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Unit 11: Marginal Costing and Profi t Planning




                                                                                                Notes

             Did u know?  What is margin of safety?
             Margin of safety is the difference between the actual sales and sales at break-even point.
             Sales beyond break-even volume brings in profits. Such sales represent a margin of safety.

             Margin of safety  = Actual sales – Break-even Sales
                              Profit
                           =
                             P/V ratio
                                    Profit × Selling Price per Unit
             or            =
                             Selling Price per Unit – Variable Cost Per Unit


          Self Assessment

          Fill in the blanks:
          10.   Break-even analysis helps in determining the ……………… of output below which it would

               not be profitable for a firm to produce.

          11.   Break-even point is the point of ………………

          12.   Break-even point is that volume of ……………… where the firm breaks even.
          11.5 Use of Cost Data in Decision Making

          The break-even analysis uses the cost data to make decisions. The following are the key methods
          used for break-even analysis:

          1.   Break-even Charts
          2.   Algebraic Method

          11.5.1 Break-even Chart


          The difference between Price and Average Variable Cost (P  –  AVC) is defined as ‘profi t
          contribution’. That is, revenue on the sale of a unit of output after variable costs are covered
          represents a contribution toward profit. At low rates of output, the firm may be losing money



          because fixed costs have not yet been covered by the profit contribution. Thus, at these low rates


          of output, profit contribution is used to cover fixed costs. After fixed costs are covered, the fi rm


          will be earning a profi t.
          A manager may want to know the output rate necessary to cover all fixed costs and to earn a


          “required” profit of R. Assume that both price and variable cost per unit of output (AVC) are
          constant. Profit is equal to total revenue (P.Q.) less the sum of Total Variable Costs (Q.TVC) and

          fixed costs. Thus,

                 p  = PQ – [(Q. AVC) + FC]
                  R
                 p  = TR – TC
                  R
          The break-even chart shows the extent of profit or loss to the firm at different levels of activity.



          A break-even chart may be defined as an analysis in graphic form of the relationship of production
          and sales to profit. The Break-even analysis utilises a break-even chart in which the Total Revenue

          (TR) and the Total Cost (TC) curves are represented by straight lines, as in Figure 11.1.
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