Marginal Costing and Cost-Volume-Profit Analysis (CVP)

References: M.N.Arrora -Cost and Management

Accounting Khan and Jain-Management Accounting Accounting for Management-Dr.

Jawahar Lal Management Accounting-I.M.Pandey Cost Accounting for Business

Managers-Ashish K Bhattacharyya

What is cost and Total cost? Cost-Amount incurred to get

something/ resources used for the production of goods and services

Total Cost-is the total cost of producing unit of product. It is the total of all variable cost and fixed cost incurred to produce the goods.

Variable

Fixed

Mixed

Types of Costs

Minutes Talked

Tota

l Lon

g D

ista

nce

Tele

phon

e B

ill variable costs change

when activity/unit changes.

Your total long distancetelephone bill is basedon how many minutes

you talk.

Variable Cost

Minutes Talked

Per M

inut

eTe

leph

one

Cha

rge

Variable costs per unit do not changeas activity/unit increases.

The cost per long distance

minute talked is constant.

For example, Rs.7 per minute.

Variable Cost Per Unit

Variable Costs Example

Consider Indian Railway. Assume that Tea costs in Indian

Railway Rs.3 per person. If the railway carries 2,000

passengers, it will spend Rs 6,000 for Tea services.

Variable Costs Example

0 1 2 3 4 5

24 –

18 –

12 –

6 –

– – ––

Volume(Thousands of passengers)

Tot

al V

aria

ble

Cos

ts(t

hous

ands

)

Number of Local Calls

Mon

thly

Bas

ic

Tele

phon

e B

ill

Total fixed costs remain unchangedwhen activity changes.

Your monthly basic

telephone bill probably

does not change when

you make more calls.

Total Fixed Cost

Mixed Costs Contain fixed portion that is incurred

even when facility is unused & variable portion that increases with usage.

Example: monthly electric utility charge Fixed service fee Variable charge per kilowatt hour used

Total mixed costVariable

Utility Charge

Activity (Kilowatt Hours)

Tota

l Util

ity C

ost

Fixed MonthlyUtility Charge

Mixed Costs

Marginal Cost

Marginal Cost-is the cost of producing an additional unit of product. It is the total of all variable cost incurred to produce the extra one unit.

Marginal Costing Marginal Costing Technique is used for

short term decision-making. It assumes that fixed costs are not

affected by the decision to allocate resources to different activities.

Therefore, variable costs are the only relevant cost for decision making.

Marginal costing is also known as Variable costing and Direct Costing

Marginal Cost StatementSales

- Variable CostsContribution - Fixed Costs

Profit

Example Mr.Thomas manufacture a device that

allows users to take a closer look at icebergs from a ship.

Expected price of the device Rs.1000 Variable costs are Rs700 per unit. He receive a proposal from a company

Tiggertol to sell 20,000 units at a price of Rs.850.

Contribution Margin Concept Example

There is sufficient capacity to produce the order.

How do we analyze this situation? Earning=Rs.850 – Rs.700 = Rs.150 Total Earning=Rs.150 × 20,000

units = Rs.30,00,000

Marginal Cost StatementSales (20,000 x Rs.850)

Rs.1,70,00000Variable costs (20,000 x Rs.700) (1,40,00000)Contribution margin

Rs.30,00000

If Fixed cost is Rs.40,00000.What will be his decision?

Cost-Volume-Profit Analysis

Cost-Volume-Profit Analysis (CVP)

CVP analysis is an extension of principles of marginal Costing

Cost-Volume-Profit Analysis (CVP) is the study of the relationship between selling prices, sales volumes, fixed costs, variable costs and profits at various levels of activity.

CVP analysis is used by the management in budgeting and profit planning.

CVP analysis is also known as Break even point Analysis

Assumptions of CVP/BEP Analysis Expenses can be classified as either

variable or fixed. Mixed cost have to be divided into

fixed and variable elements. Sales prices, unit variable cost, and

total fixed expenses will not vary. Synchronisation between production

and sales

Objective Use CVP analysis to compute Contribution Profit Volume Ratio (P/V) Break Even Point Margin of Safety

Marginal Cost StatementSales

- Variable CostsContribution - Fixed Costs

Profit

Contribution The contribution is calculated by following

formula:Contribution=Sales-Variable cost (C=S-V)Also, Contribution=Fixed cost + Profit

(C=F+P)Or Contribution=Fixed cost – Loss (C=F-L)From this the following marginal cost equation

is developedS-V = F+P

Example:If Given Sales =Rs 12000 Variable Cost = Rs 7000 Fixed Cost =Rs. 4000Find out Contribution and Profit.

Example:If Given Profit = Rs 1000 Contribution=Rs 5000 Variable Cost = Rs 7000Find out :-Sales and Fixed Cost

P/V ratio( Also Known as C/S ratio or Contribution Margin Ratio) P/V ratio= Profit-volume ratio C/S= Contribution to Sales ratio This ratio denotes the percentage

of each sales rupee available to cover the fixed cost and to provide income to firm.

Computing P/V Ratio P/V Ratio= Contribution Sales = C/S = (S-V)/SBy Transposition, we have(i) C=S X P/V ratio(ii) S= C P/V ratio

Example Sales= Rs 10000 Variable Cost = Rs. 8000Then P/V Ratio = C/S = (S-V)/S =10000-8000 10000 = 20%

Alternative Formula P/V ratio= Change in contribution Change in Sales = Change in Profit Change in sales

Example-P/V ratioYear Sales Net Profit2009 20000 10002010 22000 1600

P/V Ratio = Change in Profit Change in Sales = 1600 – 1000 X 100 = 30% 22000-20000

The unique sales level at which a company earns neither a profit nor incurs a loss.

Profit = 0Sales – Total Cost = 0

Sales – Variable Costs – Fixed Costs = 0

What is Break-Even Point?

Break-Even Analysis Break Even Analysis may be

performed by the following two methods

a) Algebraic Calculationb) Graphic presentation

Algebraic Method-

Breakeven point in Sales Rupees = Fixed costs

P/V Ratio

Breakeven point in units = Fixed costs

Contribution per unit

Break Even Point Example Sales Rs.100000 Variable cost Rs.70000 Fixed costs Rs.15000Required:

Compute the breakeven point (in Rupees)

Breakeven point is = Fixed costs P/V Ratio

= Rs.15000 30/100

= Rs 50000 Sales revenue at breakeven point = Rs.50000

Break Even Point Example Selling price per unit Rs.12 Variable cost per unit Rs.3 Fixed costs

Rs.45000Required:

Compute the breakeven point (in units) and in Rupees

Breakeven point in units = Fixed costs Contribution per unit

= Rs.45000

Rs.12-Rs.3

= 5000 units

Sales revenue at breakeven point = Rs.12 * 5000 = Rs.60000

Target Profit Example Suppose that our business would

be content with Profit of _________________.(Target Profit)

How many units must be sold?

FormulaNo. of units to be sold at target profit

Fixed cost + Target profit

Contribution per unit=

Required sales revenueFixed cost + Target profit

Contribution to sales ratio=

Example Selling price per unit Rs.12 Variable cost per unit Rs.3 Fixed costs Rs.45000 Target profit Rs.18000Required:

Compute the sales volume required to achieve the target profit

No. of units at target profit Fixed cost + Target profit

Contribution per unit=

Rs.45000 + Rs.18000

Rs.12 - Rs.3=

= 7000 units

Required to sales revenue = Rs.12 *7000 = Rs.84000

Alternative methodRequired sales revenue

Fixed cost + Target profit

Contribution to sales ratio=

Rs.45000 + Rs.18000

75%=

= Rs.84000

Units sold at target profit = Rs.84000 /Rs.12 = 7000 units

Problem:- The following data is given:Fixed Cost Rs. 12000Selling Price Rs. 12 per unitVariable Cost Rs. 9 per unitWhat will be the Amount of Sales if it is

desired to earn a profit ofa) Rs. 6000b) Rs 15000

Answer

a) Rs 72,000b) Rs. 1,08,000

Calculate the missing figures Given Break –even point=Rs 30000Profit = Rs. 1500Fixed Cost = Rs.6000What is the amount of Variable cost?

Solution Contribution=Fixed cost + Profit =6000 + 1500=7500Break-Even Point= Fixed Cost P/V Ratio

P/V Ratio=6000 x 100 = 20% 30000

P/V Ratio=Contribution/Sales Sales =7500 / 20*100 Sales = 37500Variable cost=Sales-Contribution =37500-7500 =30000

Problem:- The following data is given:Fixed Cost Rs. 12000Selling Price Rs. 12 per unitVariable Cost Rs. 9 per unitWhat will be the profit when sales area) Rs. 60000b) Rs 100000

Solution P/V Ratio=C/S=3/12=25%a) When Sales=Rs 60000 Contribution =Sales x P/V ratio =60000 x 25 % =Rs.15000 Profit = Contribution-Fixed Cost = 15000 – 12000 = 3000

B) Answer=Rs.13000

Problem The following information is given:Sales=Rs. 200000Variable Cost=Rs. 120000Fixed Cost=Rs. 30000Calculatea) Break Even Pointb) New BEP

a) If Selling price is reduced by 10%b) If Variable cost increases by 10%c) If fixed Cost increases by 10%

Answera) 75000

a) 90000b) 88235c) 82500

Home work Sales=4000 units @ Rs 10 per

unit Break Even Point=Rs. 1500 units Fixed Cost= Rs. 3,000What is the amount ofa) Variable Costb) Profit

Graphic Presentation (BEP) Use CVP analysis for profit

planning and graph the cost-volume-profit relations

Volume in Units

Cos

ts a

nd R

even

uein

Rup

ees Total fixed costs

Preparing a CVP Chart

Total costs

Volume in Units

Cos

ts a

nd R

even

uein

Rup

ees Total fixed costs

Preparing a CVP Chart

Total costs

Sales

Break-even Point

Margin of safety

Margin of safety Excess of expected sales over

breakeven sales. Margin of safety is a measure of

amount by which the sales may decrease before a company suffers a loss.

This can be expressed as a number of units or a percentage of sales

Formula

Margin of safety= Margin of safety Budget sales level

*100%

Margin of safety= Budget sales level – breakeven sales level

Sales revenueT

otal

Cos

t/Rev

enue

R

s.

Sales (units)

Total costProfit

BEP

Margin of safety

Example The breakeven sales level is at 5000

units. The company sets the target profit at Rs.18000 and the budget sales level at 7000 units

Required:Calculate the margin of safety in units and express it as a percentage of the budgeted sales revenue

Margin of safety= Budget sales level – breakeven sales level= 7000 units – 5000 units= 2000 units

Margin of safety= Margin of safety Budget sales level= 2000 7000= 28.6%

*100 %

*100 %

The margin of safety indicates that the actual sales can fall by2000 units or 28.6% from the budgeted level before losses areincurred.

Example Selling price per unit Rs.12 Variable price per unitRs.3 Fixed costs Rs.45000 Current profit Rs.18000 If the selling prices is raised from

Rs.12 to Rs.13, the minimum volume of sales required to maintain the current profit will be:

Change in Sales Price Example

If the selling prices is raised from Rs.12 to Rs.13, the minimum volume of sales required to maintain the current profit will be:

Fixed cost + Target profit

Contribution per unit

=Rs.45000 + Rs.18000

Rs.13 - Rs.3= 6300 units

Change in Fixed and Variable Costs Example If the fixed cost fall by Rs.5000 but

the variable costs rise to Rs.4 per unit, the minimum volume of sales required to maintain the current profit will be:Fixed cost + Target profit

Contribution per unit

= Rs.40000 + Rs.18000Rs.12 - Rs.4

= 7250 units

Problem-Mysore university 2009

The trading results of Manish Stores for the last two years were as under:

Year Sales(Rs.) Profit (Rs)2005 14400001080002006 1680000156000

Assuming that the capital structure and the selling price remains the same, calculate

Problem-Mysore university 2009

1) P/V Ratio 2) Break Even Point3) Margin of Safety of 2005 and

20064) Sales required to earn a desired

profit of Rs. 1,80,0005) Profit at sales of Rs. 15,00,000

Solution-1)P/V Ratio = Change in profit x 100 Change in Sales =156000-108000 x 100= 20% 1680000-1440000Fixed cost=Contribution-Profit =(1440000x20%)-108000 =288000-108000=Rs.180000

Solution-2)Break Even Point = Fixed cost P/V Ratio =180000/20% =Rs.9000003) Margin of Safety = Actual sales – BEP Sales Margin of Safety for 2005=1440000-900000 = Rs. 540000 Margin of Safety for 2006=1680000-900000 = Rs. 780000

Solution-4) Sales = Fixed cost +Target Profit P/V Ratio = 180000 + 180000 20% = 360000 x100 20 = 1800000

Solution5) Given, Sales= 1500000 Profit =? Profit = Contribution-Fixed Cost = (Sales x P/V Ratio)-Fixed Cost = (1500000 x 20%) – 1800000 = 3000000 – 1800000 = Rs.1200000

Problem-Mysore university 2010

RJM Ltd, has prepared the following budget for the year 2009-10.

Sales in units 15000Fixed Expenses(in Rs) 34000Sales in Rs. 150000Variable cost in Rs. 6 per unit

You are required to :1)Find out P/V ratio, Break even point and

Margin of Safety.2)Calculate the revised P/V ratio, break

even point and margin of safety in each of the cases:

a) Decrease of 10% in Selling Priceb) Increase of 10% in Variable costsc) Increase of Sales Volume by 2000 unitsd) Increase of Rs. 6000 in Fixed Costs.

Solution P/V Ratio = Contribution x100 Sales = Sales-V.cost x100 Sales = 150000-90000 x 100 150000 = 60000 x 100 = 40 % 150000

Break even point and Margin of Safety. B.E.P = Fixed Expenses P/V Ratio = 34000/.40 = Rs. 85000

M.O.S = Sales – B.E.P Sales = 150000 – 85000 =

Rs.65000

Decrease of 10% in Selling Price

Revised P/V Ratio = Contributionx100/ Sales = ( Sales-V.Cost)x100 / Sales = (135000-90000)x100/135000 = 33.33% Revised B.E.P = Fixed Expenses P/V Ratio = 34000/.33 = Rs. 102000Revised M.O.S = Sales – B.E.P Sales = 135000 -102000 =33000

Increase of 10% in Variable costs Revised P/V Ratio = Contributionx100/

Sales = ( Sales-V.Cost)x100 / Sales = (150000-99000)x100/150000 = 34% Revised B.E.P = Fixed Expenses P/V Ratio = 34000/.34 = Rs. 100000 Revised M.O.S = Sales – B.E.P Sales = 150000 -100000 =50000

Increase of Sales Volume by 2000 units

Revised P/V Ratio = Contributionx100/ Sales = ( 170000-V.Cost)x100 / 170000 = (170000-102000)x100/170000 =( 68000/170000) x 100=40% Revised B.E.P = Fixed Expenses P/V Ratio = 34000/40% = Rs. 85000 Revised M.O.S = Sales – B.E.P Sales = 170000 -85000 =Rs.85000

Increase of Rs. 6000 in Fixed Costs.

Revised P/V Ratio = Contributionx100/ Sales = ( Sales-V.Cost)x100 / Sales = (150000-90000)x100/150000= 40% Revised B.E.P = Fixed Expenses P/V Ratio = 40000/.40 = Rs. 100000 Revised M.O.S = Sales – B.E.P Sales = 150000 -100000 =50000

Problem Alpha Company Budgeted for the year

2010 sales of Rs. 5,00,000 (Selling price being Rs. 20 per unit), Fixed Costs Rs. 1,80,000 and variable costs Rs. 2,60,000. Find out break even point

a) taking into consideration the budgeted figure and

b) assuming 20% increase in Fixed Cost.Also draw a break even Chart

Solution P/V Ratio = Contributionx100/ Sales = ( Sales-V.Cost)x100 / Sales = (500000-260000)x100/500000 = 48% Break Even Point = Fixed Expenses P/V Ratio = 180000/48% = Rs. 375000B.E.P (in units) = 375000/20=18750 units

Assuming 20% increase in Fixed Cost P/V = 48%

Break Even Point = Fixed Expenses P/V Ratio = 180000x 1.20/48% = 216000/48% = Rs.450000B.E.P in units=450000/20= 22500 units

No. of units sold= 500000/20=25000 units

Variable cost per unit= Variable cost/No. of units =260000/25000= Rs.10.4p.u

Graphic Presentation (BEP) Use CVP analysis for profit

planning and graph the cost-volume-profit relations

Volume in Units

Cos

ts a

nd R

even

uein

Rup

ees Total fixed costs

Preparing a CVP Chart

Total costs

Volume in Units

Cos

ts a

nd R

even

uein

Rup

ees Total fixed costs

Preparing a CVP Chart

Total costs

Sales

Break-even Point

No of units soldFixed Cost

Variable Cost Total Cost Sales

0 180 0 180 0

5 180 52 232 100

10 180 104 284 200

15 180 156 336 300

20 180 208 382 400

25 180 260 440 500

30 180 312 492 600

Marginal Costing The following are some of the

managerial decision which are taken with the help of marginal costing technique

Fixation of Selling Prices Exploring new market/outsourcing Make or buy decisions Alternative methods of production and Suspending activities i.e closing down

Home work-Case Study-1 The bins and tins limited produces and markets

industrial containers and packing cases. Due to competition the company proposes to reduce the selling price. If the present level of profits is to maintained, indicate the number of units to be sold if the proposed reduction in selling price is a)5%, b) 10% and c) 15%.The following additional information is available.

Present Sales Turnover(30000)units 300000 Variable Cost (30000 units) 180000 Fixed Cost 70000

-250000 Net Profit 50000

Answer At present price = 30000 units At 5% = 34286 units At 10 % = 40000 units At 15 % = 48000 units

Case Study-2XY Co. sold in two successive years 7000 and 9000 units and incurred a loss of Rs. 10000 and earned Rs. 10000 as profit respectively,

The selling price per unit is Rs 100.You are required to find out:-a)Amount of fixed cost, b)the number of units to break even andc) the no. of units to earn a profit of Rs. 50000

Answera)Fixed Cost = 80000b)B. E. P = 8000 unitsc) 13000 units