Unit 4: MARGINAL COSTING

Meaning of Marginal Cost

Marginal cost is the variable cost comprising prime cost and variable overheads. It may be defined as “the
amount at any given volume of output by which the aggregate costs are changed if the volume of output is
increased or decreased by one unit”.

Definition of Marginal Costing

Marginal costing is, “the ascertainment by differentiating between fixed cost and variable cost of marginal
cost and of the effect on profits of changes in volume or type of output”.

Features of marginal costing

The main characteristics of marginal costing are summarized as follows:

1) All elements of costs are classified into fixed and variable components.
2) The marginal cost is treated as the cost of the product.
3) The value of stock of finished goods and work in progress also comprises only marginal cost.
4) Fixed costs are charged to profit and loss account of the period during which they are incurred.
5) Prices are based on marginal cost plus contribution.
6) The relative profitability of products is determined after a study of the contribution made available by
each product.

Profit Volume Ratio

This is a useful guide in determining the profitability of the business. Profit volume ratio shows the relationship
between contribution and sales and is usually expressed in percentage. A formula for computing profit volume
ratio is given below.

1) Profit volume ratio = Contribution x 100

Sales

2) Profit volume ratio = Sales - Variable cost x 100

Sales

3) Profit volume ratio = Fixed cost + Profit x 100

Sales

4) Profit volume ratio = Change in profit x 100

Change in sales

Uses of Profit Volume Ratio

1) The BEP and Variable cost can be easily computed with the help of profit volume ratio.
2) The margin of safety can also be calculated with the help of this ratio.
3) It is also used to ascertain the sales to attain the desired profit.
4) This ratio also helps in ascertaining the profit at any given amount of sales.

The following formula can be used to ascertain the sales or fixed cost or profit.

Sales = Fixed cost + profit

Profit volume ratio

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Sales (units) = Fixed cost + profit .
Contribution per unit

Contribution per unit = Selling price per unit - Variable Cost per unit.

How to improve profit volume ratio?

Profit volume ratio can be improved if contribution is increased and this can be done by any of the following
ways:-
a) Reducing the variable cost.
b) Increasing the selling price.
c) Selling more profitable products where the relative contribution margin is larger.

Contribution:

The difference between the selling price and the variable cost is known as contribution.
In other words, it is the excess of selling price over variable cost. A formula for computing contribution is
given below:
1) Contribution = Sales - Variable cost
2) Contribution = Fixed cost + profit
3) Contribution = Sales x Profit volume ratio

Uses of Contribution

1) The contribution margin is of considerable help in accepting or rejecting a new order.

2) It also helps in selection of a product mix.
3) The contribution margin is also used while choosing alternative methods of production.

Break Even Point

Breakeven point is the point where the total cost is equal to total revenue. It is a point of no profit and no loss.
It is also known as the volume of operations where the profit begins. The formula for computing break even
point is given below:

1) BEP (Units) = Fixed cost .

Contribution per Unit

2) BEP (Value) = Fixed cost .

Profit volume ratio

3) BEP (Value) = Fixed cost x Sales

Contribution

4) BEP (Value) = BEP (Units) x selling price per unit

Margin of Safety

The excess of actual sales over BEP is called the margin of safety. A company whose sales volume is just
equal to the BEP is making no profit or no loss. The margin of safety at BEP is therefore, equal to zero. The
formula for computing margin of safety is given below.

1) Margin of safety = Actual sales - BEP

2) Margin of safety = Profit .

Profit volume ratio

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How to improve margin of safety

The following steps may be taken to improve unsatisfactory margin of safety.

1) Control and reduce fixed cost.
2) Control and reduce variable costs.
3) Increase the selling price.
4) Increase the sales volume.
5) Improve contribution by changing the sales mix.

Angle of Incidence:

This is an angle formed by the sales line and the total cost line at the BEP. The angle of incidence indicates
the rate at which the profits are being earned. A large angle of incidence indicates a high rate of profit; a small
angle indicates a low rate of earnings.

Y SL TC

Cost &
Revenue
FC

Out put
Break Even Chart

Although break even analysis is primarily a mathematical technique it can be expressed in the break even
chart. The break even chart is the graphic presentation which shows the varying costs along with varying sales.
It indicates the break even point and also shows the estimated profit or loss at different levels of production.

Y SL TC

Cost &
Revenue
FC

x
Out put
Break Even Analysis

The study of cost - volume - profit relationship is often referred to as break even analysis. The break even
analysis is interpreted in narrow sense as well as broad sense. In its narrow sense, it is concerned with finding
out of the break even point. BEP is the point at which total cost is equal to total sales i.e., point of no profit no
loss. In its broad sense, break even analysis means a system of analysis that can be used to determine the
probable profit at any level of production.

Assumptions of break even analysis

Break even analysis is based on a series of assumptions.

1) All cost can be separated into fixed and variable components.
2) Fixed cost will remain constant at all volume of output.
3) Variable costs will fluctuate in direct proportion to volume of output.

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4) Selling price will remain constant.
5) There is only one product or in case of multiple products the sales mix will remain constant.
6) Production and sales will be synchronized.
7) Productivity per worker will remain unchanged.
8) There will be no change in the general price level.

Uses of break even analysis

The important uses to which break even analysis may be put as follows :
1) Determination of the selling price which will give the desired profit.
2) Forecasting costs and profits as a result of change in volume.
3) Suggestions for shift in sales mix.
4) Inter firm comparison of profitability.
5) Determines costs and revenues at various levels of output.
6) Impact of increase or decrease in fixed cost or variable cost on profits.

Differences between absorption costing and marginal costing.

Absorption costing and marginal costing systems differ in respect of following points:
1) Absorption costing is a total cost technique i.e., both variable cost and fixed cost are charged to products,
process or operations.
Under Marginal costing system, only variable costs are charged to products, process or operations.
2) In absorption costing the stock of finished goods and work-in-progress are valued at total cost but in
marginal costing the stock of finished goods and work-in-progress are valued at variable cost only.
3) In absorption costing, arbitrary apportionment of fixed cost leads to under or over absorption of fixed
cost. Marginal costing excludes fixed cost and the question of arbitrary apportionment does not arise.
4) In absorption costing managerial decisions are guided by profits which is excess of sales over total cost.
In marginal costing, the managerial decisions are guided by contribution which is the excess of sales
over variable cost.

Problem: 1

Company ‘A’ and Company ‘B’ both under the same management make and sell the same type of product.
Their budgeted profit and loss account for the half year ending 30th June 2010 is as follows:
Particulars ‘A’ Company ‘B’ Company
Sales 3,00,000 3,00,000
Variable cost 2,40,000 2,00,000
Fixed cost 30,000 70,000
Profit 30,000 30,000
You are required to calculate.
a. Profit volume ratio of each.
b. Breakeven point of each.
c. Margin of safety of each.
d. The sales volume at which each of the two companies will make a profit of Rs. 10,000.
e. Which company makes more profit in case of
o Heavy demand for products?
o Low demand for products.

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Problem – 2

The sales and profits during two years were as follows:

Year Sales Profit
1997 1,50,000 20,000
1998 1,70,000 25,000
You are required to calculate
a. P/v ratio
b. Fixed cost
c. BEP
d. The sales required to earn a profit of Rs. 40,000
e. The profit made when sales are Rs. 2,50,000
f. Margin of safety at a profit of Rs. 50,000
g. Variable costs of the two periods.

Problem - 3

From the following particulars calculate BEP.

Sales Rs. 2,00,000
Variable cost Rs. 1,20,000
Fixed overheads Rs. 30,000
Also calculate:
a. New BEP, if selling price is reduced by 10%.
b. New BEP, if variable cost is increased by 10%.
c. New BEP, if fixed cost is increased by 10%.

Problem : 4

From the following particulars calculate

a. P/V ratio
b. Break Even Point
c. Margin of safety
d. Sales required to earn a profit of Rs. 1,50,000
e. Profit when sales amounted to Rs. 10,00,000
f. Margin of safety if the company is earning a profit of Rs. 2,00,000
Fixed Cost Rs. 1,50,000
Profit Rs. 1,00,000
Sales Rs. 5,00,000

Problem : 5
Assuming that cost structure and selling prices will remain the same in period - I and period - II. find out:
a. P/v ratio
b. Breakeven point
c. Profit when sales amount to Rs. 1,00,000
d. Sales required to earn a profit of Rs. 20,000
e. Margin of safety at a profit of Rs. 15,000
f. Variable cost in period II
Period Sales Profit
I 1,20,000 9,000
II 1,40,000 13,000

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Problem : 6

Raj Corporation has prepared the following budget estimate for the year 2014-15
Sales (units) 15,000
Fixed cost Rs. 34,000
Sales value Rs. 1,50,000
Variable cost per unit Rs. 6
You are required to calculate
a. P/V ratio
b.Break Even Point
c. Margin of safety
d.Calculate the revised P/V ratio, BEP and Margin of safety in each of the following cases:
i. Decrease of 10% in selling price.
ii. Increase of 10% in variable cost.
iii. Increase of sales units by 2000.
iv. Increase of Rs. 6,000 in fixed cost.

Problem : 7

From the following particulars, calculate

a. BEP in terms of sales value and in units.
b. No. of units that must be sold to earn a profit of Rs. 90,000.
Fixed factory overheads - Rs. 60,000
Fixed selling overheads - Rs. 12,000
Variable manufacturing cost per unit - Rs. 12
Variable selling cost per unit - Rs. 3
Selling price per unit - Rs. 24

Problem : 8

Calculate:
a. The amount of fixed expenses.
b. The No. of units to break even
c. The No. of units to earn a profit of Rs. 40,000.
The selling price per unit can be assumed at Rs. 100.
The company sold in two successive periods 7,000 units and 9,000 units and has incurred a loss of Rs.
10,000 and earned Rs. 10,000 as profit respectively.

Problem : 9
From the following information calculate
a. Contribution / Sales ratio
b. Breakeven point
c. Margin of safety
Total sales Rs. 3,60,000
Selling price per unit Rs. 100
Variable cost per unit Rs. 50
Fixed cost Rs. 1,00,000
d. If the selling price is reduced to Rs. 90, by how much is the margin of safety reduced.

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Problem: 10

The trading results of XYZ Co. Ltd., for the last two years have been:
Year Sales Profit
1992 2,00,000 10,000
1993 1,80,000 2,000
you are required to
a. Determine P/V ratio
b. Ascertain the BEP
c. Forecast the expected profit or loss with sales of
o Rs. 1,50,000
o Rs. 3,00,000

Problem : 11

Shri Shakti Appliance Ltd., a home appliance manufacturer has always sold its products through wholesalers.
Last year its sales were Rs. 20,00,000 yielding a net profit of 10% of sales.
As a result of increase in appliance sales through departmental stores and mail order business establishments,
the company is considering the elimination of wholesalers and selling directly to retailers. It is estimated that
it would result in 40% drop in sales but net profit will be Rs. 1,80,000. Fixed expenses would increase from
Rs.2,00,000 to Rs. 3,00,000 owing to additional warehouses and distribution facilities.
You are required to find out
(i) Whether the proposed change would rise or lower the break even point in rupees and by how much?
(ii) What would be the sales volume in rupees which would enable Sri Shakti Appliances Ltd., to obtain as
much profit as it made last year?

Problem : 12

New Shoe Shine Company sells five different styles of ladies chappals with identical purchase costs and
selling prices. The company is trying to determine the desirability of opening another store which would have
the following expenses and revenue relationships.
Selling price Rs. 30 per pair
Variable cost Rs. 19.50 per pair
Salesmen’s commission (variable) Rs. 1.50 per pair
Annual fixed expenses
Rent = Rs. 60,000
Salaries = Rs. 2,00,000
Advertising = Rs. 80,000
Sundries = Rs. 20,000
You are required to calculate
a. The annual BEP in sales units and sales volume
b. Profit or loss of the stores if 35,000 pairs were sold.
c. The annual BEP in units and sales volume if the sales commission were discontinued in favour of Rs.
81,000 increase in fixed salaries.
d. The annual BEP in units and sales volume if the stores manager were paid 30 paise per pair as
commission.
e. Refer to the original data, if the stores manager were paid 30 paise per pair as commission on each
pair sold in excess of the BEP, what would be the stores profit if 50,000 pairs were sold ?
Consider each question independently.

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Problem : 13

An analysis of cost of ‘X’ manufacturing company led to the following information:

Cost elements Variable cost Fixed cost
(% of Sales)
Direct material 32.8 -
Direct labour 28.4 -
Factory overheads 12.6 1,89,900
Distribution expenses 4.1 58,400
General administration expenses 1.1 66.700
Budgeted Sales for the next year is Rs. 18,50,000. You are required to determine.
i. Break even sales volume
ii. Profit at the budgeted sales volume.
iii. Profit, if actual sales.
a) Dropped by 10%
b) Increased by 5% from budgeted sales.

Problem: 14

A company has fixed expenses of Rs. 90,000 with sales of Rs. 3,00,000 and a profit of Rs. 60,000 during the
first half year. If in the next half year the company suffered a loss of Rs. 30,000.
Calculate:
a. P/V ratio, BEP and margin of safety for the first half year.
b. Expected sales volume for the next half year assuming that the selling price and fixed expenses remain
unchanged and
c. The overall BEP and margin of safety.

Problem : 15

The Motor Industry Ltd., is engaged in the manufacture of motors the cost structure of a motor is as under :-
Material Rs. 50
Labour Rs. 80
Variable overheads 75% of labour cost,
Fixed overheads amounted to Rs. 2,40,000 per annum.
Selling price of the motor is Rs. 230 each.
a) Determine the number of motors that have to be manufactured and sold in the year in order to break even.
b) How many motors have to be made and sold to make a profits of Rs. 1,00,000 per year.
c) If the selling price is reduced by Rs.15 what is the new break even point?

Problem : 16
There are two similar plants under the same management. The management desires to merge these two plants.
The following particulars are available.
Factory 1 Factory 2
Capacity operation 100% 60%
Sales 300 Lakhs 120 Lakhs
Variable cost 220 Lakhs 90 Lakhs
Fixed cost 40 Lakhs 20 Lakhs
You are required to calculate
a) What would be the capacity of the merged plant to be operated for the purpose of break even?
b)What would be the profitability on working at 75% of the merged capacity?
Problem : 17
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You are given the following data:
Selling price per unit Rs. 350
Variable cost per unit Rs. 200
Fixed expenses Rs.16,50,000
Ascertain
(i) BEP in units (ii) Sales per unit if BEP is brought up to 15,000 units (iii) Sales per unit if BEP brought
down to 10,000 Units.

Problem : 18

Given the following Information

Units of output 5,00,000 units
Fixed cost Rs. 7,50,000
Variable cost per unit Rs. 2
Selling price per unit Rs. 5
You are required to determine
a) The breakeven point in units and in value.
b)The sales needed to earn a profit of Rs. 6,00,000
c) The profit made if 4,00,000 units are sold at Rs. 6 per unit.

Problem : 19

The following information is obtained from ‘A’ Ltd., in a certain year.

Sales Rs. 1,00,000
Variable cost Rs. 60,000
Fixed cost Rs. 30,000
a) Find P/V ratio, BEP and Margin of safety
b)Calculate the effect of
i. 20% increase in selling price
ii. 10% decrease in selling price.

Problem : 20

You are given the following data for the coming year of a factory.
Budgeted output 80,000 Units
Fixed expenses Rs. 4,00,000
Variable expenses per unit Rs. 10
Selling price per unit Rs. 20
Draw a break even chart showing the break even point. If the selling price is reduced to Rs. 18, what will be
the new break even point?

Problem : 21

You are given the following data:

Sale price Rs. 20 per unit.
Variable Manufacturing Cost Rs. 11 per unit.
Variable Selling Cost Rs. 3 per unit.
Fixed factory overhead Rs. 5,40,000 per year
Fixed selling costs Rs. 2,52,000 per year.
Calculate
a) Break-even point
b)Sales required to earn a profit of Rs. 60,000

Problem : 22

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The following data are available from the records of a company
Rs.
Sales 60,000
Variable cost 30,000
Fixed cost 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.

Problem : 23

The trading results of Sri Ganesha manufacturing company Ltd., Bangalore for the last two year were as
follows:
Year Sales (Rs.) Profit (Rs.)
1995 4,80,000 36,000
1996 5,60,000 52,000
Calculate the following from the above information :
a) P/v Ratio
b) Fixed expenses
c) Break Even Point
d) Margin of safety for 1995 and 1996.
e) Margin of Safety when sales are Rs. 7,20,000
f) Sales required to earn a desired profit of Rs. 60,000.
g) Variable Cost of 1995 and 1996.

Problem : 24

You are given the following particulars, calculate:

a) Break even point.
b) Sales to earn a profit of Rs. 10,000.
i) Fixed cost Rs. 1,00,000
ii) Variable cost Rs. 10 per unit
iii) Selling price Rs. 15 per unit.

Problem : 25

The statement of cost of an electronic set is as follows:

Rs.
Materials 2,000
Labour 600
Variable expenses 1,400
Fixed expenses 600
Total cost 4,600
Profit 400
Selling price 5,000
The number of electronic sets made and sold is 5,000.
a) Find out break even point.
b) How many electronic sets must be produced and sold if the price is reduced by Rs. 200 to obtain
the same profit as above.

Problem : 26

The following information has been extracted from the accounts of Ramesh Equipments Ltd.,

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 Sales 80,00,000
Variable cost 40,00,000
Fixed cost 24,00,000
The selling price per unit is Rs. 40/-
Compute the following :
a) The breakeven point.
b)If the price increase to 20% followed by a reduction in volume of 25%, then the effect on net profit.

Problem : 27

Two firms ‘A’ Ltd., ‘B’ Ltd., sell the same type of product in the same market, their budgeted profit & loss
statement for the year 1992 are as follows:
Particulars ‘A’ Ltd. ‘B’ Ltd.,
Sales 1,50,000 1,50,000
Variable cost 1,20,000 1,00,000
Fixed cost 15,000 35,000
Total cost 1,35,000 1,35,000
Budgeted net profit 15,000 15,000
You are required to (i) Calculate the P/v ratio of each firm. (ii) Calculate BEP of each firm.
(iii) Calculate the sales volume at which each of the firm will earn Rs. 5,000 and Rs. 8,000 profits.
(iv) Which firm earns greater profits in case of (a) Heavy demand for product. (b) Low demand for product.

Problem : 28

From the following figures. compute BEP units.

Selling price per unit - Rs. 150
Variable cost per unit - Rs. 90/-.
Fixed expenses - Rs. 6,00,000
What will be the new selling price per Unit if
a) BEP is brought down to 8000 units.
b)BEP is brought up to 12000 units.

Problem : 29

Two manufacturing companies which have the following operating details decided to merge.
Particulars Company 1 Company 2
Operating capacity 90% 60%
Sales (Rs. in Lakhs) 540 300
Variable cost (Rs in Lakhs) 396 225
Fixed cost (Rs. in Lakhs) 80 50
Assuming that the proposal is implemented, calculate.
a) Break even sales of the merged plant and the capacity at that stage.
b)Profitability of the merged plant at 80% capacity utilization.
c) Sales turnover of the merged plant to earn a profit of Rs. 75 Lakhs.

Problem : 30 (may 2017, 6m)

A firm has produced and sold 20,000 units during the year 2016. The selling price was Rs.50 per unit. The
cost details were
Direct material Rs.6 per unit
Direct labour Rs.6 per unit
Variable overhead Rs.3 per unit
Fixed expenses Rs.3,50,000
Prepare a marginal cost statement to show the profit or loss for the year and also find out the Break Even Point
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Problem : 31 (may 2017, 14m)

An industry reports the following information for two consecutive years.

Particulars 31-03-2016 31-03-2017
Sales Rs. 8,10,000 Rs. 9,00,000
Profits Rs. 18,000 Rs. 45,000
Calculate :
i) P/V Ratio
ii) Fixed cost
iii) Sales to earn a profit of Rs.3,00,000
iv) Break Even Point in rupees
v) Margin of safety at a profit of Rs.72,000
vi) Profit when sales are Rs.10,00,000

Problem : 32 (may 2018, 6m)

The following information relates to a firm

Selling price per unit Rs.200
Variable cost per unit Rs.160
Fixed cost Rs.6,00,000
Find out:
(a) BEP in units and in value
(b) Find out the selling price per unit if BEP is brought down to 8000 units

Problem : 33 (may 2018, 14m)

The sales and profit for two years are as below:

Year Sales (Rs.) Profits (Rs.)
2016 1,50,000 20,000
2017 1,70,000 25,000
Calculate:
a) P/V ratio
b) B.E point in rupees and units
c) Sales required to earn a profit of Rs.40,000
d) Margin of safety at a profit of Rs.1,25,000
e) Variable cost of the two years
f) Profit when sales are Rs.1,80,000

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