Marginal Costing and CVP Analysis: P/V Ratio, Break-even Point and Profit Planning Questions

Question 1

Define marginal costing.

Accepted Answer

Marginal costing is a technique in which variable costs are charged to units and fixed costs are treated as period costs; decisions are based on contribution.

Question 2

What is contribution?

Accepted Answer

Contribution is the excess of sales over variable cost; it contributes towards fixed cost and profit.

Question 3

Define P/V ratio.

Accepted Answer

P/V ratio is contribution divided by sales (Contribution/Sales), expressed as a percentage.

Question 4

What is break-even point (BEP)?

Accepted Answer

Break-even point is the level of sales at which total contribution equals fixed cost and profit is zero.

Question 5

What is margin of safety (MOS)?

Accepted Answer

Margin of safety is the excess of actual sales over break-even sales; it indicates the safety cushion before losses start.

Question 6

State one assumption of CVP analysis.

Accepted Answer

One assumption is that selling price per unit remains constant within the relevant range.

Question 7

Explain contribution and its importance in marginal costing.

Accepted Answer

Contribution is the difference between sales and variable cost (Contribution = Sales − Variable cost).

Importance in marginal costing:
1) Contribution first recovers fixed cost; only after fixed cost is covered, profit arises (Profit = Contribution − Fixed cost).
2) It is the key factor for short-term decisions like accepting a special order, make-or-buy, and choosing a product mix.
3) It helps in CVP analysis to compute BEP, P/V ratio and margin of safety, and to study the effect of changes in price/cost/volume on profit.

Thus, contribution is the central concept that links cost, volume and profit.

Question 8

Explain P/V ratio and state any two ways to improve it.

Accepted Answer

P/V ratio (Profit-Volume ratio) measures contribution as a proportion of sales: P/V ratio = (Contribution/Sales) × 100. It indicates contribution per rupee of sales; a higher P/V ratio generally means better profitability.

Ways to improve P/V ratio (any two):
1) Increase selling price (without increasing variable cost proportionately).
2) Reduce variable cost per unit by better purchasing, reducing wastage, improving efficiency, or using cheaper materials.
(Also, improving product mix towards higher contribution products increases overall P/V ratio.)

Hence, P/V ratio is useful for profit planning and comparison.

Question 9

Define break-even point and explain its significance.

Accepted Answer

Break-even point (BEP) is the level of sales at which total contribution equals fixed cost and profit is zero.

Significance:
1) Shows minimum sales needed to avoid loss; helps set sales targets.
2) Helps compare alternatives: lower BEP indicates lower risk and quicker profitability.
3) Provides a base to compute margin of safety and to analyse the impact of changes in price, variable cost and fixed cost.

Thus, BEP is a key tool for planning and decision-making.

Question 10

Explain margin of safety (MOS) and how it is calculated.

Accepted Answer

Margin of safety (MOS) is the excess of actual sales over break-even sales. It indicates how much sales can fall before the firm starts making losses.

Formulas:
- MOS (₹) = Actual sales − BEP sales
- MOS (%) = (MOS / Actual sales) × 100

Interpretation: Higher MOS means safer position and lower risk; low MOS means profits are sensitive to small sales declines.

Question 11

State any three assumptions of marginal costing/CVP analysis.

Accepted Answer

Assumptions (any three):
1) Selling price per unit is constant within the relevant range.
2) Variable cost per unit is constant and varies directly with volume.
3) Total fixed cost remains constant within the relevant range.
4) Volume is the only factor affecting cost and revenue (other factors remain unchanged).
5) In basic CVP problems, production equals sales (inventory change is ignored).

These assumptions allow linear CVP relationships.

Question 12

Explain the effect on BEP if (i) fixed cost increases and (ii) variable cost per unit increases.

Accepted Answer

BEP (units) = Fixed cost / Contribution per unit.

(i) If fixed cost increases (contribution per unit same), the numerator increases, so BEP increases. The company must sell more units to break even.

(ii) If variable cost per unit increases (selling price same), contribution per unit decreases. Since denominator decreases, BEP increases.

Therefore, both higher fixed cost and higher variable cost generally raise the break-even point.

Question 13

A product sells at ₹100/unit. Variable cost is ₹60/unit and fixed cost is ₹20,000. Compute (i) contribution/unit, (ii) P/V ratio, (iii) BEP in units and sales value, and (iv) profit at 750 units.

Accepted Answer

Given: SP = ₹100/unit, VC = ₹60/unit, FC = ₹20,000

(i) Contribution per unit
Contribution/unit = SP − VC = 100 − 60 = **₹40**

(ii) P/V ratio
P/V ratio = Contribution/Sales = 40/100 = **0.40 = 40%**

(iii) Break-even point (BEP)
BEP (units) = FC / Contribution per unit = 20,000 / 40 = **500 units**
BEP (sales value) = BEP units × SP = 500 × 100 = **₹50,000**
(Alternatively: BEP (₹) = FC / P/V ratio = 20,000 / 0.40 = ₹50,000)

(iv) Profit at 750 units
Sales = 750 × 100 = ₹75,000
Variable cost = 750 × 60 = ₹45,000
Contribution = 75,000 − 45,000 = ₹30,000
Profit = Contribution − FC = 30,000 − 20,000 = **₹10,000**

Therefore, contribution/unit = ₹40, P/V ratio = 40%, BEP = 500 units (₹50,000), and profit at 750 units = ₹10,000.

Question 14

Using CVP analysis, find sales required to earn a target profit of ₹15,000 when fixed cost is ₹30,000 and P/V ratio is 30%. Also compute BEP sales.

Accepted Answer

Given: Fixed cost (FC) = ₹30,000; P/V ratio = 30% = 0.30

1) BEP sales
At BEP, Profit = 0, so Contribution = FC.
BEP (₹) = FC / P/V ratio = 30,000 / 0.30 = **₹1,00,000**

2) Sales required for target profit of ₹15,000
Required contribution = FC + Target profit = 30,000 + 15,000 = **₹45,000**
Sales (₹) = Required contribution / P/V ratio = 45,000 / 0.30 = **₹1,50,000**

Conclusion:
- Break-even sales = ₹1,00,000
- Sales required for profit of ₹15,000 = ₹1,50,000

(Exam note: always convert P/V ratio % to decimal before dividing.)

Question 15

Explain marginal costing technique and discuss its limitations (exam-style).

Accepted Answer

Meaning/technique:
Marginal costing is a technique where variable costs are charged to units and fixed costs are treated as period costs. The central idea is contribution:
- Contribution = Sales − Variable cost
- Profit = Contribution − Fixed cost

How it is used (brief points):
1) Segregate costs into fixed and variable (including semi-variable separation).
2) Prepare contribution statement (Sales → Variable cost → Contribution → Fixed cost → Profit).
3) Use CVP tools like P/V ratio, BEP and MOS for profit planning and decisions.
4) Helpful in short-term decisions such as special order pricing, make-or-buy, shutdown, and product mix (based on contribution).

Limitations (write any four):
1) Assumptions may not hold: selling price and variable cost per unit may change at different output levels.
2) Separation of fixed and variable costs is difficult, especially for semi-variable costs; wrong classification gives wrong decisions.
3) Ignores inventory valuation issues: in absorption costing, fixed factory overhead is included in inventory; marginal costing treats it as period cost (can affect reported profit with inventory changes).
4) In multi-product situations, constant sales mix assumption is often unrealistic, which affects BEP and profit estimates.
5) Long-term decisions need consideration of fixed cost changes and capacity constraints; marginal costing is mainly short-term oriented.

Thus, marginal costing is very useful for planning and decisions, but results must be used carefully considering its assumptions.

Marginal Costing and CVP Analysis: P/V Ratio, Break-even Point and Profit Planning

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