Marginal costing : Marginal costing is the ascertainment of marginal cost and of the effect on profit with change in output. In Marginal costing, total cost is segregated into variable cost and fixed cost. Marginal costing assumes that only variable cost is the production cost and fixed cost is the period cost which has to be incurred regardless of the volume of the output.

Some important points of Marginal costing

• Valuation of stocks such as finished goods, work-in-progress etc. is valued at variable cost only.

• It helps in make or buy decisions.

• With the help of marginal costing, an organization will also get optimum sales mix.

• Marginal costing provides the management with useful parameters like Break even point, PV ratio, Contribution margin etc.

1. Marginal cost : Marginal cost means prime cost plus variable overhead. It is also known as Variable cost. Variable cost changes in proportion to the volume of production. Variable cost may be calculated using the following formula:

Direct Material cost + Direct labor cost + Direct expenses + Variable overhead

2. Contribution margin : The difference between selling price and the variable cost is known as contribution margin. It can be calculated using the following formulas:

• Sales - Variable cost

• Profit + Fixed cost

• Sales × PV ratio

• Quantity sold × Contribution per unit

3. PV ratio (Profit volume ratio) : It is an useful indicator to determine the profitability of any business. This ratio shows the relationship between contribution margin and sales. It is also known as contribution ratio. It can be calculated using the following formulas :

• \( \frac{\text{Contribution}}{\text{Sales}} \times 100 \)

• 100% - Variable cost ratio

• \( \frac{\text{Contribution per unit}}{\text{Selling price per unit}} \times 100 \)

• \( \frac{\text{Change in profit}}{\text{Change in sales}} \times 100 \)

4. Break even point : Break even point is the volume of sales where total cost are equal to revenue. In other words, Break even point is the volume of sales where there is no profit or loss. It can be calculated using the following formulas :

(a) BEP sales (in units)

• \( \frac{\text{Fixed cost}}{\text{Contribution per unit}} \)

• \( \frac{\text{BEP sales}}{\text{selling price per unit}} \)

• Total sales (in units) - Margin of Safety (in units)

(b) BEP sales (in ₹)

• \( \frac{\text{Fixed cost}}{\text{PV ratio}} \)

• BEP sales (in units) × Selling price per unit

• Total sales (in ₹) - Margin of Safety (in ₹)

5. Margin of Safety : It is the difference between total sales and sales at Break even point. It indicates the soundness of business. Margin of Safety can be calculated using the following formulas :

(a) Margin of Safety (in units)

• \( \frac{\text{Profit}}{\text{Contribution per unit}} \)

• \( \frac{\text{Margin of Safety }}{\text{selling price per unit}} \)

• Total sales (in units) - BEP sales (in units)

(b) Margin of Safety (in ₹)

• \( \frac{\text{Profit}}{\text{PV ratio}} \)

• Margin of Safety (in units) × Selling price per unit

• Total sales (in ₹) - BEP sales (in ₹)

6. Other Important points and formulas

• Total sales = BEP sales + Margin of Safety

• Shut down point (in ₹) = \( \frac{\text{Avoidable Fixed cost}}{\text{PV ratio}} \)

• Shut down point (in units) = \( \frac{\text{Avoidable Fixed cost}}{\text{Contribution per unit}} \)

• Indifference point (in ₹) = \( \frac{\text{Difference in Fixed cost}}{\text{Difference in PV ratio}} \)

• Indifference point (in units) = \( \frac{\text{Difference in Fixed cost}}{\text{Difference in contribution per unit}} \)

• Variable overhead per unit = \( \frac{\text{Change in total overhead}}{\text{Change in Quantity}} \)

• Desired sales (in units) = \( \frac{\text{ Fixed cost} + \text{Desired profit}} {\text{Contribution per unit}} \)

• Desired sales (in ₹) = \( \frac{\text{ Fixed cost} + \text{Desired profit}} {\text{PV ratio}} \)