Marginal Costs and Applications, Break Even Analysis Assignment Help

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As per C.I.M.A., London, marginal costs means the amount at any given volume of output by which aggregate costs gets changed when the volume of output in increased or decreased by one unit. Hence, we can say that the marginal cost is the amount by which the total cost changes when the output gets changed by one unit. The marginal cost which remains changed (per unit) irrespective of the level of output or activity is called variable cost. Marginal cost can also be determined as the sum total of direct material cost, the direct labor cost, all variable overheads and the variable direct expenses. easure the variations of cost with the volume and presents the effects of various changes in volumes on the profits. Another name given to break even analysis is CVP analysis.

Some basic assumptions of break even analysis are:-

1. All costs are classified into fixed and variable costs.

2. The sales mix always remains constant.

3. There is no change in the general price level.

4. The sole influencing variable on costs and revenues is the volume,

5. The revenue and costs are linear.

6. Company’s stocks are valued at the marginal cost.

7. The units produced and the units sold are the same.

The break even point-the point, at which an organization’s revenues and expenses are equal, is termed as the break even point. For example, when at a particular amount of sales, the organization incurs no profit or loss, it normally breaks even.

Applications of marginal costs:-

The marginal costing methods are used by an organization for taking many policy decisions. Some areas where the concept of marginal costing is applied are:

1. Alternative methods of production- by the help of marginal costing techniques, the decisions can be taken regarding the alternative methods of production.

2. Buy or make decision- the blue print helps in taking the vital decision of whether to outsource the particular activities or to undertake them within their own preview.The decision is also based on the cost of manufacture and the purchase price.

3. Various levels of activity- the marginal costing methods give the management different levels for production and selling activities and the management can decide the optimum level of activity. Such activities, when undertaken periodically, help the organization to be on right tracks for achieving their goals.

4. Fixation of selling point- marginal costing methods is highly useful for fixing the price of product.

5. Selection of optimum sales mix-for profit maximization, a product mix plays a crucial role (when a firm produces more than one product).

6. New product introduction - marginal costing helps in fixing the time horizon for recovering the fixed costs and profits. This helps in taking decisions on introduction of new products.

7. Balancing of profits - marginal costing techniques help explore the facts with regards to policy and regulations, competition at domestic, national and global levels, and help the management maintain the desired profit levels.

8. Final balancing decisions- when the sales of a product are not encouraging enough for covering the fixed costs, the firm rethinks its continuance. Marginal costing helps the management for talking sound decisions for adjusting or completely closing the operations.

Applications of break even analysis:-

The break even point is considered to be one of the simplest methods which are used for analytical tools in management. The break even analysis gives a dynamic view of the relationship between cost, profit and sales. By studying the beak even sales graph, the managers can know when to expect a break even. The use of break even point for target income sales is a very important tool in financial analysis.