# Marginal Costing Problems

1Q. Breaking up semivariable cost into fixed and variable

The following are the maintenance costs incurred in a machine shop per six months with corresponding machine hours. Month Cost Jan Feb March April May June Machine Hours 2000 2200 1700 2400 1800 1900 300 320 270 340 280 290 Maintenance

Analyze the maintenance cost which is semi variable into fixed and variable elements.

2Q.

Marginal cost statement and Break even analysis

A company is producing a single article sells it at Rs. 20/- each. The marginal cost of production is Rs 12/- each and the fixed cost is Rs. 800/- p.a. You are required to calculate: 1. 2. 3. 4. 5. The profit volume ratio Breakeven point or sales in value and volume The sales value required to earn a profit of Rs.1000/The profit at sales of Rs. 6000 The margin of safety at3,4

3Q.

The cost sheet of a steel box manufactured by Box and Roll Ltd., is as under: Particulars Sales Price Materials Labor (30% fixed) Overheads ( 30% Variable) Total Cost Profit Rs. 100 30 30 30 90 10

The current production and sales level is 1000 boxes p.a. you are required to a. Prepare a marginal cost statement for the above b. Ascertain I. p/v ratio II. BES in volume and value III. MOS at current level of production IV. Sales to earn a profit of Rs. 50000 V. Profit at sales 1500000 c. If the marginal cost of the steel box is reassessed a Rs.90/-, what should be the revised selling price to retain the same pv ratio. 4Q. The following figures related to a company manufacturing a varied range of products

Particulars Year ended 31-12-2009 Year ended 31-12-2010

Total Sales 20000 30000

Total Costs 18000 26000

Assuming stability in prices, with variable cost carefully controlled reflect predetermine relationships and on unvarying figure for fixed costs, calculate: I. II. III. IV. The pv ratio Fixed costs Bes Profit at sales Rs.40000

The sales mix in value comprises 33 1/3 . Sales to earn a profit of Rs. C and D respectively.400p.10000 6Q. of A. Sensitivity analysis The following information is obtained from Uncertain Enterprises For the Year ending 2009. 16 2/3. MOS  Calculate the effect of  20% increase in selling price  10% decrease in selling price  5% increase in sales volume  10% decrease in fixed costs  10% decrease in variable costs  20% increase in selling price accompanied with an increase of fixed overheads by Rs. C.a. Sales Variable costs Fixed costs 100000 60000 30000  Find the p/v ratio. Construct a break-even chart and a profit graph and show: Break even point Margin of safety Fixed cost Angle of incidence 7Q. 5000 5Q. D. 8 1/3.each and the total fixed cost of the concern is Rs. Combined break even point on an overall basis Brando Ltd..V. Break even chart and profit graph The selling price of an article is Rs. B. manufactuers and sells four types of products under the brand names A. B. . BEP.10/The marginal cost is Rs6/. 41 2/3.

There are two similar plants under the same management. The variable cost structure is as under:- Product A B C D Variable cost as a percentage of selling price 60 68 80 40 Fixed costs are Rs. 90 lacs Rs. The management desires to merge these two plants. 5 lacs has to be incurred? Factory-I 100% Rs. The following particulars are available. Particulars Capacity operation Sales Variable costs Fixed costs You are required to calculate a) What would be the capacity of the merged plant obtained the purpose of break even ? b) What would be the profitability on working at 75% of the merged capacity? c) At what capacity can be the merged factory make a profit of Rs. 220 lacs Rs. 18 lacs? d) What would be the breakeven point( capacity) or break even capacity as a result of merger additional fixed expenses of Rs. 20 lacs . 14700 per month Calculate the monthly overall sales required for the company to break even. 300 lacs Rs. 120 lacs Rs.The total budgeted sales(100%) are Rs. BREAK EVEN SALES ANLYSIS AFTER MERGER OF FACTORIES. 40 lacs Factory-II 60% Rs. 60000 per month. 8.

Per unit Sales Materials (Rs. 10000 Comment on the profitability of each product when:      The total sales potential in units is limited Total sales potential in value is limited Raw material is in short supply Production capacity is limiting factor When the total availability of raw material is 4000kgs. 10 per Kg. Per unit 200 50 60 20 The total fixed overheads Rs. find the product mix to yield maximum profit.) Wages(Rs. 6 per hour) Variable overheads 100 20 30 10 Product B Rs. . problems on decisions bases on Key factors.9Q.. And maximum sales potential of each product is 1000 units.( limiting factors) The following particulars are obtained from the records of a company engaged on manufacturing two products A and B from a certain raw materials:Particulars Product A Rs..

1000 And the balance of 2500 is treated as general overhead. Dept C Rs. Sales Marginal Cost Fixed cost(apportioned) Total Cost Profit/(loss) 5000 5500 500 6000 (1000) Dept B Rs. 7000 2000 1000 3000 4000 Total Rs. has an annual production of 90000 units for a motor component whose cost structure is as under: Particulars Materials Labour (25% fixed) Variable expenses Fixed expenses Total Rs.500 d. What is your advice? b) On the above information fixed cost is ascertained as follows: a. will your advice under (a) differ? How? 11Q. Make or buy decisions Spare Parts Ltd. 6000 2000 1000 3000 3000 Dept D Rs. management wants to discard dept B immediately as the loss show I maximum after the dept A will be discarded. Dept A Nil b. 26000 15500 6500 22000 4000 a) On the basis of the above information. Dept D Rs..10Q. Dept B Rs. 8000 6000 4000 10000 (2000) Dept C Rs. Per unit 270 180 90 135 675 . Decision to discontinue a department / product / product line The following are obtained from the accounts of departmental stores having four departments:Particulars Dept A Rs. 2500 c.

The purchase manager has an offer from a supplier who is willing to supply at Rs. ii. 75 per container can the company accept the offer? b.i.A. Cash subsidy @ 10% on the F. 90000 units of this product can be produced at the same cost basis as the above for labor and expenses. Supplies Containers Fixed Expenses Total costs Amount Rs. the factory‘s normal production capacity is 20000 containers of snow per month. manufactures and sells direct to consumers 10000 containers of snow per month at Rs. 540. 100000 247500 14000 43000 60000 795500 1260000 a. 200 per unit. . Will the answer to C will change if a. 485. Keeping in mind the principles of marginal costing what is the minimum export price (per container) which the company can quote? c. In the later case material price will be Rs. 42 per container can the company accept the offer/ d. Discuss whether it would be advisable to divert he resources to manufacture that new product. If the export price is Rs. 125/. instead of being produced.. Should the component be purchased and production stopped? Assume the resources now used for the manufacturing of this component are used to produce another new product for which selling price is Rs.. If the export price is Rs. 12Q. Exploring New Markets Ice Cold Ltd. would . The company has received an offer for the export of 120000 containers P. An analysis of cost for 10000 containers show: Particulars Direct materials Direct labor Power Misc. be purchased from the market .per container. at 10000 containers per month. on the footing that the component is presently being produced .B value of exports is to be received from Government of India.O.

Marginal Costing Study Material There are two main techniques for estimating product cost and profit. They are: Absorption Costing. and (b) Marginal Costing. (a) .

They are the costs ‗absorbed by‘ or ‗attached to‘ the units produced. Product costs are associated with unit of output. Absorption costing is also known as Total Cost method. It helps to confirm accrual and matching concepts which require matching costs with revenue for a particular period. Accounting Standards (AS-2) recommend the use of absorption costing for the valuation of stock and work-in-progress. The production cost of product. as well as direct and indirect cost. This method has been recognized by various bodies like. ASB (India) for the purpose of preparing external reports and valuation of inventory. process or operation consists of manufacturing cost. both fixed and variable cost. The extent of inclusion of factory costs depends on the type of costing system in forceabsorption and marginal costing. Where the marginal costing method is adopted only variable factory overheads are included as part of inventoriable cost. Traditional method. Absorption costing is an approach to product costing. b. e. Different bases are used for classifying costs for different purposes. Period costs are costs associated with time period rather than the unit of output or manufacturing activity. These costs go into the determination of inventory valuation (finished goods and partly completed goods) hence are called inventoriable cost. ASC (UK). c. FASB (USA). Table 1: Ascertainment of Profit Under Absorption Costing Amount Amount Particulars (Rs. Thus. price based on absorption costing ensures that all costs are covered.CONCEPT OF ABSORPTION COSTING Cost is the base for ascertaining of profit or fixing selling price or valuating inventory. wherein the total cost is considered.) (Rs. Conventional method and Cost Plus method. selling and distribution costs are treated as period costs and are deducted as an expense for the determination of income and are not regarded as a part of inventory. direct labor and factory overheads (partly or fully). d. These costs are not treated as part of inventory and hence are treated as expenses in the period in which they are incurred. Administrative.) Sales xxxx Less: Cost of Goods . In this chapter the terms product cost and period cost are most important for understanding the terms absorption costing and marginal costing. It discloses the efficient or inefficient utilization of production resources by indicating underabsorption or overabsorption of factory overheads. In absorption costing most of the fixed cost is treated as part of product cost and inventory values are arrived at accordingly. It is the simpler and oldest method. Under absorption costing all costs should be charged to units manufactured. Where the absorption costing method is adopted factory overheads both fixed and variable costs are included as part of product cost. in practice. They consist of direct materials. Absorption Costing Absorption costing is a cost accounting method of charging all direct costs and all production costs of an organization to specific units of production. It makes calculation of gross profit and net profit separately in income statement possible. MERITS OF ABSORPTION COSTING The following are the merits of absorption costing: a.

Comparison and control of cost is difficult because it depends on the level of output. d. which means a portion of fixed cost is carried forward to the next period. c. closing stock is valued at cost of production (fixed cost and variable cost). Figure 1: Absorption Costing .) xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx Amount (Rs.Particulars Manufactured – Direct Material – Direct Labor Factory Overheads – Variable – Fixed (at actual production basis) Add: Stock Less: Stock Add: Underabsorption of fixed overhead (or) Less: Overabsorption of fixed overhead Gross Profit Less: Administration. Selling & Distribution Expenses Fixed Variable Net Income or Profit Value of Closing Value of Opening Amount (Rs. In absorption costing. An increase in the level of production reduces the unit cost and a decrease in the production level or output increases the unit cost. in the sense all the costs incurred in the year are not charged to revenue b. Managerial decisions such as make or buy a product. number of units to be produced to earn desired profit etc. fixation of price. choice of alternatives. It is considered to be an unsound practice.) xxxx xxxx xxx xxx xxxx xxxx LIMITATIONS OF ABSORPTION COSTING a.. For different levels of output different unit costs are available. e. cannot be taken with the help of absorption costing because it considers the total cost and not the variable cost which is important for taking such decision. It lacks accuracy in determining the selling price of a product or service as it considers the total cost for its calculation.

This contribution covers the fixed cost and generates the profit. the fixed manufacturing costs are considered as period costs and charged directly to Profit and Loss Account.) (or) . Meaning of Marginal Cost and Contribution MARGINAL COST It is the cost incurred on producing an additional unit of production. According to CIMA London. Mathematically. it is the total variable cost. Under this method. The marginal cost includes all the direct costs and variable overheads. contribution can be expressed as follows: Contribution = Selling Price – Marginal Cost (or) Contribution = Fixed Cost + Profit Contribution – Fixed Cost = Profit. ―the ascertainment of marginal costs and the effect on profit of changes in volume or type of output by differentiating between fixed cost and variable cost‖. Table 2: Ascertainment of Profit Under Marginal Costing Particulars Amount Amount (Rs.) (Rs. if volume of output is increased or decreased by one unit‘.MARGINAL COSTING It is also known as variable costing or direct costing. contribution is the difference between the sales value and the marginal or variable cost of the product. As per CIMA. In other words. A detailed study based on the contribution made by each product or department helps in analyzing the relative profitability of that product or department. ‗the amount at any given volume of output by which aggregate costs are changed. This technique takes into consideration only the variable cost as product cost. Contribution minus fixed expenses equals profit. London. CONTRIBUTION In marginal costing technique. Marginal Costing is. Per unit marginal cost will remain same irrespective of the level of production. the marginal cost is.

000 Amount (Rs.000 3. Solution Profit Statement (under Absorption Costing Method) Amount Particulars Amount (Rs.14.000 Less: Rectification of over absorption of 2000 units @ Rs.000 Less: Closing stock 4.20.44.000 6.3 per unit Less: Selling & Administrative cost Fixed Variable @ 15% on sales Profit = Rs.72.4 + Rs.000 72.17 Add: Variable Selling & Administrative Cost Contribution Less: Fixed Cost: Production Selling and Administration 1.3 = Rs.000 @ Rs.4) Less: Closing Stock 4.3 = Rs.30 4.000 units @ Rs.000 3.000 69.000 cases @ Rs. There was no opening stock of finished goods and the work-in-progress stock may be assumed the same at the end of the year as it was at the beginning of the year.000 @ Rs.) (Rs.000 Particulars Sales 16.000 per case 4.Fixed Variable 15% on sales revenue.40.000 80.17 (Rs.6 + Rs.000 97.30 per case Less: Variable Cost 20.7 + Rs.20 3.000 cases @ Rs.) Sales 16.000 cases @ Rs.) 4.20 1.) 3.000 .66.000 72.000 2.000 68.000 Note: Fixed cost per unit = Production cost per unit Profit Statement (under Marginal Costing Method) Amount (Rs.7 + Rs.000 25.6 + Rs.00.000 79.36.000 Less: Production cost 20.20 25.000 54.80.80.

the products are transferred from process to process at marginal cost. Variable cost varies according to the level of activity but per unit variable cost remains fixed. Under marginal costing. the distinction between the period cost and product cost determines when costs are matched with revenues. Fixed cost is fixed in absolute value at any level of activity. vii. All the costs are classified into fixed and variable cost. Inventories are valued at marginal cost. The profitability of products and divisions are determined on the basis of contribution margin.000 FEATURES OF MARGINAL COSTING i. vi. Direct or variable or product . v. Under marginal costing. The product is priced on the basis of marginal cost and contribution. ii.Profit 57. Under marginal costing. iii. When marginal costing is used in process costing. viii. iv. Figure 2: Marginal Costing Difference between Absorption Costing and Marginal Costing The following are the main points of difference between the absorption costing and marginal costing: a. the fixed cost is treated as period cost and variable cost is treated as product cost. There is no effect of differences in the amount of opening stock and closing stock on unit cost of production in marginal costing. the importance is given to total contribution and contribution from each product while presenting the data.

by analyzing the cost data. the full loss on account of goods destroyed cannot be recovered from the insurance company. LIMITATIONS OF MARGINAL COSTING v. c. exercises effective control over it and also facilitates responsibility-oriented control. Marginal costing leads to greater accuracies in calculation of profits as the valuation of closing stock of finished goods and work-in-progress are easy and simple. while period costs are matched with revenues in the period in which the costs are incurred. showing the variable cost and contribution for each product and product line aids the management in taking appropriate decisions. arbitrary apportionment of fixed costs over the products results in underabsorption or overabsorption of such cost. which is the difference between the sales value and the total cost of the product. But in absorption costing. In absorption costing. ii. The cost information presented under marginal costing is simpler. b. fixed costs are treated as part of production cost and accordingly inventory is valued. Marginal costing. because neither the variable cost is absolutely variable nor the fixed expenses are absolutely fixed. and an effective aid to the management in decision-making. As the closing stock is valued at variable cost under marginal costing technique.costs are assigned to products and matched with revenues when they are recognized. Time factor is not given due importance in marginal costing and all those expenses connected to time are excluded. The other cost techniques such as budgetary control and standard costing can achieve better control when compared to marginal costing. there is no underabsorption or overabsorption of overheads. iii. The long run decisions are based only on total cost and not on variable cost. Some of the important limitations of marginal costing are as follows:  Separation of all expenses into fixed and variable is practically difficult. managerial decision-making is based on profit. VALUE OF MARGINAL COSTING TO MANAGEMENT Marginal costing is very useful to the managers because of the following reasons: i. as marginal costing     . meaningful. the pricing decision based on marginal costing is useful in short run but not in the long run. Marginal cost understates the stock of finished goods and work-in-progress because of which the Balance Sheet does not exhibit the true and fair view. Therefore. as it excludes the fixed costs and also avoids allocation and apportionment. iv. The data presented is more reliable and more acceptable. in marginal costing since fixed costs are excluded. Marginal costing by separating the costs into fixed and variable cost. Usually the fixed costs are not allocated and apportioned on scientific basis. This problem of classification becomes more complicated with the presence of semi-variable and semi-fixed expenses. But in marginal costing. Contribution is the difference between the sales value and the marginal cost of the product. whereas. In absorption costing. the managerial decisions are based on contribution and not profit.

If any such cost is included in the product. because. Particulars Direct Material cost per unit Direct Labor cost per unit Total fixed manufacturing OH per year Amount (Rs. Absorption Costing Method. replacement of labor force by machine. Most people tend to think that direct costing and marginal costing are one and the same. 2.deals with cost behavior but does not provide any standard for evaluation of performance.000 Variable manufacturing OH cost per unit 2 . Marginal Costing Method. only direct costs are considered in the calculation of the cost of a product. So it can be fixed or variable in nature. Effects of absorption costing and marginal costing on income statements Alternatives Absorption Marginal costing net income costing Net income High Low Equal Low Uneven income High Constant income  PV > SV PV = SV PV < SV SV (Constant). Difference between Marginal Costing and Direct Costing In case of direct costing. for example. But they are different. all direct costs may not be variable. PV (fluctuating) PV (Constant) Income changes in proportion to change in SV Low change Greater Change Change in net income over a long period Both the results becomes almost similar RG Company furnished the following data.) 3 5 60. Ascertain net income of the company under 1. All indirect expenses or costs are met from the total margin available from all products. It fails to reveal the impact of change of manufacturing practice. A direct cost can be identified with the product directly. the cost calculated under direct costing and marginal costing will be different.

00.50.) 4.80.000 Solution : Cost per unit under marginal costing Particulars Amount (Rs) Direct Materials 3 Direct Labor Variable manufacturing cost Per unit cost 5 2 10 Cost per unit under absorption costing Particulars Direct Materials Direct Labor Variable manufacturing cost Fixed manufacturing cost (60000/20000) Per unit cost Amount (Rs) 3 5 2 3 13 Marginal Costing Income statement Particulars Sales Less Variable costs Variable cost of goods sold Opening inventory Cost of goods produced( 20.000 1.000 units Rs.000 units 5.50.000 30. 40.00.000 units @ Rs.000 0 2.70.000 . 10 ) Cost of goods available for sale Closing stock (5000 units @ Rs. 30 Rs.000 50.) Amount (Rs.000 1. 2 per unit Rs.Number of units produced per year Closing stock Sales price per unit Variable selling expenses Fixed selling expenses - 20. 2) Total variable cost of good sold Contribution Less: Fixed costs Amount (Rs.000 2. 10) Variable cost of goods sold Variable selling expenses(15000 units @ Rs.000 2.

sales price.00.50..000 1.Manufacturing OH Fixed selling expense Net Income Income statement under Absorption Costing Particulars Sales Less Cost of goods sold Variable cost of goods sold Opening inventory Cost of goods produced( 20.000 40.000 1.) 4. variable cost.000 2.000 40. volume and profit.70.85.000 @ 2) Net Income 60.000 Amount (Rs. i. This is the most important technique. According to CIMA. The cost of the product determines its selling price and selling price determines the profit.000 COST-VOLUME-PROFIT ANALYSIS Cost-Volume-Profit (CVP) Analysis studies the relationship of cost. 13 ) Cost of goods available for sale Closing stock (5000 units @ Rs.000 0 2.60.000 65.000 2. In brief.) Amount (Rs.000 1.e. quantity and mix‖.55.000 70. which directly affects the volume of production and volume of production influences the cost. London. In Management Accounting it is very important to find out how costs and profits vary in relation to changes in volume.95.000 1. 13) Gross Margin Less Fixed costs Variable selling expenses (15. .60. quantity of the product manufactured and sold. ―CVP analysis is the study of the effects on future profits of changes in fixed cost.000 units @ Rs. which is used in managerial decision-making and profit planning. These three factors are interrelated.95.000 30. variations in volume of production result in changes in cost and profit. Selling price affects the volume of sales.000 1.

b. a. (or) (or) (or) Contribution/Sales (C/S) or Profit Volume (P/V) Ratio.. The selling price of the product remains the same even if volume varies. namely. Margin of Safety . volume and profit. then we can expect raw material costs also to increase by 10%. An example of a variable cost is raw material. There is only one product. variable costs vary in proportion to changes in activity.All the above linear relationships hold good under three assumptions. a. the product mix is assumed to be constant. c. their calculation and application. Marginal Cost Equation: Sales = Variable Cost + Fixed Expenses + Profit /Loss [S = V + F + P] Sales = Variable Cost + Contribution [S = V + C ] Sales – Variable Cost = Fixed Expenses + Profit/Loss [S – V = F + P] Sales – Variable cost = Contribution [S – V = C] In order to understand the mathematical relationship between cost. Fixed costs remain the same even if the volume (i. b. If volume of production increases by say 10%. On the other hand. Every cost can be classified as fixed cost or variable cost. Mathematical relationship between cost-volume-profit requires the understanding of marginal cost equation. If there is more than one product. quantity of product manufactured and sold) changes. c. it is desirable to understand the following concepts. Break Even Point. A cost like factory rent would be an example of a fixed cost.e.

At break even point. Higher the P/V ratio higher the profit and lower the P/V ratio lower is the profit. It means selling the products more. For 2000-01.. Illustration 2 Monotonous Co. ·By reducing the variable or marginal cost and ensuring the efficient utilization of men. Profitability of the product can be ascertained by comparing the P/V ratios for the different products. It is expressed in the following ways: P/V Ratio = = = = (or) (or) x 100 (or) x 100 Desired sales. organizations can improve their P/V ratio without an increase in fixed cost. Profit/volume ratio establishes the relationship between contribution and sales. Hence. It is a point at which the total sales are equal to total costs. material and machines. The profit/volume ratio is expressed in percentage. The Break Even Point A break even point is a point at which a firm earns no profit and does not bear any loss.Contribution/Sales Ratio or P/V Ratio The profitability of the operation of a business can be known with the help of profit/volume ratio. In other words. Any increase in contribution leads to increase in profit because fixed cost is assumed to be constant for all the levels of production. contribution is sufficient to cover fixed cost only. the income of the firm is equal to the expenditure. P/V ratio can be increased or improved by taking any of the following steps:    By increasing the sales price or selling price per unit. variable cost and contribution can be found out with the help of P/V ratio. manufactures and sells a single variety of a product. the Management Accountant estimated the following profit levels depending upon the different quantities of the product manufactured and sold: . Every unit produced after break even point contributes to the profit of the organization. which is having a higher P/V ratio. By changing the sales mix. A higher P/V ratio is an indicator of sound financial health of the company‘s product. The formulae are as follows: Desired Sales = Desired Contribution/P/V Ratio (or) = (Fixed Cost + Desired Profit) / P/V Ratio Variable Cost = Sales (1 – P/V ratio) Contribution = Sales x P/V Ratio Improving P/V Ratio P/V ratio shows the profitability of the organization.

The Break Even Point is a kind of borderline. as more and more units are sold the loss goes on decreasing.8 3.000 units.6 lakh.7 3.0 4.1.5 5. The above situation can be represented on a graph as follows: The graph shows that when sales quantity is 40.0 3. On the Xaxis the BEP indicates that when sales quantity is 40.4 lakh. When sales increase beyond 40.000 units the Sales Value Line and the Total Cost Line intersect at a point BEP.8 Total Costs Profit/(Loss) Rs. . there is a loss of Rs.4 0.0 4. lakh [Selling Price = Rs. the company incurs a loss. This point is called the Break Even Point.000 units the firm earns a profit. However.8) (0.4) — 0. When sales are 40. On the Y-axis BEP indicated that Total Cost equals Sales Value when each of these amounts is Rs.000 units are sold.1 4. If sales are less than break even sales.000 units there is no loss.6) (1.6 3.5 3. Total Cost equals Sales Value. If sales are more than break even sales the company earns a profit.Sales Quantity (’000 units) 20 25 30 35 40 45 50 Solution Sales Value Rs.2) (0.0 2. lakh Rs.10] 2.5 4.0 3. lakh As seen from above when 20.9 4.2 (1.

000 units.BREAK EVEN POINT ON P/V GRAPH We can plot profit against sales quantity on a Profit-Volume Graph using the figures given earlier. it is termed as break even chart. It is a point at which the total sales are equal to total costs. As seen earlier it is the point at which sales quantity is 40. In other words. the Break Even Point BEP is the point at which the Profit Line intersects the X-axis. it is called break even analysis and graphically. It is a point at which the total sales are equal to total costs. contribution is sufficient to cover fixed cost only. . We get the following P/V graph: Figure 4 Here. Arithmetically. It can be ascertained arithmetically or graphically. A break even point is a point at which a firm earns no profit and does not bear any loss. A break even point is a point at which a firm earns no profit and does not bear any loss.

In the given graph. This denotes profit. Left side area of B.E.P. denotes loss. Point. The point at which the sales line intersects the total cost line represents the B. the sales line and variable line starts from the ‗0‘ point indicating variable cost is dependent on the sales.P. and the angle between sales line and total cost line is known as angle of incidence.E. sales over the B. Area between total cost line and sales line is situated to the right side of the B. Fixed cost line is parallel to the horizontal axis denoting its fixed nature irrespective of the amount of production. Right side area of the B.P.E.E. denotes the margin of safety i.E. . Total cost line has been derived after adding variable cost line with the fixed cost.e.P.

Break Even Sales (Value) = = The above can be written as: Break Even Sales (value) = Break Even Sales Quantity x Selling price per unit. = Profit =P =P Then we have. is the C/S ratio (also called the P/V ratio or contribution margin) Break Even Sales Value = or . Profit for the period under consideration. Quantity (units) of the product manufactured and sold. sQ – [vQ + F] So. Break Even (Quantity) = We may be interested in the Break Even Sales value instead of the Break Even Sales quantity. (s – v) Q – F We can use this equation to find the quantity QB of units to be manufactured and sold in order to break even..e. Note that at the break even point profit i. Total fixed cost for the period under consideration. Variable cost per unit of the product manufactured and sold. P = 0 So the above equation becomes. (s – v) QB – F or Since QB s–v = = Unit contribution = 0 We have the formula. Sales Revenue – Total Cost So.BREAK EVEN POINT FORMULA We can arrive at the break even point using a mathematical model as shown below: Let s v Q F P = = = = = Selling price per unit of the product.

USES OF BREAK EVEN ANALYSIS Prediction: Break Even Analysis is useful in predicting what sales volume has to be achieved in order to start earning a profit. break even sales are Rs.4 lakh before the firm starts earning a profit. In practical terms this would mean deciding upon the capacity of the firm to produce and sell its products.5 lakh.4 lakh.1 lakh or 20% is called the Margin of Safety. ―How low can the sales fall before the firm will begin to incur losses?‖ In the example above. the firm will incur losses. For example.1 lakh or 20%. 10.000 units or Rs.000 units. in the above case sales should be at least 40. Margin of Safety: Break Even Analysis can also be used to answer the question. Consider the three cases illustrated below: Case I Figure 6  .000 units or Rs. Figure 5   Scale of Operations: An important decision is to decide the scale of operations of a firm. Then if actual sales are lower by more than 10. It is the difference between actual sales and Break Even sales. Actual sales are expected to be Rs. Rs.

Case II Figure 7 Case III Figure 8 .

This is relatively a safe situation because the firm can start earning profit at a relatively low level of activity. the firm begins to earn a profit.480 and the product is sold for Rs. What would be the break even point in terms of output and in terms of sales value? Solution Contribution per unit = Sales – Variable Cost = Rs. This is a riskier situation than Case I because the firm has to achieve a much higher level of activity before it can start earning profits.120 P/V = = = 20% Ratio Break Even Point (in units) Break Even Point (in Rs. = Break Even point x Selling price per unit = 24.480 = Rs.In all the cases the firm has a capacity of 100%. iii.) = Fixed cost/contribution per unit. This means that the company does not have the necessary infrastructure to produce more than 100 units in a year [capacity is usually specified as maximum possible production per year]. the firm begins to earn a profit once the sales quantity crosses 65 units or 65% of capacity. The marginal cost of each product is Rs.600 – Rs. ii.24. Fixed costs incurred by the company is Rs. In Case II. once the sales quantity crosses 25 units or 25% of capacity.000/120 = 200 units. i.  Changes in Underlying Factors: Break Even analysis can also be used to study the effect of changes in underlying factors on the Break Even Point and Margin of Safety. Case III is a disaster because the firm cannot earn a profit even when sales quantity equals the capacity of 100 which is the maximum possible production.600.000 annually. Calculate P/V ratio. . In Case I. Illustration 3 A manufacturing unit produces 750 units of products annually.

2.00.1.000.1.4. Sales to earn a profit of Rs.80.00. Break Even Point Sales to earn a profit of Rs. Illustration 4 From the following figures.20.000 = Rs.000 2.00.20. the margin of safety is nil because the actual sales and the break even sales are equal. At BEP.20. calculate i.1.) = = Rs. Break Even Point (in Rs.000 1.1. Margin of safety is the excess of actual production over the production at the break even point because of marginal costing assumption that the production or output must coincide with the sales. = Sales – Variable Cost = Rs.80. . 4.000. ii.20.000 = = =30% Calculation of Break Even Point Break Even Point (in Rupees) = ii.= 200 x 600 = Rs.000 – Rs.20.000.80.000 Break Even Point (Rs.) = Fixed Cost/ P/V Ratio = 24.1. or.10.000/ 20% = Rs. Margin of Safety Margin of safety is the difference between the actual sales and the sales at the break even point or. the excess of actual sales over the break even sales.000 Solution Contribution P/V Ratio i. Particulars Sales Fixed Cost Variable Expenses Rs.000.

The formula for calculating the margin of safety is. .Margin of safety can also be expressed in percentage.