MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)

CONCEPT OF MARGINAL COST

INTRODUCTION
The term marginal cost implies the additional cost involved in producing an
extra unit of output, which can be reckoned by total variable cost assigned to
one unit. It can be calculated as:

Marginal Cost = Direct Material + Direct Labour + Direct Expenses + Variable

Overheads.

DEFINITION
“the ascertainment of marginal costs and the effect on profit changes in
volume by differentiating between fixed cost and variable cost”.

_____________ICMA___________

MEANING
Marginal costing is a method where the variable costs are considered as the
product cost and the fixed costs are considered as the costs of the period are
written off against total contribution earned in that period. Contribution is the
excess of sales over marginal (variable) cost. Even the inventory is valued only
at marginal cost.

(OR)

In marginal costing, statements costs are separated as variable and fixed costs
for decision-making. Variable cost is a product cost and charged to units of
output whereas fixed cost is treated as period cost and is fully written off in the
income statement. (1)

PREPARED BY--------------D.D.S
MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)
MARGINAL COST EUATION The marginal cost includes any cost incurred in
producing the next unit of the product and hence is expressed as:

MC = ΔTC/ ΔQ

Where,
ΔTC = Change in total cost, ΔQ = change in quantity

The purpose of marginal cost is to determine the point where the firm reaches its
economies of scale. This can be shown in the figure given below:

The marginal cost curve is a U-shaped curve, which shows that cost starts at higher point
and declines with the increase in the production. The cost declines with the increase in the
level of output because of the economies of scale. When the cost is lower, the firm can hire
specialized labour, avail discount benefits on bulk purchase of raw materials, enjoy the full
utilization of machines and equipment, etc.

But after some time, the marginal costs starts rising, which shows, the cost increases with
the increase in the level of output. This is because the curve reaches the point where
diseconomies of scale persist. The costs rise because the resources from the current source
might have completely exhausted and the firm purchases raw materials from other sources
at a relatively higher price, hire more management, buy more machines and equipment, etc.

Till the price charged for the product is greater than the marginal cost, the revenue will be
greater than the added cost and the firm will continue its production. But, as soon as the
price charged is less than the marginal cost, the revenue declines, and it is not wise to
expand production. (2)

PREPARED BY--------------D.D.S
MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)
We know that profit is the difference between sales and total cost. Total cost
can be bifurcated into fixed costs and variable costs.

Sales—cost =profit (s-c=p)

^ M.STATEMENT

V.C F.C SALES XX

S—(V+F) =P --V.COST XX

S—V—F =P _________

S—V =F+P CONTRIBUTION XX

S—V =F+P = C --F.COST XX

S—V=C _________

F++P=C PROFIT XX

S—V=F+P

S(PVR)=F+P

S=sales f.c=fixed cost p=profit

V.c=variable cost c=contribution/cost

(3)

PREPARED BY--------------D.D.S
MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)
1) p v ratio=contribution/sales*100

( or )

Changes in profit/changes in sales*100

2) B.E.P/B.E.S=F.C/PVR (OR) F*S/S-V

3) Margin of safety=sales-B.E.S (OR) profit/pvr

4) Break even sales units=F.C

_____________________

S.P/units—v.c/units

5) S—V =F+P

} C
S(PVR)=F+P

(4)

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PREPARED BY--------------D.D.S
MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)
CHARACTERISTICS/FEATURES OF MARGINAL COSTING

1) Marginal costing is based on marginal cost, which is considered as product

cost.

2) Total cost is bifurcated into fixed and variable costs. Even the semi variable
costs are divided into fixed and variable components.

3) Variable costs are only considered in decision making and the term marginal
cost is used in the same sense as variable cost for all the practical purposes.

4) Fixed costs are ignored in managerial decision making as they are treated as
period costs.

5) Pricing of stock of finished goods and work in progress are done at marginal
cost.

6) Profits is determined by subtracting fixed costs from contribution, when

contribution is sales minus total marginal costs.

(5)

PREPARED BY--------------D.D.S
MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)
1) Decision-making marginal costing is a technique of control or decision
making.

2) Classification the total cost is divided into fixed and variable cost even
semi variable cost sir also analyser into fixed and variable costs.

3) Cost of product only the variable costs (marginal costs) are treated as the
cost of the product.

4) Valuation of stock the stock of work in progress and finished goods are
valued at variable cost fixed cost will not be included in the valuation of stocks.

5) Charge fixed costs are treated as period costs and are charged to costing
profit and loss account. (variable costs alone are charged to production. Fixed
costs are recovered from contribution. )

6) Contribution selling price is based on marginal cost by adding contribution.

Contribution is the difference between sales and marginal cost. 

7) Ascertaining the profitability at various levels of activity is affected by

calculating cost volume profit relationship.

8) Integral part B.E analysis & c-v-p analysis are integral part of product.

9) Managerial Decisions: It is a technique of analysis and presentation of

costs which help management in taking many managerial decisions such as
make or buy decision, selling price decisions etc.

(6)

PREPARED BY--------------D.D.S
MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)
USES/ADVANTAGES/UTILITIES/MERITS/IMPORTANCE

1) Simple & easy to understand it is based on variable cost. Hence,

statements prepared under this marginal costing is less complicated for
understanding as well for computation.

2) Inventory valuation while valuing stocks, fixed costs are not considered.
Hence there is no chance for untrue profits by over-valuing or under valuing
stocks.

3)Helpful to management it is very helpful to mgt exercising decisions like

make or buy ,accepting an export order, foreign sale or inland sale, problems
of key factor etc.

4) Cost control: in marginal costing there is fixed cost as well as variable

cost .Fixed cost is controlled by top management and variable cost is
controlled by lower management. Sometimes there are the cases when profit
decreases even when sale increases in such situations marginal cost helps the
concern in finding out the reasons.

5) Profit planning: profit increased and decreased due to change in selling

price, variable cost etc. marginal cost helps in profit planning. B.E charts, profit
graphs, m.o.s etc are the base in marginal costing technique. They help to cvp
relationship which in turn will reveal the efficiency of products, processes and
departments.

6) Make or buy decision: it is better for the company to use its idle capacity
and produce component parts in the factory itself rather than buying them
from the market. If its cost is less than it is better to make it in the factory.

7) Selection of good product mix: this happens in the case when company
is producing number of products in that case it is better to select a good
product mix which gives more of profit.

8) Effect of change in sale price: management must be aware of the effect

of change in price and make necessary changes from time to time.

(7)

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MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)
9) Closing down activities: sometimes it becomes necessary for the
management to close or suspend some activities of a particular product.

10) Alternative method of production: marginal costing is helpful in

knowing which alternative method of production is to be selected.

11) At the end while selecting alternative course of action management must
maintain desired level of profit.

11) Uniform stock of w-i-p and finished goods are valued at marginal cost,
which is uniform.

(8)

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MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)
LIMITATIONS/DE-MERITS/DIS-ADV/DRAWBACKS
 1) Segregation the total costs cannot be easily segregated into fixed costs
and variable costs.

2) Taxation Tax authorities do not accept the valuation of stock since the
shock does not show true value.

3) Recovery the stock is valued at marginal cost, hence in the case of loss due
to fire, full loss cannot be recovered from the insurance company.

4) Controlling in controlling costs, marginal costing is not useful in concerns

where fixed costs are huge relation to variable costs.

5) Unrealistic Marginal cost data becomes unrealistic in case of highly

fluctuating levels of production, e.g., in case of seasonal factories.

6) Effective It can correctly assess the profitability on a short-term basis only,

but for long term it is not effective.

7) Vary It is based on an unrealistic assumption that all costs can be

segregated into fixed and variable costs. In the long term sales price, fixed cost
and variable cost per unit may vary.

8) Quality decision:- the management cannot take a quality decision with

the help of contribution alone. The contribution may vary if new techniques
followed in the production process. (Fixation of selling prices in the long run
cannot be done without considering fixed costs. Thus, pricing decisions
cannot be based on marginal cost alone).

9) Variable cost remain constant:-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.

10) Selling price do not remain constant  Selling prices do not remain
constant forever and for all levels of output due to competition, discounts for
bulk orders, changes in the general price level, etc. (9)

PREPARED BY--------------D.D.S
MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)
11) Ignore fixed expenses:-It is found unsuitable in industries like ship
building, contract etc., where the value of work-in-progress is high in relation
to turn over if fixed expenses are ignored in the valuation of work-in-progress,
losses may occur every year till the contract is completed. On completion there
may be huge profit. It may create Income Tax problems.

12) Ignore time factor 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.

13) Fails to reflect the exact change:-With the change of Technology and
owing to automation of industries, it results in more fixed cost. Marginal
costing fails to reflect the exact change because of adoption of new
technology. (10)

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MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)
BREAK-EVEN ANALYSIS
INTRODUCTION

Break-even analysis is a technique which is designed to help management in

planning and decision-making functions involving the effect of change in
volume on the profitability. There may be a change in level of production due
to many reasons like competition, introduction of new product, trade
depression or boom, increased demand for products, change in selling prices
of products etc.,. In such cases, management must study the effect on profit on
account of changing levels of production. Management has to select from
among the available alternatives, the best one that can be implemented within
a one year period.

MEANING

The study of cost volume profit analysis (CVP) is often referred to as “break
even analysis”. It is a logical extension of marginal costing.

The term “break even analysis” is used into senses narrow sense and broad
sense. In its broad sense, break even analysis referred to the study of
relationship between costs, volume and profit at different levels of production.
In its narrow sense, it refers to a technique of determining that level of
operations where total revenue = total expenses, i.e., the point of no profit, no
loss.

DEFINITION

“it determines at what level cost and revenue are in equilibrium”.

------------MATX CURRY & FRANK-----------------

(11)

PREPARED BY--------------D.D.S
MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)
(IMPORTANCE OF B.E.A)

1) Sales volume necessary to produce an excellent of operating profit.

2)the operating profit or loss at X sales volume.

3)profit that results from an x % increase in sales volume.

4)the additional sales volume required to maintain the current profit level in
case of X % reduction in selling price.

5) the effect of increase in fixed cost on operating profit.

6) the effect of reduction in variable cost on income.

7) sales volume required to cover the additional fixed charges from the
proposal new project.

8) the effect of change in sales mix on operating profit of the firm.

9) the effect of an increase in fixed cost due to new plant and a decrease in
labour costs on income of the firm.

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MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)
10) the sales volume needed to achieve the budgeted profit. (12)

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(ADVANTAGES OF BREAK EVEN ANALYSIS)

1) Profit change:-Forecasting the effect of price changes on Profit.

2) Wage rate change:-Forecasting the effect of changes in wage rate and

profit.

3) Plant on profit:-Forecasting the effect of changes in the size of plant and

on Profit.

4) Sales channel:-Forecasting the effect of changes in sales channel and

methods on Profit.

5) Controlling the manufacturing expenses.

6) Controlling the distribution administrative and general expenses.

7) Promotion:-Evaluating the promotional potentially of a new undertaking

project.

8)Compare :-Comparing the profitability of two or more concerns.

9) Economics :-Analysing the effect of operating organisation and building

structure on the operational Economics of the business.

10) Taxation :-Analysing the effect of taxation on profits.

11) Examining :-Examining the operating and financial leverage.

PREPARED BY--------------D.D.S
MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)

(13)

(F)Break even analysis also helps in decision regarding addition or deletion of a

product line. (14)

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MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)
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(DISADVANTAGES OF BREAK-EVEN-ANALYSIS)

1)Proportional wrong:-In practice, the total costs do not vary in proportion

to the total output, hence the assumptions that fixed cost remains constant
and variable cost vary proportionately may be wrong.

2) Cannot attend:-Maximum profit cannot be attend at maximum output,

since there will be more increase in total costs due to operation of law of
increasing costs.

3) Change in selling price:-Sales may not be constant since the supply

brings change in selling price.

4) Dynamic & short:-The breakeven technique is a static device i.e., it

cannot represent the dynamic conditions, hence, it has short utility.

5) Ignore:-The analysis ignore the costs that are neither a fixed nature nor
variable.

6) Depreciation:-The efficiency of men does not remain constant as they

become more efficient when they acquire more experience, whereas machine
lose their efficiency because of the depreciation. These may make the analysis
difficult and ineffective.

7) Complex:-Revenue and costs may be influenced by various factors, in

addition to the volume of production and sales. If all these factors are
considered, the analysis becomes difficult and complex.

8) Not equal:-Production and sales volumes may not be equal.

PREPARED BY--------------D.D.S
MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)
9 Change in price:-Change in price level is not considered.

10) Do not replace:-Like all the techniques and tools break even analysis is
only a tool to help the management in expediting the management decisions
and not to replace the management.

(15)

(16)

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PREPARED BY--------------D.D.S
MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)

(BREAK-EVEN-POINT)

“The breakeven is that point of activity (sales volume) where total

revenue and total expenses are equal”.

----------------T.HORNGREN----------------

The break-even point may also be called critical point or equilibrium point or
balancing point or no profit no loss point or zero profit and zero loss point.

B.E.P = FIXED COST/PV RATIO

(OR)

B.E.P= F*S/S-V

1) Cost:-total costs fixed and variable costs can be read from the chart for any
level of activities.

2) Sales revenue: sales revenue can also be directly noted for any level of
activities.

3) Profit and loss: the gap between the total cost line and the sales line
gives the profit or loss.

4) B.E.P: it is the point where sales and total cost lines intersects with each
other signifying that there is no profit or no loss.

PREPARED BY--------------D.D.S
MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)
5) Margin of safety: the excess of actual sales over the break even sales is
known as margin of safety.

6) Angle of incidence: an angle at which sales line cuts the total costs line.
This angle indicates the rate at which profits are being earned over the break-
even- point. The large angle is an indication of high rate of profit. On other
hand, a small angle indicates a low rate of profit and suggests that variable
costs from a major part of total costs.

(17)

1) Output or sales are plotted on horizontally Axis that i.e., x axis.

2) Cost revenue are plotted on vertical Axis i.e., y axis.

3) Fixed cost line is drawn parallel to x axis.

4) Total cost line is drawn above the fixed cost line.

The gap between the fixed and total cost lines represents the variable cost.

5) Sales line is drawn from origin.

PREPARED BY--------------D.D.S
MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)
6) The point of intersection of total cost and sales line is called the BEP.

7) The breakeven quantity of production can be identified by drawing straight

vertical line from BEP to x-axis.

8) Break even sales value can be determined by drawing straight horizontal line
i.e., from BEP to y-axis.

9) Area below the BEP represents loss and above indicates the profit. (18)

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(C.V.P ANALYSIS)

Cost volume profit analysis is a technique for studying the relationship

between cost volume and profit.

They are interconnected and dependent on one another. For example, profit
depends upon sales, selling price to a large extent depend 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.

"the most significant single factor in profit planning of the average

business is the relationship between the volume of business, costs
and profits".

---------------HERMAN C. HEISER----------------

(OBJECTIVES)

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MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)

(19)

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MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)

****************************************** (20)

(MARGIN OF SAFETY….MOS)
It is the differences between the actual (present) sales and break
even sales. Sales or output beyond break-even point is known as mos
bcz the mos sales generates profit, as fixed expenses are already
recovered at break-even point itself. It can also be expressed in %,
rupees .

PREPARED BY--------------D.D.S
MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)
MOS =PROFIT/P.V RATIO

MOS=ACTUAL SALES-BREAK-EVEN SALES

The mos can be improved by taking the following measures:

1) by increasing level of production.

2) by increasing the selling price.

3) by reducing the fixed cost.

4) by reducing the variable cost.

5) increasing the sales volume by increasing capacity.

6) by eliminating unprofitable products.

(21)

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(PROFIT VOLUME (PV) RATIO)

The relationship between profit and volume is expressed in this ratio. In other
words, it sets out the relationship between contribution and sales. As fixed
cost are ignored in this technique, this ratio is also known as contribution to
sales ratio(c/s ratio).

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MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)
PV RATIO=C/S*100

PV RATIO=~P/~S*100 (WHEN 2 YRS GIVEN)

PV RATIO=S-VC/S*100

PV RATIO=F.C+P/S

(CONTRIBUTION)

It is the difference between sales and variable cost. It is the amount that is
contributed towards fixed expenses and profit. In practice a majority of the
managerial decisions are based on the principle of contribution.

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.

C=S-V

C=FIXED EXP+P C=FIXED EXP-LOSS

1) it helps the mgt in the fixation of s.p. (ADVANTAGES)

2) it assist in determining the break-even point.

3) it helps in taking a decision as regards to adding a new product in the

market.

4) it helps the mgt in deciding whether to purchase or manufacture a product

or a component. ******************************** (22)

(FIXED COST)

Irrespective of the level of activity, these costs are fixed in nature. Hence,
these costs are called sunk costs or period costs or time costs.

Eg: office rent, factory rent, manager’s salary, etc.

PREPARED BY--------------D.D.S
MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)
“A cost which accrues in relation to the passage of time and which within
certain output and turnover limits tend to be unaffected by fluctuations in
the level of activity. (output or turnover)”.

1)fixed costs are time related.

2)it remains fixed within the limits of output or turnover.

3)it is unaffected by changes in the level of activity.

4)though it is called fixed cost in short run, in the long it may vary as for eg
when the policy of mgt is to expand after 10 years f.c will increase no matter
what volume of output is produced. Therefore, f.c is sometimes called as
“policy cost”.

(VARIABLE COST)

These costs are varying in proportion to the level of production and sales.
Hence, these costs are also called “product cost” or “marginal cost”.

Eg direct material, direct wages, direct expenses and variable overheads.

“It is defined as a cost which, in the aggregate, tends to vary in

direct proportion to changes in the volume of output or
turnover”.

(23)

BASIS FOR
FIXED COST VARIABLE COST
COMPARISON

Meaning The cost which remains same, The cost which changes
regardless of the volume produced, with the change in
is known as fixed cost. output is considered as a

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MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)
BASIS FOR
FIXED COST VARIABLE COST
COMPARISON

variable cost.

Nature Time Related Volume Related

Incurred when Fixed costs are definite, they are Variable costs are
incurred whether the units are incurred only when the
produced or not. units are produced.

Unit Cost Fixed cost changes in unit, i.e. as Variable cost remains
the units produced increases, fixed same, per unit.
cost per unit decreases and vice
versa, so the fixed cost per unit is
inversely proportional to the
number of output produced.

Behaviour It remains constant for a given It changes with the

period of time. change in the output
level.

Combination of Fixed Production Overhead, Fixed Direct Material, Direct

Administration Overhead and Labour, Direct Expenses,
Fixed Selling and Distribution Variable Production
Overhead. Overhead, Variable
Selling and Distribution
Overhead.

Examples Depreciation, Rent, Salary, Material Consumed,

Insurance, Tax etc. Wages, Commission on
Sales, Packing Expenses,
etc.

(24)

Definition of Fixed Cost:-The cost which remains constant at different levels of

output produced by an enterprise is known as Fixed Cost. They are not

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MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)
affected by the momentary fluctuations in the activity levels of the
organization.

Fixed Cost:-Fixed Cost remains constant does not mean that they are not going
to change in future, but they tend to be fixed in the short run. This can be
explained with an example, If your company is operating the business in a
rented building, so whether you produce tons of output, or you produce
nothing, you have to pay the rent of the building, so this is a fixed expense
which is constant over a period until the rent of the building increases or
decreases.

Definition of Variable Cost The cost which changes with the changes in the
quantity of output produced is known as Variable Cost. They are directly
affected by the fluctuations in the activity levels of the enterprise.

Variable Cost

Variable cost varies with the variations in the volume, i.e. when there is an
increase in the production, variable cost will also increase proportionately with
the same percentage and when there is no production there will be no variable
cost. The Variable cost is directly proportional to the units produced by the
enterprise. (25)

(MAKE OR BUY DECISION)

PREPARED BY--------------D.D.S
MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)
The management very often faces a problem as to whether component parts
should be manufactured by it or they should be purchased from an outside
supplier. When a company has surplus capacity to manufacture, then, it should
utilize its idle capacity instead of buying them from outside supplier. But,
before arriving at such a decision, it should compare the marginal cost of
manufacturing that particular part with the price quoted by the outside
supplier. In case, the price quoted is lower than the marginal cost of
manufacture, then, it is advisable to buy the part and not to manufacture.

(26)

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MARGINAL COSTING/CVP/BE ANALYSIS (MGT A/C’S)

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