Marginal costing and CVP analysis are important management accounting techniques. Marginal costing involves separating total costs into fixed and variable components. It focuses on variable costs and marginal costs. CVP analysis examines the relationship between costs, volume, and profits. It is used to determine the break-even point and margin of safety. CVP provides important information for decision-making, budgeting, pricing, and performance evaluation.

1. Chapter 16
Marginal Costing And
CVP Analysis

2. Marginal Costing
• The term cost can be viewed from two angles basically.
– Direct Cost and Indirect Cost
– Fixed Cost and Variable Cost
• If fixed cost is included in the total cost, the per-unit
cost varies from one cost period to another with the
fluctuations in level of activities in two cost periods.
• Thus, per unit cost becomes incomparable between
two periods.
• To avoid this, it will be necessary to eliminate the fixed
costs from the determination of total cost.
• This has resulted into concept of Marginal Costing
Management Accounting
By Paresh Shah
Oxford University Press

3. Basics of marginal costing
• Marginal cost – cost of producing an
additional unit or output or service
• Marginal costing differentiates the fixed and
variable costs
Management Accounting
By Paresh Shah
Oxford University Press

4. Features Of Marginal Costing
• Semi-variable costs are included in
comparison of cost
• Only variable costs are considered
• Fixed costs are written off
• Prices are based on variable and marginal
contribution

5. Cost Behaviour Pattern
• The term cost behavior refers to the way costs
change with respect to a change in the activity
level.
• Many management decisions are affected by
cost behavior patterns.
• Numerous business decisions require
managerial accounting information on costs
by behavior patterns.

6. Segregation Of Mixed Costs
• It is essential that all costs be broken up into
their fixed and variable components.
• In case of costs like raw materials, it is
possible to conclude that they are wholly
variable costs.

7. Decision-Making
• Management accountants gather information
to be used in internal decision-making
situations of planning and control.
• Decision-making involves three basic steps:
– problem definition,
– alternative evaluation, and
– alternative selection.

8. Basic equation of Marginal Costing
• Profit = Sales – Total cost
• Profit = Sales – (Variable cost + Fixed cost)
• Profit + Fixed cost = Sales – Variable cost
• Sales – Variable cost = Contribution = Fixed
cost + Profit
• Contribution – Fixed cost = Profit

9. Marginal Cost
• Marginal cost is defined as the amount at any
given volume of output by which aggregate
costs are changed if the volume of output is
increased or decreased by one unit.

10. Determination Of Marginal Cost
• Marginal cost is the additional cost for
manufacturing one additional unit, which is
nothing else but the variable cost per unit,
and per-unit variable cost remains the same at
all the levels of activity.

11. Techniques or Methods Of Determination
Of Marginal Cost
• Two-point method
• Range Method
• Scatter Diagram Method
• Least-squares Method

12. Value Of Marginal
Costing To Management
• It integrates with other aspects of management
accounting.
• Management can easily assign the costs to products.
• It emphasizes the significance of key factors.
• The impact of fixed costs on profits is emphasized.
• The profit for a period is not affected by changes in
absorption of fixed expenses.
• There is a close relationship between variable costs
and controllable costs classification.
• It assists in the provision of relevant costs for decision-
making.

13. Limitations Of Marginal Costing
• To segregate the total cost into fixed and variable components is a
difficult task
• Under marginal costing, the fixed costs are eliminated for the
valuation of inventory , in spite of the fact that they might have
been actually incurred.
• In the age of increased automation and technological development,
the component of fixed costs in the overall cost structure may be
sizeable.
• Marginal costing technique does not provide any standard for the
evaluation of performance.
• Fixation of selling price on marginal cost basis may be useful for
short term only.
• Marginal costing can be used for assessment of profitability only in
the short run.

14. CVP Analysis
• The intention of every business activity is to
earn profit and maximize it.
• CVP analysis, also known as CVP relationship
aims at studying the relationships existing
among following factors and its impact on the
amount of profits:
– Selling price per unit and total sales amount
– Total cost, which may be fixed or variable, and
– Volume of sales

15. Relationship Of Costs
And Profits With Volume
• In Management Accounting, it is very
important to find out how costs and profits
vary in relation to changes in volume, i.e.
quantity of the product manufactured and
sold. Under certain assumptions, the
relationships are usually found to be linear.
• This means that if we draw a graph with
volume on the X-axis and costs or profits on
the Y-axis, the graph will be a straight line.

16. Relationship Of Costs
And Profits With Volume
• Assumptions for linear relationships
– Every cost can be classified as fixed or variable
– Selling price remains same
– There is only one product and in case of more
than one product, product mix is assumed to be
same.

17. Contribution
• Contribution = Sales – Variable Cost
• Contribution = Fixed Cost + Profit

18. Profit Volume (P/V) Ratio
• This ratio indicates the contribution earned
with respect to one rupee of sales.
• It is also known as Contribution Volume or
Contribution sales ratio.
• Fixed costs remain unchanged in the short
run, so if there is any change in profits, that is
only due to change in contribution.

19. P/V Ratio = Contribution x 100
Sales
P/V Ratio = Changes in profit x 100
Changes in Sales

20. Break-even Point (BEP)
• This is a situation of no profit and no loss. It
means that at this stage, contribution is just
enough to cover the fixed costs, i.e.
• In terms of Quantity:
• BEP = Fixed cost
Contribution per unit

21. • In terms of amount:
• Fixed Costs
P/V Ratio

22. Margin Of Safety
• These are the sales beyond the break-even
point.
• A business will like to have a high margin of
safety because this is the amount of sales
which generates profits.
• Margin of Safety = Sales – Break-even Sales

23. Uses Of CVP Analysis
• It enables the prediction of costs and profits for
different volumes of activity.
• It is useful in setting up flexible budgets.
• It helps in performance evaluation for the
purpose of control.
• It helps in formulating price policies by projecting
the effect on costs and profits.
• The study of CVP analysis is necessary to know
the amount of overhead costs, which could be
charged to products costs at various levels of
operation.
Management Accounting
By Paresh Shah
Oxford University Press

24. Limitations Of CVP Analysis
• Variable cost per unit may not be constant.
• Fixed costs may stabilize at higher levels as
volume increases.
• Selling prices may be lower at high volumes
because of sales discounts allowed.
• Changes in efficiency will affect the CVP
relationship.
Management Accounting
By Paresh Shah
Oxford University Press