Session on

Marginal Costing &

Cost-Volume-Profit
Analysis
 Cost-Volume-Profit Analysis
 The Profit Equation
Sales = VC + FC + P
From the above equation, we derived:
a. Contribution = Sales – VC
b. Cont. to Sales ratio = Sales – VC / Sales
c. Sales to earn a desired profit
= (FC + Desired P)/Cont. to Sales ratio
d. Break even Sales
= FC / Cont. to Sales ratio
Slide 4-2
Break-Even Point
 Margin of Safety
 The margin of safety is the difference
between the expected level of sales and
break-even sales
 If breakeven sales for Model DX375 is
$293,600 and expected sales are
$350,000, then

 The margin of safety is:

$350,000 - $293,600 = $56,400

Slide 4-4
 “What If” Analysis
 “What if” analysis examines what will
happen if an action is taken
 The profit equation can show how profit
will be affect by various options under
consideration
 CC is selling 3,000 units at $200, with
variable cost of $90.83 and fixed cost of
$160,285
 Management is considering a change to
$80.00 variable cost and fixed cost of
$210,285
Slide 4-5
 “What If” Analysis
 Change in fixed and variable costs
 Without the change, the profit is
$200(3,000) - $90.83(3,000) - $160,285 = $167,225

 If the price and quantity stay the same, the

profit assuming the alternative is selected
would be

$200(3,000) - $80(3,000) - $210,285 = $149,715

 The alternative would hurt profitability

Slide 4-6
 “What If” Analysis
 Change in selling price
 Any one of the variables in the profit
equation can be considered
 For example, if CC sells 3,000 units, what
selling price is required to earn a profit of
$200,000?

$200,000 = SP(3,000) - $90.83(3,000) - $160,285

SP(3,000) = $632,775
SP = $210.93
 Two Period Information
 If the cost and profit information of two
period is given, for instance –
Year 1 Year 2
Sales Rs.32,00,000 40,00,000
Profit Rs.6,00,000 8,00,000

Calculate VC, FC, C/S ratio, BEP of sales and

target sales of Year 3 if the target profit for
the Yearr 3 is Rs.10,00,000
 Multiproduct Analysis
 Contribution margin approach
 Used if the items sold are similar
 Calculate a weighted average contribution
margin per unit
 Use the weighted average contribution
margin in the profit formula to calculate
breakeven point and target sales
 The relative product mix is then used to
calculate the required sales of individual
items
 Multiproduct Analysis

 The company has fixed costs of $3,500,000

 Model A and B are sold in 2:1 ratio
 Multiproduct Analysis
 Break-even sales in units

𝐏𝐫𝐨𝐟𝐢𝐭+𝐓𝐨𝐭𝐚𝐥 𝐟𝐢𝐱𝐞𝐝 𝐜𝐨𝐬𝐭𝐬

=
𝐖𝐞𝐢𝐠𝐡𝐭𝐞𝐝 𝐚𝐯𝐞𝐫𝐚𝐠𝐞 𝐜𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐦𝐚𝐫𝐠𝐢𝐧 𝐩𝐞𝐫 𝐮𝐧𝐢𝐭

𝟎+$𝟑,𝟓𝟎𝟎,𝟎𝟎𝟎
= 2,500 units
$𝟏,𝟒𝟎𝟎

 The 2,500 units is made up of the 2:1 mix, so Rohr

must sell 1,667 Model A (2/3 of 2,500) and 833
Model B units (1/3 0f 2,500)

Slide 4-11
 Multiproduct Analysis
 Contribution Margin Ratio Approach
 Products are substantially different
 Calculate total company contribution
margin ratio
 Use total company contribution margin
ratio to compute required sales in dollars
 Total company fixed costs (common costs)
are not included for contribution margin
approach but used for contribution margin
ratio approach
 Multiproduct Analysis
A company with 4 divisions has the
following information available:
Total sales $6,450,000
Total variable costs $4,706,000
Total direct fixed costs $484,000
Total common fixed costs $1,120,000
1. Calculate total contribution margin ratio
($6,450,000 – $4,706,000) / $6,450,000 = .2704
2.Calculate total company break-even sales in
dollars
($484,000 + $1,120,000) / .2704 = $5,931,953
Slide 4-13
 Assumptions in CVP Analysis
 Assumptions can affect the validity of
the analysis
1. Costs can be separated into fixed and
variable components
2. Total fixed cost and unit variable cost
do not change over the levels of interest
3. Multiproduct analysis assumes the
product mix does not change
 Despite assumptions, CVP is useful
Slide 4-14
 Constraints

 Due to shortages of space, equipment or

labor there can be constraints on how many
items can be produced
 Utilize contribution margin per unit to
analyze situations
 Calculate contribution margin per unit of
constraint
 Produce product with highest contribution
margin per unit of constraint
 Linear programming can solve multiple
constraints
 Constraints
A company can produce Product A or
Product B using the same machinery. Only
1,000 machine hours are available
Product A Product B
Selling price $500 $300
Variable cost 300 200
Contribution margin $200 $100
Machine hours to
produce one unit 10 hours 2 hours
Contribution margin
per machine hour $20 $50
 Constraints
 With the 1,000 available machine hours,
 Product A generates $20,000 of
contribution margin
 Product B generates $50,000 of
contribution margin
 Although Product A has the higher
contribution margin per unit, Product B
has the higher contribution margin per
unit of constraint