CHAPTER

13:
MARGINAL COSTING AND BREAK EVEN
Techniques of
Costing
1. Marginal Costing

2. Absorption Costing / Traditional Costing

Marginal
Cost
• Marginal Cost is defined as, ‘ the change in aggregate costs due
to change in the volume of production by one unit.

• The marginal cost of a product is its “Variable cost”

• Marginal cost per unit of a product consists of:

Direct Material xx
Direct Labour
Direct Expenses xx
Variable part of overhead
Marginal cost per unit xx
Marginal
Costing
• Marginal Costing has been defined as, ‘Ascertainment of cost
and measuring the impact on profits of the change in the volume
of output or type of output.

• Marginal costing is a very useful technique of costing

for
decision-making.

• In marginal costing, costs are segregated into fixed and variable

Marginal Costing is formally defined
as:
• The accounting system in which variable cost
are charged to cost units and the fixed costs of
the period are written- off in full against the
aggregate contribution.(Terminology)
Contribution
• Contribution is the difference between the sale value and the
marginal cost of sales.

• Total contribution = Total Revenue- Total variable cost

• It is a central concepts in marginal costing.

• However , the term “contribution” is really short for describing

“ contribution towards covering fixed overheads and making
profit”
• Example 01.:
• Selling price per unit Rs.200. Direct material per unit
Rs.20 , Direct labour per unit Rs.30 , Variable
overhead per unit Rs.20. Fixed overhead per unit
Rs.50.Production units 1,000.Other fixed overhead per
unit Rs.15.

• Calculate contribution per unit & Total profit.

Formulas used in Marginal
Costing
Main Formula (When the production is n units)

Sn – Vn = F + Pn
C =F+P

Where ,
S = Selling Price
V = Variable cost of n units
F = Fixed cost
P = Profit of n units
• Total contribution > Fixed cost = …………

• Total contribution = Fixed cost = …………

• Total contribution < Fixed cost = …………

Contribution Sales
Ratio
• The contribution margin per unit expressed as a percentage of
the selling price per unit.

• Contribution to sales ration ( C/S Ration , P/V Ratio)

• Contribution *100
sales
• Changes in contribution/ profit or loss * 100
Changes in Sales
Contribution Sales
Ratio
• This ration shows the between sales and
relationship contribution.

• E.g 02.: Selling price Rs.200 , Variable cost Rs.60 .

Calculate C/S ratio.

• E.g : Sales Profit

• First year Rs. 100,00 Rs. 10,000
• Second year Rs. Rs.
150,000 12,000
Absorption costing & Marginal
Costing
• Absorption costing :It is a costing system which treats
all manufacturing costs including both the fixed and
variable costs as product costs

• Marginal Costing: It is a costing system which treats

only the variable manufacturing costs as product costs.
The fixed manufacturing overheads are regarded as
period cost
 Absorption costing Marginal costing
Rs. Rs.
Sales X Sales X
Less: Cost of goods sold X Less: Variable cost of
Goods sold

Gross profit X Product contribution margin X

Less: Expenses Less: variable non-
Selling expenses X manufacturing expenses
Admin. expenses X Variable selling expenses X
Other expenses X X Variable admin. expenses X
Other variable expenses X
Less:
Total Expenses
contribution expenses X
Variable and fixed manufacturing
Fixed selling expenses X
Fixed admin. X
expenses Other fixed X
Net Profit expenses X
X Net Profit
• Example 03:
• Budgeted activity was expected to be 20,000 units per
year.
• Sales Rs.100,000
• Manufacturing cost - Fixed cost Rs.15,000
- Variable cost Rs.35,000
Administration & Selling Expenses Rs. 25,000
• Required:
• Prepare absorption and marginal costing
statements
Marginal Costing Absorption Costing
Costs are classified as fixed Costs are classified as
& variable direct & indirect
The year end inventory is The year end inventory of
valued at variable cost finished goods valued at
only. total cost.
The fixed overheads are The fixed overheads are
charged directly to the not charged directly to the
costing profit loss account costing profit loss account
and not absorbed in the and absorbed in the
product units. product units.
Break Even Analysis / CVP
Analysis
• Breakeven analysis is the study of the relationship
between selling prices, sales volumes, fixed costs,
variable costs and profits at various levels of activity

• The Break Even Point is a level of production where

the total costs are equal to the total revenue. Thus at
the break even level, there is neither profit nor loss

• The point where total contribution margin equals total

fixed costs.
Foundational Assumption in
CVP
1. All costs can be classified into fixed & variable
elements.
2. Fixed cost will remain constant & the variable cost vary
with production levels
3. Selling price, variable cost per unit & fixed costs are all
known & constant
4. Over the activity range being considered
costs & revenue behaved in a liner fashion
5. The technology, production &efficiency remain
unchanged
6. The time value of money is ignored.
7. There is no change in stock level.
Break Even Analysis can be done in two
ways:
1. Equation approach
2. Graphical approach
 Equation approach to Break Even
Analysis
•Break Even Points = Fixed Cost
(Units) Contribution per
unit

Break Even Points( Rs.) = Fixed Costs

C/S Ratio
= BEP Unit *
Selling price

Level of sales to achieve a target profit =

•E.g. 04: Selling price per unit Rs.100
Variable cost per unit Rs.60
Fixed cost Rs.60,000
No of units sales per year 8000 units.
1. Calculate Profit
2. Calculate level of sales to achieve
Rs.400,000 profit
Margin of
safety
• Margin of safety (MOS) measures distance
the between budgeted sales and breakeven
sales.
• MOS = Budgeted Sales – BE Sales

•E.g 05: Selling price per unit Rs.20

Variable cost per unit Rs.10
Fixed cost Rs.60,000
If sale are expected to be 8000 units calculate margin of
safety in units & rupee value.
Graphical approach to Break Even
Analysis
•The graphical approach may be prefer when a simple
overview is sufficient or when greater visual impact is
required .e.g. A report given for a manager.

• The basic chart is known as a break even and can be

drawn in two ways.

1. Traditional approach
2. Contribution approach
Traditional Break Even
Chart
• This is prepared by drawing the
following curves.
I. Fixed cost
II. Total cost
III. Total Revenue
Traditional Break Even
Chart
Contribution Break Even
Chart
• In order to prepare the contribution chart following
curves should be drawn
1. Total cost curve
2. Variable cost curve
3. Total revenue curve
Alternative form of contribution break even
chart
• Following alternative curves can be drawn
to illustrate break even pint using
contribution chart.
1. Contribution curve
2. Fixed cost curve
Profit
Chart
• Under this method of CVP analysis, only profit
or loss curve is drawn in order to identify the
break even level.

• Profit graph that focuses more directly on how

profits change with changes in volume.
E.g.06:
• A company makes a single product where the total
capacity of 4000 liters per annum. Costa and sales data
are as follows:
Selling price Rs. 100 per liter
Marginal cost Rs.50 per liter
Fixed cost Rs.100,000

Draw Tradition , contribution , alternative form of

contribution and profit chart.
Multi- Product Break Even
Chart
• When a company deals in a number of products, it is
possible , to draw break even chart for the as a whole.

• In such a case , the break even point is where the

average contribution line cuts the fixed cost line ,
assuming proportions of sales – mix remain
unchanged.
The procedure for drawing up a multi break
even chart
1. Calculate P/V ratio for each product and arrange the products
in descending order on the basis of P/V ratio.
2. “ X “ axis would represent sales value & “Y” axis
would represent contribution & fixed cost.
3. Draw the total fixed cost line
4. Take the product having the highest P/V ratio & plot its
contribution against sales: then take the product having
second highest P/V ration & plot cumulative contribution
against cumulative sales , the process will end with plotting
by the product having the lowest P/V ratio.
5. Obtain the average contribution slope by joining the origin to
the last line plotted.
Illustration
• ABC Co . Ltd produce and sells three products – Y , X and Z .
From the following information relating to these a period , draw
up a break even chart to determine the break even point.

X Y Z Total
Sales 25,000 40,000 35,000 100,000
Variable costs 15,000 20,000 28,000 63,000
Fixed costs 18,500
Limitation of Break Even
Chart
• A liner relationship does not always exist.
• We assume that a company manufactures only
one product . In reality, a company may
produce two or more product.
• We focus on short period where the fixed cost is
fixed. However , in the long run fixed cost
varies.
• We assume that technology and other factors
does not change.
Marginal Costing & Management
Decision In Short Run
Management Decision In Short
Run
• Concept of Marginal costing is very useful in making
management decision in short run ,
1. When a limiting factors exits
2. Acceptance of special order
3. Dropping a loss Making product
4. Make or buy Decision
When a limiting factors
exits
• Factors which limits indefinite expansion of an
organization or earning of profit are called limiting
factor.
• E.g.; Finance , sales, Raw materials , Skilled labour

Steps:
1. Ascertain the contribution per each good
2. Ascertain the contribution per limiting factor
3. List the order of preferences.
Acceptance of special
order
• Special order is an order , it different from terms for
normal sales.

• Such an order can be considered only if the

organization has not utilized its capacity to the fullest
extent.

• In this decision the fundamental criteria whether to

accept or not , is based on the comparison of the
variable cost with the price in the special offer.
Dropping a loss Making
product
• When a company is producing a range of products,
which include a product incurring losses, business will
have to decide whether such product to be
discontinued

• The decision can also be based on by comparing

variable cost and selling price. In other words, by
determine whether the product is having a
contribution..
Make or buy
Decision
• Frequently the management is faced with the decision
whether to make a particular product or component or
whether to buy it from outside.

• Apart from over riding the technical reason the

decision is usually based on an analysis of the cost
indicators.

• Under these type of decisions the most important

factor is that the costs are divided into fixed and
variable cost.