Page 75 - DCOM206_COST_ACCOUNTING_II

Cost Accounting – II

Notes 7. P/V ratio is also known as contribution to sales or the …………………… income ratio.
8. Break-even analysis is a technique of studying …………………… relationship.
9. Break-even analysis is aimed at measuring variations of …………………… with volume.
10. …………………… is the point at which sales revenue equals the cost to make and sell the
product and no profit or loss is reported.”

4.5 Margin of Safety

Margin of safety is an important concept in marginal costing approach. Margin of safety is the
difference between the actual sales and the sales at break-even point. This is represented by
excess sales over and above the break-even point. The margin of safety refers to amount by
which sales revenue can fall before a loss is incurred. That is, it is the difference between the
actual sales and sales at the break-even point.

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Caution Margin of safety indicates the soundness of the business firm. High margin of
safety indicates the soundness of a business firm because even with substantial fall in sale
or fall in production, some profit shall be made. Small margin of safety on the other hand
is an indicator of the weak position of the business firm and even a small reduction in sale
or production will adversely affect the profit position of the business firm.
To improve the margin of safety, the following measures may be adopted:
(i) Increase the level of production,
(ii) Increase the selling price,
(iii) Reducing the fixed and variable costs,

(iv) Substitute the existing products by more profitable products, and
(v) Changing to a product mix that improves P/V ratio.
Margin of safety can be calculated with the help of the following formula:

Margin of Safety = Total sales – Sales at B.E.P.
Profit
OR Margin of Safety =
P/Vratio
Profit
OR Margin of Safety =
Contribution
Margin of safety
Margin of Safety (as a percentage) = ×100
Total sales
Problem 7:
From the following details find out:
(i) P/V Ratio, (ii) Break-even Point, and (iii) Margin of safety.
Sales ` 1,00,000

Total cost ` 75,000
Fixed cost ` 20,000
Net profit ` 25,000

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