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Unit 6: Marginal Costing and Absorption Costing
TFC = Q . (P – AVC) Notes
B
TFC TFC
OB (the break even output ) = =
(P – AVC) ACM
The denominator in the above equation (i.e., P – AVC) is called the contribution margin per unit
(ACM) because it represents the portion of the selling price that can be applied to cover the fi xed
costs of the firm and to provide for profi ts.
Task Break even sales `1,60,000
Sales for the year 1987 ` 2,00,000
Profit for the year 1987 ` 12,000
Calculate:
1. Profit or loss on a sale value of ` 3,00,000.
2. During 1988, it is expected that selling price will be reduced by 10%. What should be
the sale if the company desires to earn the same amount of profit as in 1987?
Self Assessment
State whether the following statements are true or false:
13. The difference between Price and Average Variable Cost is defined as ‘break even point’.
14. The break even chart shows the extent of profit or loss to the firm at different levels of
activity.
15. Contribution profit analysis provides a useful format for examining a variety of price and
output decisions.
6.8 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. It is
important that there should be a reasonable margin of safety to run the operations of the company
in profitable position. A low margin of safety usually indicates high fixed costs. A margin of
safety provides strength and stability to a concern. The margin of safety is an important measure,
especially in times of receding sales, to know the real position to operate without incurring losses
and to take steps to increase the margin of safety to improve the profitability. The margin of
safety is calculated by using the following formulae:
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
Margin of safety as % of total sales
Margin of Safety
= × 100
Total sales
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