the assumption that fixed cost will remain
static throughout is not correct. Fixed cost may change from one
period to another. For example, salaries bill may go up because of
annual increments or due to change in pay rate etc. The variable
costs do not remain constant per unit of output. There may be
changes in the prices of raw materials, wage rates etc. after a
certain
 MARGINAL COSTING

level of output has been reached due to shortage of material,

shortage of skilled labour, concessions of bulk purchases etc.
6. Marginal costing ignores time factor and investment: The
marginal cost of two jobs may be the same but the time taken for
their completion and the cost of machines used may differ. The true
cost of a job which takes longer time and uses costlier machine
would be higher. This fact is not disclosed by marginal costing.
7. Understating of W-I-P: Under marginal costing stocks and work in
progress are understated.

Meaning: It is a managerial tool showing the relationship between

various ingredients of profit planning viz., cost, selling price and volume of
activity. As the name suggests, cost volume profit (CVP) analysis is the
analysis of three variables cost, volume and profit. Such an analysis
explores the relationship between costs, revenue, activity levels and the
resulting profit. It aims at measuring variations in cost and volume.
Assumptions:
1. Changes in the levels of revenues and costs arise only
because of changes in the number of product (or service)
units produced and sold – for example, the number of television
sets produced and sold by Sony Corporation or the number of
packages delivered by Overnight Express. The number of output
units is the only revenue driver and the only cost driver. Just as a
cost driver is any factor that affects costs, a revenue driver is a
variable, such as volume, that causally affects revenues.
2. Total costs can be separated into two components; a fixed
component that does not vary with output level and a variable
component that changes with respect to output level. Furthermore,
variable costs include both direct variable costs and indirect
variable costs of a product. Similarly, fixed costs include both direct
fixed costs and indirect fixed costs of a product
3. When represented graphically, the behaviours of total revenues
and total costs are linear (meaning they can be represented as a
straight line) in relation to output level within a relevant range (and
time period).
4. Selling price, variable cost per unit, and total fixed costs
(within a relevant range and time period) are known and
constant.
 COST AND MANAGEMENT ACCOUNTING

5. The analysis either covers a single product or assumes that the

proportion of different products when multiple products are
sold will remain constant as the level of total units sold changes.
6. All revenues and costs can be added, subtracted, and compared
without taking into account the time value of money. (Refer to
the FM study material for a clear understanding of time value of
money).
Importance
It provides the information about the following matters:
1. The behavior of cost in relation to volume.
2. Volume of production or sales, where the business will break-even.
3. Sensitivity of profits due to variation in output.
4. Amount of profit for a projected sales volume.
5. Quantity of production and sales for a target profit level.
Impact of various changes on profit:
An understanding of CVP analysis is extremely useful to management in
budgeting and profit planning. It elucidates the impact of the following on
the net profit:
(i) Changes in selling prices,
(ii) Changes in volume of sales,
(iii) Changes in variable cost,
(iv) Changes in fixed cost.
14.7.1 Marginal Cost Equation
The contribution theory explains the relationship between the variable
cost and selling price. It tells us that selling price minus variable cost of
the units sold is the contribution towards fixed expenses and profit. If the
contribution is equal to fixed expenses, there will be no profit or loss and if
it is less than fixed expenses, loss is incurred. Since the variable cost
varies in direct proportion to output, therefore if the firm does not
produce any unit, the loss will be there to the extent of fixed expenses.
These points can be described with the help of following marginal cost
equation:
 MARGINAL COSTING

Marginal Cost Equation = S -V = C = F ± P Where,

S = Selling price per unit,V = Variable cost per unit, C = Contribution,
F = Fixed Cost,

Marginal Cost Statement

(`)
Sales xxx
x
Less: Variable Cost xxx
x
Contribution xxx
x
Less: Fixed Cost xxx
x
Profit xxx
x
14.7.2 Contribution to Sales Ratio (Profit Volume Ratio or P/V
ratio)
This ratio shows the proportion of sales available to cover fixed
costs and profit. Contribution represent the sales revenue after
deducting variable costs. This ratio is usually expressed in percentage.

or, P/V Ratio = Change in contribution / Profit ×100

P / V Ratio= Contribution×100
Sales Change in sales

A higher contribution to sales ratio implies that the rate of growth of

contribution is faster than that of sales. This is because, once the
breakeven point is reached, profits shall grow at a faster rate when
compared to a product with a lesser contribution to sales ratio.
By transposition, we have derived the following equations:
(i) C = S × P/V ratio
C
(ii) S=
P / VRatio

14.7.3 Break-Even Analysis

Break-even analysis is a generally used method to study the CVP analysis.
This technique can be explained in two ways:
 COST AND MANAGEMENT ACCOUNTING

(i) In narrow sense it is concerned with computing the break-even point.

At this point of production level and sales there will be no profit and
loss i.e. total cost is equal to total sales revenue.
(ii) In broad sense this technique is used to determine the possible
profit/loss at any given level of production or sales.

METHODS OF BREAK -EVEN ANALYSIS

Break even analysis may be conducted by the following two methods:
(A) Algebraic computations
(B) Graphic presentations
(A) ALGEBRAIC CALCULATIONS
14.8.1 Breakeven Point
The word contribution has been given its name because of the fact that it
literally contributes towards the recovery of fixed costs and the making of
profits. The contribution grows along with the sales revenue till the time it
just covers the fixed cost. This is the point where neither profits nor
losses have been made is known as a break-even point. This implies that
in order to break even the amount of contribution generated should be
exactly equal to the fixed costs incurred. Hence, if we know how much
contribution is generated from each unit sold we shall have sufficient
information for computing the number of units to be sold in order to
break even. Mathematically,

Break-even point in units =Fixed costs

Contribution per unit

Example 3: ABC Ltd. manufacturing a single product, incurring variable costs of `

300 per unit and fixed costs of ` 2,00,000 per month. If the product sells for
` 500 per unit, the breakeven point shall be calculated as follows;
Fixed costs
Break- even point in units =
`2,00,000 = 1,000 units
Contribution per unit =
`200
Total
Break- even points (in Value) =
fixed cost × Sales

Contribution
Total
Break- even point (in Value) =
fixed cost
P / V Ratio
 MARGINAL COSTING

14.8.2 Cash Break-even point

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

ILLUSTRATION 2
MNP Ltd sold 2,75,000 units of its product at `37.50 per unit. Variable costs are
` 17.50 per unit (manufacturing costs of ` 14 and selling cost ` 3.50 per
unit). Fixed costs are incurred uniformly throughout the year and
amounting to ` 35,00,000 (including depreciation of ` 15,00,000). There
is no beginning or ending inventories.
Required:
COMPUTE breakeven sales level quantity and cash breakeven sales level quantity.
SOLUTION
Fixed cost ` 35,00,000
Break even Sales Quantity = =
Contribution margin per `20
unit

= 1,75,000 units
Cash Fixed Cost ` 20,00,000
Cash Break-even Sales Quantity = =
Contribution margin per `20
unit

=1,00,000 units.
14.8.3 Multi- Product Break-even
Analysis
In a multi-product environment, where more than one product is
manufactured by using a common fixed cost, the break-even point
formula needs some adjustments. The contribution is calculated by
taking weights for the products. The weights may be of sales mix
quantity or sales mix values. The calculation of Multi-Product Break-even
analysis can be understood with the help of the following example.

Example 4: Arnav Ltd. sells two products, J and K. The sales mix is 4
units of J and 3 units of K. The contribution margins per unit are ` 40 for J
and ` 20 for K. Fixed costs are ` 6,16,000 per month.
 COST AND MANAGEMENT ACCOUNTING

Sales mix (in quantity) is 4 units of Product- J and 3 units of Product- K

i.e. Sales ratio is 4 : 3

Composite contribution per unit by taking weights for the product sales quantity
=Product `40 `20
+ Product = `22.86 + `8.57 = `31.43
J- 4 3
K-
7 7

Composite Break-even point = `6,16,00

Common Fixed Cost 0
=
Composite Contribution per `31.43
unit
= 19,600 units
4
Break-even units of Product-J = 19,600 = 11,200 units
7
3
Break-even units of Product- K = 19,600 = 8,400 units
7
ILLUSTRATION 3

You are given the following particulars CALCULATE:

(a) Break-even point

(b) Sales to earn a profit of ` 20,000

i. Fixed cost ` 1,50,000

ii. Variable cost ` 15 per unit
iii. Selling price is ` 30 per unit
SOLUTION
Fixed cost
(a) Break-even point (BEP) = = `1,50,0
= 10,000 Units
Contribution per unit 00
* `1
5

* (Contribution per unit = Sales per unit – Variable cost per unit = ` 30 - `15)
(b) Sales to earn a Profit of ` 20,000:
Fixed cost+Desired profit
= Contribution per unit
×Selling price per
unit
 MARGINAL COSTING

`1,50,000+`20,000
=
×`30
`15
= ` 3,40,000

Or
Fixed cost+Desired
profit `1,70,000 `1,70,000
=
P / V Ratio
P / V Ratio = 50% = `3, 40,000

PV Ratio Contribution
Sales
= 100
ILLUSTRATION 4

A company has a P/V ratio of 40%. COMPUTE by what percentage

must sales be increased to offset: 20% reduction in selling price?
SOLUTION
Desired Contribution 0.40
Revised Sales Value = = = 1.6
Revised P / VRatio * 0.25

This means sales value to be increased by 60% of the existing sales.

Revised Contribution 0.80- 0.60
*Revised P/V Ratio = = = 0.25
Revised Selling Price 0.80
Desired Contribution 0.40
Required Sales Quantity = = =2
Revised P / VRatio *×Revised Selling Price 0.25×0.80
Therefore, Sales value to be increased by 60% and sales quantity to be
doubled to offset the reduction in selling price.
Proof:
Let selling price per unit is `10 and sales quantity is 100 units.
Data before change in selling price:
(`)
Sales (`10 × 100 units) 1,000
Contribution (40% of 1,000) 400
Variable cost (balancing figure) 600
 COST AND MANAGEMENT ACCOUNTING

Data after the change in selling price:

Selling price is reduced by 20% that means it became `8 per unit. Since,
we have to maintain the earlier contribution margin i.e. `400 by increasing
the sales quantity only. Therefore, the target contribution will be `400.
The new P/V Ratio will be
(`)
Sales 8.00
Variable cost 6.00
Contribution per unit 2.00
P/V Ratio 25%

DesiredContribution `400
Sales Value = = = `1,600
Revised P / VRatio 0.25
Sales value
Sales quantity = = `1,600
Selling price per = 200 units
unit `8

ILLUSTRATION 5
PQR Ltd. has furnished the following data for the two years:
20X3 20X4

Sales ` ?
Profit/Volume Ratio (P/V ratio) 8,00,000 37.5%
Margin of Safety sales as a % of total 50% 21.875
sales 40% %
There has been substantial savings in the fixed cost in the year 20X4 due
to the restructuring process. The company could maintain its sales
quantity level of 20X3 in 20X4 by reducing selling price.
You are required to CALCULATE the following:
(i) Sales for 20X4 in Value,
(ii) Fixed cost for 20X4,
(iii) Break-even sales for 20X4 in Value.
 MARGINAL COSTING

SOLUTION
In 20X3, PV ratio = 50%
Variable cost ratio = 100% - 50% = 50%
Variable cost in 20X3 = ` 8,00,000  50% = ` 4,00,000
In 20X4, sales quantity has not changed. Thus variable cost in 20X4 is
` 4,00,000. In 20X4, P/V ratio = 37.50%
Thus, Variable cost ratio = 100%  37.5% = 62.5%
4,00,000
(i) Thus sales in 20X4 = `6,40,000
= 62.5%
In 20X4, Break-even sales = 100%  21.875% (Margin of safety)
= 78.125%
(ii) Break-even sales = 6,40,000  78.125% = ` 5,00,000
(iii) Fixed cost = B.E. sales  P/V ratio
= 5,00,000  37.50% = `1,87,500.
B. GRAPHICAL PRESENTATION OF BREAK EVEN CHART
14.8.3 Break-even Chart
A breakeven chart records costs and revenues on the vertical axis and the
level of activity on the horizontal axis. The making of the breakeven
chart would require you to select appropriate axes. Subsequently, you
will need to mark costs/revenues on the Y axis whereas the level of
activity shall be traced on the X axis. Lines representing (i) Fixed costs
(horizontal line at ` 2,00,000 for ABC Ltd), (ii) Total costs at maximum
level of activity (joined to the Y-axis where the Fixed cost of ` 2,00,000 is
marked) and (iii) Revenue at maximum level of activity (joined to the
origin) shall be drawn next.
The breakeven point is that point where the sales revenue line intersects
the total cost line. Other measures like the margin of safety and profit can
also be measured from the chart.
The breakeven chart for ABC Ltd (Example-3) is drawn below.
 COST AND MANAGEMENT ACCOUNTING

` 000

14.8.4 Contribution Breakeven chart

It is not possible to use a breakeven chart as described above to measure
contribution. This is one of its major limitations especially so because
contribution analysis is literally the backbone of marginal costing. To
overcome such a limitation, accountants frequently resort to the making
of a contribution breakeven chart which is based on the same principles
as a conventional breakeven chart except for that it shows the variable
cost line instead of the fixed cost line. Lines for Total cost and Sales
revenue remain the same. The breakeven point and profit can be read
off in the same way as with a conventional chart. However, it is also
possible to read the contribution for any level of activity.
Using the same example of ABC Ltd as for the conventional chart, the total
variable cost for an output of 1,700 units is 1,700 × `300 = `5,10,000.
This point can be joined to the origin since the variable cost is nil at zero
` 000

activity.
 MARGINAL COSTING

The contribution can be read as the difference between the sales

revenue line and the variable cost line.
14.8.5 Profit-volume chart
This is also very similar to a breakeven chart. In this chart the vertical axis
represents profits and losses and the horizontal axis is drawn at zero
profit or loss.
In this chart each level of activity is taken into account and profits marked
accordingly. The breakeven point is where this line interacts the horizontal
axis. A profit-volume graph for our example (ABC Ltd) will be as follows,

` 000

Loss

The loss at a nil activity level is equal to ` 2,00,000, i.e. the amount of
fixed costs. The second point used to draw the line could be the
calculated breakeven point or the calculated profit for sales of 1,700
units.
Advantages of the profit-volume chart
1. The biggest advantage of the profit-volume chart is its capability of
depicting clearly the effect on profit and breakeven point of any
changes in the variables. The following example illustrates this
characteristic,
Example 5:
A manufacturing company incurs fixed costs of `3,00,000 per annum. It
is a single product company with annual sales budgeted to be 70,000
units at a sales price of
`300 per unit. Variable costs are `285 per unit.
 COST AND MANAGEMENT ACCOUNTING

(i) Draw a profit volume graph, and use it to determine the breakeven point.
The company is deliberating upon an increase in the selling price of
the product to `350 per unit. This shall be required in order to
improve the quality of the product. It is anticipated that despite
increase in the selling price the sales volume shall remain
unaffected, however, the fixed costs shall increase to `4,50,000 per
annum and the variable costs to `330 per unit.
(ii) Draw on the same graph as for part (a) a second profit volume graph
and give your comments.
SOLUTION
Figure showing changes with a profit-volume chart
` 000

Working notes (i)

The profit for sales of 70,000 units is ` 7,50,000.
(`’000)
Contribution 70,000 × (`300 – `285) 1050
Fixed costs 300
Profit 750

This point is joined to the loss at zero activity, ` 3,00,000 i.e., the fixed costs.
 MARGINAL COSTING

Working notes (ii)

The profit for sales of 70,000 units is ` 9,50,000.
(`’000)
Contribution 70,000 × (`350 – `330) 1400
Fixed costs 450
Profit 950

This point is joined to the loss at zero activity, ` 4,50,000 i.e., the fixed costs.
Comments:
It is clear from the graph that there are larger profits available from
option (ii). It also shows an increase in the break-even point from 20,000
units to 22,500 units, however, the increase of 2,500 units may not be
considered large in view of the projected sales volume. It is also possible
to see that for sales volumes above 30,000 units the profit achieved will
be higher with option (ii). For sales volumes below 30,000 units option (i)
will yield higher profits (or lower losses).
ILLUSTRATION 6
You are given the following data for the year 20X7 of Rio Co. Ltd:
Variable cost 60,000 60%
Fixed cost 30,000 30%
Net profit 10,000 10%
Sales 1,00,000 100%

FIND OUT (a) Break-even point, (b) P/V ratio, and (c) Margin of safety.
Also DRAW a break-even chart showing contribution and profit.
SOLUTION
Sales - Variable Cost 1,00,000 - 60,000
P / V ratio = Sales =1,00,000 = 40%
Fixed Cost 30,000
Break Even Point = = = ` 75,000
P / V ratio 40%
Margin of safety = Actual Sales – BE point = 1,00,000 – 75,000 =
` 25,000 Break even chart showing contribution is shown below:
 COST AND MANAGEMENT ACCOUNTING

Cost and Revenue (`

Break-even chart

ILLUSTRATION 7
PREPARE a profit graph for products A, B and C and find break-even
point from the following data:
Products A B C Total
Sales (`) 7,50 7,50 3,75 18,750
0 0 0
Variable cost (`) 1,50 5,25 4,50 11,250
0 0 0
Fixed cost (`) --- --- --- 5,000

SOLUTION
Statement Showing Cumulative Sales & Profit
Sale Cumulative Variabl Contributio Cumulative Cumulativ
s Sales e n Contributio e Profit
Cost n
(`) (`) (`) (`) (`) (`)
A 7,500 7,500 1,500 6,000 6,000 1,000
B 7,500 15,00 5,250 2,250 8,250 3,250
0
C 3,750 18,75 4,500 (750) 7,500 2,500
0
 MARGINAL COSTING

Profit in `
(+) 5,000
`3,250
(+) 2,500 `2,500
`1,000

0 2,500 5,000 7,500 10,00012,500 15,000 17,500 20,000

BEP
Sales in `
(-) 2,500
Profit Line
(-) 5,000
Loss in `

Break Even Point (BEP) = ` 12,500

LIMITATIONS OF BREAK-EVEN ANALYSIS

The limitations of the practical applicability of breakeven analysis
and breakeven charts stem mostly from the assumptions
underlying CVP which have been mentioned above. Assumptions like
costs behaving in a linear fashion or sales revenue remain constant at
different sales levels or the stocks shall remain constant period after
period are unrealistic. Similarly, the assumption that the only factor which
influences costs is the ‘activity level achieved’ is erroneous because other
factors like inflation also have a bearing on costs.

MARGIN OF SAFETY
The margin of safety can be defined as the difference between the
expected level of sale and the breakeven sales. The larger the
margin of safety, the higher is the chances of making profits. In the
Example-3 if the forecast sale is 1,700 units per month, the margin of
safety can be calculated as follows,
Margin of Safety = Projected sales – Breakeven sales
= 1,700 units – 1,000 units
= 700 units or 41% of sales.
The Margin of Safety can also be calculated by identifying the difference between
 COST AND MANAGEMENT ACCOUNTING

the projected sales and breakeven sales in units multiplied by the

contribution per unit. This is possible because, at the breakeven point all
the fixed costs are recovered and any further contribution goes into the
making of profits. It also can be calculated as:

Margin of Safety = Profit

P / V Ratio

ILLUSTRATION 8
A company earned a profit of ` 30,000 during the year 20X4. If the
marginal cost and selling price of the product are ` 8 and ` 10 per unit
respectively, FIND OUT the amount of margin of safety.
SOLUTION
Selling price- Variable cost per
P/V ratio
unit = `10-`8
= `10 = 20%
Selling price
Profit 30,000
Margin of safety = ` 1,50,000
= 20%
=
P/V ratio

ILLUSTRATION 9
A Ltd. Maintains margin of safety of 37.5% with an overall contribution to
sales ratio of 40%. Its fixed costs amount to ` 5 lakhs.
CALCULATE the following:
i. Break-even sales
ii. Total sales
iii. Total variable cost
iv. Current profit
v. New ‘margin of safety’ if the sales volume is increased by 7 ½ %.
SOLUTION
(i) We know that: Break- even Sales (BES) × P/V Ratio =
Fixed Cost Break-even Sales (BES) × 40% = ` 5,00,000
Break- even Sales (BES) = ` 12,50,000
 MARGINAL COSTING

(ii) Total Sales (S) = Break Even Sales + Margin of

Safety S = ` 12,50,000 + 0.375S
Or, S – 0.375S = `
12,50,000 Or, S =`
20,00,000
(iii) Contribution to Sales Ratio = 40%
Therefore, Variable cost to Sales Ratio = 60%
Variable cost = 60% of sales = 60% of
20,00,000 Variable cost = 12,00,000
(iv) Current Profit = Sales – (Variable Cost + Fixed Cost)
= ` 20,00,000 – (12,00,000 + 5,00,000) = ` 3,00,000
(v) If sales value is increased by 7 ½ %
New Sales value = ` 20,00,000 × 1.075 = `
21,50,000 New Margin of Safety = New Sales
value – BES
= ` 21,50,000 – ` 12,50,000 = ` 9,00,000

VARIATIONS OF BASIC MARGINAL COST

EQUATION AND OTHER FORMULAE
i.Sales – Variable cost = Fixed cost ± Profit/ Loss
By multiplying and dividing L.H.S. by S

S(S  V) 
ii. P
F
S
   
iii. S × P/V Ratio = F + P or Contribution
 P/V Ratio 
 S 

iv BES × P/V Ratio = F ( at BEP profit is zero)

BES = Fixed Cost

v
P / V Ratio
 COST AND MANAGEMENT ACCOUNTING

P/V Ratio = Fixedcost

vi
BES
S × P/V Ratio = Contribution (Refer to iii)
vii
viii
P/V Ratio  Contribution
Sales
(BES + MS) × P/V Ratio = Contribution (Total sales = BES + MS) (BES × P/V Ra
ix
By deducting (BES × P/V Ratio) from L.H.S. and F from R.H.S. in (x) above, we
x
M.S. × P/V Ratio = P

xi
P/V Ratio = Change in profit
xii
Change in sales

P/V Ratio = Change in contribution

xiii
Change in sales
Profitability = Contribution
xiv
Key factor

Margin of Safety = Total Sales – BES or Profit.

xv
P / V ratio
XviBES = Total Sales – MS
Margin of Safety Ratio = Total sales - BES
Total sales

ILLUSTRATION 10
By noting “P/V will increase or P/V will decrease or P/V will not change”, as
the case may be, STATE how the following independent situations will
affect the P/V ratio:
(i) An increase in the physical sales volume;
(ii) An increase in the fixed cost;
(iii) A decrease in the variable cost per unit;
(iv) A decrease in the contribution margin;
(v) An increase in selling price per unit;
 MARGINAL COSTING

(vi) A decrease in the fixed cost;

(vii) A 10% increase in both selling price and variable cost per unit;
(viii) A 10% increase in the selling price per unit and 10% decrease in
the physical sales volume;
(ix) A 50% increase in the variable cost per unit and 50% decrease in the fixed cost.
(x) An increase in the angle of incidence.
SOLUTION
Item no. P/V Ratio Reason
(i) Will not
change
(ii) Will not
change
(iii) Will increase
(iv) Will decrease
(v) Will increase
(vi) Will not
change
(vii) Will not Reasoning
change 1
(viii) Will increase Reasoning
2
(ix) Will decrease Reasoning
3
(x) Will increase Reasoning
4
A 10% increase in both selling price and variable cost per unit.
Reasoning 1. Assumptions: a) Variable cost is less than selling
price.
b) Selling price `100 variable cost ` 90 per unit.
100  90
c) P/V ratio =
= 10%
100
10% increase in S.P. = `110
10% increase in variable cost =
`99
110 
P/V ratio = = 10% i.e. P/v ratio will not change
99
10
Reasoning 2. Increase or decrease in physical sales volume will not
change P/V ratio. Hence 10% increase in selling price per unit
will increase P/V ratio.
 COST AND MANAGEMENT ACCOUNTING

Reasoning 3. Increase or decrease in fixed cost will not change P/V ratio.
Hence 50% increase in the variable cost per unit will
decrease P/V ratio.
Reasoning 4. Angle of incidence is the angle at which sales line cuts the
total cost line. If it is large, it indicates that the profits are
being made at higher rate. Hence increase in the angle of
incidence will increase the P/V ratio.

ANGLE OF INCIDENCE
This angle is formed by the intersection of sales line and total cost line at
the break- even point. This angle shows the rate at which profit is
earned once the break- even point is reached. The wider the angle
the greater is the rate of earning profits. A large angle of incidence with
a high margin of safety indicates extremely favourable position.
The shaded area in the graph given below is representing the angle of
incidence. The angle above and below the break-even point shows the
rate of earning profitability (loss). Wider angle denotes higher rate of
earnings and vice-versa.
280

260

240

220

200

Angle of incidence
180 Break even point
Cost and Sales (`

160Margin of
Safety
140
120 Variable cost

100
'000)

80

60
Margin of
Safety Fixed cost
40

20
0
24 6810121416182022242628
B.E.salesActual sales

Volume of sales (Unit ‘000)

 MARGINAL COSTING

APPLICATION OF CVP ANALYSIS IN

DECISION MAKING
As discussed earlier CVP analysis is used as an evaluation tool for
managerial decisions. In this chapter we will discuss the use of CVP
Analysis for short term decision making. Before going into illustration, let
us discuss the decision making framework.
14.13.1 Framework for Decision Making
Step 1: Identification of Problem Step 2: Indentification of Options Step 3: Evaluation of t
Step 4: Selection of the Option

Step-1: Identification of Problem

Every organisation has its own objectives, and goals are set to achieve
these objectives. To reach at the goal, actions are to be taken. For
example, if an organisation wants to be a cost leader in the industry it
operates in, it has to achieve 3Es in its all activities. 3Es means economy
in inputs, efficiency in process and operations and effectiveness in output.
An entity that exists for profit may identify few areas (problem areas)
which if worked on can add to the profit or wealth maximisation. For
example, Arnav Ltd. a manufacturer of Steel products, has identified that
it can be leader in the industry if it can produce steel products at
lower cost than its rival. Here the goal should be (problem area) low cost
production.
Step- 2: Identification of Options
After identification of problem(s), the next step is identification of options
to achieve the goal (to answer the problem). Every possible options need
to be explored. In the above example, the Arnav Ltd. may have the
following options for low cost production:
(a) Purchase of inputs from specialised market- Local vs Import
(b) Make the input in its own factory- Make or Buy
(c) Bulk purchase to avail discount offer- How much to purchase
 COST AND MANAGEMENT ACCOUNTING

(d) Make in-house- Make vs Outsource

(e) Bulk processing- How much to produce
(f) Using efficient machine for manufacturing- Old machine vs New machine
(g) Optimisation of key resources- Product mix decisions etc.
Step- 3: Evaluation of the Options
After identification of options, each option is to be evaluated against the
objective criteria. An entity with objective of making profit may evaluate
options on the basis of financial measures like impact of profit or loss,
market share, overall impact on profitability, return on investment etc.
Non-financial factors like customer satisfaction, impact on existing
market/ customer, ethics of decision are also evaluated.
This step is a very important and may be grouped into two tasks
(i) Identification of Cost and Benefits of each options
(ii) Estimation of amount of each options
Step-4: Selection of option:
After evaluation of the options, the best option is selected and implemented.
14.13.2 Principles for Identification of Cost and Benefits for
measurement
The cost and benefit of an options is identified for measurement if it
passes the principles of Controllability and Relevance.
(i) Controllability: Those cost and benefits which arise due to choice
of an option. In other words, benefits received and cost incurred are
directly related with the choice of the option. Thus, the costs and benefits
which are controllable are considered for measurement for making
decision.
(ii) Relevance: The costs which are controllable need to be relevant for
decision making. This means all controllable costs are not relevant for
decision making unless it differs under the two options. Thus, a cost is
treated is relevant only if
(a) it is a future cost and (b) it differs under two options under
consideration.
For Example, Arnav Ltd. wants to manufacture 1,000 additional units of
Product X. It is considering either to manufacture in its own factory or to
outsource to job workers. In this example cost of raw materials to
manufacture additional 1,000 units is controllable as it arises due to
management’s decision to make additional units.
 MARGINAL COSTING

But it is not relevant for making choice between manufacture in-house

and outsource to job workers, as under the both options, the raw
materials cost would be same.
Hence, for decision making purpose only those cost and benefits are
identified for measurement which are both Controllable and Relevant.
Below is an analysis of few costs for its relevance:
Cost Relevanc Reason
e
(i) Irrelevant The cost has already been incurred and
do not affect the decision. Example:
Historic Book value of machinery etc.
al Cost
(ii) Sunk Cost Irrelevant The cost which are already paid either
for goods or services availed or to be
availed. Example: Raw material
purchased and held in store without
having replacement cost, Cost of
drawing, blueprint etc.
(iii) Committed Irrelevant The committed costs are the pre-
Cost agreed cost which cannot be revoked
under the normal circumstances. This is
also a sunk cost. Examples: Cost of
materials as per rate agreement, Salary
cost to employees etc.
(iv) Opportunity Relevant The opportunity cost is represented by
Cost the forgone potential benefit from the
best rejected course of action. Had the
option under consideration not chosen,
the benefit would come to the
organisation.
(v) Notional Relevant Notional costs are relevant for the
decision making only if company is
or Imputed actually forgoing benefits by employing
Cost its resources to alternative course of
action. For example, notional interest
on internally generated fund is treated
as relevant notional cost only if
company could earn interest from it.
(vi) Shut-down Relevant When an organization suspends its
Cost manufacturing operations, certain fixed
expenses can be avoided and certain
extra
fixed expenses may be incurred
depending
 COST AND MANAGEMENT ACCOUNTING

upon the nature of the industry. By

closing down the manufacturing, the
organization will save variable cost of
production as well as some
discretionary fixed costs. This particular
discretionary cost is known as shut-
down cost.
14.13.3 Principles of Estimation of Costs and Benefits
After identification of the costs and benefits, it is now required to be
quantified i.e. the cost and benefit should be measured and estimated.
The estimation is done by following the two principles as discusses below:
(i) Variability: Variability means by how much a cost or benefit
increased or decreased due to the choice of the option. Variable costs are
the cost which differs under the different volume or activities. On the
other hand, fixed costs remain same irrespective of volume and activities.
(ii) Traceability: Traceability of cost means degree of relationship
between the cost and the choice of the option. Direct costs are directly
assigned to the option on the other hand indirect costs needs to be
apportioned to the option on some reasonable basis.
For Example, Arnav Ltd. wants to manufacture 1,000 units of Product X. It
is considering to manufacture the same in its own factory. To manufacture
in its own factory it requires 1,000 hours of employees and a specialised
machine. In this example, employee cost for labour of 1,000 hours is
variable cost for in-house manufacturing and it is directly traceable. Cost
of machinery is also direct cost but so far as traceability of the
machinery cost is concerned it is direct cost for 1,000 units as a whole
but indirect cost for a unit.
Hence, the cost and benefits of an option is measured at directly traceable
and variable costs.
14.13.4 Short-term Decision Making using concepts of CVP Analysis
Management uses marginal costing and CVP concepts for making
various decisions. In this chapter we will learn how the concepts of
marginal costing and CVP is applied for analysis of identified options for
short-term decision making. Generally, short-term decisions are related
with temporary gaps between demand and supply for available resources.
The areas of short term decision may be classified into two broad
categories:
 MARGINAL COSTING

(i) Decisions related with excess supply, such as:

(a) Processing of Special Order
(b) Determination of price for stimulating demand
(c) Local vs Export sale
(d) Determination of minimum price for price quotations
(e) Shut-down or continue decision etc.
(ii) Decisions related with excess demand, such as:
(a) Make or Buy/ In-house-processing vs Outsourcing
(b) Product mix decision under resource constraints (limiting factors)
(c) Sales mix decisions
(d) Sale or further processing etc.
What is a Limiting Factor? Limiting factor is anything which limits
the activity of an entity. The factor is a key to determine the level of
sale and production, thus it is also known as Key factor. From the supply
side the limiting factor may either be Men (employees), Materials (raw
material or supplies), Machine (capacity), or Money (availability of fund
or budget) and from demand side it may be demand for the product,
other factors like nature of product, regulatory and environmental
requirement etc. The management, while making decisions, has objective
to optimise the key resources upto maximum possible extent.
ILLUSTRATION 11
A company can make any one of the 3 products X, Y or Z in a year. It can
exercise its option only at the beginning of each year.
Relevant information about the products for the next year is given below.
X Y Z
Selling Price (` / unit) 10 12 12
Variable Costs (` / unit) 6 9 7
Market Demand (unit) 3,00 2,00 1,00
0 0 0
Production Capacity (unit) 2,00 3,00 900
0 0
Fixed Costs (`) 30,00
0
 COST AND MANAGEMENT ACCOUNTING

Required
COMPUTE the opportunity costs for each of the products.
SOLUTION
X Y Z

I. Contribution per unit (`) 4 3 5

II. Units (Lower of Production / Market 2,00 2,00 900
Demand) 0 0
III. Possible Contribution (`) [ I × II ] 8,00 6,00 4,50
0 0 0
IV. Opportunity Cost* (`) 6,00 8,00 8,00
0 0 0
(*) Opportunity cost is the maximum possible contribution forgone by not
producing alternative product i.e. if Product X is produced then opportunity cost
will be maximum of (` 6,000 from Y, ` 4,500 from Z).
ILLUSTRATION 12
M.K. Ltd. manufactures and sells a single product X whose selling price
is ` 40 per unit and the variable cost is ` 16 per unit.
(i) If the Fixed Costs for this year are ` 4,80,000 and the annual sales
are at 60% margin of safety, CALCULATE the rate of net return on
sales, assuming an income tax level of 40%
(ii) For the next year, it is proposed to add another product line Y whose
selling price would be ` 50 per unit and the variable cost ` 10 per
unit. The total fixed costs are estimated at ` 6,66,600. The sales mix
of X : Y would be 7 : 3. DETERMINE at what level of sales next year,
would M.K. Ltd. break even? Give separately for both X and Y the
break-even sales in rupee and quantities.
SOLUTION
(i) Contribution per unit = Selling price – Variable cost
= `40 – `16 = `24

Break-even Point `4,80,00

= 20,000 units
0
=
`24
Actual Sales – Break - even Sales
Percentage Margin of Safety = Actual Sales
 MARGINAL COSTING

Actual Sales –
Or, 60% = 20,000units
Actual Sales

 Actual Sales = 50,000 units

(`)
Sales Value (50,000 units × `40) 20,00,000
Less: Variable Cost (50,000 units × `16) 8,00,000
Contribution 12,00,000
Less: Fixed Cost 4,80,000
Profit 7,20,000
Less: Income Tax @ 40% 2,88,000
Net Return 4,32,000
 `4,32,000 
Rate of Net Return on Sales = 21.6%   ×100
`20,00,000
 
(ii) Products
X Y
(`) (`)
Selling Price 40 50
Less: Variable Cost 16 10
Contribution per unit 24 40
Sales Ratio 7 3
Contribution in sales Ratio 168 120
Based on Weighted Contribution
24 ×7 + 40
Weighted Contribution = = ` 28.8 per unit
×3

10
Total Fixed 6,66,600
Total Break-even Point = = = 23,145.80 units
Cost
28.80
Weighted Cost
Break-even Point
7
X = ×23,145.80 =16,202 units
10
or 16,202 × ` 40 = ` 6,48,080
3
Y = ×23,145.80 = 6,944 units or 6,944 × ` 50 =` 3, 47,200
10
 COST AND MANAGEMENT ACCOUNTING

Based on distributing fixed cost in the weighted Contribution Ratio

Fixed Cost
168
X =
= ` 3,88,850
×6,66,600
288 = ` 2,77,750
120
Y =
×6,66,600
288
Break-even Point
Fixed Cost 3,88,850
X = Contribution per = =16,202 units or ` 6, 48,000
unit 24
2,77,750
Fixed Cost = = 6,944 units or ` 3, 47,200
Y =
Contribution per unit 40
ILLUSTRATION 13
X Ltd. supplies spare parts to an air craft company Y Ltd. The
production capacity of X Ltd. facilitates production of any one spare part
for a particular period of time. The following are the cost and other
information for the production of the two different spare parts A and B:
Part A Part B
Per unit
Alloy usage 1.6 kgs. 1.6 kgs.
Machine Time: Machine A 0.6 hrs 0.25 hrs.
Machine Time: Machine B 0.5 hrs. 0.55 hrs.
Target Price (`) 145 115
Total hours available Machine A 4,000 hours
Machine B 4,500 hours
Alloy available is 13,000 kgs. @ ` 12.50 per kg.
Variable overheads per machine hoursMachine
A: ` 80
Machine B: ` 100
Required
(i) IDENTIFY the spare part which will optimize contribution at the offered price.
(ii) If Y Ltd. reduces target price by 10% and offers ` 60 per hour of
unutilized machine hour, CALCULATE the total contribution from the
spare part identified above?
 MARGINAL COSTING

SOLUTION
(i)
Part A Part B
Machine “A” (4,000 hrs) 6,666 16,000
Machine “B” (4,500 hrs) 9,000 8,181
Alloy Available (13,000 kg.) 8,125 8,125
Maximum Number of Parts to be 6,666 8,125
manufactured (Minimum of the above
three)

(`) (`)
Material (`12.5 × 1.6 kg.) 20.00 20.00
Variable Overhead: Machine “A” 48.00 20.00
Variable Overhead: Machine “B” 50.00 55.00
Total Variable Cost per unit 118.00 95.00
Price Offered 145.00 115.00
Contribution per unit 27.00 20.00
Total Contribution for units produced …(I) 1,79,98 1,62,50
2 0
Spare Part A will optimize the contribution.
(ii)
Part A
Parts to be manufactured numbers 6,666
Machine A : to be used 4,000
Machine B : to be used 3,333
Underutilized Machine Hours (4,500 hrs. – 3,333 hrs.) 1,167
Compensation for unutilized machine hours (1,167hrs. × 70,020
`60) (II)
Reduction in Price by 10%, Causing fall in Contribution of 96,657
`14.50
per unit (6,666 units × `14.5) (III)
Total Contribution (I + II – 1,53,34
III) 5
ILLUSTRATION 14
The profit for the year of R.J. Ltd. works out to 12.5% of the capital
employed and the relevant figures are as under:
 COST AND MANAGEMENT ACCOUNTING

Sales............................................................ ` 5,00,000
Direct Materials........................................... ` 2,50,000
Direct Labour…............................................ ` 1,00,000
Variable
Overheads…………………………………………… `
.................................................................. 40,000
Capital Employed......................................... `
4,00,000
The new Sales Manager who has joined the company recently estimates
for next year a profit of about 23% on capital employed, provided the
volume of sales is increased by 10% and simultaneously there is an
increase in Selling Price of 4% and an overall cost reduction in all the
elements of cost by 2%.
Required
FIND OUT by computing in detail the cost and profit for next year,
whether the proposal of Sales Manager can be adopted.
SOLUTION
Statement Showing “Cost and Profit for the Next Year”
Particulars Existing Volume, Costs, Estimated
etc. after 10% Sale, Cost,
Volume,
Increase Profit, etc.*
etc.
(`) (`) (`)
Sales 5,00,000 5,50,000 5,72,000
Less: Direct Materials 2,50,000 2,75,000 2,69,500
Direct Labour 1,00,000 1,10,000 1,07,800
Variable 40,000 44,000 43,120
Overheads
Contribution 1,10,000 1,21,000 1,51,580
Less: Fixed Cost# 60,000 60,000 58,800
Profit 50,000 61,000 92,780
(*) for the next year after increase in selling price @ 4% and overall cost
reduction by 2%. (#) Fixed Cost = Existing Sales – Existing Marginal Cost –
12.5% on `4,00,000
= `5,00,000 – `3,90,000 – `50,000 = `60,000
 `92,780 
Percentage Profit on Capital Employed equals to 23.19%
  x 100
`4,00,000
 
Since the Profit of `92,780 is more than 23% of capital employed, the
proposal of the Sales Manager can be adopted.
 MARGINAL COSTING

SUMMARY
 Marginal Cost: Marginal cost as understood in economics is the
incremental cost of production which arises due to one-unit increase
in the production quantity. marginal cost is measured by the total
variable cost attributable to one unit.
 Marginal Costing: It is a costing system where products or services
and inventories are valued at variable costs only. It does not take
consideration of fixed costs.
 Absorption Costing: a method of costing by which all direct cost
and applicable overheads are charged to products or cost centers for
finding out the total cost of production. Absorbed cost includes
production cost as well as administrative and other cost.
 Contribution: Contribution or contribution margin is the difference
between sales revenue and total variable costs irrespective of
manufacturing or non- manufacturing.
 Cost-Volume-Profit (CVP) Analysis: It is an analysis of reciprocal
effect of changes in cost, volume and profitability. Such an analysis
explores the relationship between costs, revenue, activity levels and
the resulting profit. It aims at measuring variations in cost and
volume.
 Contribution to Sales Ratio (Profit Volume Ratio or P/V ratio):
This ratio shows the proportion of sales available to cover fixed costs
and profit. Contribution represent the sales revenue after deducting
variable costs.
 Break-even Point (BEP): The level of sales where an entity neither
earns profit nor incurs loss. BEP is indicated in both quantity and
monetary value terms.
 Margin of Safety (MOS): The margin between sales and the break-
even sales is known as margin of safety. It can either be indicated in
quantitative or monetary terms.
 Angle of Incidence: This angle is formed by the intersection of
sales line and total cost line at the break-even point. This angle
shows the rate at which profits is earned once the break-even point
is reached.
 Limiting (Key) factor: Limiting factor is anything which limits the
activity of an entity. The factor is a key to determine the level of sale
and production, thus it is also known as Key factor.
 COST AND MANAGEMENT ACCOUNTING

TEST YOUR KNOWLEDGE

MCQs based Questions
1. Under marginal costing the cost of product includes
(a) Prime costs only
(b) Price costs and variable overheads
(c) Prime costs and fixed overheads
(d) Prime costs and factory overheads
2. The main difference between marginal costing and absorption
costing is regarding the treatment of
(a) Prime cost
(b ad
) ixed
(c irect mater
overhe D ial
)
ari e rheads
(d )
3. Period costs are
(a) Variable costs
(b) Fixed costs
(c) Prime costs
(d) Overheads costs
4. When sales and production (in units) are same then profit under
(a) Marginal costing is higher than that of absorption costing
(b) Marginal costing is lower than that of absorption costing
(c) Marginal costing is equal to that of absorption costing
(d) None of the above
5. When sales exceed production (in units) then profit under
(a) Marginal costing is higher than that of absorption costing
(b) Marginal costing is lower than that of absorption costing
(c) Marginal costing is equal than that of absorption costing
 MARGINAL COSTING

(d) None of above

6. Reporting under marginal costing is accomplished by
(a) Treating all costs as period costs
(b) Eliminating the work-in-progress inventory account
(c) Matching variable costs against revenue and treating fixed
costs as period costs
(d) Including only variable costs in income statement
7. Under profit volume ratio, the term profit
(a) Means the sales proceeds in excess of total costs
(b) Here mean the same thing as is generally understood
(c) Is a misnomer, it in fact refers to contribution i.e. (sales
revenue-variable costs)
(d) None of the above
8. Factors which can change the int
break-even
(a) Change in fixed costs po
(b) Change in variable costs
(c) Change in the selling price
(d) All of the above
9. If P/V ratio is 40% of sales then what about the remaining 60% of sales
(a) Profit
(b) Fixed cost
(c) Variable cost
(d) Margin of safety
10. The P/V ratio of a product is 0.6 and profit is ` 9,000. The margin of
safety is (a) ` 5,400
(b) ` 15,000
(c) ` 22,500
(d) ` 3,600
 COST AND MANAGEMENT ACCOUNTING

Theoretical Questions
1. EXPLAIN and ILLUSTRATE break-even point with the help of break-even chart.
2. WRITE a short note on Angle of Incidence.
3. DISCUSS basic assumptions of Cost Volume Profit analysis.
4. DISCUSS the practical application of Marginal Costing.
5. DISCUSS the points of difference between absorption costing and
marginal costing
6. WRITE a short note on Margin of safety.
Practical Questions
1. XYZ Ltd. has a production capacity of 2,00,000 units per year.
Normal capacity utilisation is reckoned as 90%. Standard variable
production costs are `11 per unit. The fixed costs are `3,60,000 per
year. Variable selling costs are `3 per unit and fixed selling costs are
`2,70,000 per year. The unit selling price is `20.
In the year just ended on 30th June, 20X4, the production was
1,60,000 units and sales were 1,50,000 units. The closing inventory
on 30th June was 20,000
units. The ari e production costs for the year were ` 35,000 higher
abl
actual v than
the standard.
(i) CALCULATE the profit for the year
(a) by absorption costing method and
(b) by marginal costing method.
(ii) EXPLAIN the difference in the profits.
2. An Indian soft drink company is planning to establish a subsidiary
company in Bhutan to produce mineral water. Based on the
estimated annual sales of 40,000 bottles of the mineral water, cost
studies produced the following estimates for the Bhutanese
subsidiary:
Total annual Percent of Total
costs Annual Cost which
is variable
Material 2,10,000 100
%
Labour 1,50,000 80%
Factory Overheads 92,000 60%
Administration 40,000 35%
Expenses
 MARGINAL COSTING

The Bhutanese production will be sold by manufacturer’s

representatives who will receive a commission of 8% of the sale
price. No portion of the Indian office expenses is to be allocated to
the Bhutanese subsidiary. You are required to
(i) COMPUTE the sale price per bottle to enable the management
to realize an estimated 10% profit on sale proceeds in Bhutan.
(ii) CALCULATE the break-even point in rupees sales as also in
number of bottles for the Bhutanese subsidiary on the
assumption that the sale price is ` 14 per bottle.
3. If P/V ratio is 60% and the Marginal cost of the product is ` 20.
CALCULATE the selling price?
4. The ratio of variable cost to sales is 70%. The break-even point
occurs at 60% of the capacity sales. Find the capacity sales when
fixed costs are ` 90,000. Also COMPUTE profit at 75% of the capacity
sales.
5.

(`)
( i) TERMINE profit en sa
les= 2,00,000
ixed
C ost ,
whDE = 40,000
F = 1,60,000
(ii) DETERMINE sales, when fixed cost = 20,000
Profit = 10,000
BEP = 40,000
6. A company has three factories situated in north, east and south with
its Head Office in Mumbai. The management has received the
following summary report on the operations of each factory for a
period:
(` in ‘000)
Sale Profi
s t
Actu Over/ Actu Over/(Under)
al (Under) al Budget
Budget
North 1,100 (400 135 (180
) )
East 1,450 150 210 90
South 1,200 (200 330 (110
) )
 COST AND MANAGEMENT ACCOUNTING

CALCULATE for each factory and for the company as a whole for the period :
(i) the fixed costs. (ii) break-even sales.
7. A company sells its product at ` 15 per unit. In a period, if it
produces and sells 8,000 units, it incurs a loss of ` 5 per unit. If the
volume is raised to 20,000 units, it earns a profit of ` 4 per unit.
CALCULATE break-even point both in terms of Value as well as in
units.
8. The product mix of a Gama Ltd. is as under:
Produc
ts
M N
Units 54,00 18,00
0 0
Selling price ` 7.50 `
15.00
Variable cost ` 6.00 ` 4.50
FIND the break-even points in units, if the company discontinues
product ‘M’ and replace with product ‘O’. The quantity of product
‘O’ is 9,000pric units and
its selli . e evari
costs respectively are ` 18 and ` 9. Fixed Cost is
`1 s ` 2,0
9. Mr. X investments
0,0 in his business firm. He wants a 15 per cent
ha
return on his money. From an analysis of recent cost figures, he finds
that his variable cost of operating is 60 per cent of sales, his fixed
costs are ` 80,000 per year. Show COMPUTATIONS to answer the
following questions:
(i) What sales volume must be obtained to break even?
(ii) What sales volume must be obtained to get 15 per cent return
on investment?
(iii) Mr. X estimates that even if he closed the doors of his
business, he would incur ` 25,000 as expenses per year. At
what sales would he be better off by locking his business up?
10. An automobile manufacturing company produces different models of
Cars. The budget in respect of model 007 for the month of March,
20X9 is as under:
Budgeted Output 40,000 Units
` In ` In lakhs
lakhs
Net Realisation 2,10,000
 MARGINAL COSTING

Variable Costs:
Materials 79,200
Labour 15,600
Direct expenses 37,200 1,32,000
Specific Fixed Costs 27,000
Allocated Fixed Costs 33,750 60,750
Total Costs 1,92,750
Profit 17,250
Sales 2,10,000
CALCULATE:
(i) Profit with 10 percent in sellinge h a 10 percent
increase reduction in sales pricwit
volume. th fter a 10
(ii) Volume to be achieved to al e originalofit percent price
maintain rise in material costs, ly pra per unit.
at the origin budgetedellin
sg
11. You are given the following data: le
Sa s
0 Pr fit
Year 20X8 ` o
1,20,00 0 00
8 0
Year 20X9 ` ,
1,40,00 00
13 0
FIND OUT –
,
(i) P/V ratio,
0
(ii) B.E. Point,
,0
(iii) Profit when sales are 0
`1,80,000, it. In 20X8, the
f costs amounted
(iv) Sales required earn a profit of du s
`12 ,
c ys 0% and the fixed
(v) Margin of safety in year o er
20X9. to t at ` 60 un
p 40%. fixed
12. A single product company sells its c
The %.
pro company operated at a margin o
ales was
of safet to ` 3,60,000 and the by
variable cost ratio 80 t will 1
In 20X9, it is estimated that the go up
variable cost will increase by 5%.
 COST AND MANAGEMENT ACCOUNTING

(i) FIND the selling price required to be fixed in 20X9 to earn the
same P/V ratio as in 20X8.
(ii) Assuming the same selling price of ` 60 per unit in 20X9, FIND
the number of units required to be produced and sold to earn
the same profit as in 20X8.
13. A company has made a profit of ` 50,000 during the year 20X8-X9. If
the selling price and marginal cost of the product are ` 15 and ` 12
per unit respectively, FIND OUT the amount of margin of safety.
14. (a) If margin of safety is ` 2,40,000 (40% of sales) and P/V ratio
is 30% of AB Ltd, CALCULATE its (1) Break even sales, and (2)
Amount of profit on sales of `9,00,000.
(b) X Ltd. has earned a contribution of `2,00,000 and net profit of `1,50,000
sales of ` 8 . What is its margin of safety?
o ,00,
15. A
compan ed f es of ` 4,50,000, with sales of
y ixed expens
had nc
` 15,00,000 i urr prfit of ` 3,00,0
00of ` 1,50,000 n
a o d uring the first half the
re los .
second
half s
CALCULATE
:
(i) The profit-volume ratio, break-even point and margin of safety
for the first half year.
(ii) Expected sales volume for the second half year assuming that
selling price and fixed expenses remained unchanged during
the second half year.
(iii) The break-even point and margin of safety for the whole year.
16. The following information is given by Star Ltd.:
Margin of Safety ` 1,87,500
Total Cost ` 1,93,750
Margin of Safety 3,750 units
Break-even Sales 1,250
units Required:
CALCULATE Profit, P/V Ratio, BEP Sales (in `) and Fixed Cost.
17. (a) You are given the following data for the coming year for a factory.

© The Institute of Chartered Accountants of India

MARGINAL COSTING
 Budgeted output 8,00,000
units

Fixed expenses `40,00,000

Variable expenses per unit ` 100
Selling price per unit ` 200

(b) If price is reduced to ` 180, what will be the new break-even point?
18. The following are cost data for three alternative ways of processing
the clerical work for cases brought before the LC Court System:
A B C
Manual Semi-Automatic Fully-Automatic
(`) (`) (`)
Mont
hly fixed costs:
Occupancy 15 00 15,00 15,00
, 0 0 0
Maintenance --- 5,00 10,00
contract 0 0
Equipment --- 25,00 1,00,000
lease 0
Unit variable costs
(per report):
Supplies 40 80 20
Labour `200 `60 `20
(5 hrs × (1 hr × `60) (0.25 hr × `80)
`40)
Required
(i) CALCULATE cost indifference points. Interpret your results.
(ii) If the present case load is 600 cases and it is expected to go
up to 850 cases in near future, SELECT most appropriate on
cost considerations?
19. XY Ltd. makes two products X and Y, whose respective fixed costs
are F1 and F2. You are given that the unit contribution of Y is onefifth
less than the unit contribution of X, that the total of F 1 and F2 is
`1,50,000, that the BEP of X is 1,800 units (for BEP of X, F2 is not
considered) and that 3,000 units is the indifference point between
X and Y.(i.e. X and Y make equal profits at 3,000 unit volume,
considering their respective fixed costs). There is no inventory
buildup as whatever is produced is sold.
 COST AND MANAGEMENT ACCOUNTING

Required
FIND OUT the values F1 and F2 and units contributions of X and Y.

ANSWERS/ SOLUTIONS
Answers to the MCQs based Questions
1. (b 2. (b) 3 (b) 4. (c) 5. (a) 6. (c)
) .
7. (c) 8. (d) 9 (c) 10. (b)
.
Answers to the Theoretical Questions
1. Please refer paragraph 14.8
2. Please refer paragraph 14.12
3. Pl
efer paragraph
eas
4. Please 14.7
efer paragr
r
aph 14.3
5. Pl
eas 4.5
efer ra ap
6.
efer p 4.10
eas
paragra
Pl
Answers to the Practical Questions
1. Income Statement (Absorption Costing) for the year
ending 30th June 20X4
(`) (`)
Sales (1,50,000 units @ `20) 30,00,000
Production Costs:
Variable (1,60,000 units @ `11) 17,60,000
Add: Increase 35,000 17,95,000
Fixed (1,60,000 units @ `2*) 3,20,00
0
Cost of Goods Produced 21,15,000
Add: Opening stock (10,000 units @ `13) * 1,30,00
0
22,45,000
 ` 21,15,000 2,64,375
Less: Closing stock ×20,000

 units
1,60,000 units
 
 MARGINAL COSTING

Cost of Goods Sold 19,80,625

Add: Under absorbed fixed production 40,000
overhead (3,60,000 – 3,20,000)
20,20,625
Add: Non-production costs:

Variable selling costs (1,50,000 units @ `3) 4,50,000

Fixed selling costs 2,70,000
Total cost 27,40,625
Profit (Sales – Total Cost) 2,59,375
* Working Notes:
1. Fixed production overhead are absorbed at a pre-determined
rate ased on normal capacity, i.e. `3,60,000 ÷ 1,80,000 units
b
= ` 2.
2. Opening stock is 10,000 units, i.e., 1,50,000 units + 20,000 units –
is valued at `13 per unit, i.e., `11 + `2 (Variable +
,6 00 ts.

Income ent (Marginal Costing) for the year

ended 30th June, 20X4
(`) (`)
Sales (1,50,000 units @ `20) 30,00,00
0
Variable production cost (1,60,000 17,95,00
units @ 0
`11 + `35,000)
Variable selling cost (1,50,000 units @ 4,50,000
`3)
22,45,00
0
Add: Opening Stock (10,000 units @ 1,10,000
`11)
23,55,00
0
Less: Closing stock
 `17,95,000   2,24,375
1,60,000 units×20,000 units
 
Variable cost of goods sold 21,30,62
5
Contribution (Sales – Variable cost 8,69,375
of goods sold)
Less: Fixed cost – Production 3,60,00
0
– Selling 2,70,00 6,30,000
0
 COST AND MANAGEMENT ACCOUNTING

Profit 2,39,375

Reasons for Difference in Profit: (`)

Profit as per absorption costing 2,59,375
Add: Op. stock under –valued in marginal costing 20,000
(`1,30,000 – 1,10,000)
2,79,375
Less: Cl. Stock under –valued in marginal closing 40,000
(`2,64,375 – 2,24,375)
Profit as per marginal costing 2,39,375

2. (i) Computation of Sale Price Per

Bottle
Output: 40,000
Bottles
(`)
Variable
Cost:
Material 2,10,000
Labour (`1,50,000 × 80%) 1,20,000
Factory Overheads (`92,000 × 60%) 55,200
Administrative Overheads (`40,000 14,000
× 35%) Commission (8% on 48,000
`6,00,000) (W.N.-1)
Fixed Cost:
Labour (`1,50,000 × 20%) 30,000
Factory Overheads (`92,000 × 40%) 36,800
Administrative Overheads (`40,000 × 65%) 26,000
Total Cost 5,40,000
Profit (W.N.-1) 60,000
Sales Proceeds (W.N.-1) 6,00,000
 `6,00,000  15
Sales Price per bottle

 40,000 
(ii) Calculation of Break-even Point
Sales Price per Bottle = `14

Variable Cost per

`4,44,000 (W.N.- 2)
Bottle= 40,000 Bottles = `11.10
 MARGINAL COSTING

Contribution per Bottle = `14 − `11.10 =

`2.90 Break -even Point
Fixed Costs
(in number of Bottles) =
Contribution per Bottle
`92,800
= = 32,000Bottles
`2.90
Break- even Point
(in Sales Value) = 32,000 Bottles × `14
=`4,48,000
Working
Note W
.N.
Le Sales Price b
t e
Commission 8x
100
=
Profit =
10
x
10
0
8x 10x
x = 4,92,000 + +
100 100
100x - 8x - = 4,92,00,000
10x
82x = 4,92,00,000
x = 4,92,00,000 / 82 =
`6,00,000
W.N.-2
Total Variable Cost (`)
Material 2,10,000
Labour 1,20,000
Factory Overheads 55,200
Administrative Overheads 14,000
Commission [(40,000 Bottles × `14) × 8%] 44,800
4,44,000
 COST AND MANAGEMENT ACCOUNTING

3. Variable Cost = 100 – P/V Ratio

= 100 – 60 = 40
If Variable cost is 40, then selling price = 100
If Variable cost is 20, then selling price = (100/40) × 20 = ` 50
4. Variable cost to sales = 70%, Contribution to sales
= 30%, Or P/V Ratio 30%
We know that: BES × P/V Ratio = Fixed
Cost BES × 0.30 = ` 90,000
Or BES = ` 3,00,000
It is given that break-even occurs at 60%
capacity. Capacity sales = ` 3,00,000 ÷ 0.60
= ` 5,00,000 Computation of profit of 75%
Capacity
city es 5,00
,000 × 0.
75% of e. ` 5,000
× 0.70)75) = ` 3,75,000
Less: Variable cost (i.e.
= ` 2,62,500
` 3,7
= ` 1,12,500
=` 90,000
Less: Fixed Cost
= ` 22,500
Profit
5. (i) We know that: B.E. Sales  P/V Ratio =
Fixed Cost or ` 1,60,000  P/V ratio = `
40,000
P/V ratio = 25%
We also know that Sales  P/V Ratio = Fixed Cost +
Profit or ` 2,00,000  0.25 = ` 40,000 + Profit
or Profit = ` 10,000
(ii) Again B.E. Sales  P/V ratio =
Fixed Cost or ` 40,000  P/V Ratio
= ` 20,000
or P/V ratio = 50%
We also know that: Sales  P/V ratio = Fixed Cost + Profit
 MARGINAL COSTING

or Sales  0.50 = ` 20,000 + `

10,000 or Sales = ` 60,000.
6. Calculation of P/V Ratio (`‘000)
Sales Profit
North : Actual 1,100 135
Add : Under budgeted 400 180
Budgeted 1,500 315

P/V ratio 180

= Diferenece in
Profit 315  135 =  100  100 = 45%
= =
Difference in 1,500  400
Sales 1,100
(`‘000)

Sales Profit
East : Actual 1,450 210
Less : Over (150) (90)
budgeted
P/V ratio Budgeted 1,300 120
90
= 15
 100 =
60%
0 (`’000
)
Sale Profit
s 330
South : Actual
1,200 110
Add: Under budgeted
200
Budgeted 1,400 440
P/V ratio 110
=  100 = 55%
200
(i) Calculation of fixed cost
Fixed Cost = (Actual sales  P/V ratio) –
Profit North = (1,100  45%) – 135=
360
East = (1,450  60%) – 210= 660
South = (1,200  55%) – 330= 330
Total Fixed Cost 1,350
 COST AND MANAGEMENT ACCOUNTING

(ii) Calculation of break-even sales (in `’000)

B.E. Sales Fixed

Cost P/V
=
ratio

North = 360 = 800

45%
660
East = = 1,100
60%
330
South = = 600
55%
Total 2,500
7. We know that S – V = F + P
Suppose variable cost = x, Fixed Cost = y

In firs
t situa
tion:
x = y 40,000
– (
15
0
-
ond x = y + 80,000
situati = y – 40,000
In on:
= y + 80,000
15  20,000 - 20,000
(
or, 1,20,000 – 8,000 x 2
3,00,000 – 20,000 x )

From (3) & (4) we get x = ` 5, Variable cost per unit (

= ` 5 Putting this value in 3rd equation:
1,20,000 – (8,000  5) = y –
40,000 or, y = ` 1,20,000
Fixed Cost = ` 1,20,000

P/V ratio =
S  V 15  5 200 2
  100   66 %.
S 15 3 3
Suppose break-even sales = x
15x – 5x = 1,20,000(at BEP, contribution will be equal to fixed cost)
x = 12,000 units.
or, Break-even sales in units = 12,000, Break-even sales in Value =
 MARGINAL COSTING

12,000  15 = `1,80,000.
8. N = 18,000 units
O = 9,000 units
Ratio (N : O) = 2:1
Let
t = No. of units of ‘O’ for BEP
N = 2t No. of units for BEP
Contribution of ‘N’ = `10.5 per unit
Contribution of ‘O’ = `9 per
unit At Break Even Point:
x (2t) + 9 x t -15,000 = 0
1
30t = 15,000
t = 500 un 2t
= i
BEP of
‘N’
= 1,000
BEP of ‘O’ = units t
= 500
9.
(`)
Suppose sales 100
Variable cost 60
Contribution 40
P/V ratio 40%
Fixed cost = ` 80,000
(i) Break-even point = Fixed Cost  P/V ratio = or ` 2,00,000
80,000  40%
(ii) 15% return on ` 2,00,000 30,000
Fixed Cost 80,000
Contribution required 1,10,000
 COST AND MANAGEMENT ACCOUNTING

Sales volume required = ` 1,10,000  40% or ` 2,75,000

(iii) Avoidable fixed cost if business is locked up = `80,000 - `
25,000
= `55,000
Minimum sales required to meet this cost: ` 55,000  40% or
`1,37,500
Mr. X will be better off by locking his business up, if the sale is less than
` 1,37,500
10. (i) Budgeted selling price = 2,10,000 lakhs/ 40,000 units = `5,25,000
per unit. Budgeted variable cost = 1,32,000 lakhs/ 40,000 units
= ` 3,30,000 per unit. Increased selling price = `5,25,000 +
10% = ` 5,77,500 per unit
New volume 40,000 – 10% = 36,000 units
Statement of Calculation of Profit:
(` In
Sales 36,000 units at ` lakhs)
5,77,500 = 2,07,90
0
Less: Variable cost: 36,000 × `3,30,000 = 1,18,800
Contribution 89,100
Less: fixed 60,750
costs Profit 28,350
(ii) Budgeted Material Cost = 79,200 Lakhs/ 40,000 Units = `1,98,000 per Unit

Increased material cost = `1,98,000×110% 2,17,800

=
Labour cost 15,600 lakhs/ 40,000 units = 39,000
Direct expenses, 37,200 lakhs/ 40,000 93,000
units =
Variable cost per unit 3,49,800
Budgeted selling price per unit 5,25,000
Contribution per unit (5,25,000 – 3,49,800) 1,75,200
Fixed costs+Profit 60,750 lakhs +17,250 lakhs
Sales volume =
Contribution Per = `1.752 lakhs
Unit
= 44,521 units are to be sold to maintain the original profit of
` 17,250 lakhs.
 MARGINAL COSTING

11.
Sales Profit
Year 20X8 ` 1,20,000 8,000
Year 20X9 ` 1,40,000 13,000
Difference ` 20,000 5,000

Difference inprofit 5,000

(i)
P/V Ratio =   100 = 25%
100 = 20,000
Difference in Sales
(`)
Contribution in 20X8 (1,20,000  25%)
30,000 Less: Profit 8,000
Fixed Cost* 22,000
*Contribution = Fixed cost + Profit
 Fixe = Contribution - Profit
d t
co
Break s = Fixed = 22,000 = ` 88,000
(ii - cost P/V 25%
) `1,80
,000
poi ratio
nt
(iii) Profit when sales are
(`
Contribution (`1,80,000 
)
25%) Less: Fixed cost
45,00
Profit
0
22,000
23,000
(iv) Sales to earn a profit of `12,000
Fixed cost  Desired
profit 22,000 
= = `1,36,000
P/V ratio 12,000
25%
(v) Margin of safety in 20X9
–
Margin of safety = Actual sales – Break-even sales
= 1,40,000 – 88,000 = ` 52,000.
12. (i) Profit earned in 20X8:
(`)
Total contribution (50,000  ` 12) 6,00,000
 COST AND MANAGEMENT ACCOUNTING

Less: Fixed cost 3,60,000

Profit 2,40,000
Selling price to be fixed in 20X9:
Revised variable cost (` 48  1.10) 52.80
Revised fixed cost (3,60,000  1.05) 3,78,000
P/V Ratio (Same as of 20X8) 20%
Variable cost ratio to selling price 80%
Therefore, revised selling price per unit = ` 52.80  80% = ` 66
(ii) No. of units to be produced and sold in 20X9 to earn
the same profit:
We know that Fixed Cost plus profit = Contribution

(`)
Pro it in 0X8 2,40,000
f 2 X9
3,78,000
Fix d in utio
cost 20per n in20X9
Contribution
e 6,18,000
it.
unit = Selling price per unit – Variable cost
per un
nits
No. of units to be pro = ` 60 – ` 52.80 = ` 7.20.
Workings: duced in 20X9 = ` 6,18,000  ` 7.20 =
.
1. PV Ratio in 20X8

(`)
Selling price per unit 60
Variable cost (80% of Selling 48
Price)
Contribution 12
P/V Ratio 20%
2. No. of units sold in 20X8
Break-even point = Fixed cost  Contribution per unit
= ` 3,60,000  ` 12 = 30,000 units.
Margin of safety is 40%. Therefore, break-even sales will be 60%
 MARGINAL COSTING

of units sold.
No. of units sold = Break-even point in units  60%
= 30,000  60% = 50,000 units.
13.
P/V Ratio = Contrib × 100
ution
Sales
= [(15 – 12)/15] × 100
= (3/15) x 100 = 20%
Marginal of Safety = Profit ÷ P/V Ratio
= 50,000 ÷ 20% = ` 2,50,000

14. (a) Total Sales = 2,40,000 

100 = `6,00,000

40
Contrib = `1,80,000
utio = 6,00,000  30%
Profit n P/V ratio=ution – P  30% = `72,000
2,40,000
= M/S 00 – 72,0 rofit
Fixed
= Contrib 00 = `1,08,000
cost
= 1,80,0
Fixed 1,08,000
(1) Break-even Sales = = `3,60,000
Cost
= 30%
P / V ratio

(2) Profit = (Sales  P/V ratio) – Fixed cost

= (9,00,000  30%) – 1,08,000 = `1,62,000
Contribution
(b) P/V ratio = 2,00,000
= 8,00,000 = 25%
Sales

Margin of safety Profit 1,50,000

= ` 6,00,000
=
= 25%
P/V ratio

Alternatively:
Fixed cost = Contribution – Profit
= ` 2,00,000 – `1,50,000 = ` 50,000
B.E. Point = ` 50,000 ÷ 25% = ` 2,00,000
Margin of Safety = Actual sales – B.E. sales
 COST AND MANAGEMENT ACCOUNTING

= 8,00,000 – 2,00,000 = 6,00,000

15. (i) In the First half year
Contribution = Fixed cost + Profit
= 4,50,000 + 3,00,000 = ` 7,50,000
Contribution
P/V ratio = 7,50,000
×100 = 15,00,000 × 100 = 50%
Sales

Break-even point Fixed cost 4,50,000

× 100 = ` 9,00,000
=
= 50%
P/V ratio

Margin of safety = Actual sales – Break-even point

= 15,00,000 – 9,00,000 = ` 6,00,000
( ii) In the d f r
seconContributio
yea t – Loss
n = Fixed cos
– 1,50,000 = ` 3,00,000
= 4,50,000t - Loss = 3,00,000 = ` 6,00,000

Expected sales Fixed cos

volume = 50%
P/V
ratio
(iii) For the whole year
4,50,000  2
B.E. point = Fixed = = `18,00,000
cost P/V 50%
ratio
Profit 3,00,000 
Margin of safety = ` 3,00,000.
= 1,50,000
=
P/V ratio 50%
3,750units
16. Margin of Safety (%) =
3,750units+1,250units

= 75%

Total Sales `1,87,500

0.75
=
= `2,50,000
Profit = Total Sales – Total Cost
= `2,50,000 – `1,93,750
 MARGINAL COSTING

= `56,250
Profit
P/V Ratio =
×100 Marginof
Safety(`)

`56,250
= `1,87,500×100
= 30%
Break-even Sales = Total Sales × [100 – Margin of Safety %]
= ` 2,50,000 × 0.25
= ` 62,500
Fixed Cost = Sales × P/V Ratio – Profit
= `2,50,000 × 0.30 – `56,250
= `18,750
17. (a) Contribution = S – V = ` 200 – ` 100 = ` 100 per unit.

B.E. Point = 40,00,000

Fixed cost = = 40,000 unit
Contribution per `100
unit
(b) When selling price is
reduced New selling price
= ` 180
New Contribution = ` 180 – ` 100 = ` 80 per unit.
`40,00,000
New B.E. Point = = 50,000 units.
` 80
 COST AND MANAGEMENT ACCOUNTING

T he break-even chart is shown below:

200
)0
00
0
Cost and Revenue (`

0 160
'
s.
R
( 120
e
u B.E.P.
80 New break-even point

40 Fixed cost
line

0
20
50 80 100
40
60
Output ('000 units)

18. (i) Cost Indifference

Point
A and B A and C B and C
(`) (`) (`)
Differential Fixed Cost (I) `30,000 `1,10,000 `80,000

(`45,000 – (`1,25,000 (`1,25,000 –

`15,000) – `45,000)
`15,000)
Differential Variable Costs (II) `100 `200 `100
(`240 –`140) (`240 – (`140 – `40)
`40)
Cost Indifference Point (I/II) 300 550 800
(Differential Fixed Cost / Cases Cases Cases
Differential Variable Costs per
case)
Interpretation of Results
At activity level below the indifference points, the alternative with
lower fixed costs and higher variable costs should be used. At
activity level above the indifference point alternative with higher
fixed costs and lower variable costs should be used.
 MARGINAL COSTING

No. of Cases Alternative to be

Chosen
Cases ≤ 300 Alternative ‘A’
300 ≥ Cases ≤ 800 Alternative ‘B’
Cases ≥ 800 Alternative ‘C’

(ii) Present case load is 600. Therefore, alternative B is suitable. As

the number of cases is expected to go upto 850 cases,
alternative C is most appropriate.
19. Let Cx be the Contribution per unit of Product X.
Therefore, Contribution per unit of Product Y =C y=4/5Cx =
0.8Cx Given F1 + F2 = 1,50,000,
F1 0Cx ev Volume × Contribution per unit)
=
(Break
Th e, F2 = 1,50 – 1,800Cx.
eref ,00
3, x – F2 or 3,000Cx – F1 =2,400 Cx-F2 (Indifference Point)
00 –F1 00 0.
0
i.e. Cx – 1,800Cx = 2,400Cx – 1,50,000 + 1,800Cx
,
i.e., 3,000Cx = 1,50,000, There
fore, Cx = ` 50/- (1,50,000 / 3,000)
Therefore, Contribution
nit of X = `
per u Fixed Cost of X = F1
50 0
= ` 90,00
Therefore, Contribution per unit of Y is ` 50 × 0.8 = ` 40
and Fixed Cost of Y = F2 = ` 60,000 (1,50,000 – 90,000)
The Value of F1 = ` 90,000, F2 = ` 60,000 and X = ` 50 and Y = ` 40