Company X is producing 1 00 000 units. The variable cost per unit is Rs.5 and the fixed costs are Rs.5, 00,000. If we work out the total cost per unit, it will be variable cost + fixed cost per unit [at present level of production] that means, the total cost will be Rs.5 + Rs.5 = Rs.10. But as per the technique of marginal costing, the variable cost only i.e. Rs.5, will be charged to the production while the fixed cost of Rs.5, 00, 000 will not be charged to the cost of production, it will be charged to the Costing Profit and Loss Account. Thus the selling price of the product will be fixed on the basis of variable costs of Rs.5 per unit. This may result in charging the price below the total cost but producing and selling a large volume of the product will cover the fixed costs. Suppose, in the above example, selling price is Rs.9, which covers the variable cost but not the total cost, efforts of the company will be to maximize the volume of sales and through the margin between the selling price and variable cost, cover the fixed cost. The difference between the selling price of Rs.10 per unit and the variable cost of Rs.5 per units is the margin, which is called as ‘Contribution”. The contribution margin in this case is Rs.5 per unit. If the company is able to produce and sell, say, 1 50 000 units it will earn a total contribution of Rs.5 ×1 50 000 units = Rs.7, 50, 000 which will cover the fixed costs and earn profit. However if the company is not able to sell sufficient number of units, it will incur a loss. The concept of break even point which is discussed in detail later in this chapter is based on the same calculation.
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