Marginal Costing

2nd February 2011

Case of the Airplane Ticket
 3 Seats available in a flight
 Total cost/ seat = Rs.4000
 What should be price of ticket?
Case of Airplane Ticket contd..
 3 Seats available in a flight
 Variable cost/ seat = Rs.350
 What should be price of ticket?
What is Marginal Cost?
 Marginal cost represents the prime
costs plus the variable cost
 It is arrived at by separating the –
 Fixed cost and
 Variable cost
 Used very often in short term decision
making
Evolution of Marginal Cost
 If total cost is attributed to the unit, the
cost will vary with the number of units
produced
 Every month the unit cost will differ
 This making pricing very difficult
Marginal Costing Vs.
Absorption Costing
 Marginal Costing  Absorption Costing
 Only variable cost  Both variable and
is considered fixed costs are
 Fixed cost is taken considered
as a period cost  Considered as a
 Cost data highlights unit cost
the contribution per  Cost data gives net
unit profit per unit
Marginal Cost Equation
 S = Selling price  C=S-V
 V = Variable cost
 C = Contribution
Breakeven Point
 Breakeven point (BEP) denotes the
point where
 the contribution is equal to fixed costs
 In effect, it is the point where company
has made no profit or no loss
Breakeven Point Sales
 Selling price per unit = Rs.200
 Variable cost = Rs.120
 Contribution = Rs.80
 BEP sales = Fixed costs/ Contribution
 Fixed cost = Rs.2000
 BEP sales = Rs.2000/Rs.80 = 25 units
Margin of Safety
 Margin of safety = Expected sales –
BEP sales
 Expected sales = 100 units
 BEP sales = 25 units
 Margin of safety = 100 – 25 = 75 units
This is equal to 75/ 100 = 75%
Profit Volume Ratio
 Profit Volume Ratio = Contribution/
Selling price
 Selling Price = Rs.200
 Variable cost = Rs.120
 Contribution = Rs.80
 Profit volume ratio = 80/200 = 40%
Fixing Sales Required for
Expected Profit
 Fixed expenses + expected profit /
contribution
 Fixed expenses = Rs.200,000
 Expected Profit = Rs.25,000
 Contribution = Rs.1,000
 Sales required = 200000+25000/1000
or 225,000/1000 = 225 units
Sensitivity Analysis
 It is done based on margin of safety
 Selling price = Rs.200
 Variable cost = Rs.120
 Contribution = Rs.80
 Fixed cost = Rs.2000
 BEP = 2000/ 80 = 25 units
 Expected sales = 100
 Margin of safety = 100 – 25 = 75 unit
Sensitivity Analysis contd…
 Due to competitive pressure, price drops
 Selling price = Rs.180
 Variable cost = Rs.120
 Contribution = Rs.60
 Fixed Cost = Rs.2000
 BEP = 2000/60 = 33 units
 Expected sales = 100
 Margin of safety = 100 – 33 = 67 units
 Margin of safety has dropped by 11%
Sensitivity Analysis contd…
 If the raw materials price goes up by
Rs.20…
 …the result would be the same
 Product Mix
Assume that 2 products are produced. In both cases total production is
2000 units. Figures below represent prices and costs

A B Total A B Total

Sales 5000 3000 8000 Sales 7500 1500 9000

V Cost 3500 2000 5500 V Cost 4750 1000 5750

Contrib 1500 1000 2500 Contrib 2750 500 3250

ution ution

F Cost 1000 F Cost 1000

Profit 1500
Profit 2250