MARGINAL COSTING CVP ANALYSIS BASIC TWO TECHNIQUES OF

MARGINAL COSTING & C-V-P ANALYSIS BASIC TWO TECHNIQUES OF COST ASCERTAINMENT ARE§ABSORPTION COSTING §MARGINAL COSTING. Marginal Costing – It is the technique of ascertainment of marginal cost by segregating fixed cost and variable cost and of effect of cost on the profit or volume and type of output. Material = Direct + Indirect Labour = Direct + Indirect Expenses = Direct + Indirect ------------------------ Total cost = Prime cost + Overheads = Prime cost + Variable + Fixed Overheads Marginal Costs

Assumptions of Marginal Costing • Costs can be segregated into fixed and variable. • Variable costs are considered as product costs, while fixed costs are considered as period costs. • There is a linear relation between costs and revenue. • There will be no change in the technological state of affairs. • The firm produces as much quantity as could be be sold in the market , i. e. there will be no closing stock. Methods of segregating Costs: There are several methods that segregate costs into fixed and variable. Those are • High-Point and Low-point method • Simultaneous Equation Method • Scattered Diagram method

Basic marginal Cost Equation: Sales – Variable Cost = Contributions = Fixed Costs + Profit • Contribution- Under marginal costing importance is given on contribution and not on profit. The excess of sales over variable costs are considered to form a pool of fund that is contributing towards absorption of fixed costs and balance left for profit. Thus, contribution is the key to marginal costing system. Under Marginal Costing the following are important • Profit- Volume ratio (P/V Ratio) • Break Even Analysis • Margin of Safety

P/V Ratio – It is the ratio between contribution to sales. Contribution Change in profit P/V ratio = ---------- x 100 or = --------------Sales Change in sales Higher the P/V ratio better is the profitability and vice versa. Improvement of p/v ratio – P/V ratio can be improved as below (i) By increasing selling price per unit. (ii) By decreasing variable cost per unit (iii) By changing product mix. Uses of P/V ratio- The following are some uses of P/V ratio(i) It is used to find BEP (ii) It is used to find profit for a definite volume of sales (iii) It is used to find the profit for a given volume of sales.

Break Even Point- a break-even Point is the volume of sales where the firm neither earns any profit nor suffers any loss. Break-even Point is measured as below. Fixed Cost Break-even Point = --------------( in units) Contribution per unit Fixed Cost Break-even Point = --------------( in Value) P/V Ratio Improvement of BEP- BEP can be improved as below(i) Increase in Selling price (ii) Decrease in variable costs (iii) Decrease in Fixed Costs.

Break-even Chart- A break-even chart is a graphical presentation of cost-volume –profit relationship. A normal BEP Chart is drawn as below- Cost & Sales Output

• The point at which the total cost line and total sales line meet is known as Break-even point. The angle formed between the two lines represent the P/V ratio graphically. • Higher the BEP lower is the profitability of the company. • Lower the BEP higher is ability of the company to face the cost pressure or even reduction in the sales. • Margin of Safety- A margin of safety is the excess of actual sales over break-even sales. The higher margin of safety reflects the strength of the business. Even a high margin of safety may allow the management to reduce sales price in times of depression and the company even in such situation will be able to meet the reduction in the sales and cost gap.

• A margin of safety is measured as below. Margin of safety = Actual sales – Break-even sales Profit Margin of Safety = ---------P/V ratio Improvement of Margin of safety- MS can be improved as below(i) By increasing the selling price per unit (ii) By decreasing variable cost per unit. (iii) By decreasing fixed costs.

• The chart shows the impact of selling price, variable costs and fixed costs on P/V Ratio, BEP and MS. P/V ratio (i) Increase in Selling Price Increase (ii) Decrease in Selling Price Decrease (iii) Increase in Variable cost Decrease (iv) Decrease in Variable cost Increase (v) Increase in Fixed cost No effect (vi) Decrease in Fixed cost No effect BEP Decrease Increase Decrease MS Increase Decrease Increase.