Marginal Costing and Break Even Analysis

Learning Objective:
1. Understand the meaning of Marginal Cost and
Marginal Costing
2. Understand Concepts of Contribution
3. Determine Break-even point and Margin of Safety
4. Prepare Break-even Charts.
5. Understand the application and limitations of
marginal costing.


Concepts of Marginal Costing
Marginal Costing is developed to overcome the deficiencies
of absorption costing.
In absorption costing both Fixed and Variable cost are
charged to the products manufactured.
Variable cost vary in the production with the change in the
volume of the output.
Hence they do not affect the production.
Quite opposite to this Fixed Cost remain constant upto
certain level of output. Fixed Costs per unit go on changing
per unit with every increase in production.
Because of the changing effect to fixe cost, the cost
of production per unit changes at different levels of
production.
To overcome this major limitation marginal costing
has been developed

The Term Marginal Costing is defined by the ICMA
London as follow

The ascertainment of marginal costing and of the
effect on profit of changes in volume or type of
output by differentiating between fixed costs and
variable costs.

Under marginal Costing only variable costs are
charged to operation and processes or Products.
Fixed Cost are charged against the excess of sales
revenue over the total variable costs.
Difference between Variable and Fixed Cost

Marginal Cost
Marginal Cost incurrent when one more unit is
produced.
It is typically differs across different range of
production quantities because the efficiency of the
production process changes.
The marginal Cost of producing a unit declines as
output increases.
So Marginal Cost means the amount at any given
volume of output by which aggregates costs are
changed if the volume of output is increased or
decreased by one unit.

Marginal cost included three elements :
1. Ascertainment of marginal costs
2. Finding out effects on profit, due to changes in
volume of production and type of output.
3. Differentiating between Fixed and Variable costs.
In Short run ,
Marginal cost refers to the aggregate of variable cost
i.e Prime cost + All variable overheads
Marginal Cost=Prime Cost +Total Variable Overheads
Or
Marginal Cost = Total Variable Cost.

Differentiation Fixed and Variable costs
Fixed Costs: Remain Fixed within a given rage of
output. They depend mainly on passage of time.
The do not vary directly with rate of output. Hence
they called Period Cost.

Example of Fixed Costs: Management expenses, Rent
rates, Insurance.

Fixed Costs are Transferred to the marginal profit
and loss account of the period. It is not carried to
the next Financial Period through Closing Stock in
the unit.

Variable Cost: is also called marginal Cost. Total
Variable costs increase with the increase in the
volume of output. But Variable cost per unit of
production remain constant at different lave of
output. Hence it is called Product Cost.

Valuation of Closing stock: Fixed Cost is not
changed to finished stock or work in progress as it is
treated as period cost. It is recovered during the
period in which it is incurred by transferring to the
profit and loss account. Thus closing stock(including
working progress) is valued at marginal
cost(Variable cost) only.

Concepts of Marginal Costing
The Difference between Selling Price and Marginal
cost (Variable cost) is called Contribution.
It Contributes towards fixed costs and Profit. It can
be represented as follow:
Contribution=Selling Price Variable (Marginal Cost)
Or Contribution = Fixed Cost + Profit (Or - Loss)
Thus
Sales= Variable Cost+ Fixed Cost + Profit (Or Loss)
Sales - Variable cost = Fixed Cost+ Profit (Or- Loss)


Concepts of P/V Ratio
[Profit Volume Ratio Or Contribution Sales Ratio]
A basic assumption in marginal costing is that
selling price remains constant at different levels of
sales.
Further marginal cost per unit also remains
constant at different volumes of production.
As a result these two factors contribution per unit
must also remain the same at all level of Sales.
Contribution always bears definite percentage to
sales. This relation of contribution to sales is called
P/V ratio.
P/V ratio measures profitability of Product, process,
departments etc. the P/V ratio can be increased by
improving the P/V ratio.
The P/V ratio can be improved by:
1. Increasing the Selling Price Per Unit
2. Decreasing the Marginal cost(mainly PC +VC)
3. Increasing the Sales and Decreasing the Marginal
costs.
P/V ratio is used in the determination of
1. Break Even Point
2. Profit at any volume of Sales
3. Sales Volume to earn a desired Profit
4. Profitability of Product and Process
P/V ratio is calculated as Follows
P/V ratio = Contribution/Sales
Or P/V ratio= (Fixed Cost + Profit) /Sales
OR (Sales Variable Cost)/Sales
P/V ratio may be expressed as percentage by
multiplying the above calculation by 100.
Concept of Break- Even Point
Break Even point: represents the volume of sales or
production where there is No Profit No Loss.
At this point TOTAL SALES is just equal to TOTAL COST.
At Break Even point contribution is equal to fixed costs.
Sales below this point results in loss as the sales value
is less then the total cost.
Sales above the break-even point brings profit since
the total cost is less than the sales value.
Break even point is the point at which the total cost
line the total sales lines.

Break Even Point (Units)= Total fixed Cost/Contribution
per unit

Break Even Sales = Total Fixed Costs * Selling Price Per unit
Contribution Per Unit

Library Work:
Break Even Chart :
Advantages and Disadvantages of Break Even Chart
Margin of Safety: The Difference between sales and
the break even sales is called Margin of Safety. This
is the area of earning profit. A reasonable margin of
safety should be there, otherwise a small fall in
demand may be result in total loss.

Margin of Safety : Sales Break- even Sales
Or Profit / P/V ratio

Break Even Analysis
It is popularly know as cost volume profit
relationship. It show the level of operation where
cost and revenue are in equilibrium. It indicates
clearly the effect of changes in volume on profits.
As analysis of break-even data will reveal the effect
of various decision changing the size of fixed and
variable costs, Volume of production, Selling Prices
and Product Mix.
Advantages of Marginal costing
Fixation of Price:
Fixation of Price below the TOTAL COST of Production
In Special circumstances price may be below total cost
for Example:
1. Recession or depression
2. Competition
3. New level of Product
4 .Special Markets.
5. Special Customers etc.

Cost Control: Marginal Cost provides variable costs and
fixed costs separately. Cost information is reported
periodically and regularly to the management for decision
making and controlling the cost
Make or Buy Decision : it is often necessary to decided
whether a component be produced internally or to be
bought from outside. This decision can be taken by
comparing the purchase price with the marginal cost of
producing it. If the Marginal cost is less than the purchase
price the component may be manufacture utilizing existing
capacity.
Profit Planning: It is easy to plan the future operation to
earn maximum profit or to maintain specific levels of
production through break-even analysis
Utilization of Scares Resources:
{Problem of Key factor or limiting Factor}
Key factor is that resources which limits the
production and consequently decides the profit of
firm.
Limiting factor may be raw materials, Labor, Plant
capacity or capital.
The best utilization of such scarce resources is
guided by marginal costing technique. Contribution
and Contribution per unit of limiting factor indicates
the product or products whose production is to be
increased or reduced to stopped to earn the
maximum profit .
Choice of Profitability Product mix: Where
factory manufacture two or more product the
problem of selecting suitable combination of
different product arises. Marginal costing guides
that the products which gives the maximum
contribution, are to be produced in larger
quantities and products which gives lower
contribution are to reduced.
Performance Evaluation of Product.
Library Work
P/V Ratio = C/S; (S-V)/S ; (F+P)/S F/BEP;
Change in Profit
=(Changing in profit/Change in Sales)*100
BEP {Sales} = F/PV; (F*S)/ (S-V) ; (F*S)/C
B.E. Units = Total FC/ Contribution Per Unit
Profit = (PV)*(S-F); PV * Margin of safety
Fixed Cot = PV*BEP ; PV*(S-P)
Variable Cost = S-(F+P); S-C
Sales = C/PV; (S-V)/PV; (F+P)/PV
Desired Sales (units) = (F+ Desired Profit) C. per Unit
Desired Sales (Value) = Total C desired *Selling price
C. per Unit
Margin of Safety = S-BEP
Contribution = S-V
Contribution Margin Approach
How many Ice-Cream, having a unit costs of Rs. 2
and a selling price of Rs. 3, must a vendor sell in a
fair to recover the Rs. 800 fees paid by him for
getting a selling stall and additional cost of Rs. 400
to install the Stall?

A Company budget productions of 5,00,000 units at a
variable cost of Rs. 20 each. Fixed Costs are Rs. 20,00,000.
the selling price is fixed to yeild 25% profit on total cost.
You are required to calculate
A. P/V Ratio B. Break-even Point
Ans: Variable Cost: Rs. 20
Fixed Cost Rs. 4
Total Cost =Rs. 24
Profit = 24*25/100 = Rs. 6
Selling Price = Rs. 30
Contribution = Selling Price Variable Cost = 30 20= Rs.10
P/V ratio= C/S = 10/30 = 1/3 0r 33.33%
BEP = F/P/V = 20,00,000/1/3 or
= 20,00,000*3/1 = Rs. 60,00,000



1. Calculate the break-even point from the following
figures. Total sales Rs. 2,75,000 Variable Exp. Rs.
5,00,000 Net Profit Rs. 1,08,000.
2. From the following Details find out the BEP
Variable cost per unit Rs. 30. Total Fixed Cost
Rs.1,08,000. Selling Price per unit Rs. 40. What
should be the selling Price per unit is BEP should
be bought down to 6,000 units?
3. From the following data calculate BEP and number
of units to be sold to earn a profit of Rs. 3,000 per
year. Selling price per unit Rs. 10, Variable cost per
unit Rs. 7. Fixed cost Rs. 27,000 Selling Rs. 12,600.


The cost data of Makaibari Tea Estate Ltd as
Material Rs.400; Labour- Skilled (Fixed) Rs. 200
other Rs 300: fixed Expenses Rs.400; Variable
Expenses Rs.200. the selling price per(kg) is Rs.
1700. These Figures are for an output of 80,000 Kg.
The capacity is 1,00,000 Kg. A foreign customer is
desirous of buying 20,000 Kg at a price of Rs.1200/
per Kg. Advice the manufacturer whether the order
should be accepted or rejected.
KS oil factory is producing two different product
kinds of articles, the limiting factor is the availability
of labour. From the following information show
which product is more profitable.
Product Blue Product Red
Material Rs. 5 Rs. 5
Labour 6 hr @Rs. 5 Per Hr Rs. 30
Labour 3 hr @Rs. 5 Per Hr Rs.15
Fixed Overheads- 50% :Labour Rs. 15 Rs. 7
Variable Cost Rs. 15 Rs. 15
Selling Price Rs. 95 Rs.65
Total production units 500 600
The Following Figures are available from the records
of Venus Enterprises as at 31
st
March
2008 2009
Sales (Rs. Lacs) 150 200
Profit (Rs.Lacs) 30 50
Calculate:
a) the P/V Ratio and Total Fixed Expenses
b) The Break-even Analysis
C) Sales Required to earn a profit of Rs.90Lacs
d) Profit Or loss that would arise if the Sales were
Rs. 280 lacs.
Reprographics Ltd. Manufacture a duplicating machine
which gas a variable cost structure as material Rs.
40,Labor Rs. 10, Overhead Rs. 4 and selling price of
Rs.90. Sales During the current year are expected to be
Rs. 13,50,000 and fixed cost Rs.1,40,000. Under a
Wages agreement, an increment of 10% is payable to
all direct workers from the beginning of the information
year while material costs are expected to increase by
7.5% Variable cost by 5% and fixed cost by 3%
You are required to calculate:
A . New selling Price if the current P/V ratio is to
maintained
The quantity to be sold during the forthcoming year to
yield the same amount of profit s the current year
assuming the selling price to remain at Rs. 90.
From the following information, calculate the
turnover required to earn a profit of Rs. 30,000 and
Break-even Point. Fixed Cost Rs. 21,000 variable
Cost Rs. 2 per unit; Selling Price Rs. 5 Per Unit. if
the company is earning a profit of Rs. 30,000
express the margin of Safety available to it.
From the Following Data calculate the Break-even
Point; Sales Price Rs. 40, Direct Material Rs.16
Direct Labour Rs. 4 Variable Overheads Rs. 6.
Fixed Cost Rs. 40,000. if Sales are 20% above the
Break-even Point, Calculate the profit.
Calculate the Break even Volume From the
Following information. Profit Rs. 10,000 [20% Sales]
P/V ratio 50%.
Find out the total Profit and Marginal Cost per unit
from the following details. Fixed cost Rs. 9000
Break-even Units 3000, Total Sales (units) 5000
Selling Price per Units Rs. 9.00.
From the Following Details, find out the BEP.
Variable cost per unit Rs. 30. Total Fixed Cost Rs.
108000. Selling Price Per Unit Rs. 40. What would
be the selling price per unit if the BEP should be
brought down to 6000 units.

A Company established that next year it would be
possible to sell 100000 units of product at Rs. 1 per
unit. The estimated Fixed cost and Variable cost are
Rs. 50000 and Rs. 40,000 respectively. Assuming the
price increase of 10% and consequently a reduction
of 5% is sale volume, compute the amount of sales
which company will earn Rs. 30,000 more profit
that the estimated Profit.
Mr. Ramesh sells a line of article for Rs. 18 per unit.
Each unit sold contributes Rs. 60 to the recovery of
fixed cost and to profit. His fixed cost of operation is
Rs. 84000. show how many units must be sold to
Break-even and compute the sales revenue at the
BEP and the sales required to earn a net profit of
Rs. 54000
Profit/ Volume Analysis
A Cost Volume Profit analysis can be used to
measure the effect of factor changes and
management decision alternative on profit.
These Factors Include possible changes in Selling
Price, Changes in Variable Cost or Fixed Cost
Expansion or Contraction of Sales Volume, or other
changes in operating methods.
It More useful in Profit Analysis is also useful for
problems of Product pricing, Sales mix, Adding and
Deleting product lines and Accepting a new sales
order.


Changes in Selling Price: (Effects)
Increase In Selling Price:
Will Increase P/V ratio, and the
Rate of Fixed Cost recovery is Increased
The breakeven Point (Sales Volume) declines.
Profit beyond the break point will increase
Loss below the break even point will decrease.
Decrease in Selling Price
All point will reverse.


A Company produce a product with a selling price
of Rs. 10 per unit and a variable cost of Rs. 4 per
unit. Fixed Costs are Rs. 36,000 per year.
Show the effect of 20% increase and decrease in the
present selling price.
Change in Variable Cost
Increase in Variable Cost:
(increase in Variable Cost has the same effect in
Decrease in Selling Price)
It Decrease the P/V Ratio
fixed Cost Recovery is slower
The break Even point will move to higher side
Profit after the break even point decreases
Loss before the Break Even Point will increase.
Decrease in Variable Cost:
Same Effect as Increase in Selling Price

A Company is selling a product for Rs. 40 a
unit and has a variable cost of Rs. 20 per unit.
Fixed cost total Rs.48,000 per year. Show the
effect of a 20% increased and a 20 % decrease
in Variable cost.
Change in Fixed Cost
Increase in Fixed Costs : (Effects)
The break-even point (Volume) will increase.
Profit Above the break-even point are lower by
the amount of the increase in Fixed cost.
Below the Break Even point losses Increase
Decrease in Fixed Costs : (Effects)
It Lowers the break-even point
The Profit are greater by the amount of the
decrease, and the losses are smaller by the
amount of the decrease in Fixed Cost.

A Company has a P/V ratio of 40% and present Fixed
Cost of Rs. 50,000. Show the effects of changes in
the fixed cost by Rs. 10,000.