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margin of Safety

margin of Safety: It is the difference between the Actual Sales and the Sales at the Break-even point.  Larger Margin of safety indicates stronger business. Such business can continue to earn profits, even if sales decrease (i.e. in recession). Thus,
Margin of Safety (in Rs.)   =  Actual Sales – BEP Sales (Rs.)
Margin of safety (in units) = Actual Sales(units) – BEP Sales (in units)
Formulae for Marginal Costing
Problems for Marginal Costing

  1. S. Ltd. furnishes you the following information relating to the half year ending 30th September 2007. Fixed expenses Rs.50,000, sales value Rs.2,00,000 and Profit Rs.50,000. During the second half of the same year the company, has projected a loss of Rs.10,000. Calculate:
    1. PV ratio, break-even point and margin of safety for six months ending 30th September 2007.
    2. Expected sales volume for second half of the year assuming that selling price and fixed expenses remain unchanged in the second half year also.
    3. The break-even point and margin of safety of the whole year 2007-08.
    4. A company had incurred fixed expenses of Rs.2,25,000 with sales of Rs.7,50,000 and earned a profit of Rs.1,50,000 during the first half-year. In the second half-year, it suffered a loss of Rs.75,000. Calculate:
      1. The PV ratio, BEP, margin of safety of the first half-year
      2. Expected sales-volume for the second half year assuming that selling price and fixed expenses remained unchanged during the second half-year.
      3.  A retail dealer in garments is currently selling 24,000 shirts annually. He supplies the following details for the year ended 31st December 2007.
Selling price per shirt Rs.40
Variable cost per shirt Rs.25
Fixed cost:
Staff salaries for the year Rs.1,20,000
General office costs for the year Rs.80,000
Advertising costs for the year Rs.40,000.
As a management accountant of the firm, you are required to answer each of the following independently.
  1. Calculate the BEP and margin of safety in sales revenue and number of shirts sold.
  2. Assume that 20,000 shirts were sold in a year. Find out the net profit of the firm.
  3. If it is decided to introduce selling commission of Rs.3 per shirt, how many would require to be sold in a year to earn a net income of Rs.15,000.
  4. Assuming that for the year 2008 an additional staff salary of Rs.33,000 is anticipated and price of a shirt is likely to be increased by 15% what should be the BEP in number of shirts and sales revenue?

  1. Present the following information to show to the management
    1. The marginal product cost and the contribution per unit.
    2. The total contribution and profits resulting from each of the following sales mixtures:

Product                       Rs. Per Unit
                        Direct materials                                              A                                 10
                                                                                                B                                 9
                        Direct wages                                                   A                                 3
                                                                                                B                                 2
                        Fixed expenses Rs.800
Variable expenses are allocated to products as 100% of direct wages.
Sales price                                                      A                                 20
                                                                        B                                 15
Sales mixtures:
                                          i.     1000 units of product A and 2000 units of B
                                        ii.     1500 units of product A and 1500 units of B
                                      iii.     2000 units of product A and 1000 units of B
Which product mix is most profitable?
  1. The following particulars are extracted from the records of a company:
Particulars                                                           Per Unit
                                                            Product A                    Product B
Sales                                                   Rs.100                         Rs.120
Consumption of raw materials           2 Kg.                           3 Kg.
Material Cost                                      Rs.10                           Rs.15
Direct Wages Cost                             Rs.15                           Rs.10
Direct Expenses                                  Rs.5                             Rs.6
Machine hours used                           3hrs.                            2hrs.
Overhead expenses:
Fixed                                                   Rs.15                           Rs.10
Variable                                              Rs.15                           Rs.20
Direct Wages per hour is Rs.5. Comment on the profitability of each product (both products need the same raw materials) when:
                                          i.     Total sales potentials in units is limited.
                                        ii.     Total sales potential in value is limited.
                                      iii.     Raw materials are in short supply.
                                      iv.     Production capacity (in terms of machine hours) is the limiting factor.
Assuming raw materials as the key factor, availability of which is 10,000 kg. and maximum sales potential of each product being 3,500 units, find the product mix which will yield the maximum profit.
  1. A company produces a single product which is sold by it presently in the domestic market at Rs.75 per unit. The present production and sales is 40,000 units per month representing 50% of the capacity available. The cost data of the product are as under:
Variable costs per unit           Rs.50    Fixed costs per month                       Rs.10 lakhs.
            To improve the profitability, the management has 3 proposals on hand as under:
  1. To accept an export supply order for 30,000 units per month at a reduced price of Rs.60 per unit, incurring additional variable costs of Rs.5 per unit towards export packing, duties etc.
  2. To increase the domestic market sales by selling to a domestic chain stores 30,000 units at Rs.55 per unit, retaining the existing sales at the existing price
  3. To reduce the selling price for the increased domestic sales as advised by the sales department as under:
Reduce selling price per unit by Rs.                          Increase in sales expected (in units)
            5                                                                      10,000
            8                                                                      30,000
            11                                                                    35,000
Prepare a table to present the results of the above proposals and give your comments and advice on the proposals.
  1. A company manufactures three products by processing materials through machine shop and finishing departments. Standard product costs are based on the following figures.
Particulars A B C
Material Cost Rs.2.30 Rs.3.50 Rs.5.00
Labour Hours:Machine shop @50paise per hour Finishing department @60paise per hour  2 hrs 2 hrs  2 ½ hrs 1 ½ hrs  3 hrs 1 hr
Selling price Rs.8.50 Rs.10.20 Rs.12.00
Overhead rates based on normal production are Machine shop @Re.1 per hour and Finishing department @60 paise per hour. At the budgeted level of production half of the total overheads charged to each department is variable and the other half is fixed. Present the information to the management to assess the profitability of the products when there is a shortage of any of the three factors viz., time, labour and raw materials.

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