Marginal costing

MARGINAL COSTING
MARGINAL
COSTING
Operating
Cost
Job
Costing
Process
Costing

MARGINAL COSTING
 Marginal Costing is not a system of costing such a
Job Costing and Process Costing. Marginal Costing
is the cost of producing one extra unit of the
output.
 Marginal costing is helpful for industries to perform
the functions like profit planning, cost control and
decision-making.
 Marginal costing basically concern with the
determination of product cost, which consist of
TOTAL COST- FIXED COST
e.g. Direct Material, Direct Labour, Direct Expenses
and Variable Overheads.

APPLICATION OF MARGINAL COSTING FOR
INDUSTRIES
Application
for
Industries
Profit
Planning
Cost
Control
Decision
making

DEFINITIONS OF MARGINAL COSTING
 ICMA London- “The ascertainment of marginal cost
by differentiating between fixed and variable cost
and of the effect of profit or changes in volume or
type of output”.
 “The ascertainment of marginal cost, of the effect
on profit of changes in volume or types of output”.

FORMULA
 Marginal Cost = Variable Cost
Hence, Marginal Cost = Direct Material+ Direct Labour+ Direct
Expenses+ Variable Overheads.
In brief,
Marginal Cost = Prime Cost + Variable Overhead.
Similarly, Sales = Variable Cost + Fixed Cost + Profit
(if loss less)
So, Sales = Variable Cost + Fixed Cost + Profit
But, by marginal costing,
Sales – Variable Cost = Contribution
Again,
Contribution – Fixed Cost = Profit
Hence, Contribution = Fixed Cost + Profit

CONTRIBUTION
 Contribution is the excess of selling price over
variable cost. It is known as contribution, because it
contributes towards recovery of the fix cost and
profit.
Contribution= Sales – Variable Cost
OR
Contribution = Fixed Cost + Profit

IMPORTANT POINTS OF CONTRIBUTION
Contribution is not a profit.
It covers fixed cost and balance
left out is profit.
Plays important role in decision-
making.

PROFIT/ VOLUME RATIO
CONTRIBUTION
SALES

PROFIT / VOLUME RATIO (P/V RATIO)
 It expresses the relationship between
contribution and sales.
 P/V Ratio is most important to watch in business.
 It is the indicator of rate at which the organization
is earning profit.
 A high ratio indicates high profitability and low
ratio indicates low profitability.
 Uses:-
1. For calculation of Break- Even point.
2. Profit at a given level of sales.
3. Sales required to earn a certain amount of profit.

FORMULA FOR P/V RATIO
 P/V Ratio =
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
𝑆𝑎𝑙𝑒𝑠
× 100
OR
P/V Ratio =
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑜𝑓𝑖𝑡
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑠𝑎𝑙𝑒𝑠
× 100
OR
 P/V Ratio =
𝑆−𝑉
𝑆
× 100
 P/V Ratio =
𝐹𝐶+𝑃
𝑆
× 100
 This ratio is always expressed in percentage.

BREAK – EVEN POINT
SALES
PRODUCTION
BEP
[No Profit, No Loss]
Loss

BREAK – EVEN POINT [BEP]
 Break- Even Point is the point at which total
revenue is equal to total cost.
 It is that level of output (sale) where there is
situation like no profit or no loss.
TR=TC
 At this stage contribution is just sufficient to absorb
fixed cost. The organization starts earning profit
when output activity crosses this point.

FORMULA (IN UNITS)
 BEP(in units) =
𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡
𝐶𝑜𝑛𝑡𝑖𝑟𝑏𝑢𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
OR
 BEP(in units) =
𝑇𝑜𝑡𝑎𝑙 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡
𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡−𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
OR
 BEP(in units) =
𝐵𝑟𝑒𝑎𝑘 𝐸𝑣𝑒𝑛 𝑆𝑎𝑙𝑒𝑠 (𝑖𝑛 𝑅𝑠)
𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡

FORMULA (BASED ON BUDGET TOTALS)
 BEP ( in units) =
𝑃/𝑉𝑅𝑎𝑡𝑖𝑜
OR
 BEP (in units)=
× 𝑆𝑎𝑙𝑒
OR
 BEP (in units)= 1 −
𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
OR

FORMULA (BASED ON BUDGET TOTALS)
 BEP (in units)=
𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡×𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
OR
 BEP (in units)=
𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡×𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡−𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
OR
 BEP (in units)=
𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡×𝑆𝑎𝑙𝑒𝑠
𝑆𝑎𝑙𝑒𝑠−𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡

ASSUMPTIONS OF BEP
 Break-Even Analysis is based on the following
assumptions:-
 Market is sufficient to absorb the entire output.
Cost
• Classified as
• Fixed and variable categories
Fixed Cost
• Remains fix
• For entire volume
Selling per
unit
• Remains same
• For entire volume

USES OF BEP
 Facilitate determination of selling price which will
give desired profits.
 Makes possible to divide the sale volume to cover a
given rate of return on cash employed.
 Used for management for forecast profit and
volume at level of activity.
 Suggest to make a change in sales mixed.
 Helps management to do interfirm comparison of
profitability
 Shows the impact of changes in cost on profit.
 Enables management to plan for optimum
utilisation of the capacity.

LIMITATIONS OF BEP
COST&SALES(inRs.)
Y
PRODUCTION (in Volume)
X
BEP
TOTAL COST LINE
FIXED COST LINE (F.C. LINE)
VARIABLE COST
O

LIMITATIONS OF BEP
 Break- Even Analysis is the subject to certain
limitations which are as follows:-
 BEP is based on the assumptions that cost can be
classified into fixed and variable categories. In
practice, it is very difficult to have such a clear- cut
distinct between fix and variable cost. These costs
which cannot be classified accordingly.
 BEP indicates a static picture. It becomes out of
date if, there is a change in the assumptions or
conditions.

LIMITATIONS OF BEP
 Company manufacturing variety of product cannot
represent the fact of each product in the chart.
 Break – Even Chart does not considered the
amount of capital employed which is very vital in
many decisions.
 In a practice, assumption and fixed cost remains
constant, may not hold true.
 Selling price may not remain constant.
 Variable cost may not vary in direct proportion to
the volume.

MARGIN OF SAFETY
 It shows that BEP is much below the actual
sales. In this cases if there is a fall in the sales
there will still be profit but if the margin of safety is
low, any reducing in sales will be of agrave concern
for the company.
 The fixed cost are recovered up to the Break Even
Point [BEP].
 Hence, all the contribution after BEP (sales)
amount at profit. Margin of safety is always
related to profit.

GRAPHICAL REPRESENTATION (M/S)
SALES LINE
FIXED COST LINE
BEP
SALE
ACTUAL
SALE
X
Y
0

FORMULA FOR MARGIN OF SAFETY
 Selling Price < Total Cost = Loss.
 Selling Price > Total Cost = Profit.
 Profit = Margin of Safety × P/V Ratio.
 Margin of Safety =
𝑃𝑟𝑜𝑓𝑖𝑡

EXAMPLE
 If profit is 25%, PV Ratio is 50%
 Margin of Safety =
=
25
50
× 100
= 50

When the Margin of Safety is not satisfactory the
following steps become necessary:-
1. Reduction of Fixed Cost.
2. Reduction of Variable Cost.
3. Increasing the Selling Price.
4. Increasing the Sales Volume.
5. Improving the contribution by changing the sales
mix.

INTRODUCTION
 Break- Even chart is a graphical representation of
marginal costing.
 It indicates the relationship between cost and
volume of profits.
 It shows not only the BEP but also shows the effect
of cost and revenue at varying levels of sales.

SHOWS THE FOLLOWING INFORMATION
 Fixed Cost.
 Variable Cost.
 Total Cost.
 Sales Volume/Value.
 Profit or Loss.
 Break Even Point.
 Margin of Safety.

ASSUMPTIONS
 The following are the assumptions, which are listed
below:-
 Fixed Cost will remain constant.
 Price of Variable Cost factors will remain
unchanged.
 Semi- variable cost is separated into Fixed Cost
and Variable Cost.
 Method of production will not change.
 Operating efficiency will remain unchanged.
 No changes in Pricing policy.
 Sales equals production.
 Production mix will remain constant.

GRAPHICAL PRESENTATION
Y
0
X
SALES LINE
TOTAL LINE
FIXED COST LINE
PRODUCTION (VOLUME)
COSTSALES(InRs.)

ADVANTAGES OF BREAK EVEN CHART
Simple to construct and understand.
Studying the relationship between cost,
volume and profit for decision of sale.
Understanding the strength and profit
warning of Business concern.
Selecting the most profitable product
mix.

ADVANTAGES OF BREAK EVEN CHART
 It is simple to construct and understand, facts
represents graphical are understood well.
 Helps management in studying the relationship
between cost, volume and profit for decision of
sale.
 Helps management in understanding the strength
of profit and warning capacity.
 Helps management in selecting the most profitable
product mix.

LIMITATIONS OF BREAK EVEN CHART
Indicates a static picture.
Cannot represent the fact of each product
in the chart.
Does not considers the amount of capital
employed which is very important for many
decisions.

LIMITATIONS OF BREAK EVEN CHART
 BEC indicates a static picture due to this it
becomes out dated if there is change in
assumptions and conditions.
 A company manufacturing monthly of product
cannot represent the fact of each product in the
chart.
 BEC does not consider the amount of capital
employed which is very vital in many decisions.

CALCULATING FACTORS/ ELEMENTS
Collection of
Cash (in Rs.)
Unit / Rs.
(in %)
Unit / Rs. Unit / Rs.
Contribution P/V Ratio Break Even Point
(BEP)
Margin of Safety
(M/S)
(4) (5) (6) (4)
Sales
Variable Cost
Fixed Cost
Profit
Contribution
Sales
Fixed Cost
Profit
Variable Cost
Fixed Cost
Contribution
Sales
Variable Cost
Profit
P/V Ratio
Profit
P/V Ratio
Sales
Break Even Point

FORMULAS AT A GLANCE
Contribution P/V Ratio
(in %)
Break Even Point (BEP) Margin of
Safety
(M/S)
Contribution –
Fixed Cost =
Profit
P/V Ratio =
× 100
BEP (in units) =
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 (𝑝𝑒𝑟 𝑢𝑛𝑖𝑡)
M/S= Sales
Unit –
Break Even
Point (in
units)
Contribution =
Fixed Cost +
Profit
P/V Ratio =
𝑆𝑎𝑙𝑒𝑠 −𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡
×
100
BEP (in units) =
𝑆𝑎𝑙𝑒𝑠−𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡 (𝑝𝑒𝑟 𝑢𝑛𝑖𝑡)
M/S =
Contribution =
Sales – Variable
Cost
Sales =
BEP (based on Budget
cost)=
Profit =
Margin of
Safety ×
P/V Ratio
Contribution =
Sales × P/V
Ratio
P/V Ratio =
𝐶ℎ𝑎𝑛𝑔𝑒𝑠 𝑖𝑛 𝑃𝑟𝑜𝑓𝑖𝑡
𝐶ℎ𝑎𝑛𝑔𝑒𝑠 𝑖𝑛 𝑆𝑎𝑙𝑒𝑠
× 100
BEP (in units) =
× 𝑆𝑎𝑙𝑒𝑠
P/V Ratio =
𝐶ℎ𝑎𝑛𝑔𝑒𝑠 𝑖𝑛 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
𝐶ℎ𝑎𝑛𝑔𝑒𝑠 𝑖𝑛 𝑆𝑎𝑙𝑒𝑠
×100
BEP (in units) =
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 (𝑝𝑒𝑟 𝑢𝑛𝑖𝑡)

ANGLE OF INCIDENCE
Y
0
XPRODUCTION (in Volume)
COST&SALES(inRs.)
SALES LINE
TOTAL COST LINE
FIXED COST LINE
PROFIT AREA

EXPLANATION
 It is formed by intersection of sales line and total
cost line at the BEP.
 Shows rate of organization of earning profit.
 Wider the angle, greater is the rate of earning profit
with increase in sales.
 Large angle of incidence greater margin of safety
shows extremely favorable situations.
 Hence, efforts are made to increase this angle as
wide as possible by the management. It shows high
margin of safety and best business position.
Companies like:- Apple , Reliance Jio ,etc
$ 265,595 ₹1,148 crore
 (Revenue) $ 170 million

COST – PROFIT VOLUME ANALYSIS

 The objective of any organization is to earn profit. It
depends upon a large number of factors, but mostly on
cost of manufacture and volume of sales effected.
 Cost is affected by :-
 Volume of Production.
 Production mix.
 Internal Efficiency.
 Methods of Production.
 Size of Plant.
These factors volume is most significant which
influences greater on cost.

 Cost is divided into two categories they are fixed cost and
variable cost. Volume is affected by many factors. There
are some outside factors which are beyond the control of
management. Profits are affected by cost and volume
both.
 Cost – volume profit analysis shows the picture of profits
at various levels of production activities such as purchases
of raw materials, work in progress and sales, etc.
 It distinguishes between the impact of sales fluctuations
and results of price of cost upon profit i.e.
𝐶
𝑃
.
 It enables the management to understand the change in
profit in a relation of output and sales.

 Volume is expressed in terms of sales capacity i.e. percentage
of maximum sales,
value of sales,
unit of sales.
 Production capacity is expressed in terms of
percentage of maximum production,
production in physical terms,
direct labour hours and
machine hours.
 C- VP analysis involves consideration of the following factors:-
1. Volume of Sales.
2. Selling Price.
3. Product Mix.
4. Variable Cost per unit.
5. Total Fixed cost.

KEY FACTOR
 We studied under marginal costing, that the
profitability of a proposal is in terms of its
contribution.
 For maximization of profit, the firm would imply all
its resources and produce that quantity which will
give maximum contribution to profit. (i.e. Use of
optimum resources).
 Constraints are faced by organization daily in
production process, such constraints / problems are
called as limited constraints.

Marginal costing

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