In: Accounting
If variable costs? decrease, and all other factors remain the? same, the margin of safety will become larger.
True or False?
The Correct Answer would be True
Margin of Safety = Actual Sales in dollars - Break even point in dollars
Where Break even point dollars = Sales Price per unit * Break even point in Units
Break even point in Units = Fixed Cost / (Sales Price per unit - Variable Cost per unit)
Now let us understand our answer with an example
Sales Price per unit = $40
Variable Cost per unit = $20
Fixed Cost is $7,500
Number of Units = 500
Step 1 - Break even point in Units = $7,500 / ($40 - $20)
Break even point in Units = 375
Step 2 - Break even point dollars = $40 * 375
= $15,000
Step 3 - Margin of Safety
= (500 * 40) - $15,000
= $5000
All the data of the above example remaining same, only variable cost decreases to $15 per unit
Step 1 - Break even point in Units = $7,500 / ($40 - $15)
Break even point in Units = 300
Step 2 - Break even point dollars = $40 * 300
= $12,000
Step 3 - Margin of Safety
= (500 * 40) - $12,000
= $8000
The margin of safety increased from $5000 to $8000 due to reduction in variable cost.
Thus it can be concluded that if variable costs? decrease, and all other factors remain the? same, the margin of safety will become larger.