Page 80 - DCOM206_COST_ACCOUNTING_II

Unit 4: Cost Volume Profit Analysis

4.7 Practical Application of CVP Analysis for Decision-making Notes

Marginal cost helps management to make decision involving consideration of cost and revenue.
Basically, marginal costing furnishes information regarding additional costs to be incurred if an
additional activity is to be taken up or the saving in costs which may be expected if an activity
is given up. This can be compared with the benefit expected from the proposed course of action
and thus the management will be able to take the appropriate decision.
Decision-making describes the process by which a course of action is selected as the way to deal
with a specific problem. A decision involves the act of choice and the alternative chosen out of
the available alternatives.
According to Heinz Weihrich and Horold Koontz, “Decision-making is defined as the selection
of a course of action from among alternatives.”
George R. Terry says, “Decision-making is the selection based on some criteria from two or
more possible alternatives.”
According to Haynes and Masie, “Decision-making is a course of action which is consciously
chosen for achieving the desired results.”
Following are the important areas of decision-making or applications of marginal costing:
1. Fixation of Price,
2. Decision to Make or Buy,
3. Selection of a Profitable Product Mix,

4. Decision to Accept a Bulk Order,
5. Closure of a Department or Discontinuing a Product,
6. Maintaining a Desired Level of Profit, and

7. Evaluation of Performance.
Let us discuss all of the above areas of decision-making in detail.
1. Fixation of Price: Product pricing is a most important function of management. One of the
purposes of cost accounting is the ascertainment of cost for fixation of selling price of
product. Marginal cost of a product represents the minimum price of the product. During
normal circumstances, price of product is based on full cost. The theory is that only those
products should be produced or sold which make the largest contribution towards the
recovery of fixed costs. The selling price fixation is also done under different circumstances.
Problem 9:
P/V ratio is 50% and the marginal cost of the product is ` 60. What will be the selling
price?
Solution:
Variable cost 60
Selling Price = =
(100 P/V ratio) (100 50%)


60 100
= = ` 120
50
Contribution S  V
Verification: P/V Ratio =  100 OR =  100
Sales S

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