Unit 4: Marginal costing & break-even analysis
Cost and Management Accounting notes · PTU syllabus (BBA 303-18)
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Unit summary
Marginal costing separates fixed and variable costs to show how profit changes with volume. This unit covers absorption versus marginal costing, cost-volume-profit (CVP) analysis, the P/V ratio, break-even analysis (algebraic and graphic), margin of safety, key factors and the cost indifference point.
After this unit you can
- Distinguish absorption costing from marginal costing
- Compute contribution, P/V ratio and break-even point
- Draw a break-even chart and compute the margin of safety
- Use key-factor analysis and the cost indifference point for decisions
PTU syllabus topics
- Absorption vs. variable costing
- distinctive features and income determination
- cost-volume-profit analysis
- profit/volume ratio
- algebraic and graphic break-even analysis
- margin of safety
- key factor
- cost indifference point
Contribution
Sales − variable cost
P/V ratio
Contribution / sales × 100
Break-even sales
Fixed cost / P/V ratio
Margin of safety
Actual sales − break-even sales
Cost indifference point
Difference in fixed cost / difference in variable cost per unit
Topic 1
Absorption vs marginal costing
Fixed costs
Included in product cost
Treated as period cost, charged to P&L
Stock valuation
At total cost
At variable cost
Profit when stock changes
Differs from marginal costing
Depends only on sales
Use
External reporting
Internal decisions
Under marginal costing: Sales − Variable cost = Contribution; Contribution − Fixed cost = Profit.
Topic 2
CVP analysis and the P/V ratio
Cost-volume-profit analysis studies how changes in volume, price and costs affect profit.
Contribution
Sales − variable cost
P/V ratio
Contribution / sales × 100
Break-even point (units)
Fixed cost / contribution per unit
Break-even point (₹)
Fixed cost / P/V ratio
Margin of safety
Actual sales − break-even sales = profit / P/V ratio
Sales for target profit
(Fixed cost + target profit) / P/V ratio
Example
Selling price ₹50, variable cost ₹30, fixed cost ₹40,000. Contribution = ₹20 per unit; P/V ratio = 40%; BEP = 2,000 units or ₹1,00,000. If sales are ₹1,50,000, margin of safety = ₹50,000 and profit = ₹20,000.
Topic 3
Break-even chart
A break-even chart plots sales and total costs against volume: the point where the total sales line crosses the total cost line is the break-even point. The area to the right is profit; to the left is loss. The angle of incidence (between sales and cost lines) shows the rate of profit earning — a larger angle means higher profit.
Topic 4
Key factor and cost indifference point
- Key (limiting) factor limits output — materials, labour hours or machine hours. Rank products by contribution per unit of the key factor and produce the highest first.
- Cost indifference point: the output at which two alternatives (e.g. two machines or methods) have equal total cost: difference in fixed costs / difference in variable cost per unit.
Example
Machine A: fixed ₹20,000, variable ₹10 per unit; Machine B: fixed ₹30,000, variable ₹8. Indifference point = 10,000/2 = 5,000 units; above it B is cheaper.
Key terms
- Contribution
- Sales minus variable cost
- P/V ratio
- Contribution as a percentage of sales
- Break-even point
- The sales level with no profit and no loss
- Margin of safety
- Sales above the break-even point
- Key factor
- The factor limiting a firm's output
Quick revision
- Marginal costing charges fixed costs to the period.
- BEP = FC / contribution per unit = FC / P/V ratio.
- MOS = actual − BE sales = profit / P/V ratio.
- Rank products by contribution per key factor.
- Indifference point = ΔFC / ΔVC per unit.
Important exam questions
Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).
Short-answer questions
- Q1.Differentiate between absorption and marginal costing.
- Q2.Define contribution and P/V ratio.
- Q3.What is the break-even point?
- Q4.What is the margin of safety?
- Q5.What is a key factor?
- Q6.Define the cost indifference point.
Long-answer questions
- Q1.Compare absorption and marginal costing with a profit statement.
- Q2.Calculate the P/V ratio, BEP, margin of safety and sales for a target profit from given data.
- Q3.Draw and explain a break-even chart.
- Q4.Explain key-factor analysis and the cost indifference point with examples.
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