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Fixed COSTS are ALREADY incurred and so they do not influence the future ‘Make or Buy’ decisions. HENCE, they are ignored for comparison. Only variable costs, in both OPTIONS, are compared and that OPTION is chosen, where the variable costs are lower.

Fixed costs are already incurred and so they do not influence the future ‘Make or Buy’ decisions. Hence, they are ignored for comparison. Only variable costs, in both options, are compared and that option is chosen, where the variable costs are lower.

‘Sunk COSTS’ are FIXED costs. What is sunk cannot be retrieved. In a SIMILAR MANNER, fixed costs, once incurred, cannot be REVERSED.

‘Sunk costs’ are fixed costs. What is sunk cannot be retrieved. In a similar manner, fixed costs, once incurred, cannot be reversed.

Fixed costs are sunk costs. What is sunk cannot be retrieved in the same condition. Fixed costs cannot be reversed, without loss. Machinery PURCHASED, already, cannot be SOLD, without loss, in terms of money. Fixed costs that are incurred are not RELEVANT for our decision-making. Costs that will be incurred, in any event, should not be considered in the decision-making. In other WORDS, the existing fixed costs, which cannot be saved, do not influence the decision as those costs are already incurred and cannot be reversed, whether the FIRMS makes or buys.

Fixed costs are sunk costs. What is sunk cannot be retrieved in the same condition. Fixed costs cannot be reversed, without loss. Machinery purchased, already, cannot be sold, without loss, in terms of money. Fixed costs that are incurred are not relevant for our decision-making. Costs that will be incurred, in any event, should not be considered in the decision-making. In other words, the existing fixed costs, which cannot be saved, do not influence the decision as those costs are already incurred and cannot be reversed, whether the firms makes or buys.

‘CONTRIBUTION’ is a fund that is equal to the selling price of a PRODUCT less MARGINAL cost.

Contribution MAY be described as FOLLOWS:

Contribution = Selling Price – Marginal Cost
Contribution = Fixed Expenses + Profit
Contribution – Fixed Expenses = Profit

‘Contribution’ is a fund that is equal to the selling price of a product less marginal cost.

Contribution may be described as follows:

Contribution = Selling Price – Marginal Cost
Contribution = Fixed Expenses + Profit
Contribution – Fixed Expenses = Profit

• Variable cost per unit remains constant; any increase or decrease in PRODUCTION CHANGES the total cost of output.
• Total fixed cost remains unchanged up to a certain LEVEL of production and does not VARY with increase or decrease in production. It means the fixed cost remains constant in terms of total cost.
• Fixed expenses EXCLUDE from the total cost in marginal costing technique and provide us the same cost per unit up to a certain level of production.

Evaluation of Performance : The evaluation of the performance of VARIOUS DEPARTMENTS or products can be evaluated with the HELP of marginal costing which is based on contribution GENERATING capacity.

Evaluation of Performance : The evaluation of the performance of various departments or products can be evaluated with the help of marginal costing which is based on contribution generating capacity.

Contribution: It is the difference between sales revenue and variable cost (also KNOWN as variable cost). Variable cost is the IMPORTANT cost in deciding profitability as FIXED costs are IGNORED by marginal costing.

It can be expressed in two ways:

• Sales Revenue – Variable Cost
• Fixed Cost + PROFIT

Contribution: It is the difference between sales revenue and variable cost (also known as variable cost). Variable cost is the important cost in deciding profitability as fixed costs are ignored by marginal costing.

It can be expressed in two ways:

• Sales Revenue – Variable Cost
• Fixed Cost + Profit

PROFIT PLANNING : This technique through the calculation of P/V RATIO HELPS the management to plan the ACTIVITIES in such a way that the profit can be maximised.

Profit Planning : This technique through the calculation of P/V Ratio helps the management to plan the activities in such a way that the profit can be maximised.

Fixation of Selling Price : The technique of MARGINAL costing assists the management to fix the price in such a WAY so that PRICES fixed can cover at LEAST the variable cost.

Fixation of Selling Price : The technique of marginal costing assists the management to fix the price in such a way so that prices fixed can cover at least the variable cost.

Make or BUY decision : Marginal COST analysis helps the management in MAKING or BUYING decision.

Make or Buy decision : Marginal cost analysis helps the management in making or buying decision.

Optimizing PRODUCT Mix : To maximise profits and INCREASE SALES volume it is necessary to DECIDE an optimized mix or proportion in which various products of a company can be sold.

Optimizing Product Mix : To maximise profits and increase sales volume it is necessary to decide an optimized mix or proportion in which various products of a company can be sold.

COST Control : MARGINAL COSTING is a technique of cost classification and cost presentation which enable the management to concentrate on the CONTROLLABLE costs.

Cost Control : Marginal Costing is a technique of cost classification and cost presentation which enable the management to concentrate on the controllable costs.

FLEXIBLE Budget PREPARATION: As the marginal costing particularly classifies costs as fixed and variable costs which FACILITATES the preparation of flexible BUDGETS.

Flexible Budget preparation: As the marginal costing particularly classifies costs as fixed and variable costs which facilitates the preparation of flexible budgets.

Margin of Safety is the amount of sales which generates profit. In other words, sales beyond Break EVEN Point are known as Margin of Safety. It is calculated as the difference between total sales and the break even sales. It can be EXPRESSED in monetary terms or number of units. It can be expressed as below:

Margin of Safety = Sales – Break Even Sales
 = Sales - {(Fixed Cost) / (P/V Ratio)}
= ((Sales * (P/V) Ratio) - Fixed Cost) / (P/V) Ratio
= (Contribution - Fixed Cost) / (P/V) Ratio
= Profit / (P/V) Ratio

The size of margin of safety is an extremely important guide to the financial strength of a business. If margin of safety is large, which indicates that BEP is much below the actual sales, that means business is in a sound condition and REDUCTION in sales will not affect the profit of the business. On the other hand, if margin of safety is low, any loss of sales may be a serious matter. Thus, efforts need to be made to reduce fixed costs, variable costs or increasing the selling PRICE or sales volume to improve contribution and overall P/V Ratio.

Margin of Safety is the amount of sales which generates profit. In other words, sales beyond Break Even Point are known as Margin of Safety. It is calculated as the difference between total sales and the break even sales. It can be expressed in monetary terms or number of units. It can be expressed as below:

Margin of Safety = Sales – Break Even Sales
 = Sales - {(Fixed Cost) / (P/V Ratio)}
= ((Sales * (P/V) Ratio) - Fixed Cost) / (P/V) Ratio
= (Contribution - Fixed Cost) / (P/V) Ratio
= Profit / (P/V) Ratio

The size of margin of safety is an extremely important guide to the financial strength of a business. If margin of safety is large, which indicates that BEP is much below the actual sales, that means business is in a sound condition and reduction in sales will not affect the profit of the business. On the other hand, if margin of safety is low, any loss of sales may be a serious matter. Thus, efforts need to be made to reduce fixed costs, variable costs or increasing the selling price or sales volume to improve contribution and overall P/V Ratio.

Break Even Point (BEP) is a volume of sales where there is neither loss nor profit. That means contribution is enough to cover the fixed costs.

Thus, we can say that Contribution = Fixed Cost

Any contribution generated after BEP will directly result into profits as the fixed costs are fully covered now. BEP can be COMPUTED in two ways:

In terms of Quantity-

Fixed Costs / Contribution per unit

In terms of Amount-

(Fixed Costs) / (P/V Ratio):

BEP (Break Even Point) is the SITUATION where there is neither loss nor profit. At this stage, the contribution is enough to cover the fixed costs i.e contribution is equal to fixed cost. Contribution generated after the break even point will result in profits for the organisation. Profit MAXIMIZATION is the motive of every organisation. Thus, every organisation use BEP as a base to take various decisions in regard to its sales volume and tries to increase it so that total fixed costs can be covered as early as possible and more profits can be earned.

Break Even Point (BEP) is a volume of sales where there is neither loss nor profit. That means contribution is enough to cover the fixed costs.

Thus, we can say that Contribution = Fixed Cost

Any contribution generated after BEP will directly result into profits as the fixed costs are fully covered now. BEP can be computed in two ways:

In terms of Quantity-

Fixed Costs / Contribution per unit

In terms of Amount-

(Fixed Costs) / (P/V Ratio):

BEP (Break Even Point) is the situation where there is neither loss nor profit. At this stage, the contribution is enough to cover the fixed costs i.e contribution is equal to fixed cost. Contribution generated after the break even point will result in profits for the organisation. Profit maximization is the motive of every organisation. Thus, every organisation use BEP as a base to take various decisions in regard to its sales volume and tries to increase it so that total fixed costs can be covered as early as possible and more profits can be earned.

P/V Ratio:

P/V Ratio (Profit Volume Ratio) is the ratio of contribution to sales which indicates the contribution earned with respect to one rupee of sales. It also measures the rate of change of profit due to change in volume of sales. Its fundamental property is that if per unit sales price and variable cost are constant then P/V Ratio will be constant at all the levels of activities. A change is FIXED cost does not affect P/V Ratio. It is CALCULATED as under:

(Contribution * 100) / Sales
(Change in profits * 100) / (Change in sales)

A high P/V Ratio indicates that a slight INCREASE in sales without increase in fixed costs will result in HIGHER profits. A low P/V ratio which indicates low profitability can be improved by increasing selling price, reducing marginal costs or selling products having high P/V ratio.

Contribution:

It is the difference between sales revenue and variable cost (also known as variable cost). Variable cost is the important cost in deciding profitability as fixed costs are ignored by marginal costing.

It can be expressed in two ways: 

• Sales Revenue – Variable Cost
• Fixed Cost + Profit

The SITUATION generating higher contribution is treated as a profitable situation.

P/V Ratio:

P/V Ratio (Profit Volume Ratio) is the ratio of contribution to sales which indicates the contribution earned with respect to one rupee of sales. It also measures the rate of change of profit due to change in volume of sales. Its fundamental property is that if per unit sales price and variable cost are constant then P/V Ratio will be constant at all the levels of activities. A change is fixed cost does not affect P/V Ratio. It is calculated as under:

(Contribution * 100) / Sales
(Change in profits * 100) / (Change in sales)

A high P/V Ratio indicates that a slight increase in sales without increase in fixed costs will result in higher profits. A low P/V ratio which indicates low profitability can be improved by increasing selling price, reducing marginal costs or selling products having high P/V ratio.

Contribution:

It is the difference between sales revenue and variable cost (also known as variable cost). Variable cost is the important cost in deciding profitability as fixed costs are ignored by marginal costing.

It can be expressed in two ways: 

The situation generating higher contribution is treated as a profitable situation.

Cost Volume-Profit (CVP) relationship is an analysis which studies the relationships between the following factors and its impact on the amount of profits.

• Selling price per unit and total sales amount • Total cost which may be in any form i.e. fixed cost or Variable cost.
• Volume of sales

In SIMPLE words, CVP is a management ACCOUNTING tool that expresses relationship among total sales, total cost and profit. Cost Volume-Profit relationship is one of the important TECHNIQUES of cost and management accounting. It is a POWERFUL tool which furnishes the complete picture of the profit structure and helps in planning of profits. It can also answer what if type of questions by telling the volume required to produce. This concept is relevant in all decision making AREAS, particularly in the short run.

Cost Volume-Profit (CVP) relationship is an analysis which studies the relationships between the following factors and its impact on the amount of profits.

In simple words, CVP is a management accounting tool that expresses relationship among total sales, total cost and profit. Cost Volume-Profit relationship is one of the important techniques of cost and management accounting. It is a powerful tool which furnishes the complete picture of the profit structure and helps in planning of profits. It can also answer what if type of questions by telling the volume required to produce. This concept is relevant in all decision making areas, particularly in the short run.

The concept of marginal COSTING is practically applied in the following situations:

• Evaluation of Performance : The evaluation of the performance of VARIOUS departments or products can be evaluated with the help of marginal costing which is based on contribution generating capacity.
• Profit Planning : This technique through the calculation of P/V Ratio helps the management to plan the activities in such a way that the profit can be maximised.
• Fixation of Selling Price : The technique of marginal costing assists the management to fix the price in such a way so that prices fixed can cover at least the variable cost.
• Make or Buy decision : Marginal cost analysis helps the management in MAKING or buying decision.
• Optimizing Product MIX : To maximise profits and increase sales volume it is necessary to decide an optimized mix or proportion in which various products of a company can be sold.
• Cost Control: Marginal Costing is a technique of cost classification and cost presentation which enable the management to concentrate on the controllable COSTS.
• Flexible Budget preparation: As the marginal costing particularly classifies costs as fixed and variable costs which facilitates the preparation of flexible budgets.

The concept of marginal costing is practically applied in the following situations:

Marginal Costing is ascertainment of the marginal cost which varies directly with the volume of production by differentiating between FIXED costs and variable costs and finally ascertaining its effect on profit.

The basic assumptions made by marginal costing are following:

• Total variable cost is directly proportion to the level of activity. However, variable cost PER unit remains constant at all the levels of activities.
• Per unit selling price remains constant at all levels of activities.
• All the items produced by the organisation are sold off.

Features of Marginal costing:

• It is a method of recoding costs and reporting PROFITS.
• It involves ascertaining marginal costs which is the difference of fixed cost and variable cost.
• The operating costs are differentiated into fixed costs and variable costs. Semi variable costs are also divided in the individual components of fixed cost and variable cost.
• Fixed costs which remain constant regardless of the volume of production do not FIND place in the product cost determination and inventory valuation.
• Fixed costs are treated as period charge and are written off to the profit and loss account in the period incurred.
• Only variable costs are taken into consideration while COMPUTING the product cost.
• Prices of products are based on variable cost only.
• Marginal contribution decides the profitability of the products.

Marginal Costing is ascertainment of the marginal cost which varies directly with the volume of production by differentiating between fixed costs and variable costs and finally ascertaining its effect on profit.

The basic assumptions made by marginal costing are following:

Features of Marginal costing: