INTRODUCTION

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Marginal Costing is entirely based on the distinction between Fixed Costs and Variable Costs. Marginal Costs classifies the total costs into Fixed Costs and Variable Costs. In Marginal Costing only Variable Costs are charged to the product. Variable Costs vary with level of output and hence are „Product Costs‟. Therefore only variable costs are charged directly to the products. The Fixed Costs are not charged to the product. Fixed Costs are related to period rather than level of output. In Marginal Costing, Fixed Costs, being „Period Costs‟, are directly transferred to the Costing Profit and Loss Account for the relevant period.

Objective of Study:
• To study the distinction between a) Relevant cost and irrelevant costs b) Marginal cost and differential cost c) Breakeven point and cost indifference point d) Relevant cost and opportunity cost and g) Traceable cost and common cost. • To know the importance of qualitative factors in decision making. • The impact of opportunity cost, shadowprice or incremental opportunity cost and imputed cost on decision making.

Research methodology:
The information collected to conduct the research on Marginal Costing is collected from secondary data only.

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MARGINAL COSTING AS A COSTING SYSTEM:
Marginal Costing is a type of flexible standard costing that separates fixed costs from proportional costs in relation to the output quantity of the objects. In particular, Marginal Costing is a comprehensive and sophisticated method of planning and monitoring costs based on resource drivers. Selecting the resource drivers and separating the costs into fixed and proportional components ensures that cost fluctuations caused by changes in operating levels, as defined by marginal analysis, are accurately predicted as changes in authorized costs and incorporated into variance analysis. This form of internal management accounting has become widely accepted in business practice over the last 50 years. During this time, however, the demands placed on costing systems by cost management requirements have changed radically. MARGINAL COST In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. It is the cost of producing one more unit of a good. Mathematically, the marginal cost (MC) function is expressed as the first derivative of the total cost(TC) function with respect to quantity (Q). Note that the marginal cost may change with volume, and so at each level of production, the marginal cost is the cost of the next unit produced.

MC= Total Cost\Quantity
In general terms, marginal cost at each level of production includes any additional costs required to produce the next unit. If producing additional vehicles requires, for example, building a new factory, the marginal cost of those extra vehicles includes the cost of the new factory. In practice, the analysis is segregated into short and long-run cases, and over the longest run, all costs are marginal.

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At each level of production and time period being considered. price discrimination and others. Thus MARGINAL COST = VARIABLE COST DIRECT LABOUR +DIRECT MATERIAL +DIRECT EXPENSE 3 . and other costs are considered fixed costs. (Terminology. The marginal cost of a product –“ is its variable cost”. the presence of negative or positive externalities. This is normally taken to be. marginal costs include all costs which vary with the level of production. direct expenses and the variable part of overheads. Marginal costing is formally defined as: „the accounting system in which variable costs are charged to cost units and the fixed costs of the period are written-off in full against the aggregate contribution. Marginal costing – definition: Marginal costing distinguishes between fixed costs and variable costs as convention ally classified. direct material. direct labour. Some of these may be considered market failures. transaction costs.) The term „contribution‟ mentioned in the formal definition is the term given to the difference between Sales and Marginal cost. Its special value is in decision making‟. These may include information a symmetries. A number of other factors can affect marginal cost and its applicability to real world problems.

CHARACTERISTICS: 1. 2. The meaning is usually clear from the context.Alternative names for marginal costing are the contribution approach and direct costing In this lesson. we will study marginal costing as a technique quite distinct from absorption costing.MARGINAL COST The term marginal cost sometimes refers to the marginal cost per unit and sometimes to the total marginal costs of a department or batch or operation. Marginal Costing is the ascertainment of Marginal Cost by differentiating between Fixed Costs and Variable Cost. Note:.+VARIABLE OVERHEADS CONTRIBUTION= SALES . Marginal Costing is also the ascertainment of the effect on profit of changes in the volume and type of output. 4 .

Conversely. if an output reduces. the cost per unit increases. therefore. for example. the cost per unit in normal circumstances reduces. If the volume of output increases.25 5 .25. London is as follows: In relation to a given volume of output. the aggregate of certain items of cost will tend to remain fixed and only the aggregate of the remainder will tend to rise proportionately with an increase in output. Conversely. by understood in the following two steps: 1. the marginal cost of additional output will be $. additional output can normally be obtained at less than proportionate cost because within limits. If an increase in output is more than one. It can be described as follows: Additional cost \Additional units = $ 45 0 = $2. If a factory produces 1000 units at a total cost of $3.045.Theory of Marginal Costing: The theory of marginal costing as set out in “A report on Marginal Costing” published by CIMA. a decrease in the volume of output will normally be accompanied by less than proportionate fall in the aggregate cost. The theory of marginal costing may. 2.2.002. the average marginal cost per unit is $2.000 and if by increasing the output by one unit the cost goes up to $3. the output is increased to 1020 units from 1000 units and the total cost to produce these units is $1. If. the total increase in cost divided by the total increase in output will give the average marginal cost per unit.

marginal costing is a popular phrase whereas in US. Variable costing is another name of marginal costing. It consists of prime cost. Marginal cost means the cost of the marginal or last unit produced. it is known as direct costing and is used in place of marginal costing. Rather it is simply a method or technique of the analysis of cost information for the guidance of management which tries to find out an effect on profit due to changes in the volume of output. In UK. a unit may mean a single commodity.The ascertainment of marginal cost is based on the classification and segregation of cost into fixed and variable cost. Similarly if the production of X-1 units comes down to $ 280. i. The marginal cost varies directly with the volume of production and marginal cost per unit remains the same. the cost of marginal unit will be $ 20 (300–280). In this connection. It is also defined as the cost of one more or one less unit produced besides existing level of production. It does not contain any element of fixed cost which is kept separate under marginal cost technique. cost of direct materials. There are different phrases being used for this technique of costing. Marginal costing may be defined as the technique of presenting cost data wherein variable costs and fixed costs are shown separately for managerial decision-making.e. a dozen. it is essential to understand the meaning of marginal cost. the cost of an additional unit will be $ 20 which is marginal cost. It should be clearly understood that marginal costing is not a method of costing like process costing or job costing. 6 . if a manufacturing firm produces X unit at a cost of $ 300 and X+1 units at a cost of $ 320. a gross or any other measure of goods. In order to understand the marginal costing technique. direct labor and all variable overheads. For example.

and is equal to fixed cost plus profit (C = F + P). The principles of marginal costing: The principles of marginal costing are as follows. a. contribution goes toward the recovery of fixed cost and profit. For any given period of time. Profit will increase by the amount of contribution earned from the extra item. by selling an extra item of product or service the following will happen. Thus. contribution will be just equal to fixed cost (C = F). Similarly.    Revenue will increase by the sales value of the item sold. Costs will increase by the variable cost per unit. It has a fixed relation with sales. b.Marginal costing technique has given birth to a very useful concept of contribution where contribution is given by: Sales revenue less variable cost (marginal cost) Contribution may be defined as the profit before the recovery of fixed costs. Therefore. fixed costs will be the same. if the volume of sales falls by one item. the profit will fall by the amount of contribution earned from the item. The proportion of contribution to sales is known as P/V ratio which remains the same under given conditions of production and sales. In case a firm neither makes profit nor suffers loss. The concept of contribution is very useful in marginal costing. for any volume of sales and production (provided that the level of activity is within the „relevant range‟). This is known as break even point. 7 .

Features of Marginal Costing: The main features of marginal costing are as follows: 1. Since fixed costs relate to a period of time. the extra costs incurred in its manufacture are the variable production costs. inventory/stock for profit measurement is valued at marginal cost. it is misleading to charge units of sale with a share of fixed costs. d. It is in sharp contrast to the total unit cost under absorption costing method. Stock/Inventory Valuation: Under marginal costing. and no extra fixed costs are incurred when output is increased. 2. Cost Classification: The marginal costing technique makes a sharp distinction between variable costs and fixed costs. Profit measurement should therefore be based on an analysis of total contribution. It forms the basis for judging the profitability of different products or departments.c. It is the variable cost on the basis of which production and sales policies are designed by a firm following the marginal costing technique. Marginal contribution is the difference between sales and marginal cost. When a unit of product is made. 8 . Marginal Contribution: Marginal costing technique makes use of marginal contribution for marking various decisions. Fixed costs are unaffected. and do not change with increases or decreases in sales volume. 3.

the effect of varying charges per unit is avoided. and decisions taken would yield the maximum return to business. 7. By not charging fixed overhead to cost of production.Advantages and Disadvantages of Marginal Costing Technique: Advantages: 1. 6. 5. By avoiding arbitrary allocation of fixed overhead. 4. The effects of alternative sales or production policies can be more readily available and assessed. Practical cost control is greatly facilitated. Comparative profitability and performance between two or more products and divisions can easily be assessed and brought to the notice of management for decision making. 3. both in terms of quantity and graphs. 2. efforts can be concentrated on maintaining a uniform and consistent marginal cost. It is useful to various levels of management. It prevents the illogical carry forward in stock valuation of some proportion of current years fixed overhead. It eliminates large balances left in overhead control accounts which indicate the difficulty of ascertaining an accurate overhead recovery rate. 9 . It helps in short-term profit planning by breakeven and profitability analysis. Marginal costing is simple to understand.

In order to know the net profit. The exclusion of fixed costs from inventories affect profit and true and fair view of financial affairs of an organization may not be clearly transparent.Disadvantages: 1. Marginal cost data becomes unrealistic in case of highly fluctuating levels of production. Normal costing systems also apply overhead under normal operating volume and this shows that no advantage is gained by marginal costing. we should not be satisfied with contribution and hence. absorption costing is the only answer. sales price.. In practice. the assumptions underlying the theory of marginal costing sometimes becomes unrealistic. fixed cost and variable cost per unit may vary.g. Thus. 2. Volume variance in standard costing also discloses the effect of fluctuating output on fixed overhead. Control affected by means of budgetary control is also accepted by many. 7. 3. Under marginal costing. 6. fixed overhead is also a valuable item. stocks and work in progress are understated. e. For long term profit planning. 5. 10 . Application of fixed overhead depends on estimates and not on the actual and as such there may be under or over absorption of the same. The separation of costs into fixed and variable is difficult and sometimes gives misleading results. A system which ignores fixed costs is less effective since a major portion of fixed cost is not taken care of under marginal costing. in case of seasonal factories. 4.

power and cost of raw material. •Average variable cost: Average variable cost are variable costs divided by the quantity of output. •Average fixed cost: Average fixed cost is the fixed cost divided by the quantity of output. rent. for example. prime costs. •Social costs: Social costs of production are costs incurred by society. on costs and direct costs. are costs which vary directly with the level of output. • Average total cost: Average total cost is the total cost divided by the quantity of output. 11 . resulting from private production. for example. operating costs. In the long run all costs can be considered variable. labour. as a whole. •Variable cost: Variable cost also known as.Other cost definitions in marginal costing •Fixed costs: Fixed cost are costs which do not vary with output. fuel.

investment analyses. Businesses today frequently voice their disapproval of the traditional cost accounting approaches. The main thrust of the dissatisfaction with conventional cost accounting methods is that they are too highly developed and too complex. This line of criticism sees little relevance in traditional cost accounting tasks such as monitoring the economic production process or assigning the costs of internal activities. and furthermore are no longer needed in their current form since other tools are now available. At the beginning of the1990s. have begun to lose their significance. At their current level of detail. 12 . Some of the classical applications of management accounting.MARGINAL COSTING AS A MANAGEMENT ACCOUNTING TOOL: 1. Marginal Costing is clearly the core aspect of traditional management accounting. however. The viewpoint of the present author is that cost accounting has by no means lost its right to exist. The question thus arises: What is the current role of Marginal Costing in modern management accounting. such tasks are neither necessary nor does their perceived pseudo accuracy further the goals of management. Calls for increased use of cost management tools. 2. these criticisms were taken up by researchers involved with the applications of cost accounting concepts. for it is an easily overlooked fact that the data structure required by the new tools is already present in traditional cost accounting. and value-based tool concepts are frequently associated with criticism of the functionality of current cost accounting approaches as management tools.

At the same time.3. In particular. 13 . More significant than influencing the current costs of production with cost center controlling and authorized-actual comparisons of the cost of goods manufactured is timely and market-based authorized cost management. The need for exact cost planning for profitability management is thus touched on ex ante. (i) cost planning takes precedence over cost control. An alternative increasingly being called for is to control costs through direct activity/process information (quantities. (ii) cost accounting must be employed as a tool for cost control at an early stage. We need first to look at how the purposes of cost accounting are shifting before we can determine its significance. The relative significance of traditional cost accounting as a management accounting tool will decline as it is applied mainly to fields where costs cannot be heavily influenced. This requires different methods of cost planning than those normally provided by Marginal Costing. in the context of continuous improvement and modern managerial concepts. The effort involved in planning and monitoring costs is increasingly being seen as excessive. is based on this view. this is the stage where cost information is most urgently needed since the time and quantity standards as defined by Bills of Materials (BOMs) and production routings are still lacking. The charge levied against traditional cost accounting--that its complex cost allocations merely generate a kind of pseudo precision-lends further credence to this assessment. The greatest scope for influencing costs is at the early product development phase and when setting up the production processes.S. To assess the present-day value of Marginal Costing. quality) for cost management at local. decentralized levels instead of relying on delayed and distorted cost data. times. research on appropriate variables for performance measurement. empirical U. the changes occurring in the business world must be analyzed more closely.

for example. This applies to the management of the profitability of products and product lines. The information required for this purpose can only be supplied by multilevel and multidimensional marketing segment accounting based on contribution margin accounting. In addition. There is a strong current of accounting research in the U. as well as distribution channels and increasingly customers.(iii) the behavioral effect of cost information is starting to be recognized. Competitive dynamics are giving rise to an increasing differentiation of market-based profitability controlling. The shift in the purposes of cost accounting is being accompanied by a shift in the main applications of standard costing. that takes human psychological factors into consideration. 4. on the principal-agent theory indicate that knowledge of the "relevant" costs does not always lead to the optimization of overall enterprise profitability. cost accounting must be integrated into performance measurement. They should be implemented both in indirect areas and at the corporate level. Long-term cost planning based on the idea of lifecycle costing isgaining in prominence compared with short-term standard costing. Product decisions are increasingly based on more than just the cost of goods manufactured and sales costs and now tend to include pre-production 14 . and markets. Hence. Results of theoretical and empirical research based. the perspective that formed the basis for the absorption costing issue has changed.S. This is resulting in an extension of cost theory beyond its pure microeconomic basis. Costing solutions for market-oriented profitability management and life-cycle-based planning and monitoring should be developed further. Theories according to which cost allocations can contain information and increase the efficiency of the use of available capacity. or where future allocations can influence ex-ante decisions. customer groups. require empirical research.

Whether or not a product is successful is determined by the amortization of its overall cost. the tool requirements increase. This process of costing operations using proportional costs competes with the attempt to achieve better cost transparency in indirect areas with process costing tools to also improve the planning and control of costs that were previously budgeted only as a lump sum. As management accounting is increasingly applied to the growing share of the costs of indirect areas. providing the cost-volume is large enough. This shift in cost and revenue planning is moving cost and revenue accounting in the direction of investment-related calculations. it was only a small step to the identification of the lost relevance of conventional cost accounting by H. Miller's and T. E. S. Improving the cost transparency of indirect activity areas through Marginal Costing requires a thorough understanding of the output processes. Vollmann's discovery of the "hidden factory" as an area whose costs are neglected by conventional production costing in the U. product costing. Kaplan and their call to develop accounting systems separated into "process control." which eventually led to activity-based costing. Analysis frequently shows that even many support activities have a wide range of repetitive processes for which planning and cost allocation using drivers is worthwhile. G..costs (such as development costs) and phasing-out costs(such as disposal costs).S. The number of these operations is used as the driver. Johnson and R. for which resource consumption is then planned and tracked. T. the cost and revenue trend forecasts should be more dynamic to support the life cycle pricing policy. After J. Product decisions are viewed strategically. For this purpose. and financial reporting. Furthermore. 15 . the different operations in the cost centers must be identified.

and the use of incentive systems. the costing basis of transfer prices. the management of business units. It was recognized that short-term accounting information is insufficient to 16 . Since the 1980s there has been a growing consciousness of the significance of continuously improving the performance capabilities of the company. Marginal Costing and its tools have been developed for individual companies and are the suitable platform for this expansion. Using modeling and empirical research. Standard U.  The strategic dimension.  The motivational effects of performance measurement.S. This necessity results mainly from the requirements of inventory valuation. Group cost accounting leads to the definition of independent group cost categories. Performance measures are gaining increasing prominence in decentralized management accounting.  The assessment of teamwork. The concept is broad for the reason that performance measurement is accompanied by the provision of decision-support information. the exponents of this area are developing the idea that monetary factors are not the only possible components of performance measurement. The recent literature on performance measurement has focused on problems in the following areas:  The usability of performance information for managers. resulting in the increased importance of nonmonetary indicators. To plan and monitor the costs of these activities calls for the establishment of independent group cost accounting.Industrial production and marketing are increasingly being handled by groups of affiliated companies. and to further the consistency of corporate cost accounting. management books devote a great deal of space to performance measurement in the broad sense of the word. The tenor of the recent investigations into performance measurement reflects the general criticism of management accounting voiced by Johnson and Kaplan in Relevance Lost.

In the strategic dimension. While top management benefits most from financial success indicators that it examines in monthly or longer intervals and that can consist of multidimensional aggregate figures. underestimates the problem of increasing numbers of variants. and initiatives for each of the four perspectives of financial. the Balanced Scorecard developed by Kaplan and Norton--which links financial and nonfinancial indicators from different strategically relevant perspectives including cause-effect chains--is the main proposal under consideration for performance measurement. targets. the conventional allocation approach based on the operating rate encourages high utilization of capacity at any cost. uses the wrong overhead allocation base. and fails to appreciate interdepartmental interrelationships. In particular. degree of utilization (ratio of actual output quantity to planned output quantity). and error rate-are becoming increasingly significant for controlling business processes. quantity. The Balanced Scorecard therefore provides a framework for systematic mapping and control of the critical success factors for an enterprise. A Balanced Scorecard is a system that defines objectives. and very short-term data at the day or shift level. it was acknowledged that the use of standard costs does not adequately take performance improvements into consideration. and quality--such as equipment downtime. In concrete terms. sales orders. Moreover. internal business process. customer. operational. incorporates success factors of the future. measures in the categories of time. measures.evaluate and control company activities effectively. response time. and learning and growth. Further analyses and experience in 17 . lead time. and explicitly includes monetary and non monetary parameters. The Balanced Scorecard links strategic contingencies to financial measures. lower management must necessarily be concerned mainly with nonfinancial.

measuring performance can enable identification and assessment of cause-effect relationships within the four perspectives (such as the effect of delivery time on customer satisfaction) and between the perspectives (such as the effect of customer satisfaction on profitability). on the other hand. In deciding which option to choose he will need all the information which is relevant to his decision. and relationships between them.g. A 'quantitative' decision. e. is possible when the various factors. such as a lower authorized cost of goods manufactured as a benchmark. Concrete planned costs and planned results must be rigorously derived from higher-level target factors so that specific requirements can be derived in turn when they are broken down into smaller organizational units for the time and quantity standards. Information for decision making the need for a decision arises in business because a manager is faced with a problem and alternative courses of action are available. are measurable. in deciding which of two personnel should be promoted to a managerial position. the manager will have to make 'qualitative' judgments‟. This chapter will concentrate on quantitative decisions based on data expressed in monetary value and relating to costs and revenues as measured by the management accountant. The knowledge so gained may eventually lead to are formulation of strategy. 18 . Some of the factors affecting the decision may not be expressed in monetary value. Hence. In the context of comprehensive performance measurement. even short-term costs and financial results can serve as control instruments for strategic enterprise management. and he must have some criterion on the basis of which he can choose the best alternative.

INDIFFERENCE POINT 6. produces a number of products).THE BASIC DECISION MAKING INDICATORS INMARGINAL COSTING: 1. MARGIN OF SAFETY 5. Improvement of PV Ratio •By reducing the variable costs. In the case of the firm enjoying steady business conditions over a period of years. Use of PV Ratio (where a firm 19 . • If PV Ratio is improved. the better it is for the business. SHUT – DOWN POINT ii. •By increasing the selling price •By increasing the share of products with higher PV Ratio in the overall sales mix. It is also termed as Contribution to Sales Ratio Formula : P V Ratio = Contribution X 100\Sales Significance of PV Ratio •It is considered to be the basic indicator of profitability of business. PROFIT VOLUME RATIO (P\V RATIO ): The profit volume ratio is the relationship between the Contribution and Sales value. CASH VOLUME PROFIT ANALYSIS 4. PROFIT VOLUME RATIO 2.EVEN POINT 3. it will result in better profits. •The higher the PV Ratio. BREAK. the PV Ratio will also remain stable and steady.

Variable costs vary directly with the number of units that you sell. if there is a direct 20 . • The analysis generally assumes linearity (100% variable or100% fixed) of costs. Some costs are difficult to classify. Examples include general office expenses. BREAK – EVEN ANALYSIS: •Break-Even Analysis is a mathematical technique for analyzing the relationship between sales and fixed and variable costs. rent. interest. This point determines the number of units produced to achieve breakeven. postage. If the firm is to avoid losses. The overall profitability of the firm can be improved by increasing the sales/output of product giving a higher PVRatio. Break-even analysis is also a profit-planning tool for calculating the point at which sales will equal total costs. •Fixed costs are those expenses associated with the project that you would have to pay whether you sold one unit or 10.000 units. and advertising. direct labour. If a firm‟s costs were all variable. Examples include materials. packaging. ii. salaries. research and development. •The break-even point is the intersection of the total sales and the total cost lines. and utilities. depreciation. As a general guideline. • To determine the Break – Even Point and the level of outputrequired to earn a desired profit. •To decide the most profitable sales – mix. its sales must cover all costs that vary directly with production and all costs that do not change with production levels. the firm could be profitable from the start.• To compute the variable costs for any volume of sales •To measure the efficiency or to choose a most profitable line.

 When managing inventory. you should aim for the Economic Order Quantity (EOQ). the firm begins to make a profit. and order costs. it suffers a loss. You calculate the break-even amount with the following equation: Sales Price per Unit * Quantity Sold = Fixed Costs + [Variable Costs per Unit * Quantity Sold] For example. you can solve for the fourth factor. The break-even point is the intersection of the total sales and the total cost lines. If you could sell the units for $10 each.relationship between cost and number of units sold. If there is no relationship. which decrease with the amount ordered. then consider the cost fixed. This is the level of inventory that balances two kinds of inventory costs: holding (or carrying) costs. Represent fixed costs by a horizontal line since they do not change with the number of units produced. If you knew you could sell 400units. consider the cost variable. the equation indicates that you need to sell 300 units to break even. assume you have total fixed monthly costs of $1200 and total variable costs of $6 per unit. but below that point. the equation would indicate that the sales price would need to be $9 per unit to break even. Above that point. 21 .  The algebraic equation for break-even analysis consists of four factors. Represent variable costs and sales by upward sloping lines since they vary with the number of units produced and sold.  A break-even chart is constructed with a horizontal axis representing units produced and a vertical axis representing sales and costs. which increase with the amount of inventory ordered. If you know any three of the four.

and the labour costs of processing and inspecting incoming inventory. The algebraic expression of EOQ is as follows: EOQ = square root of [2*U*O divided by H] where U is the number of units used annually. associated telephone and mail costs. Other components include the labour cost associated with inventory maintenance and insurance costs. You compute it as follows: EOP = Lead time * Average usage per unit of time For example.  EOQ is the size of order that minimizes the total of holding and ordering costs. it costs $50 to place an order. O is the order cost per order. Also include deterioration. The reorder point. if available and appropriate. spoilage and obsolescence costs. “Just In Time” allows you to keep minimal 22 . tells you when to place an order. which is the number of units you need to order at one time to minimize total costs. or  Economic Order Point (EOP). The costs of more frequent orders include lost discounts for larger quantity purchases and labour and supply cost of writing the orders. assume you use 40.1 week * [6400 units / 50 weeks] = 128 units You might also consider “Just In Time” inventory management. For example. and H is the holding cost per unit. assume you need 6400 units evenly throughout the year.  Additional costs includepaying the bills and processing the paperwork. The largest components of holding costs for most companies are the cost of space to store the inventory and the cost of tying up capital in inventory. there is a lead time of one week. Calculating the reorder point requires you to know the lead time from placing to receiving an order. and it costs $20 to hold the raw materials for one unit. You calculate the reorder point to be 128 units asfollows. The equation yields an amount of 447. and there are 50 working weeks in the year.000 units annually.

it assumes that the relativeproportions of each product sold and produced are constant ( i.. the sales mix is constant).e.e . ii. linearity) •It assumes that the quantity of goods produced is equal to the quantity of goods sold (i. it looks at the effects on profits of changes in such factors as variable costs. as it tells you nothing about what sales are actually likely to be for the product at these various prices. there is no change in the quantity of goods held in inventory at the beginning of the period and the quantity of goods held in inventory at the end of the period). You must be able to satisfy the customer as well as keep your inventory investment minimized. selling prices. COST VOLUME PROFIT ANALYSIS: •Analysis that deals with how profits and costs change with a change in volume. Carefully analyze the time lag. (I. costs only)analysis. volume. Limitations of BEP Analysis: •Break-even analysis is only a supply side (i. and mix of products sold.e..inventory in stock. More specifically. •In multi-product companies. at least in the range of likely quantities of sales. You only order when you make a sale.e. •It assumes that fixed costs (FC) are constant •It assumes average variable costs are constant per unit of output. 23 . fixed costs.

or break-even analysis. fixed costs. •By studying the relationships of costs. management is better able to cope with many planning decisions. sales. for example. total revenues and total profits are related to sales volume. •There are a number of costs that vary or change. but if the variation is not due to volume changes.” The analysis is based on a set of linear equations for a straight line and the separation of variable and fixed costs. Total fixed costs do not vary as volume levels change within the relevant range. the business organization is said to be “breaking even. to the number of welfare cases processed. It is also known as „breakeven analysis‟. it is not considered to be a variable cost. the units produced might refer. When total costs and total revenues are equal. issued to compute the volume level at which total revenues are equal to total costs.•CVP analysis involves the analysis of how total costs. •Total variable costs are considered to be those costs that vary as the production volume changes. variable costs. Examples of fixed costs are straight-line depreciation and annual insurance charges. production volume is considered to be the number of units produced. For example. CVP analysis attempts to answer the following questions: (1) What sales volume is required to break even? (2) What sales volume is necessary in order to earn a desired (target) profit? (3) What profit can be expected on a given sales volume? (4) How would changes in selling price. Examples of variable costs are direct materials and direct labour. and is therefore concerned with predicting the effects of changes in costs and sales volume on profit. and output affect profits?(5) How would a change in the mix of products sold affect the break-even and target volume and profit potential? •Cost-volume-profit analysis (CVP). and net income. 24 . In a factory. but in a governmental organization with no assembly process.

below this point. below which it is not justifiable to pursue production. or contribution 5. By suspending the operations. then the firm will make a profit. MARGIN OF SAFETY: Margin of safety represents the strength of the business. The focus of shut down point calculation is to recover the avoidable fixed costs in the first place. It enables a business to know that what is the exact amount he/ she has gained or loss over or below break even point). For this purpose fixed expenses of a business are classified as (ii) avoidable or discretionary fixed costs (ii) unavoidable or committed fixed costs. The decision is based on whether contribution is more than the difference between the fixed expenses incurred in normal operation and the fixed expense incurred when the plant is 25 . Break-even quantity is calculated by: Total fixed costs / (selling price – average variable costs). the firm may save as also incur some additional expenditure.Margin of safety = (sales – break-even sales) / sales) x 100% If P/V ratio is given then sales/ p\v ratio In unit sales If the product can be sold in a larger quantity that occurs at the breakeven point. a loss. SHUT DOWN PROBLEMS: Shut down point indicates the level of operation (sales). “price minus average variable cost” is the variable profit per unit.Explanation – in the denominator.ii.

shut down. A firm has to close down if its contribution is insufficient to recover even the avoidable fixed costs. 26 .

CONCLUSION: Marginal Cost is the change in the cost. therefore. 27 . Marginal Cost is thus the cost of an option. Clearly. It is the cost of doing or not doing a certain thing. It is the cost of the Marginal Unit. Marginal Cost helps the management in ascertaining the cost of an option and taking decisions as to which option to accept or reject.

scribd.com www.com www.Bibliography: Websites: www.google.oppapers.com 28 .com www.Wikipedia.