MARGINAL

COSTING
INTRODUCTION
Is a technique of determining the cost.

MARGINAL COST

Cost of producing one additional unit of output by

differentiating between fixed cost and variable cost.
Marginal Costing defined :

The technique which studies the increase or

decrease in total production costs as a result of
increase or decrease in the units of production &
which recognizes variable costs as main part of
production costs.
CONTINUED…..
 Helps in management decision making.

 Provides management with the information

regarding the costs behavior and incidence of
costs on profitability of an undertaking.

 It
is only a technique used by accountants to aid
management decision.

 Also called ‘Direct Costing’, ‘Variable Costing’,

‘Differential Costing’.
MARGINAL COSTING-DEFINITION

“Ascertainment of marginal
costs and of the effect on profit
of changes in volume or type
of output by differentiating
between fixed costs and
variable costs”

CIMA
 FEATURES OF MARGINAL
COSTING
 Costs are separated into fixed and variable elements.
 Only variable costs are taken in consideration.

 Fixed costs are charged against the revenues during the

period they are incurred.
 It combines the techniques of cost recording and cost
reporting.
 Profitability of departments or products is determined in
terms of marginal contribution.
 The unit cost of a product means the average variable cost
of manufacturing the product.
 DETERMINATION OF
PROFIT UNDER MARGINAL
COSTING
Based on the theory of CONTRIBUTION

Also known as “MARGIN”

Excess of sales over variable cost

 Contribution is different from Profit.

 It is first used to meet the fixed expenses and then it
contributes to the profit.
 Also known as “Marginal Approach to Profit Determination”
or “Contribution Approach to Profit Determination”
 CONTRIBUTION
Viewed from 2
angles
From where
How contribution
contribution
is applied
emanates
C = FC + P (2)
C= S-VC (1)
From (1) and (2)
S-VC = FC+P
S= VC+FC+P
VC = S-C
F = C-P
P = C-F
 CONTRIBUTION
 It is the difference between selling price and variable cost
of sales.

Contribution = Selling Price – Variable Cost

(C ) = (SP) – (VC)

 Excess of contribution over fixed costs is Profit.

Profit = Contribution – Fixed Cost

(P) = (C) – (FC)
 CONTRIBUTION UNDER
VARIOUS CIRCUMSTANCES
 Selling price containing profit :

Contribution = Fixed Cost + Profit

 Selling price at cost :

Contribution = Fixed Cost

 Selling price at loss :

Contribution = Fixed Cost - Loss
 SALIENT FEATURES OF
CONTRIBUTION
 If contribution is zero, C=0 :
Loss = Fixed Cost

 If Contribution is Negative :

Loss > Fixed Cost

 If Contribution is Positive and more than FC :

Contribution >Fixed Cost = Profit

 If Contribution is Positive and less than FC :

Contribution < Fixed Cost = Loss < FC
 MARGINAL COST
EQUATION
Sales – Cost = Profit
or Sales – (Fixed cost + Variable Cost) = Profit
or Sales – Variable Cost = Fixed Cost + Profit

S–V=F+P

Where,
S = sales
V = Variable Cost
F = Fixed Cost
P = Profit
BREAK-EVEN
ANALYSIS
COST-VOLUME-
PROFIT
RELATIONSHIP
BREAKEVEN ANALYSIS DEFINED
 Breakeven analysis examines the short run relationship
between changes in volume and changes in total sales
revenue, expenses and net profit
 Also known as C-V-P analysis (Cost Volume Profit
Analysis)
USES OF BREAKEVEN ANALYSIS
 C-V-P analysis is an important tool in terms of
short-term planning and decision making
 It looks at the relationship between costs,
revenue, output levels and profit
 Short run decisions where C-V-P is used include
choice of sales mix, pricing policy etc.
 DECISION MAKING AND BREAKEVEN
ANALYSIS: EXAMPLES

 How many units must be sold to breakeven?

 How many units must be sold to achieve a target
profit?
 Should a special order be accepted?
 How will profits be affected if we introduce a new
product or service?
KEY TERMINOLOGY: BREAKEVEN
ANALYSIS
 Break even point-the point at which a company
makes neither a profit or a loss.
 Contribution per unit-the sales price minus the
variable cost per unit. It measures the
contribution made by each item of output to the
fixed costs and profit of the organisation.
 KEY TERMINOLOGY CTD.
 Margin of safety-a measure in which the
budgeted volume of sales is compared with the
volume of sales required to break even
 Marginal Cost – cost of producing one extra
unit of output
BEP ANALYSIS
BREAKEVEN CHART
BREAKEVEN FORMULA
Fixed Costs
*Contribution per unit

*Contribution per unit = Selling Price per unit – Variable Cost per
unit
BREAK-EVEN ANALYSIS

 Total cost = fixed costs + variable costs (quantity):

 Revenue = selling price (quantity)

 Break-even point is where total costs = revenue:

EXAMPLE

 A firm estimates that the fixed cost of producing a line of

footwear is $52,000 with a $9 variable cost for each pair
produced. They want to know:
 If each pair sells for $25, how many pairs must they sell to break-
even?
 If they sell 4000 pairs at $25 each, how much money will they
make?
EXAMPLE SOLVED

 Break-even point:

 Profit = total revenue – total costs

MARGIN OF SAFETY
 The difference between budgeted or actual sales and the
breakeven point
 The margin of safety may be expressed in units or
revenue terms
 Shows the amount by which sales can drop before a loss
will be incurred
EXAMPLE 1
Using the following data, calculate the
breakeven point and margin of safety in units:
 Selling Price = €50

 Variable Cost = €40

 Fixed Cost = €70,000

 Budgeted Sales = 7,500 units

EXAMPLE 1: SOLUTION
 Contribution = €50 - €40 = €10 per unit
 Breakeven point = €70,000/€10 = 7,000 units

 Margin of safety = 7500 – 7000 = 500 units

TARGET PROFITS
 What if a firm doesn’t just want to breakeven – it
requires a target profit
 Contribution per unit will need to cover profit as well as
fixed costs
 Required profit is treated as an addition to Fixed Costs
EXAMPLE 2
Using the following data, calculate the level of sales
required to generate a profit of €10,000:
 Selling Price = €35

 Variable Cost = €20

 Fixed Costs = €50,000

EXAMPLE 2: SOLUTION
 Contribution = €35 – €20 = €15
 Level of sales required to generate profit of €10,000:

€50,000 + €10,000
€15
4000 units
LIMITATIONS OF B/E ANALYSIS
 Costs are either fixed or variable
 Fixed and variable costs are clearly discernable
over the whole range of output
 Production = Sales
 One product/constant sales mix
 Selling price remains constant
 Efficiency remains unchanged
 Volume is the only factor affecting costs
FROM THE FOLLOWING DATA, YOU
ARE REQUIRED TO CALCULATE:
(a) P/V ratio
(b) Break-even sales with the help of P/V ratio.
(c) Sales required to earn a profit of Rs. 4,50,000

Fixed Expenses = Rs. 90,000

Variable Cost per unit:
Direct Material = Rs. 5
Direct Labour = Rs. 2
Direct Overheads = 100% of Direct Labour
Selling Price per unit = Rs. 12.
 From the following information, calculate the break-
even point in units and in sales value:
 Output = 3,000 units

 Selling price per unit = Rs. 30

 Variable cost per unit =Rs. 20

 Total fixed cost = Rs. 20,000

EXAMPLE
 You are given the following data for the coming year
of a factory:
 Budgeted output:80,000 units

 Fixed expenses: rs 4,00,000

 VC per unit: Rs 10

 SP Per unit: Rs 20

Calculate break-even point. If the selling price is reduced

to Rs. 18 per unit, what will be the new break-even
point?
PROBLEM
Pepsi Company produces a single article.
Following cost data is given about its product:‐
Selling price per unit Rs.40
Marginal cost per unit Rs.24
Fixed cost per annum Rs. 16000
Calculate:
(a)P/V ratio (b) break even sales (c) sales to earn a
profit of Rs. 2,000 (d) Profit at sales of Rs.
60,000 (e) New break even sales, if price is
reduced by 10%.
PROBLEM
 From the following information's find out:
a. P/V Ratio
b. Sales &
c. Margin of Safety

 Fixed Cost = Rs.40, 000

 Profit = Rs. 20,000

 B.E.P. = Rs. 80,000

PROBLEM
 A manufacturer produces 1500 units of products
annually. The marginal cost of each product is Rs. 960
and the product is sold for Rs. 1200. Fixed cost incurred
by the company is Rs. 48, 000 annually. Calculate P/V
Ratio and what would be the break ‐even point in terms
of output and in terms of sales value?
PROBLEM
 From the following data calculate Margin of Safety.
 Particulars Rs.
 Sales 15, 00, 000
 Fixed expenses 4, 50, 000
 Profit 3, 00, 000
PROBLEM
 From the following information, calculate Break‐even
point and Sales to earn profit of Rs. 2, 40, 000.
 Particulars Rs.
 Sales 8, 00, 000
 Fixed cost 3, 60, 000
 Variable cost 5, 60,000
PROBLEM
 A company makes a product with a selling price of $20
per unit and variable costs of $12 per unit. The fixed
costs for the period are $40,000. What is the required
output level to make a target profit of $10,000?
CALCULATE BEP
 The following information relates to a company, which
produces a single product.
 Direct labour per unit $ 22
 Direct materials per unit $ 12
 Variable overheads per unit $6
 Fixed costs $ 400,000
 Selling price per unit $ 60
PROBLEM
 The Sherston Brick Company manufactures a
standard stone block for the building industry. The
production capacity for the year is 100,000
standard blocks. The selling price per block is
$1.60, variable costs are $0.60 per brick and fixed
costs are $60,000 per annum.
 Determine:

 The break-even point in terms of sales revenue

and output.
 The margin of safety if sales amount to 90,000
bricks in the year.
PROBLEM
 A company has fixed costs of $20,000 in order to sell a
product that costs them $50 per unit. If a company sells
the product for $120 per unit
 Determine the break-even units

 Determine the units required to produce $100,000 in

profit?
PROBLEM
 The contribution margin for a product is 70%. a.The
company wants to price the product so that it contributes
$5 for each unit. How should they price the product?
What Is the variable cost associated with one product?
 The machine to make the product costs $500. The
entrepreneur hopes to make $5000 in profits selling the
product over the summer. How many units do they need
to sell?
NUMERICAL PROBLEM
 The following data is available for a company: Rs.
Selling price 20 per unit Variable manufacturing costs 11
per unit Variable selling costs 3 per unit Fixed factory
overheads 5,40,000 per year Fixed selling costs 2,52,000
per year You are required to compute: (i) Break-even
point expressed in amount of sales in rupees; (ii)
Number of units that must be sold to earn a profit of Rs.
60,000 per year; (iii) How many units must be sold to
earn a net income of 10% of sales? (5 marks)
 APPLICATIONS OF
MARGINAL COSTING
• Profit Planning
• Evaluation of Performance
• Make or Buy Decisions
• Closure of a Department or Discontinuance of a
Product
• Maintaining a desired level of Profit
• Offering Quotations
• Accepting an Offer or Exporting below Normal Price
• Alternative Use of Production Facilities
• Problem of Key Factor
• Selection of a Suitable Product Mix