ALLIANCE UNIVERSITY

ALLIANCE SCHOOL OF BUSINESS

Class: BBA Semester 5th Subject: MA
Faculty Name: Dr. Tarun Kashni (Asst Prof)
NOTES
Unit: 5

Meaning of Marginal Cost in Management Accounting

Marginal cost refers to the additional cost incurred when producing one extra unit of a product. It
helps businesses determine the impact on overall cost when production is increased or decreased.
Marginal cost is important because it allows managers to make decisions about pricing, production
levels, and resource allocation. It focuses on variable costs, such as materials and labor, and ignores
fixed costs (like rent and salaries) that remain constant regardless of output.

Formula
𝛥 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡
𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝐶𝑜𝑠𝑡 (𝑀𝐶) =
𝛥 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦
Symbol Δ (Delta) is a Greek letter commonly used in mathematics and science to represent a change
or difference in a variable.

Important Definitions
Marginal Cost: The term Marginal Cost refers to the amount at any given volume of output by which
the aggregate costs are charged if the volume of output is changed by one unit. Accordingly, it means
that the added or additional cost of an extra unit of output.
Marginal cost may also be defined as the "cost of producing one additional unit of product." Thus,
the concept marginal cost indicates wherever there is a change in the volume of output, certainly
there will be some change in the total cost. It is concerned with the changes in variable costs. Fixed
cost is treated as a period cost and is transferred to Profit and Loss Account.
Marginal Costing: Marginal Costing may be defined as "the ascertainment by differentiating
between fixed cost and variable cost, of marginal cost and of the effect on profit of changes in
volume or type of output." With marginal costing procedure costs are separated into fixed and
variable cost.
According to J. Batty, Marginal costing is "a technique of cost accounting pays special attention to
the behaviour of costs with changes in the volume of output." This definition lays emphasis on the
ascertainment of marginal costs and also the effect of changes in volume or type of output on the
company's profit.
Example 1:
you own a bakery in India, and you are producing 100 cupcakes. The total cost for making these
100 cupcakes is ₹200.
• Current production: 100 cupcakes
• Cost of making 100 cupcakes: ₹200
Now, you decide to make 1 more cupcake (so 101 cupcakes), and your total cost increases to ₹202.
• Total cost for 101 cupcakes: ₹202
Steps to Calculate Marginal Cost:
1. Change in Total Cost (ΔTC) = ₹202 − ₹200 = ₹2
(The extra cost incurred for producing the additional cupcake)
2. Change in Quantity (ΔQ) = 101 − 100 = 1 cupcake
2
3. 𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝐶𝑜𝑠𝑡 (𝑀𝐶) = 1
= 𝑅𝑠. 2

The marginal cost of producing one more cupcake is ₹2. This means, for each additional cupcake
produced, the cost increases by ₹2.

Example 2
the cost of 100 articles is Rs. 50,000 and that of 101 articles is Rs. 50,450, the marginal cost is Rs.
450 (i.e., Rs. 50,450 –50,000)

Marginal Costing
Marginal costing is a technique of costing where costs are divided into two groups based on their
behavior:

Marginal
Cost

Variable
Fixed cost
Cost

Unavoidable

Avoidable
Total Variable costs vary proportionately with volume (level of activity, production or sales). Total
Fixed costs remain unchanged with volume. Fixed costs are often called period costs.

Features Of Marginal Costing

1. All elements of costs are classified into fixed and variable costs.
2. Marginal costing is a technique of cost control and decision making.
3. Variable costs are charged as the cost of production.
4. Valuation of stock of work in progress and finished goods is done on the basis of variable
costs.
5. Profit is calculated by deducting the fixed cost from the contribution, i.e., excess of selling
price over marginal cost of sales.
6. Profitability of various levels of activity is determined by cost volume profit analysis.

Advantages of Marginal Costing (or) Important Decision Making Areas of Marginal

Costing
The following are the important decision making areas where marginal costing technique is used •
1. Pricing decisions in special circumstances .
2. Pricing in periods of recession;
3. Use of differential selling prices.
4. Acceptance of offer and submission of tenders.
5. Make or buy decisions.
6. Shutdown or continue decisions or alternative use of production facilities.
7. Retain or replace a machine.
8. Decisions as to whether to sell in the export market or in the home market.
9. Change Vs status quo.
10. Whether to expand or contract.
11. Product mix decisions like for example :
a. Selection of optimal product mix;
b. Product substitution;
c. Product discontinuance.
12. Break-Even Analysis.

Limitations of Marginal Costing

1. It may be very difficult to segregation of all costs into fixed and variable costs.
 2. Marginal Costing technique cannot be suitable for all type of industries. For example, it is
difficult to apply in ship-building, contract industries etc.
3. The elimination of fixed overheads leads to difficulty in determination of selling price.
4. It assumes that the fixed costs are controllable, but in the long run all costs are variable.
5. Marginal Costing does not provide any standard for the evaluation of performance which is
provided by standard costing and budgetary control.
6. With the development of advanced technology fixed expenses are proportionally increased.
Therefore, the exclusion of fixed cost is less effective.
7. Under marginal costing elimination of fixed costs results in the under valuation of stock of
work in progress and finished goods. It will reflect in true profit.
8. Marginal Costing focuses its attention on sales aspect. Accordingly, contribution and profits
are determined on the basis of sales volume. It does not consider other functional aspects.
9. Under Marginal Costing semi variable and semi fixed costs cannot be segregated accurately.

Absorption Costing
Absorption costing is also termed as Full Costing or Total Costing or Conventional Costing, It is a
technique of cost ascertainment. Under this method both fixed and variable costs are charged to
product or process or operation. Accordingly, the cost of the product is determined after
considering both fixed and variable costs.
Absorption Costing Vs Marginal Costing : The following are the important differences between
Absorption Costing and Marginal Costing :
(1) Under Absorption Costing all fixed and variable costs are recovered from production
while under Marginal Costing only variable costs are charged to production.
(2) Under Absorption Costing valuation of stock of work in progress and finished goods
is done on the basis of total costs of both fixed cost and variable cost. While in Marginal
Costing valuation of stock of work in progress and finished goods at total variable cost
only.
(3) Absorption Costing focuses its attention on long-term decision making while under
Marginal Costing guidance for short-term decision making.
(4) Absorption Costing lays emphasis on production, operation or process while
Marginal Costing focuses on selling and pricing aspects.

Differential Costing
Differential Costing is also termed as Relevant Costing or Incremental Analysis. Differential Costing
is a technique useful for cost control and decision making.
According to ICMA London differential costing "is a technique based on preparation of adhoc
information in which only cost and income differences between two alternatives / courses of
actions are taken into consideration."
Marginal Costing and Differential Costing : The following are the differences between Marginal
Costing and Differential Costing :
Differential Costing can be made in the case of both Absorption Costing as well as Marginal
Costing
(2) While Marginal Costing excludes the entire fixed cost, some of the fixed costs may be
taken into account as being relevant for the purpose of Differential Cost Analysis.
(3) Marginal Costing may be embodied in the accounting system whereas Differential
Cost are worked separately as analysis statements.
(4) In Marginal costing, margin of contribution and contribution ratios are the main
yardstick for the performance evaluation and for decision making. In Differential Cost
Analysis, differential costs are compared with the incremental or decremental revenues as
the case may be.

Calculation of Cost
Calculation of
Cost

After Before
Production Production

Absorbtion Marginal
Costing Costing

or Historical or Relevant
costing Costing

or Traditional or Decision
Costing Making Costing

Marginal Costing or Relevant or Decision-Making Costing is used to take decision of whether to

Produce or manufacture the Product or Not

Difference Between Marginal Costing and Absorption Costing

S.No MARGINAL COSTING ABSORPTION COSTING

1 Only variable cost is charged to products Total cost (both fixed and variable) is charged
and inventory valuation. to the cost of products and inventory
valuation.
2 Fixed cost is not included in the cost of Fixed cost is included in the cost of products.
products. It is transferred to Costing Profit
and Loss Account.

3 Stocks are valued only at variable costs. Opening and closing stocks are valued at total
Stock values are lower in Marginal costing cost which inducts both fixed and variable
than in Absorption costing. costs. Stock values in Absorption costing are,
therefore, higher than in Marginal costing.

4 Profitability is judged by the contribution Profitability is measured by profit earned by

made by various products or departments. various products or departments.

5 Cost data helps to know the total Cost data is arrived on conventional pattern
contribution and contribution of each and hence is only the net profit for each
product. product that is arrived at.

6 Difference in valuation of opening and Valuation of opening and closing stock is

closing stock does not affect the unit cost of affected due to the fixed costs.
production

Calculation of Absorption Costing (Postproduction)

Particular Amount
Direct Material XXX
Direct Labour XXX
Direct Expenses XXX

Indirect Variable Cost XXX

Less: Fixed Cost:
a) Avoidable Fixed Cost XXX
b) Unavoidable Fixed Cost XXX

Add: Profit XXX

Selling Price XXX

Direct Variable Cost

• Factory Variable Cost
• Administrating Variable Cost
• Selling and Distribution Variable
Cost
Calculation of Marginal Costing (Preproduction) for Decision Making
Particular Amount
Direct Material XXX
Direct Labour XXX
Direct Expenses XXX
Prime Cost XXXX

Add: Variable Overhead

a) Variable Factory Overhead XXX
Marginal Variable Cost XXXX
b) Variable Administrative Overhead XXX
Marginal Cost of Production XXXX
Add: Variable Selling and Distribution Overhead XXX
Total Marginal Cost XXXXX

Interpretation

1. Direct Material
This is the cost of raw materials used directly in producing a product.
• Example: For a chair factory, this could be the cost of wood, nails, and glue used to make
each chair.
• Cost of Direct Material per chair: ₹500
2. Direct Labour
This refers to the wages paid to workers who are directly involved in the production process.
• Example: Wages paid to a worker assembling the chair.
• Cost of Direct Labour per chair: ₹300
3. Direct Expenses
These are other direct costs related to production but not covered by direct material or labor.
• Example: Cost of hiring special equipment to polish the chairs.
• Cost of Direct Expenses per chair: ₹100
4. Prime Cost
This is the sum of Direct Material, Direct Labour, and Direct Expenses. It represents the direct
cost of manufacturing a product.
Prime Cost=Direct Material+Direct Labour+Direct ExpensesPrime Cost=Direct Material+Direct Labo
ur+Direct Expenses
• Prime Cost per chair = ₹500 + ₹300 + ₹100 = ₹900

5. Add: Variable Factory Overhead

These are variable costs incurred within the factory that are not directly tied to the product but vary
with production.
• Example: Power and electricity used by the machines that make chairs.
• Variable Factory Overhead per chair: ₹50
6. Marginal Variable Cost
This is the total of the Prime Cost and the Variable Factory Overhead.
Marginal Variable Cost=Prime Cost+Variable Factory OverheadMarginal Variable Cost=Prime Cost+
Variable Factory Overhead
• Marginal Variable Cost per chair = ₹900 + ₹50 = ₹950

7. Add: Variable Administrative Overhead

These are the costs related to running the administrative side of the business that vary with
production.
• Example: Additional clerical work related to processing orders for chairs.
• Variable Administrative Overhead per chair: ₹20
8. Marginal Cost of Production
This is the total of the Marginal Variable Cost and the Variable Administrative Overhead.
Marginal Cost of Production=Marginal Variable Cost+Variable Administrative OverheadMarginal Co
st of Production=Marginal Variable Cost+Variable Administrative Overhead
• Marginal Cost of Production per chair = ₹950 + ₹20 = ₹970

9. Add: Variable Selling and Distribution Overhead

These are costs related to selling and delivering the products, which vary with the number of units
sold.
• Example: Cost of packaging and shipping each chair to customers.
• Variable Selling and Distribution Overhead per chair: ₹30
10. Total Marginal Cost
This is the final marginal cost, including all variable costs associated with producing, managing,
selling, and delivering the product.
Total Marginal Cost=Marginal Cost of Production+Variable Selling and Distribution OverheadTotal
Marginal Cost=Marginal Cost of Production+Variable Selling and Distribution Overhead
• Total Marginal Cost per chair = ₹970 + ₹30 = ₹1,000
From the above information put Values in Format of Calculating Marginal Cost

Particular Amount
Direct Material 500
Direct Labour 300
Direct Expenses 100
Prime Cost 900

Add: Variable Overhead

c) Variable Factory Overhead 50
Marginal Variable Cost 950
d) Variable Administrative Overhead 20
Marginal Cost of Production 970
Add: Variable Selling and Distribution Overhead 30
Total Marginal Cost 1000

Computation of Profit Statement under Marginal Costing for

Decision Making
Particular Amount
Sales XXX
Less: Variable Cost (Marginal Cost) XXX
1. Direct Materials xxx
2. Direct Wages xxx
3. Direct Expenses xxx
4. Variable Overheads xxx
Contribution XXX
Less: Fixed Cost XXX
Add: Profit XXXX

Components of Marginal Costing

Contribution
Components of Marginal

P/V ratio
Costing

Break-Even
analysis

Margin of Safety

CVP analysis
Important Formulas
Fixed Cost Formula
𝐹𝑖𝑥𝑒𝑐 𝐶𝑜𝑠𝑡 = 𝑆𝑎𝑙𝑒𝑠 𝑋 𝐶/𝑆 𝑅𝑎𝑡𝑖𝑜 − 𝑃𝑟𝑜𝑓𝑖𝑡

Marginal Cost Equation:

The following equation is known as basic marginal cost equation:
If Profit : Sales – Variable Cost = Fixed Cost + Profit or
Loss If Loss : Sales – Variable Cost = Fixed Cost – Loss

Contribution
Contribution is the difference between sales and variable cost. In other words, contribution is the
excess of sales over the variable cost. It is also known as gross margin or marginal income. It
enables to meet fixed costs and contributes to profit.
= Sales – Variable Cost (Marginal Cost)
Or
=Fixed Cost + Profit
Or
=Fixed Cost – Loss
Contribution-to-sales (C/S) ratio is:
(𝑆𝑎𝑙𝑒𝑠 − 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡)
𝐶/𝑆 𝑅𝑎𝑡𝑖𝑜 =
𝑆𝑎𝑙𝑒𝑠

PV ratio (Profit Volume Ratio) / Contribution Ratio

P/V Ratio is a ratio of contribution to sales. It states the relationship between contribution and ales.
Therefore it is also called as contribution/sales ratio, or contribution ratio or marginal ratio. It is
calculated by using the following formula:

𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
PV ratio = 𝑆𝑎𝑙𝑒𝑠
X 100

For 1 Period/Year
Or
𝑆𝑎𝑙𝑒𝑠−𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡
PV ratio = 𝑆𝑎𝑙𝑒𝑠
X 100
Or
𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡+𝑃𝑟𝑜𝑓𝑖𝑡
PV ratio = 𝑆𝑎𝑙𝑒𝑠
X 100

𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡+𝑃𝑟𝑜𝑓𝑖𝑡
PV ratio = 𝑆𝑎𝑙𝑒𝑠
X 100

𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
PV ratio = X 100
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑆𝑎𝑙𝑒𝑠

For 2 Period/Year
Or
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑜𝑓𝑖𝑡/𝐿𝑜𝑠𝑠
PV ratio = 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑆𝑎𝑙𝑒𝑠
X 100
𝑷𝑽 𝑹𝒂𝒕𝒊𝒐 = 100% − 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡 𝑡𝑜 𝑆𝑎𝑙𝑒𝑠 𝑅𝑎𝑡𝑖𝑜

Problem 1 on PV Ratio
Calculate P/V ratio, from the following:

Particulars Years

2010 2011

Sales (Rs.) 1,50,000 2,00,000

Profit (Rs.) 25,000 40,000

Change in Profit Change in Sales

Solution
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑜𝑓𝑖𝑡/𝐿𝑜𝑠𝑠
PV ratio = X 100
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑆𝑎𝑙𝑒𝑠

40000−25000 15000
PV ratio = 200000−150000 X 100 = 50000 X 100 = 30%
So 30% or 0.3 is your PV Ratio

Problem 2 on PV Ratio
From the following particulars, calculate P/V Ratio:

Year Sales(Rs.) Profit/Loss (Rs.)

2010 6,00,000 60,000 (loss)
2011 12,00,000 90,000 (Profit)
Solution
90000−(−60000) 150000
PV ratio = X 100 = X 100 = 25%
1200000−600000 600000

So 25% or 0.25 is your PV Ratio

Problem 3 on PV ratio
Calculate P/V Ratio from the following information:

Year Sales (Rs.) Total Cost (Rs.)

2010 7,00,000 5,50,000
2011 10,00,000 8,00,000

Solution
Particulars Years

2010 2011

Sales (Rs.) 7,00,000 10,00,000

Total Cost (Rs.) 5,50,000 8,00,000

Profit 1,50,000 2,00,000

20000−150000 50000
PV ratio = 1000000−700000 X 100 = 300000 X 100 = 16.67%

CVP Analysis
Cost-volume-profit (CVP) analysis is a financial planning tool that helps businesses understand how
changes in costs, volume, and selling prices affect their profits. It's also known as break-even
analysis.
CVP analysis can help businesses:
• Calculate the break-even point: Determine how many units need to be sold to cover all
costs
• Calculate the sales volume required to achieve a target profit: Determine how many
units need to be sold to reach a certain minimum profit margin
• Calculate the contribution margin: Determine the difference between total sales and total
variable costs
• Understand overall performance: Determine how many units must be sold to reach a
certain profit threshold or the margin of safety

Break Even Point (BEP):

Break-even point is a point at which the total costs are equal to sales. It is a volume of sales at which
there is neither profit nor loss. Hence, it is also called as no profit no loss point. If the sale is
increased beyond break-even-point level, profit will accrue and if sale is decreased below the BEP
level, loss will occur.

A point where a business has no profit and no loss that is known as break even point
𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡
BEP (per Unit) = 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖
𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡
BEP = 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖 X Sales

BEP (in Rs.) = BEP units × Selling price per unit

𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡
BEP (in Rs./ Amount) =
𝑃/ 𝑉 𝑅𝑎𝑡𝑖𝑜
Problem 1 on Break Even point
Diya Ltd. Gives the following information, calculate BEP in value and in units.
1. Sales – 40,000 units at Rs. 20 per unit.
2. Profit volume ratio = 50%
3. iii. Fixed Cost = Rs. 3,20,000 Solution:

Solution:

640000
BEP (per Unit) = = 32000 𝑈𝑛𝑖𝑡𝑠
20

320000
BEP (Value) = 0.5
= 640000

Margin of Safety:
Margin of safety is the excess of actual sales over sales at break-even-point. In other words, sales
over and above the break-even point are known as margin of safety.
If the margin of safety is large, it is the sign of soundness of the business and if the margin of safety
is small, it is a sign of weak position of business.
The margin of safety can be expressed in absolute sales amount or in terms of percentage to sales.
Margin of Safety = Actual sales – Sales at BEP

𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡

= 𝑃𝑉 𝑅𝑎𝑡𝑖𝑜
– 𝑃𝑉 𝑅𝑎𝑡𝑖𝑜

𝑃𝑟𝑜𝑓𝑖𝑡
Margin of Safety (Amount) =
𝑃𝑉 𝑅𝑎𝑡𝑖𝑜

𝑃𝑟𝑜𝑓𝑖𝑡
Margin of Safety (Per Unit) =
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑃𝑒𝑟 𝑈𝑛𝑖𝑡

𝑃𝑟𝑜𝑓𝑖𝑡
Margin of Safety (Percentage (%)) = 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑋 100

Margin of Safety (Units) = Actual Sales units – BEP Sales units

Problems with Solution

Problem 1
Calculate contribution in each of the following independent situations
(ii) Fixed cost Rs. 8,000, Profit Rs. 5,600.
(iii) Variable cost Rs. 7,000, Sales Rs. 11,000.
(iv) Contribution per unit Rs.7, Profit Rs. 3000, BEP= 2,000 units.

Solution
Solution
Contribution = Fixed Cost + Profit
= Rs. 8000 + Rs. 5600 = 13600
Contribution = Sales – Variable Cost
= Rs. 11000 - Rs. 7000 = 4000
Contribution = {BEP (in Units) X Contribution Per Unit} + Profit
= 2000 X 7 +3000 = 17000

Problem 2
Calculate P/V ratio in each of the following independent situation
1. Variable cost Rs. 60/-, contribution Rs. 40/-.
2. Sales Rs.20/-, variable cost Rs. 15/-.
3. Ratio of variable cost to sales 84%.
4. Profit Rs. 5,000/-. Sales Rs. 25,000/-, Fixed cost Rs. 8,000/-.
5. Year I sales Rs. 50,000/-, total cost Rs. 40,000/-
Year II sales Rs. 60,000/-, total cost Rs. 45,000/-

Solution
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝐶𝑜𝑛𝑡𝑖𝑏𝑢𝑡𝑖𝑜𝑛
1. 𝑃𝑉 𝑅𝑎𝑡𝑖𝑜 = 𝑆𝑎𝑙𝑒𝑠
= 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡+𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
 40
𝑃𝑉 𝑅𝑎𝑡𝑖𝑜 = 𝑋 100 = 40%
60 + 40

𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑆𝑎𝑙𝑒𝑠−𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡

2. 𝑃𝑉 𝑅𝑎𝑡𝑖𝑜 = 𝑆𝑎𝑙𝑒𝑠
= 𝑆𝑎𝑙𝑒𝑠
20 − 15
𝑃𝑉 𝑅𝑎𝑡𝑖𝑜 = 𝑋100 = 25%
20

3. 𝑃𝑉 𝑅𝑎𝑡𝑖𝑜 = 100% − 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡 𝑡𝑜 𝑆𝑎𝑙𝑒𝑠 𝑅𝑎𝑡𝑖𝑜

= 100% − 84% = 16%
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡+𝑃𝑟𝑜𝑓𝑖𝑡
4. 𝑃𝑉 𝑅𝑎𝑡𝑖𝑜 = =
𝑆𝑎𝑙𝑒𝑠 𝑆𝑎𝑙𝑒𝑠
8000 + 5000 13
𝑃𝑉 𝑅𝑎𝑡𝑖𝑜 = = 𝑋 100 = 52%
25000 25
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑜𝑓𝑖𝑡 15000−10000
5. 𝑃𝑉 𝑅𝑎𝑡𝑖𝑜 = 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑆𝑎𝑙𝑒𝑠 = 60000−50000 𝑋 100 = 50%

Problem 3
From the following data, calculate the break-even point:
Direct material per unit Rs. 3
Direct labor per unit Rs. 2
Fixed overheads Rs. 10,000/-
Variable overheads 100% on direct labor
Selling price per unit Rs. 10/-
Trade discount 5%
Also, determine the net profits if sales are 10% above the break-even point.

Solution
Step 1: Calculate Variable Costs per Unit
1. Direct Material per Unit = Rs. 3
2. Direct Labor per Unit = Rs. 2
3. Variable Overheads = 100% of Direct Labor = Rs. 2
Variable cost per unit = Direct material cost + Direct labour cost + Variable overheads
Variable cost per unit = Rs 3 + Rs 2 + 2 = Rs 7

Step 2: Calculate Contribution margin per unit

Contribution margin per unit = Selling price per unit - Variable cost per unit
Contribution margin per unit = 10 – 7 = 3
Contribution margin per unit = 3

Step 3: Calculate Break-even Point in Units

𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡
BEP (per Unit) =
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
10000
Break-even point (in units) = 3 = 3333.33 (approx.)
Step 3: Calculate Net Profit if Sales are 10% Above the Break-even Point
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 = (𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑀𝑎𝑟𝑔𝑖𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 𝑋 𝑆𝑎𝑙𝑒𝑠 𝑉𝑜𝑙𝑢𝑚𝑒) − 𝐹𝑖𝑥𝑒𝑑 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
110
𝑆𝑎𝑙𝑒𝑠 𝑣𝑜𝑙𝑢𝑚𝑒 = 𝐵𝑟𝑒𝑎𝑘 𝑒𝑣𝑒𝑛 𝑝𝑜𝑖𝑛𝑡 𝑋 (10% 𝑎𝑏𝑜𝑣𝑒 𝑏𝑟𝑒𝑎𝑘 𝑒𝑣𝑒𝑛 𝑣𝑜𝑙𝑢𝑚𝑒)
100
110
𝑆𝑎𝑙𝑒𝑠 𝑣𝑜𝑙𝑢𝑚𝑒 = 3333 𝑋 = 3666
100
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 = (3 𝑋 3666) − 100000