Quick answer: Marginal costing separates costs into fixed and variable and treats only variable cost as product cost. Cost-volume-profit analysis then uses contribution (sales minus variable cost) to find the break-even point (fixed cost ÷ contribution per unit), the margin of safety (actual sales minus break-even sales) and the profit at any sales level. Example: fixed cost ₹1,20,000 and contribution ₹20 a unit give a break-even point of 6,000 units.
| Term | Formula |
|---|---|
| Contribution | Sales − variable cost |
| P/V ratio | Contribution ÷ sales × 100 |
| Break-even point | Fixed cost ÷ contribution per unit (or ÷ P/V ratio for sales value) |
| Margin of safety | Actual sales − break-even sales; profit = MOS × P/V ratio |
Marginal Costing and Cost Volume Profit Analysis: Q&A
Marginal costing is the ascertainment of marginal cost and its effect on profit of changes in volume or type of output by differentiating between fixed cost and variable cost.
1. What do you understand by marginal cost?
It is the amount by which aggregate cost is changed if the volume of output is increased or decreased by one unit at any given volume of output.
2. What do you mean by break-even point?
The break-even point is that point of sales where there is no profit and loss at this point contribution is just equal to fixed costs.
3. Explain the meaning of contribution?
When variable cost is deducted from sales the residual is termed as the contribution.
4. State factors affecting the break-even point?
The following factors will affect the break-even point:
- Increase in fixed cost.
- The decrease in fixed cost.
- Increase in variable cost.
- The decrease in variable cost.
5. Give any two applications of contribution?
- Helpful in taking the decision to accept or reject the new order.
- Determination of selling price in certain circumstances etc.
6. What is the meaning of margin of safety?
The margin of safety is the excess of actual sales over the break-even sales volume.
7. What do you understand by key factor?
It is an internal or external factor that restricts production sales or profit of the concern it is also known as the limiting factor or principal budget factor.
What is the angle of incidence? When the total sales line and the total cost line are drawn on a break-even chart, the angle at which the sales line cuts the cost line is the angle of incidence. A large angle means profit rises quickly once the break-even point is passed.
8. What do you understand by cost volume profit analysis?
Cost-volume-profit (CVP) analysis studies how costs and profit change as output and sales volume change. Costs are split into fixed and variable, and the analysis is used to find the break-even point, the margin of safety, the sales needed for a target profit and the effect of changes in price, cost or sales mix on profit.
9. What is the assumption of break-even analysis?
The selling price per unit stays constant and is higher than the variable cost per unit; variable cost per unit stays constant; and total fixed cost stays the same within the relevant range of output.
The presentation of break-even analysis in the form of a chart or graph is termed a break-even chart.
The manager can appraise the business situation at a glance and it is easy to understand for the person not possess accounting knowledge.
Marginal cost at the different production levels, fixed cost. The volume of sales and profit or loss can be understood with this chart.
It helps in analyzing the effect of the change in one factor over other factors and re vales margin of safety.
11. What is the importance of the Margin of Safety?
It indicates the profitability and safety of any business. A comparative study is feasible between two or more business enterprises with the help of computing safety and a margin of safety.
The Margin of safety may increase on account of the following changes:
- Increase in selling price.
- the decrease in variable cost.
- the decrease in fixed costs and.
- shut down for non-profitable production and start profitable production.
Worked Example
Fixed costs are ₹1,20,000, the selling price is ₹50 a unit and the variable cost is ₹30 a unit. Contribution is ₹20 a unit, so the P/V ratio is 20 ÷ 50 = 40%.
- Break-even point = 1,20,000 ÷ 20 = 6,000 units, or ₹3,00,000 of sales
- If actual sales are ₹4,00,000 (8,000 units), margin of safety = ₹1,00,000, or 25% of sales
- Profit = margin of safety × P/V ratio = 1,00,000 × 40% = ₹40,000 (check: 8,000 × 20 − 1,20,000 = ₹40,000)
