By Prof.

Mamta Chhajer
CHAPTER 2

ABSORPTION
COSTING,
MARGINAL
COSTING
& CVP ANALYSIS
 2.1 METHODS V/S TECHNIQUES OF COSTING

METHODS • Ascertainment of Costs

• Unit, Contract, Process Costing

• Analysis of Cost data for decision

TECHNIQUES making
• Absorption, Marginal, Standard Costing

By Prof. Mamta Chhajer

 2.2 ABSORPTION COSTING

MEANING : Analysis of Cost data for the purpose of

allotment of costs to cost units

LIMITATIONS

Fixed and
Includes Fixed Arbitrary Ignores Cost
Variable cost Unsuitable for
Costs in closing absorption of Volume
are charged to decision making
stock fixed costs Relation
products

By Prof. Mamta Chhajer

 2.3 MARGINAL COSTING

Fixed Costs, being

Based on the Semi Variable Costs
Only Variables Costs period costs are
distinction between are also analyzed into
are charged to the directly transferred to
Fixed Costs and fixed and variable
product. the Costing Profit and
Variable Costs elements
Loss Account

Profitability of
Prices are determined Value of finished goods
departments and
with reference to and work in progress is
products is determined
marginal costs and also made up of
with reference to
contribution margin marginal costs
contribution margin

By Prof. Mamta Chhajer

 2.4 ASSUMPTIONS OF MARGINAL COSTING

Product specifications
Productivity and
Variable Cost changes and methods of
Semi variable costs operating efficiency
in direct proportion to manufacturing and
can be segregated will not increase or
the volume of output. selling will not undergo
decrease
any change.

There will be no
change in selling price
Fixed Costs will remain or pricing policy due to Sale mix remains
constant changes in volume, unchanged
competition etc.

By Prof. Mamta Chhajer

 2.5 MARGINAL COSTING VS
ABSORPTION COSTING

Marginal Costing Absorption Costing

Only Variable Costs are considered for product costing and Both fixed and variable costs are considered for product
inventory valuation costing and inventory valuation

Fixed costs are regarded as period costs. Profitability of Fixed Costs are charged to the cost of production. Each
different products is judged by their P/V Ratio product bears a reasonable share of fixed cost and the
profitability of product is influenced by apportionment of
fixed costs

Difference in opening and closing stock does not affect the Difference in opening and closing stock affects the unit cost
unit cost of production of production

Cost per unit remains same irrespective of the production as Cost per unit falls as the production increases because fixed
it is valued at variable cost cost falls but the variable cost remains same

By Prof. Mamta Chhajer

 2.6 MARGINAL COST

 As per CAS -1, Aggregate of Variable Costs

 Marginal Cost per unit is the change in amount at any given volume of
output by which aggregate cost changes if the output is increased or
decreased by one unit

Variable
Prime Cost
Overheads Marginal
- Direct Material
- Direct Labour
- Production
Costs
- Administration
- Direct Expenses
- Selling

By Prof. Mamta Chhajer

 2.7 Marginal Costing Equations

VARIABLE
SALES CONTRIBUTION
COSTS

FIXED
CONTRIBUTION PROFITS
COSTS

By Prof. Mamta Chhajer

 2.8 CONTRIBUTION

 Contribution equal to Fixed Costs – Break Even

 Contribution less than Fixed Costs – Loss
 Contribution greater than Fixed Costs – Profits
 Helps in many important decisions

Break Even Production,

Fixation of Profitable Continue/
Point Selling Price Product Mix Discontinue
Product

By Prof. Mamta Chhajer

 2.9 COST VOLUME PROFIT ANALYSIS

 Managerial Tool
 Shows relationship between ingredients of Profit Planning

Volume

By Prof. Mamta Chhajer

 2.9.1 ASSUMPTIONS OF CVPA ANALYSIS

Profit is measured as Contribution Costs can be

less fixed costs and it can be separated into two
maximized by maximizing components fixed
contribution and variable

Constant Costs, Changes in revenue only

Selling Price and Assumptions due to change in volume
Contribution

By Prof. Mamta Chhajer

 2.9.2 Importance of CVPA Analysis

It provides volume
Provides
of production or
Helpful in Budgeting information about
sales where the
and Profit Planning behaviour of cost in
business will break
relation to volume
even

It helps in It helps in estimating

It helps in finding
calculating amount quantity of
out sensitivity of
of profits for a production and
profits due to
projected Sales sales for a target
variation in output
Volume profit level

By Prof. Mamta Chhajer

 2.9.3 TECHNIQUES OF CVPA ANALYSIS

BREAK
P/V EVEN
RATIO ANALYSIS

By Prof. Mamta Chhajer

 2.9.3.1 PROFIT – VOLUME RATIO (P/V RATIO)

𝐂𝐎𝐍𝐓𝐑𝐈𝐁𝐔𝐓𝐈𝐎𝐍
 P/V RATIO =
𝐒𝐀𝐋𝐄𝐒

 Direct Relationship between Volume, Variable Cost and Contribution

 Ascertainment of the effect on profit of changes in volume and type of output
is done by P/V Ratio
 It indicates contribution per rupee of sales
 High P/V Ratio means high profitability
 P/V ratio can be improved by increasing sales prices, reducing marginal costs,
concentrating on products having large contribution

By Prof. Mamta Chhajer

  DETERMINATION OF BREAK-EVEN POINT
𝐅𝐈𝐗𝐄𝐃 𝐂𝐎𝐒𝐓
B.E.P (Rs.) = 𝐏.𝐕 𝐑𝐀𝐓𝐈𝐎

𝐅𝐈𝐗𝐄𝐃 𝐂𝐎𝐒𝐓
B.E.P (Units.) =
𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐩𝐞𝐫 𝐮𝐧𝐢𝐭

 Helps in ascertaining Margin of Safety

USES OF
𝐏𝐫𝐨𝐟𝐢𝐭
Margin of Safety (Rs.) = 𝐏.𝐕 𝐑𝐀𝐓𝐈𝐎

P/V RATIO Margin of Safety (units) =

𝐏𝐫𝐨𝐟𝐢𝐭
𝐂𝐨𝐧𝐭𝐫𝐢𝐮𝐭𝐢𝐨𝐧 𝐩𝐞𝐫 𝐮𝐧𝐢𝐭

Margin of Safety = Actual Sales – Break Even Sales

 Helps in determining Sales Volume for a desired amount of Profit

𝐅𝐈𝐗𝐄𝐃 𝐂𝐎𝐒𝐓+𝐃𝐄𝐒𝐈𝐑𝐄𝐃 𝐏𝐑𝐎𝐅𝐈𝐓

Sales (Rs.) to get desired Profit = 𝐏.𝐕 𝐑𝐀𝐓𝐈𝐎

𝐅𝐈𝐗𝐄𝐃 𝐂𝐎𝐒𝐓+𝐃𝐄𝐒𝐈𝐑𝐄𝐃 𝐏𝐑𝐎𝐅𝐈𝐓

Sales (units) to get desired Profit =
𝐂𝐎𝐍𝐓𝐑𝐈𝐁𝐔𝐓𝐈𝐎𝐍 𝐏𝐄𝐑 𝐔𝐍𝐈𝐓
By Prof. Mamta Chhajer
 Change Impact

Impact of Increase in Selling Price Improves P/V Ratio

Selling Decrease in Selling Price

Increase / Decrease in
Lowers the P/V Ratio
No Change
Price, Fixed Fixed Cost
Increase in Variable Cost Lowers the P/V Ratio
Cost & per unit

Variable Decrease in Variable Cost

per unit
Improves P/V Ratio

Cost on P/V Increase in P/V Ratio Lower Break Even Point

and Higher Margin of
Ratio Safety
Decrease in P/V Ratio Higher Break Even Point
and Low Margin of Safety

By Prof. Mamta Chhajer

  Narrow focus on excess of revenue over
variable costs
 Fails to take into consideration capital
investment required for additional
Limitations of production capacity
Gives only an indication of relative
P/V Ratio 
profitability
 Difficult to segregate costs into fixed
and variable

By Prof. Mamta Chhajer

 2.9.3.2 BREAK EVEN ANALYSIS - IMPORTANCE

Decision regarding
Decision regarding Decision regarding
continue or Decision regarding
increase/ decrease optimum product
discontinue pricing
of production mix
product

Break Even Point,

Decision regarding Margin of Safety
Cost Control
Make or Buy and Break-Even
Charts are used

By Prof. Mamta Chhajer

 2.9.3.2 BREAK EVEN ANALYSIS- BREAK
EVEN POINT

 Break Even Point is point of No Profit and No Loss

 A Break-Even Chart shows the different amounts of Sales and Costs at
different volumes.
 Advantages

Indicate Tool of Cost

Simple form
Profitability Control

Profit Clearly
Planning shows BEP
By Prof. Mamta Chhajer
 2.9.3.2 BREAK EVEN ANALYSIS- MARGIN OF
SAFETY

 Margin of Safety is the difference between the Actual Sales and

Sales at the Break Even Point
 Increase in Selling Price leads to higher Margin of Safety
 Margin of Safety can be improved by increasing sales volume,
increase in selling price, change in product mix, lowering variable
overhead, lowering fixed cost
 MOS indicates the cushion or safety margin available to the firm

By Prof. Mamta Chhajer

 2.9.3.2 BREAK EVEN ANALYSIS- BREAK
EVEN CHART

 A chart which indicates approximate profit or loss at different levels of

sales volume within a limited range.
 A Break Even Chart shows the different amount of Sales and Costs at
different volumes
 Break Even Point on the chart indicates the volume at which sales are
equal to the Total Costs

By Prof. Mamta Chhajer

 25000

BREAK EVEN CHART

20000 ANGLE OF
INCIDENCE
AMOUNT IN RUPEES

PROFIT
15000 BREAK EVEN POINT

10000

LOSS
5000

OUTPUT IN UNITS
0
40 80 120 200
SALES 4000 8000 12000 20000
FIXED COST 4000 4000 4000 4000
VARIABLE COSTS 2400 4800 7200 12000
TOTAL 6400 8800 11200 16000
By Prof. Mamta Chhajer
 Assumptions of Break Even Chart

Variable costs
Costs are classified Fixed Cost remain Selling Price is
change in
into fixed and constant at all same at different
proportion to
variable levels of activity levels of output
output

Level of efficiency
No change in and management All the units
product mix policy do not produced are sold
change

By Prof. Mamta Chhajer

 Simple Form of Analysing relationship between
costs, volume and profit

Indicate Profitability

Significance Provides insights

of Break
Even Chart Tool of Cost Control

Presentation of flexible budgets

Helpful in profit planning

By Prof. Mamta Chhajer

 Limitations of Break Even Chart

Assumption of Assumption
Assumption of all
Fixed Cost remains regarding
units produced are
constant does not constant selling
sold is wrong
hold good price is wrong

Management Assumption of
Policy keeps on Product Mix may
changing not hold good

By Prof. Mamta Chhajer

 2.10 Advantages of Marginal Costing

Overhead Simple to Production

Pricing
recovery operate Planning

Control over Profit Performance Managerial

expenditure Planning Evaluation Decisions

By Prof. Mamta Chhajer

 2.11 Limitations of Marginal Costing

Difficulty in Fixed costs

No standard for
classifying fixed Stock cannot be
evaluation of
and variable undervalued ignored in the
performance
costs long run

Assumption of
Ignores time
Fixed Ignores Price
factor and
Production Changes
investment
Capacity

By Prof. Mamta Chhajer

 2.12 Applications of Marginal Costing

Decision Decision
Decision
regarding regarding
regarding
optimum utilisation of
Marginal Unit
product mix scarce resources

Decision
Decision
regarding make Cost Control
regarding Pricing
or buy

By Prof. Mamta Chhajer

 This Photo by Unknown Author is licensed under CC BY-SA

By Prof. Mamta Chhajer