costing.

2. All elements of cost—production, administration and selling and distribution are classified into
variable and fixed components. Even semi-variable costs are analysed into fixed and variable.
3. The variable costs (marginal costs) are regarded as the costs of the products.
4. Fixed costs are treated as period costs and are changed to profit and loss account for the period for
which they are incurred.
5. The stocks of finished goods and work-in-process are valued at marginal costs only.
6. Prices are determined on the basis of marginal cost by adding ‘contribution’ which is the excess of
sales or selling price over marginal cost of sales.
Contribution
Contribution is the difference between sales and variable cost or marginal cost of sales. It may also be
defined as the excess of selling price over variable cost per unit. Contribution is also known as
Contribution Margin or Gross Margin. Contribution being the excess of sales over variable cost is the
amount that is contributed towards fixed expenses and profit.
Contribution can be represented as : Contribution = Sales - Variable (Marginal) Cost (or)
Contribution (per unit) = Selling Price-Variable (or Marginal) cost per unit (or)
Contribution = Fixed Costs + Profit (- Loss)
Advantages of Contribution
The concept of contribution is a valuable aid to management in making managerial decisions. A few
benefits resulting from the concept of contribution margin are given below :
1. It helps the management in the fixation of selling prices.
2. It assists in determining the break-even point.
3. It helps management in the selection of a suitable product mix for profit maximisation.
4. It helps in choosing from among alternative methods of production; the method which gives highest
contribution per limiting factor is adopted.
5. It helps the management is deciding whether to Purchase or manufacture a product or a component.
6. It helps in taking a decision as regards to adding a new product in the market.
Marginal Cost Equation
For the sake of convenience, a marginal cost equation can be derived as follows :
Sales -Variable cost = Contribution or
Sales = Variable cost + Contribution or,
Sales = Variable cost + Fixed Cost +or- Profit /Loss or,
Sales - Variable cost = Fixed cost +or- Profit / Loss or,
S – V = F +or- P
where ‘S’ stands for Sales ‘V’ stands for Variable cost ‘F’ stands for Fixed cost ‘P’ stands for
Profit/Loss.
Ex.1: Determine the amount of variable cost from the following particulars ;
Sales Rs.1,50,000; Fixed Cost Rs.30,000; Profit Rs.40,000.
Solution:
Marginal Cost Equation is: Sales-Variable Cost +Fixed Cost +Profit/Loss
Or 1,50,000 – VC + 30,000 + 40,000
Or Variable Cost = 1,50,000 – 70,000 = Rs.80,000.
Ex 2. From the following information find out the amount of profit earned during the year using the
marginal costing technique.
Fixed cost Rs, 2,50,000; Variable cost Rs.10 per unit; Selling price Rs. 15 per unit;
Output level 75,000 units.
Solution:
S–V=F+P
Sales = 75,000 x15 = Rs. 11, 25,000
Variable Cost = Rs. 75,000 x 10 = Rs. 7, 50, 000
Fixed Cost = Rs. 2, 50,000
Profit (P) = ?
11, 25,000 -7, 50,000 = 2, 50,000 + P
3, 75,000 = 2, 50,000 + P
P = 3, 75,000 - 2, 50,000
Profit = Rs. 1, 25,000.
Profit /Volume Ratio (P/V Ratio or C/S Ratio)
The Profit/volume ratio, which is also called the ‘contribution ratio’ or ‘marginal ratio’, expressed the
relation of contribution to sales and can be expressed as follows:
P/V Ratio = Contribution / Sales
Since Contribution = Sales -Variable Cost = Fixed Cost + Profit,
P/V ratio can also be expressed as,
(Sales - Variable Cost ) / Sales ie.,(S – V) / S or
P/V Ratio = (Fixed Cost + Profit) / Sales ie., (F + P) / S or
P/V Ratio = (Change in profits or Contribution) / Change in Sales

The formula for sales volumes required to earn a given profit is:
P/V Ratio = Contribution / Sales or
P/V Ratio = (Fixed Cost + Profit) / Sales or
Sales = (Fixed Cost + Profit) / P/V ratio = (F + P) / P/V Ratio
Ex 3. Sales Rs. 1,00,000; Profit Rs. 10,000; Variable cost 70%. Find out (i) P/V ratio, (ii) Fixed Cost
(iii) Sales volume to earn a Profit of Rs. 40,000.
Sales Rs.1,00,000
Variable Cost = 70%
(70/100) X 1,00,000 = Rs.70,000
(i)P/V Ratio = (Sales — Variable Cost) / Sales x 100
= [(1,00,000 - 70,000)/ 1,00,000] x 100 = 30%
(ii) Contribution = Fixed Cost + Profit
or, 30,000 = Fixed Cost + 10,000
or, Fixed Cost = 30,000 -10,000 = Rs, 20,000
(iii) Sales = (Fixed Cost + Profit) / P/V Ratio
= (20,000 + 40,000) / 30%
(60,000 x 100)/ 30 = Rs, 2,00,000
Proof: Sales = Rs, 2,00,000
Variable Cost (70%) = Rs. 1,40,000
----------------
Contribution = Rs. 60,000
Fixed Cost = Rs. 20,000
------------------
Profit = Rs. 40,000
----------------
Ex 5: The sales turnover and profit during two years were as follows :
Year Sales Profit
Rs. Rs.
1981 1,40,000 15,000
1982 1,60,000 20,000
You are required to calculate : (i) P/V ratio (ii) Sales required to earn a profit of Rs. 40,000.
(iii) Profit when sales are Rs. 1,20,000.
Solution:
(i) P/V Ratio = [(Change in profit) / (Change in Sales)]x 100
(5,000/ 20,000) x 100 = 25%
(ii) Sales required to earn a profit of Rs. 40,000
P/V ratio = (Fixed Cost + Profit) / Sales
25/100 = (F+15,000)/ 1,40,000 OR (1,40,000 x25)/ 100 = F+15,000
35,000 - 15,000 = F ; Fixed Cost = Rs.20,000
Desired Sales = (F + P)/ P/V ratio
= (20,000+40,000)/ (25/100) = (60,000 X100)/25 = Rs.2,40,000.
(iii) Profit when sales are Rs. 1,20 000
S= (F+P) /P/V ratio ; or S x P/V ratio = F+P
Or 1,20,000 x (25/100) = 20,000 + P
Or 30,000 = 20, 000 + P
Or Profit = 30,000 - 20,000 = Rs. 10,000
COST-VOLUME-PROFIT ANALYSIS AND BREAK-EVEN ANALYSIS
Cost-Volume-Profit analysis is a technique for studying the relationship between cost,
volume and profit. Profits of an undertaking depend upon a large number of factors. But the
most important of these factors are the cost of manufacture, volume of sales and the selling
prices of the products. The CVP relationship is an important tool used for the profit planning
of a business.
The three factors of CVP analysis i.e., costs, volume and profit are interconnected and
dependent on one another, For example, profit depends upon sales, selling price to a large
extent depends upon cost and cost depends upon volume of production as it is only the
variable cost that varies directly with production, whereas fixed cost remains fixed regardless
of the volume produced. In cost-volume-profit analysis an attempt is made to analyse the
relationship between variations in cost with variations in volume. The cost-volume-profit
relationship is of immense utility to management as it assists in profit planning, cost control
and decision making.
Break-even Analysis
The study of cost-volume-profit analysis is often referred to as “break-even analysis’ and the
two terms are used interchangeably by many. This is so, because break-even analysis is the
most widely known form of cost-volume-profit analysis. The term “break-even analysis’ is
used in two senses—narrow sense and broad sense. In its broad sense, break-even analysis
refers to the study of relationship between costs, volume and profit at different levels of sales
or production, In its narrow sense, it refers to a technique of determining that level of
operations where total revenue equal total expenses, i.e., the point of no profit, no loss.
Break-even Point - The break-even point may be defined as that point of sales volume at
which total revenue is equal to total cost. It is a point of no profit, no loss. A business is said
to break-even when its total sales are equal to its total costs. The break-even point refers to
that level of output which evenly breaks the costs and revenues and hence the name. At this
point, contribution, i.e., sales minus marginal cost, equals the fixed costs and “hence this
point is often called as ‘Critical Point’ or ‘Equilibrium Point’ or ‘Balancing Point’ or no
profit, no loss.
Break-even point can be stated in the form of an equation :
Sales revenue at break-even point = Fixed Costs + Variable Costs.
Computation of the Break- Even Point
The break-even point can be computed by the following methods :
(i) Algebraic Formula Method
(ii) Graphic or Chart Method.
Algebraic Formula Method for Computing the Break-even Point
The break-even point can be computed in terms of : (a) Units of sales volume,(b) Budget total
or in terms of money value. (c) As a percentage of estimated capacity.
(a) Break-even Point in Units - As the break-even point is the point of no profit no loss, it is
that level of output at which the total contribution equals the total fixed costs. It can be
calculated with the help of following formula :
Break-Even Point = Fixed Cost / (Selling Price per unit - Variable Cost per unit)
=Fixed Cost /Contribution per unit
(b) Break-even Point in terms of budget-total or money value
At break-even point: Total Sales = Total Fixed Cost + Total Variable Cost
Or S=F+V (where S = Sales, F = Fixed Cost and V = Variable cost)
or S –V = F or (S-V)/(S-V) = F / (S-V) (dividing both sides by S – V)
or I= F/(S-V)
or S x I = (F x S)/ (S-V) (Multiplying both sides by S)
Hence, break-even sales = [Fixed Cost/ (Sales — Variable Cost)] x Sales
= [Fixed Cost/ Contribution] x Sales
With the use of P/V Ratio,
B.E.P = Fixed Cost/ P/V ratio As [Contribution /Sales] = P/V Ratio.
(c) Break-even Point as a percentage of estimated Capacity
Break-even point can also be computed as a percentage of the estimated sales or capacity by
dividing the break-even sales by the capacity sales.
B.E.P (as % age of capacity) = Fixed Cost / Total Contribution
Ex. 6. From the following information , calculate break-even point in units and in sales value:
Selling price per unit Variable cost per unit Total fixed cost
Output = 30,000 units; Selling price per unit Rs.30; Variable cost per unit Rs.20;Total Fixed
Cost Rs.20,000.
Solution
Break-even point (in units) = Fixed Cost / (Selling price per unit-Variable cost per unit)
=20,000/ (30-20) = 20,000/10 = 2,000 units.
Break-even point (in Sales Value) = (Fixed Cost x Sales) / (Sales - Variable cost)
Fixed Cost = Rs.20, 000 (given); Sales 3,000 x 30 = Rs.90,000 ;
Variable Cost = 3,000 x 20 = Rs.60,000.
Hence, B.E.P. (In Sales Value) = (20,000x90,000)/(90,000-60,000)
= (20,000x90,000) / 30,000 = Rs.60,000.
Otherwise, as BEP is 2,000 units, break – even sales would be = 2,000 x 30 = Rs.60,000.
Ex.7.From the following information, ascertain by how much the value of sales must be
increased by the company to breakeven:
Sales Rs. 3,00,000 ;Fixed Cost Rs. 1,50,000 ;Variable Cost Rs. 2,00,000.
Solution :
Break-even point = (Fixed Cost x Sales)/( Sales -Variable Cost)
= (1,50,000 x 3,00,000) / (3,00,000 - 2,00,000)
= (1,50,000 x 3,00,000) /1,00,000 = Rs. 4,50,000.
Hence, Sales to be increased by the company to break-even are,
= Rs. 4,50,000-3,00,000 = Rs. 1,50,000.
BREAK-EVEN CHART
The break-even point can also be computed graphically. A breakeven chart is a graphical
representation of marginal costing. The breakeven chart portrays a pictorial view of the
relationships between costs, volume and profits. It shows the break-even point and also
indicates the estimated profit or loss at various levels of output. The break-even point as
indicated in the chart is the point at which the total cost line and the total sales line intersect.
There are three methods of drawing a break-even chart.
Ex 8. Plot the following data on a graph (break-even chart) and determine
(a) break-even point (b) profit if the output is 25,000 units.

Output Variable Total Fixed Total Cost Selling Total

(Units) Cost Variable Expenses (Rs.) price/unit Sales
/Unit(Rs.) cost (Rs.) (Rs.) (Rs.) (Rs.)
0 5 0 75,000 75,000 10 0
5,000 5 25,000 75,000 1,00,000 10 50,000
10,000 5 50,000 75,000 1,25,000 10 1,00,000
15,000 5 75,000 75,000 1,50,000 10 1,50,000
20,000 5 1,00,000 75,000 1,75,000 10 2,00,000
25,000 5 1,25,000 75,000 2,00,000 10 2,50,000
30,000 5 1,50,000 75,000 2,25,000 10 3,00,000

First Method - Under this method following steps are taken to draw chart:
Second Method : Under this method Variable cost line is drawn first and then Fixed cost line
is drawn over and parallel to the Variable cost line.

Third Method: Total cost line is not drawn instead Contribution line is drawn.

Margin of Safety
The excess of actual or budgeted sales over the break-even sales is known as the margin of
safety. It is the difference between actual sales minus the sales at break-even point. It
represents the amount by which sales revenue can fall before a loss is incurred. As at break-
even point there is no profit no loss, sales beyond the break-even point represent margin of
safety because any ‘sales above the break-even point will give’ some profit.
Thus, Margin of Safety = Total Sales — Sales at Break-even Point.
Say, actual present sales are Rs. 5,00,000 and the break-even sales are Rs. 4,00,000, then
margin of safety is equal to Rs. 1,00,000, ie.5,00,000 - 4,00,000.
Margin of Safety can also be expressed in percentage. For example, if a company can break-
even at 60 per cent of the expected sales ; then it has a margin of safety of (100 — 60) 40 % .
In the previous example, margin of safety in percentage can be calculated as.
(1,00,000) / 1,50,000) x 100 = 20%.
Margin of safety calculated in percentage is also known as Margin of Safety Ratio and can be
expressed as:
M.S. Ratio = (M.S/ Sales) x 100
= [(Actual Sales - Sales at B.E.P)/Sales] x 100
Margin of safety can also be calculated with the help of the following formula :
Margin of Safety (M/S) =Profit / P/V Ratio
This is so because margin of safety is the volume of sales beyond break-even point and all
sales above the break-even point give some profit which can be calculated as :
Profit = Margin of Safety x P/V ratio
or M.S. = Profit / P/V Ratio
Ex 9. The following data are available from the records of a company:
Sales Rs. 60,000 ;Variable Cost Rs. 30,000; Fixed Cost Rs. 15,000.
You are required to :
(a) Calculate the P/V Ratio, Break-Even Point and Margin of Safety at this level.
(b) Calculate the effect of 10% increase in sale price. (c) Calculate the effect of 10% decrease
in sale price.
Solution:
(a) Contribution P/V Ratio= Contribution / Sales
Contribution = Sales — Variable Cost
= Rs. 60,000 -30,000 = Rs. 30,000

P/V Ratio = (30,000/ 60,000)x100 = 50%

Break even point = (Fixed Cost)/ P/V Ratio
= 15,000 /50% = (15,000 x 100)/ 50 = Rs. 30,000
Margin of Safety = Present Sales - Sales at B.E.P.
= Rs. 60,000 -30,000 = Rs, 30,000
(b) Effect of 10% increase in Sales Price :
Sales = Rs. 60,000 + 10% = Rs. 66,000
P/V Ratio = (Contribution/ Sales) x 100 = [(66,000 - 30, 000)/ 66,000]x100
=(36,000/66,000) x 100 = 54.55%
 Break-Even Point = Fixed Cost / P/V Ratio
= (Fixed Cost /Total Contribution) x Total Sales
=(15,000 /36,000 )x 66,000 = Rs. 27,500
Margin of Safety = Actual Sales - Sales at B.E.P.
= 66,000 -27,500 = Rs, 38,500

(c) Effect of 10% decrease in Sales Price :

Sales = Rs, 60,000 - 10% = Rs. 54,000
P/V Ratio = (Contribution / Sales) * 100
= (54,000 - 30,000) / 54,000 x 100
= (24,000/ 54,000) x 100 = 44.44%

Break-Even Point = (FC/ Total contribution ) x Sales

=(15,000/24,000) x 54,000 =Rs.33,750.
Margin of Safety = Actual Sales – Sales at B.E.P
= 54,000- 33,750 = Rs.20,250.

Advantages of Marginal Costing . The following are the important advantages of marginal
costing :
1, The technique of marginal costing is very simple to operate and easy to understand. Since,
fixed costs are kept outside the unit cost, the cost statements prepared on the basis of
marginal cost are much less complicated.
2. It does away with the need for allocation, apportionment and absorption of fixed
overheads and hence removes the complexities of under absorption of overheads.
3. Marginal cost remains the same per unit of output irrespective of the level of
activity. It is constant in nature and helps the management in production planning.
4. It prevents the carry forward of current year’s fixed overheads through valuation of
closing stocks. Since fixed costs are not considered in valuation of closing stocks,
there is no possibility of fictitious profits by over-valuing stocks.
5. It facilitates the calculation of various important factors, viz., break-even point,
expectations of profits at different levels of production, sales necessary to earn a
predetermined target of profit, effect on profit due to changes of raw materials prices,
increased wages, change in sales mixture, etc.
6.It is a valuable aid to management for decision-making and control. It helps
management in taking many crucial decisions, such as fixation of selling prices,
selection of a profitable product/sales mix, make or buy decision, problem of key or
limiting factor, determination of the optimum level of activity, close or shut down
decisions, evaluation of performance and capital investment decisions, etc.
7. It facilitates the study of relative profitability of different product lines,
 departments, production facilities, sales divisions, etc.
8. It is complementary to standard costing and budgetary control and can be used
along with them to yield better results.
9. Since fixed costs are not controllable and it is only variable or marginal cost that is
controllable, marginal costing, by dividing costs into controllable and non-
controllable, helps in cost control.
10. It helps the management in profit planning by making a study of relationship
between cost, volume and profits. Further, break-even arts and profit graphs make the
whole problem easily understandable even to a layman.
11. It is very useful in management reporting. Marginal costing facilitates
‘management by exception’ by focussing attention of the management towards more
important areas than to waste time on problems which do not require urgent attention
of the higher managements.
Limitations or Disadvantages of Marginal Costing
In spite of so many advantages, the technique of marginal costing suffers from the following
limitations :
1. The technique of marginal costing is based upon a number of assumptions which may not
hold good under all circumstances.
3. All costs are not divisible into fixed and variable. There are certain costs which are
semi-variable in nature. It is very difficult and arbitrary to classify these costs into
fixed and variable elements.
4. Variable costs do not always remain constant and do not always vary in direct
proportion to volume of output because of the laws of diminishing and increasing
returns.
4.Selling prices do not remain constant for ever and for all levels of Output due to
competition, discounts for bulk orders, changes in the general price level. Further,
marginal costing ignores the fact that fixed costs are also controllable.
6. The exclusion of fixed costs from the stocks of finished goods and work-in-
progress is illogical since fixed costs are also incurred on the “manufacture of
products, Stocks valued on marginal costing are undervalued and the profit and loss
account cannot reveal true profits. Similarly, as the stocks are undervalued, the
balance sheet does not give a true picture.
 7. Although the technique of marginal costing overcomes the problem of under or over-
absorption of fixed overheads, the problem still exists in fegard to under or over-
absorption of variable overheads.
8. Marginal costing completely ignores the ‘time factor’, Thus, if two jobs give equal
contribution but one takes longer time to complete, the one which takes longer time
should be regarded as costlier than the other. But this fact is ignored altogether under
marginal costing.
9. The technique of marginal costing cannot be applied in contract or ship-building
industry because in such cases, normally the value of work in-progress is very high and
the exclusion of fixed overheads may results into losses every year and a huge profit in
the year of completion of the job.
10. Cost control can better be achieved with the help of other techniques, viz., standard
costing and budgetary control than by marginal costing technique.

The contents in the E-Material have been prepared from the Text books and Reference books given in the Syllabus.