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MODULE V
Cost Volume Profit analysis-Standard costing- Analysis of Material and Labour Variances
MARGINAL COSTING
The basic objectives of Cost Accounting are cost ascertainment and cost control
...
Marginal costing
and Break even analysis are important techniques used for cost control and decision nmaking
...
It is the

addition made to total cost when the output is increased by one unit
...

Marginal cost of nth unit = Total cost of nth unit- total cost
Eg
...
5000
...
e, 101

of n-1

units, total cost is Rs
...
Then marginal cost of 101th unit is Rs
...
The chartered Institute of Management Accountants [CIMA] England defines Marginal as "the amount

atany

given volume of output by which aggregate costs are changed if the volume of output is increased or

decreased by one unit

MARGINAL COSTING
It is the technique of costing in which only marginal costs or variable are charged to output or production
...
Fixed costs are not charged to output
...
Therefore, these fixed costs are directly transferred to Costing Profit and Loss

Account
...

of
assumed that all costs can be classified into fixed and variable costs
...
Variable costs

in direct

proportion with

the volume of

output
...
Fixed costs

marginal

are

first

an

index of

profitability
...


It is

not

met out of contribution and

profit
...


only

fixed relationship with sales
...

Contribution = Sales --Variable cost

Marginal cost equation
Sales-Variable Cost = Contribution

Contribution = Fixed costs + Proit

Therefore, Fixed cost = Contribution-Profit

PROFIT VOLUME RATIO [PV RATIOJ
...


an

absolute

measure

of profitability but it

Therefore, the contribution is related

cannot

to volume

be used for

comparison

of two

products

or

of sales
...


profitability

of the

product

will also be

higher
...


It is

Marginal cost statement
The

Marginal

cost statement

is a profitability statement prepared
prepared in the following format
...
It is simple to understand and easy to apply to any firm

2
...
Fixed costs are transferred to costing profit and
Loss account
...
It also prevents the illegal carry forward in stock valuation of some proportion of current years fixed cost
...
The effect of different sales mix on profit can be ascertained and management can adopt the optimum sales mix
5
...


Disadvantages
Important disadvantages of marginal costing are
1,All Assumptions of marginal costing are not appropriate
...

2
...


3
...

4
...

5
...


BREAK EVEN ANALYSIS
Every business is interested in ascertaining the breakeven point
...
It is the point of no profit or no loss
...
The firm ceases to incur losses at this point or it
starts to earn a profit from this point
...


43|P a Be

1
...
Break even point in value = Total Fixed costs or Total Fixed cost x sales/ P/V Ratio Contribution
3
...
P/V Ratio
2
...
Breakeven point in Value
Given:

Selling price per unit Rs
...
12

Fixed costs Rs
...
PV Ratio = Contribution/Sales x 100=20-12/20x100 = 40 %
2
...
Breakeven point in value = Fixed costs = 32000/40 x100 = Rs
...
The fim can decide upon the target return or profit in advance
...
The volume of sales required to achieve the desired level of profit may be
computed as follows -

Number of units to be sold = Fixed costs + desired Profiv Contribution per unit
Sales volume required = Fixed costs+ Desired Profits/ P/V Ratio

Illustration 3
Product A is sold at a unit selling price of Rs
...
32
...
40000
...
The number of units to be produced to break even

2
...
10000

Solution
Contribution = SP-VC = 40-32 = 8 per unit

1
...
Number of units to be sold to

Fixed Cost

+

Desired Profit

earn a

=

4000/8

5000 units
...
10000

40000+10000/8

=

=

=

6250 units

Contribution per unit

Break Even Chart
It is the

graphical presentation

fixed costs
...


point
...
It is constructed using a database of variable costs, fixed costs, total costs and sales
Output,
The units of output
and sales

are

or

sales

plotted along

revenue are

plotted along

the X

axis, using

the Y axis
...
It forms

a

measurement
...
The variable cost line is plotted next, starting

from zero it progresses continuously indicating that the variable cost increase with the volume fixed cost line of
sales
...
It starts from the fixed cost line on the Y axis and
follows the same patterm of variable cost line
...
It starts from the zero and progresses

continuously, indicating that the sales increase with larger units of output
...
A vertical line drawn to the X axis from this point shows the
volume of output required to Break even
...
The width
of the angle represents the rate of profitability i
...
It is the excess of
actual sales over break even sales
...


Margin of safety
Margin

of safety

=

Actual sales- Break even sales

=

Profit/P/V Ratio

Or Profit margin ofsafety x P/V Ratio
Illustration 5

Calculate BEP and Margin of safety from the following?
Sales 50000 units @ Rs
...
3 per unit

Variable overhead Rs
...
75000 per annum
Solution- BEP

75000

Fixed Cost

=

=

37500 units

SP- VC per unit 6-4
BEP in value = 37500 x 6= 225000

Margin of safety

=

Actual sales

-

BE sales

=

[50000x6]-225000= Rs
...

Period I Period II
Sales 300000 320000

Total cost 260000 272000

Calculate
1
...
Profit when sales are Rs
...

3
...
50000
Solution:
P/V Ratio Change in Profit
Change in Sales
=

profit

Change

in

Change

in Sales

=

=

x

100

48000-40000= 8000

320000-300000

=

Rs
...
BEP

=

=

Contribution

Fixed

Profit

=

are

Profit

-

8000/40

=

100

x

=

Rs
...
360000

360000x40/100

Contribution

=

Rs
...
Profit when sales
Contribution

40/100

x

144000-80000=Rs
...
50000

required to earn a profit
Fixed cost + Profit required
Contribution required
P/V ratio
Sales Contribution requires/
3
...
325000

Analysis [ CVP Analysis)] (5 marks)
is a n a r r o w
volume on profit
...

volume profit analysis
...
It helps management
Cost-Volume Profit

analysis the relationship
planning,

decision

between cost, volume and

profit

cost control
...


variable components
...
e,
at

The

ever output is produced,

the same is sold

during that

period
...
When the output is zero, total
When the output
recovered gradually when the volume of output is increased
...
The fixed costs are
reaches the Break even point, the whole fixed costs are recovered
...


and the amount of profit increases with the increase in sales volume
...


The

important

uses

of

marginal costing

and Break Even analysis are the following
1
...
Once BEP is found

out

the

management

can

even

point
...

2
...
In marginal costing all costs are classified into fixed and

variable elements
...
But variable costs can be controlled by
managerial actions
...

3
...

II
...

IV
...

VI
...

VII
...


X
...
Fixation of selling price

actually the profit plus

Selling price

is

Sometimes a

firm may receive

cost
...
In marginal

depressed market,

sales
...

which gives the positive contribution is profitable
product
costing any
Offer
Accepting Special Offer / Export
the current selling price
...
This
quoted
price
any
technique,
costing
Marginal
According
If the new offer is accepted,
in the domestic market and making a profit
...
However,
and therefore the total profit of the
the contribution from such offer is purely profit
and there is no increase in fixed
confirmed that it is within the capacity
before accepting the offer, it should be
to

COsts as a result of increasing the output

Selection of a Product/ sales mix
The

shows

mix
...
Therefore, the company

marginal costing technique

is useful for

which

higher PV ratio is
shows the highest P/V ratio so as to maximize profits
...
Here, the
the supplier's price, it is profitable to
the supplier
...

the
component
produce
to buy the component from outside
...
Should this product
product
be discontinued
...


factor or

of operation of the firm
...
when
or
scarce supply
materials, labour hours production
Sometimes a firm may be confronted with
of the limiting factor is
that gives a higher contribution per unit
the
in
factor
product
operation,
a
there is limiting
the
of the limiting factor and choose
therefore contribution is related to unit
than
more profitable
other products
...
The CIMAIerminologydefinesthis term as,"abenchmark measurement ofresources usage, setin
defined conditions
Standardcostis apredeterminedoperatingcostcalculated from management'sstandards ofefficientoperation
and
the relevant necessary expenditure
...
Cost control
2
...
Fixation of selling price
4
...
Estimated cost is a pre determined

cost for a future period under normal conditions of operations
...
Cost estimation is made
for submitting tenders or quoting
Definition of standard costing:

price of a product or a

unit of

services

Standard costing is a technigque of cost control
...
" In standard costing the actual costs incurred are compared with the standard costs
...

Features: The following are the important characteristics of the standard costing system
1
...
It makes a comparison of actual cost with standard cost

3
...
Variances

are

reported to management for the purpose of decision making

Standard costing and Budgetary control
Both standard

costing

and

budgetary

control

similar in

principle

since both are concerned with setting
performance and cost levels for control purposes
...


are

Budgetary

control and standard costing are
Distinction between standard costing and budgetary control:

inseparably

linked

together
...
Budget is based on past performance, while standard is established on the basis of technical estimates
...
Budgets consider both income and
expenditure whereas standards are for

expenditure only
...
Budgets projects financial accounts, while standard cost project cost accounts

4
...

5
...

7
...

Budgets are used for the forecasting men, money and materials,

Budgetary

control

technique

is

applicable to all types

manufacturing organizations
8
...

of businesses
...


But standard

in total
...


analysis

Budgetary control does

product
...
Performance measurement
2
...
Stock valuation

4
...
Profit planning and decision making
6
...
Assisting establishment of budgets

Basic requirements of standard costing:
a
...


b
...

c
...
The manual

should describe the system to be introduced and the benefits thereof
...
Type of standards: It is very necessary to determine the type of standard to be used, whether current, basic or
normal standard
...
Co-operation of Executives and staff:- Without the co-operation of the executives and staff, it is very difficult to
run the standard costing system
...
Fixation of standards: Standard should be set for each element of cost and it should be scientific
...
Establishment ofcost centres: A cost centre is a location, person or item of equipmentfor which costs may be
ascertained and used for the purpose of cost control
...

2
...


3
...
Standards are always established scientifically
...
Ascertainment of actual cost: Measuring the actual cost which is incurred in the next stepin the standard costing
...
Comparison of Standard cost and Actual cost
...
Analysis of Variances
7
...
Basic standards: A standard established for use over a long period is known as the basic standard
...
Its use is to show long term trends, and it operates in a similar way to index numbers
...
This standard is used for items or costs which are likely to remain
constant over a long period
...
Current standard: A standard established for use over a short period of time and related to current conditions, is

known as the 'current standard"
...

Conditions during which period the standard is used are known as current conditions
...
Ideal standards & Expected standards:- Ideal standard is that which can be attained under the most favourable
conditions, while expected standard is that which is expected to be attained during a specified budget period
...

49 | P a ge

4
...
"It is difficult to follow normal standards in
practice as it is not possible to forecast performance with a reasonable degree of accuracy for a long period of time
...
It is the

deviation of actual cost from the standard cost
...
If the actual cost is less than the standard, the

difference is known as favourable or positive variance and it is symbol of efficiency
...
Analysis of variance means carrying out the
appropriate investigation to identify the reasons for the variance
...
Such variance can be corrected by taking a suitable action
...


reasons like increase in prices of material, labour etc it is a case of uncontrollable variances
...
It includes
I
...
Direct labour variance
3
...
Sales variance

MATERIAL VARIANCES
It includes:
a
...
It may be expressed as:
MCV=Standard cost of materials for actual output - Actual cost of materials used
Std
...
Material Price Variance (MPV): It is that
portion of the material cost variance which is due to the difference
between the standard cost of materials used for the output achieved and the actual cost of materials used
...


actual
d
...
MUV

variance
output and the

=Std price per unit (Std qty

Actual

cost

qty)

Material Mix Variance (MMV): It is that portion of the material usage variance which is due

to

the difference

between standard and actual composition of a mixture
...
In case of material mix
variance, two situations may arise:
Actual weight of mix and the A

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