Chapter 4:

Marginal Costing and Cost Volume Costing Analysis

Academic Areas of Competence
*Basic Principles of Marginal Costing *CPV Sensitivity Analysis
*Basic assumption within the relevant range *BEP Graph and CVP graph
*Understanding the Marginal Income Statement *The Indifference point
*Relevant Formulas in Marginal Costing *Operating leverage computation and analysis

Basic Principles
 Cost and expenses are segregated into fixed and variable elements.
 Profit = Sales – Cost and Expenses
 Profit = Sales – Fixed Cost – Variable Costs*
(*The term cost means costs and expenses)
 Activities and operations are made within the relevant range.

Basic Assumptions within the relevant range

 Linearity – The behavior of sales and cost is linear
 Behavior of sales, costs and expenses:
 Sales – it changes directly in relation to the level of units sold.
 Fixed Costs – Total fixed cost is constant without regard to the change in the level of units of
production and sales; unit fixed cost changes (I.e., unit foxed cost decreases as the level of
production increases, and vice-versa).
 Variable Costs – Total variable costs change in direct proportion with the level of units produced
and sold; unit variable cost is constant.
 Selling Price – assumed to be constant.
 WIP inventory – disregarded, there is no WIP inventory
 FG inventory – no charge in the FG inventory (i.e., production = sales).
 Product(s) and sales mix:
 There is only one product, or
 If there are 2 or more products produced and sold, the sales mix is assumed to be constant

The Marginal income statement (or variable income statement)

 The condensed format  The expanded format

Sales Px Sales Px
-Variable costs and expenses x -Variable costs of goods sold x
Contribution margin x Manufacturing Margin x
-Fixed cost and expenses x -Variable Expenses x
Income before income tax Px Contribution margin x
-Direct fixed costs and expenses x
Direct margin (or segment margin) x
-Indirect fixed costs and expenses x
Income before income tax Px

 Variable Production costs refer to direct materials direct labor, and variable overhead
 Examples of variable expenses are delivery expenses, salesmen’s commission, and packing supplies
 Direct fixed costs and expenses are those that are directly related to the segment (i.e., division,
department, or product line); these costs are directly identified with the segment that once the segment
is discontinued, these costs are avoided.
 Indirect fixed costs and expenses = sometimes called as allocated costs or unavoidable costs
 Summary of costs and expenses behavior within the relevant range.

Production and sales volume Unit sales price

↑ ↓ ↑ ↓
Variable cost
Per total ↑ ↓ Ne Ne
Per unit constant constant Ne Ne
Variable cost
Per total Constant Constant Ne Ne
Per unit ↓ ↑ Ne Ne
(ne = no effect)
Relevant Formulas
 Contribution Margin
 CM = Sales - Variable Cost  CM = Fixed Cost + IBIT
 CM = Sales x CMR  CM = Quantity sold x UCM
 Contribution Margin Ratio
 CMR = 100% - VC Ratio  CMR = CM/SALES
 CMR = UCM/UCP  CMR = NPR/MSR
 CMR = △EBIT/△SALES (if FC
remains the same)
 Unit Contribution Margin
 UCM = USP - UVC
 UCM = FC/BEP (units)
 UCM = CM/Quantity Sold
 Profit
 Profit = CM – Fixed Cost
 Profit = Sales x MS Ratio x CM Ratio
 Profit = Sales x NP Ratio
 △Profit = △CM – ↑ in FC
 △Profit = △CM + ↓ in FC
 Break Even Point
 BEP (units) = FC/UC Margin
 BEP (pesos)= FC/CM Ratio
 Comp. BEP (units) = FC/Average UCM
 Comp. BEP (pesos)= FC/Average CMR
 BEP (units) = Actual sales x (1 - MS Ratio)
 At BEP: Profit (loss) = 0
Sales = Total costs
Contribution margin = total fixed costs
 Fixed Costs
 FC = CM (at BEP)
 FC = CM = Profit
 FC = BEP (units) x UCM
 Variable Cost Ratio
 VC Ratio = VC/Sales
 VC Ratio = UVC/USP
 VC Ratio = 100% - CMR
 VC Ratio = △Costs/△Sales
 VC Ratio = (△Costs – ↑ in FC)/ △Sales
 VC Ratio = (△Costs – ↓ in FC)/ △Sales
 Margin of Safety
 MS = Actual Sales – Actual Breakeven Sales
 MS = Budgeted Sales – Budgeted Breakeven Sales
 MS = Sales x MS Ratio
 MSR = MS/Actual (or Budgeted) Sales
 MSR = NPR/CMR
 MSR = [1 – (BE Sales/Actual Sales)]
 Net Profit Ratio
 Unit Profit Margin / USP
 NP Ratio = MSR x CMR
 Degree f Operating Leverage (DOL)
 DOL = CM/EBIT
 DOL = % △ in EBIT / % △ in Sales
 % △ in EBIT = % △ in Sales x DOL