A company earned a profit of Rs. 30,000 during the year 2014-15. If the marginal cost and selling price of a product are Rs. 8 and Rs. 10 respectively, find out the amount of margin of safety:

Question

Accepted Answer

The correct option is 4:

Margin of Safety (MOS) is a crucial concept in Cost-Volume-Profit (CVP) analysis, representing the excess of actual or budgeted sales over the break-even sales. It essentially measures the cushion a business has before it starts incurring a loss. The amount of Margin of Safety in value is determined by the formula: $	ext{MOS (in value)} = \frac{	ext{Profit}}{	ext{P/V Ratio}}$. The P/V Ratio (Profit-Volume Ratio) is the ratio of Contribution to Sales. In this case, the Contribution per unit is the Selling Price (Rs. 10) minus the Marginal Cost (Rs. 8), which equals Rs. 2. Therefore, the P/V Ratio is $\frac{	ext{Rs. 2}}{	ext{Rs. 10}} = 0.2$ or $20%$. By substituting the given Profit (Rs. 30,000) and the calculated P/V Ratio (0.2) into the formula, we get $	ext{MOS} = \frac{	ext{Rs. 30,000}}{	ext{0.2}} = 	ext{Rs. 1,50,000}$. This is the correct amount of the margin of safety.

The incorrect option is 1:
Rs. 1,00,000 is an incorrect result. This figure would only be correct if the Profit-Volume Ratio was mistakenly calculated as 0.3 or 30% ($\text{Rs. 30,000} / 0.3 = \text{Rs. 1,00,000}$). Since the correct P/V Ratio is clearly 0.2 based on the provided marginal cost and selling price, this option represents an error in calculating the P/V ratio, leading to a mathematically incorrect margin of safety.

The incorrect option is 2:
Rs. 1,20,000 is mathematically incorrect for the given problem parameters. This amount does not correspond to the actual P/V Ratio of 0.2 or 20%. This result would only be generated if the profit was divided by an incorrect ratio of 0.25 ($\text{Rs. 30,000} / 0.25 = \text{Rs. 1,20,000}$). Always remember that the margin of safety calculation is directly dependent on the correct determination of the contribution margin.

The incorrect option is 3:
Rs. 90,000 is also an incorrect value. This outcome is likely the result of a significant conceptual error or an arbitrary miscalculation, as it does not align with any logical application of the Margin of Safety formula with the figures provided. For example, it would imply an unrealistically high P/V ratio of about 0.33, which contradicts the actual data. The proper method dictates a margin of safety of Rs. 1,50,000.