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Marginal costing

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Marginal costing

  1. 1. 1 INTRODUCTION TO MARGINAL COSTING The costs that vary with a decision should only be included in decision analysis. For many decisions that involve relatively small variations from existing practice and/or are for relatively limited periods of time, fixed costs are not relevant to the decision. This is because either fixed costs tend to be impossible to alter in the short term or managers are reluctant to alter them in the short term. Marginal costing distinguishes between fixed costs and variable costs as conventionally classified. The marginal cost of a product –“is its variable cost”. This is normally taken to be; direct labor, direct material, direct expenses and the variable part of overheads. Like Marginal costing or job costing, Marginal costing is not a distinct method of ascertainment of cost but is a technique which applies existing methods in a particular manner so that the relationship between profit & the volume of output can be clearly brought out. Marginal costing ascertains marginal or variable costs & the effect on profit, of the changes in volume or type of output, by differentiating between variable costs & fixed costs. To any type of costing such as historical, standard, Marginal or job; the Marginal costing technique may be applied. Under the Marginal of Marginal costing, from the cost components, fixed costs are excluded. The difference which arises between the variable costs incurred for activities & the revenue earned from those activities is defined as the gross margin or contribution. It may relate to total sales or may relate to one unit. For the business as a whole, Contribution earned by specific products or group of products, are added so as to calculate the ‘pool’ of total contribution. The fixed costs of the business are paid from this ‘pool’ & then the part of the total contribution which remains becomes the profit of the business as a whole.
  2. 2. 2 A typical format for Marginal costing statement is as below: Product types or departments A B C Total Sales Revenue X X X X Less Variable cost of production X X X X Contribution X X X X Less: Fixed Costs X Total Profit X Under Marginal costing, for the calculation of profits for individual products or departments, no attempt is made only calculation of individual Contribution is done. The fixed cost does not allocate to or gets absorbed by the individual products or departments. Thus, accounting techniques relating to the treatment of fixed costs will not influence the decisions which are based on Marginal costing system. Examples of typical problems which require executive decisions are:  At a lower price should a particular order be accepted or declined?  Should purchase of a particular component be made from an outside supplier or manufactured within the factory?  Concentration should be given on which products?  By which profit-mix, profit will be maximized?  What should be the effect on the business when an existing department is being closed or a new department is being opened?  To make up for wage rise, what should be the additional volume of business?
  3. 3. 3 MEANING OF MARGINAL COSTING It is the amount by which total cost increases when one extra unit is produced, or the amount of cost which can be avoided by producing one unit less. Accordingly, marginal cost may also be defined as the variable cost incurred due to a specific activity. It is concerned with variable costs, because fixed costs by definition do not change with the volume produced. DEFINITION OF MARGINAL COSTING The Official C.I.M.A Costs of the Terminology defines Marginal costing as, “The ascertainment, by differentiating between fixed and variable costs, of marginal costs, and of the effect on profit of changes in the volume and type of output.” Its special value is in decision-making ´Accordingly, Marginal cost = Variable cost = Direct material + Direct labor +Direct expenses + Variable overheads. Marginal costing is formally defined as: ‘the accounting system in which variable costs are charged to cost units and the fixed costs of the period are written-off in full against the aggregate contribution. Its special value is in decision making’. The term ‘contribution’ mentioned in the formal definition is the term given to the difference between Sales and Marginal cost. Thus MARGINAL COST= VARIABLE COST= DIRECT LABOUR+ DIRECT MATERIAL+ DIRECT EXPENSE+ VARIABLE OVERHEADS. CONTRIBUTION= SALES - MARGINAL COST. The term marginal cost sometimes refers to the marginal cost per unit and sometimes to the total marginal costs of a department or batch or operation.
  4. 4. 4 FEATURES OF MARGINAL COSTING  Classification of costs into fixed costs & variable costs is done under Marginal costing system. Also semi-fixed or semi-variable cots get further classified into fixed & variable elements.  To the product, only variable elements of cost, which constitute marginal cost, are attached.  After the marginal cost & marginal contribution are taken into consideration; price is fixed.  From the total contribution for any period, fixed cost for the period are deducted.  The profitability of a department or product is decided by the marginal contribution.  At variable production cost, the valuation of work-in-progress & finished product is made.
  5. 5. 5 ADVANTAGES OF MARGINAL COSTING  As there is involvement of computation of variable costs only in Marginal costing, it is easy to understand & operate the same.  Among different products or departments, arbitrary apportionment of fixed costs is avoided & the under-recovery or over-recovery problems are eliminated.  Any attempt of measurement of relative profitability of different products or different departments becomes complicated due to the arbitrary apportionment of fixed costs.  Analysis of contribution, break even charts & analysis of cost-volume-profit- analysis are resulted out of a Marginal costing system; for making short term decisions all of these are important.  More uniform & realistic figures are resulted out of Marginal costing system because fixed overhead costs are excluded from valuation of stock & work-in- progress.  Apportionment of responsibility of control can be more easily done since to each level of management only variable costs are presented over which they have control.  The effects of their decisions can be more readily seen by all levels of management sometimes even before taking of an action.
  6. 6. 6 DISAVANTAGES OF MARGINAL COSTING The Marginal of separating semi-variable or semi-fixed costs into their variable & fixed elements is an arbitrary exercise which at different levels of output may be subject to fluctuations & inaccuracy. Consequently, a substantial degree of error may be contained in the basic cost information which is used in decision making Marginal.  When selling prices are based on marginal costs, great care need to be exercised, as in the long run, all fixed overheads should be covered by the prices & a reasonable margin over & above the total costs should be left.  Under many circumstances, the deduction of contribution made by some production units may be difficult. Thereby the effectiveness of the system is lost.  Since on the basis of variable costs only the valuation of stock of finished goods & work-in-progress is done, they are always understated. As a result profit is also understated.  More effective utilization of present resources or by expansion of resources or by mechanization, increased production & sales may be effected. The disclosure of this fact cannot be done by Marginal costing.
  7. 7. 7 MARGINAL COST Definition Marginal Cost is the amount by which total costs change if the output is changed by one unit. If the output is increased by one unit, the Variable Costs will increase. The total cost by 10. This is the marginal cost of producing the additional unit. Marginal Cost= Prime Cost+ Variable Overheads. MARGINAL UNIT ‘One unit’, in the above definition may indicate a single article, a batch of articles, an order, a process, a department and so on. This can also be called the marginal unit. ‘Change in Output’ may also indicate increase or decrease. Thus, change in output by one unit may indicate-  Increase or decrease of a single article  Addition or discontinuance of one batch of articles  Accepting or not accepting a specific order  Addition or discontinuance of a specific process  Addition or discontinuance of a department Marginal cost is the change in the cost in each of the above circumstances. It is the cost of the marginal unit. It is the cost of doing or not doing a certain thing. Marginal cost is thus the cost of an option. Clearly, therefore, marginal cost helps the management in ascertaining the cost of an option and taking decisions as to which option to accept or reject.
  8. 8. 8 DETERMINANTION OF MARGINAL COST Computation Marginal cost is equal to variable costs i.e. Prime cost+ Variable overheads. Thus Marginal Cost= Prime Cost+ Variable Overheads. Marginal Cost= Prime Cost Direct material cost Direct labour cost Direct expenses + Variable Overheads Variable production overheads Variable administration overheads Variable sales and distribution overheads Thus marginal cost excludes the fixed overheads. It excludes the Fixed Production Overheads + Fixed Administration Overheads + Fixed Sales and Distribution Overheads. As far as semi-fixed or semi-variable costs are concerned, they are separate into their fixed elements and variable elements. The fixed element is added to the Fixed Costs and the variable is added to the Variable Costs. Procedure Marginal cost of a product is determined in the following manner- 1. Classification of Costs into Fixed and Variable Costs: The costs collected from different sources such as material records, labour records, expense vouchers are classified into fixed costs and variable costs. Fixed Costs are those costs which do not vary with change in volume. Fixed costs accrue in relation to time e.g. rent accrues on per month basis. Fixed costs therefore are related to the passage of time. For this reason, fixed costs are also known as period costs. Fixed costs are also known as capacity costs. Capacity costs are the costs incurred to create the existing production capacity of business. Thus, fixed costs will not change so long as the capacity remains the same. Increase in capacity, however will
  9. 9. 9 require additional fixed costs. Examples of fixed costs are rent, insurance, property taxes, executive salaries etc. Variable Costs are costs that tend to vary in direct proportion to volume. Variable costs increase when the volume increases. On the contrary, variable costs decrease when the volume decreases. Examples of variable costs are direct costs e.g. raw material, wages paid on piece rate basis. 2. Allocation of Marginal Cost to Product: Marginal Costs, as seen earlier, is = Prime Cost + Variable Overheads. This marginal cost is allocated to the product(s). Thus the cost allocated to each product is the marginal cost of that product. The fixed costs are not allocated, apportioned or absorbed to the products. In fact there is no complicated process of apportionment or absorption of overheads in marginal costing. This is the main difference between absorption costing and marginal costing. 3. Valuation of Stocks at Marginal Cost: the closing stocks of each product are valued at its marginal cost. Since the marginal cost excludes the fixed costs, the closing stocks are valued only at the product costs. The period costs i.e. the fixed costs are not included in the closing stock and hence not carried forward to the next year. 4. Contribution: the difference between the sale value and the marginal cost is called contribution. Thus, Contribution = Sales Value less Marginal Cost. Contribution is similar to the gross profit of a product. The fixed costs are deducted from the contribution to arrive at the net profits of the concern. In the case f a number of products, the contributions from all the products are added together to determine the total contribution available for the meeting the fixed costs. If the contribution is less than the fixed costs, the concern is said to suffer a loss.
  10. 10. 10 BASIC PRINCIPAL OF MARGINAL COST PRICING For years economists have noted the benefits of marginal cost based prices and have advocated their use. Not until fairly recently, however, has the concept of marginal cost pricing received widespread attention in electric utility rate setting in the United States. Economic theory states that maximum economic benefits to society can be achieved if prices are set equal to marginal costs. Marginal cost is the cost of producing one additional unit of an industry's output, other things remaining the same. If the price of all units sold is set equal to the marginal cost, the customer will pay an amount that adequately reflects the cost to society of producing the product. In this way, economic efficiency is achieved in that society's scarce resources are used in productive Marginal’s where the prices of finished goods and services adequately reflect the actual costs of producing them.
  11. 11. 11 ABSORPTION COSTING Meaning Absorption costing refers to the analysis of the cost data for the purpose of allotment of costs to cost units. In absorption costing fixed as well as variable costs are charged to products. We have already seen in the previous chapters on unit costing, Marginal costing and contract costing, how the direct costs and overheads, whether fixed of variable, are charged to the individual product, Marginal or contract. The Technique of absorption costing thus refers to the principal of allocation, apportionment and absorption of costs used for ascertaining the cost of a product, Marginal or contract. Advantages ofAbsorptionCosting:  It recognizes the importance of fixed costs in production;  This method is accepted by Inland Revenue as stock is not undervalued;  This method is always used to prepare financial accounts;  When production remains constant but sales fluctuate absorption costing will show less fluctuation in net profit and  Unlike Marginal costing where fixed costs are agreed to change into variable cost, it is cost into the stock value hence distorting stock valuation. Disadvantages of Absorption Costing:  As absorption costing emphasized on total cost namely both variable and fixed, it is not so useful for management to use to make decision, planning and control;  As the manager’s emphasis is on total cost, the cost volume profit relationship is ignored. The manager needs to use his intuition to make the decision.
  12. 12. 12 MARGINAL COSTING V/S ABSORPTION COSTING The difference between Marginal costing & absorption costing is as below: 1. Under Marginal costing: for product costing & inventory valuation, only variable cost is considered whereas, under absorption costing; for product costing & inventory valuation, both fixed cost & variable cost are considered. 2. Under Marginal costing, there is a different treatment of fixed overhead. Fixed cost is considered as period cost & by Profit/Volume ratio (P/V ratio), profitability of different products is judged. On the other hand, under absorption costing system, the fixed cost is charged to cost of production. A reasonable share of fixed cost is to be borne by each product & thereby subjective apportionment of fixed overheads influences the profitability of product. 3. Under Marginal costing, the presentation of data is so oriented that total contribution & contribution from each product gets highlighted. Under absorption costing, the presentation of cost data is on conventional pattern. After deducting fixed overhead, the net profit of each product is determined. 4. Under Marginal costing, the unit cost of production does not get affected by the difference in the magnitude of opening stock & closing stock. Whereas, under absorption costing, due to the impact of the related fixed overheads, the unit cost of production get affected by the difference in the magnitude of opening stock & closing stock.
  13. 13. 13 Effects of opening & closing stock onprofit: When income statements under absorption costing & Marginal costing are compared, the under mentioned points should be considered: 1. The results under both the methods will be same in situations where sales & production coincide i.e., there is neither opening stock nor closing stock. 2. Profit under absorption costing will be more than the profit under Marginal costing, when closing stock is more than the opening stock. The reason behind this is that, under absorption costing, a portion of fixed overhead, instead of being charged to the current period, is charged to the closing stock & carried over to the next period. 3. Profit shown under absorption costing will be lower than the profit shown under Marginal costing, when closing stock is less than the opening stock. The reason behind this is that, under absorption costing, to the current period, a portion of fixed cost related to previous year is charged.
  14. 14. 14 Reconciliationofresults of absorption costing & Marginal costing: When comparison of the results of absorption costing & Marginal costing is undertaken, the adjustments for under- absorbed & / or over absorbed overheads becomes necessary. Under absorption costing, on the basis of normal level of activity, the fixed overhead rate is predetermined. A situation of under-absorption &/or over-absorption arises when there is a difference between actual level of activity & normal level of activity. (i) Under-absorbed fixed overhead = Excess of normal level of activity over actual level of activity * Fixed overhead rate per unit. If there is under-absorption, the profit under absorption costing, before comparison with profit as per Marginal costing, should be reduced with under-absorbed fixed overheads. Alternatively, by adding the under-absorbed fixed overhead to the cost of production, the same objective can be achieved. (ii) Over absorbed Fixed overhead = Excess of actual level of activity over normal level of activity * Fixed overhead rate per unit. If there is over absorption, then before the comparison of profit as per absorption costing with the profit as per Marginal costing, with over-absorbed fixed overheads, the profit under absorption costing should be increased. Alternatively, by reducing the over- absorbed fixed overhead from the cost of production, the same objective can be achieved
  15. 15. 15 CONTRIBUTION ANALYSIS Contribution is the most important concept in Marginal costing. It is, as seen above equal to Sales Less Variable Cost. Contribution is the profit before adjusting the fixed costs. Marginal costing is concerned with the `product costs` rather than the `periods costs`. Contribution indicates the Product profit = product Income – product cost i.e. Contribution = sale Value – Variable cost. Marginal costing assumes that ht excess of sales value over variable costs contributes to a fund which will cover fixed costs as well as provide the concern`s profits. The amount of contribution is credited to the marginal profit and loss account. The fixed costs are debited to the marginal profit and loss account. If the contribution is equal to the fixed costs, the concern is said to break- even profit. If the contribution is less than the fixed costs, there will be net loss. Thus, the fixed costs which are period costs do not affect the product cost. Fixed costs are directly adjusted in the profit and loss account prepared for the relevant period. The concept of contribution plays a key role in assisting the management in taking many important decisions such as- 1. Deciding the break-even point, 2. Deciding which article to produce, or continue or discontinue to produce, 3. Deciding the quantity of each article to be produce or sold, 4. Fixing the selling price, especially in a trade depression, or for a special order. The difference between contribution and accounting profit is explained below. No. 1. 2. 3. Contribution It is a concept used in Marginal costing. It is before deducting Fixed Costs. At break- over point, Contribution is equal to fixed cost. Profit It is an accounting concept. It is after deducting Fixed Costs. Profit arises only when Sales go beyond the break- even point.
  16. 16. 16 BREAK – EVEN ANAYSIS Break – even point means the point of no profit and no loss. BEP is the volume of output or sales at which the total cost is exactly equal to the revenue. Below the BEP the concern makes losses, at the BEP, the concern makes neither profit nor loss, above the BEP, the concern earns profits. The focal point of this analysis is the determination of the sales volume (in pesos or in units) that will equal its total revenues to its total costs, thus, where the profit equals zero. As stated earlier, since direct connection of expenses to production cannot be conclusively established under functional classification of costs, analysis under CVP, as well as BE analysis, is directed towards cost behavior. Thus, if we reclassify our costs from functional to behavioral, our income statement would look like this: Sales xx Less: Variable Cost (VC) (xx) Contribution Margin (CM) xx Less: Fixed Cost (xx) Profit (loss) xx Contribution Margin (CM) is the excess of sales over variable cost or the excess from sales when variable costs are deducted. It can be computed per unit or total. In computing for the CM per unit, simply deduct the VC per unit from the selling price of each unit. This is also synonymous with marginal income, marginal balance, profit contribution and others. MARGIN OF SAFETY (MOS) Margin of Safety is the difference between the actual sales and the sales at the break-even- point. Thus, Margin of Safety ( ) = Actual Sales – BEP Sales ( ) Margin of safety (units) = Actual sales (units) – BEP (units) Larger MS indicates stronger business. Such business can continue to earn profits, even if the sales decrease (i.e. in recession). MS is directly linked to profits. Increase in price leads to higher MOS; reduction in price leads to lower MOS.
  17. 17. 17 In order to improve the MOS, the management should: 1. Increase the selling price, provided the demand is inelastic so as to absorb the increased prices. 2. Reduce variable costs. 3. Reduce fixed costs. 4. Increase the sales volume, provided capacity is available. 5. Substitute or introduce a product mix such that more profitable lines are introduced. Assumptions and Limitations Underlying BREAK-EVEN ANALYSIS 1. All costs are classified as either fixed or variable. If not impossible or impractical, dividing costs into the variable and fixed cost elements as an extremely difficult job. This is attributable to the inherent nature or characteristics of the cost per se. 2. Fixed costs remain constant within the relevant range. Fixed costs remain unchanged at any level of activity within the relevant range, even at the zero level. 3. The behavior of total revenues and total costs will be linear over the relevant range, i.e. will appear as a straight line on the BE chart. This is based on the idea that
  18. 18. 18 variable costs vary in direct proportion to volume; the fixed costs remain unchanged, hence drawn as a straight horizontal line on the graph within the relevant range; and that selling price is constant. 4. In case of multiple product companies, the selling prices, costs and proportion of units (sales mix) sold will not change. This cannot always be correct. Sales mix ratio may be due to the change in the consuming habits of customers. Selling prices of the individual products may likewise change due to competition, popularity and salability of the products, etc. 5. There is no significant change in the inventory levels during the period under review. Stated in another way, production volume is assumed to be almost (if not exactly) equal to the sales volume, which causes an immaterial (or none at all) difference between the beginning and ending inventories. 6. Other assumptions which have already been discussed in the preceding numbers, are again credited and highlighted here as follows: o Unit selling price will remain constant. o Unit variable cost will not change. (This may include prices of the factors of production like material costs, labor costs etc.) o There will be no change in efficiency and productivity. o The design of the product will not change.(A change in the design of the product may bring about a change in production costs, selling price and production volume.
  19. 19. 19 COST-VOLUME-PROFIT(CVP) ANALYSIS/ PROFIT- VOLUME RATIO Cost-Volume-Profit (CVP) Analysis is defined as a systematic examination of the relationships among costs, activity levels, or volume, and profit. CVP analysis establishes the relationship of profit to level of sales. And one of these relationships is the Break-even analysis. Since direct connection of expenses to production cannot be conclusively established under functional classification of costs, analysis under CVP is directed towards cost behavior; the way costs behave or change with respect to a change in the activity level. Costs can be classified according to its behavior as: 1. Fixed Costs These are costs that do not change regardless of changes in the level of activity within a relevant range. In other words, they remain constant regardless of the change in the activity level per total; however, fixed cost per unit is inversely proportional to the activity level. 2. Variable Costs In total, these costs change directly and proportionately with the level of activity. As the activity level increases, variable cost per total will also increase proportionately to the increase in activity level. However, variable cost per unit remains constant, within the relevant range. 3. Semi-Variable Costs A cost that varies with the change of activity level but not proportionately, they are called semi-variable costs. They may either increase at an increasing rate or increase at a decreasing rate. A typical example of this is the cost of electricity (increasing at an increasing rate) because it is subject to graduated brackets, thus, the greater the consumption, the higher the rate per kilowatt hour as they will be categorized in a
  20. 20. 20 higher bracket. 4. Semi-Fixed Costs This kind of costs has the characteristics of both variable and fixed cost and is usually known as the step function cost or step cost. Like semi-variable cost, semi-fixed cost increases with activity level but not proportionately. And like fixed cost, it is constant for some stretches of activity levels. 5. Mixed Costs Costs that cannot be identified by a single cost behavior pattern are called mixed costs. This kind of cost is composed of variable and fixed cost. We have concluded earlier that costs are more meaningful when they are classified according to behavior. When costs therefore are mixed, it is important that we know how to segregate them. Some tools and techniques popularly used are the High-Low Method, Scatter Graph Method, Regression Analysis, and Correlation
  21. 21. 21 MARGINAL COSTING AND DECESION MAKING The supreme goal of every management is to maximize profits. To achieve this goal, management has to take several decisions regarding the marginal unit, the product mix, the pricing, making or buying an Article and so on. It has also to ascertain the cost that are controllable and establish a system to actually control them. Marginal costing is an effective policy decisions such as pricing, product mix, special offers, discontinued a product, optimum level of production, cost control and so on. It also help in ‘profit planning`. Marginal costing enables the management to study different scenarios (cost and revenue situations) under various alternatives. The management can plan its short- term profits. When Marginal Costing Is Useful For Fixing Price Marginal costing helps the management in taking price decisions. In Absorption costing, the prices are fixed so as to cover the total costs which include Fixed Costs as well as Variable Costs. In Marginal costing the price can be fixed on the basis of only Variable Costs. This can be useful in the following situations  when supply exceeds demand  pricing of new products  utility services  cut-throat competition in market  Export orders or special orders.
  22. 22. 22 TECHNIQUES OF COSTING Besides the methods of costing, following are the types of costing techniques which are used by management only for controlling costs and making some important managerial decisions. As a matter of fact, they are not independent methods of cost finding such as job or Marginal costing but are basically costing techniques which can be used as an advantage with any of the methods discussed above. 1. Marginal costing Marginal costing is a technique of costing in which allocation of expenditure to production is restricted to those expenses which arise as a result of production, e.g., materials, labor, direct expenses and variable overheads. Fixed overheads are excluded in cases where production varies because it may give misleading results. The technique is useful in manufacturing industries with varying levels of output. 2. Direct Costing The practice of charging all direct costs to operations, Marginal or products and leaving all indirect costs to be written off against profits in the period in which they arise is termed as direct costing. The technique differs from Marginal costing because some fixed costs can be considered as direct costs in appropriate circumstances. 3. Absorption or Full Costing The practice of charging all costs both variable and fixed to operations, products or Marginal is termed as absorption costing. 4. Uniform Costing A technique where standardized principles and methods of cost accounting are employed by a number of different companies and firms is termed as uniform costing. Standardization may extend to the methods of costing, accounting classification including codes, methods of defining costs and charging depreciation, methods of
  23. 23. 23 allocating or apportioning overheads to cost centers or cost units. The system, thus, facilitates inter- firm comparisons, establishment of realistic pricing policies, etc. Systems of Costing It has already been stated that there are two main methods used to determine costs. These are:  Job cost method • Marginal cost method It is possible to ascertain the costs under each of the above methods by two different ways:  Historical costing  Standard costing Historical Costing Historical costing can be of the following two types in nature:  Post costing  Continuous costing Post Costing Post costing means ascertainment of cost after the production is completed. This is done by analyzing the financial accounts at the end of a period in such a way so as to disclose the cost of the units which have been produced. For instance, if the cost of product A is to be calculated on this basis, one will have to wait till the materials are actually purchased and used, labor actually paid and overhead expenditure actually incurred. This system is used only for ascertaining the costs but not useful for exercising any control over costs, as one comes to know of things after they had taken place. It can serve as guidance for future production only when conditions in future continue to be the same. Continuous Costing In case of this method, cost is ascertained as soon as a job is completed or even when a job is in progress. This is done usually before a job is over or product is made. In the
  24. 24. 24 Marginal, actual expenditure on materials and wages and share of overheads are also estimated. Hence, the figure of cost ascertained in this case is not exact. But it has an advantage of providing cost information to the management promptly, thereby enabling it to take necessary corrective action on time. However, it neither provides any standard for judging current efficiency nor does it disclose what the cost of a job ought to have been. Standard Costing Standard costing is a system under which the cost of a product is determined in advance on certain pre-determined standards. With reference to the example given in post costing, the cost of product A can be calculated in advance if one is in a position to estimate in advance the material labor and overheads that should be incurred over the product. All this requires an efficient system of cost accounting. However, this system will not be useful if a vigorous system of controlling costs and standard costs are not in force. Standard costing is becoming more and more popular nowadays.
  25. 25. 25 MARGINAL COSTING EQUATIONS  Sales – Variable Cost = Contribution  Contribution – Fixed Cost = Profit  Sales – Variable Cost = Fixed Cost + Profit  Profit Volume Ratio = Contribution / Sales  Contribution = Sales * PV Ratio  Sales = Contribution / PV Ratio  BEP (in units) = Fixed Cost / Contribution per unit  BEP (in rupees) = Fixed Cost / Contribution * Sales  BEP (in rupees) = Fixed Cost / PV ratio  Required Sales (in rupees) = Fixed Cost + Profit / PV ratio  Required Sales (in units) = Fixed Cost + Profit / Contribution per unit  Actual Sales = Fixed Cost + Profit / PV ratio  Margin of safety (in rupees) = Actual Sales – BEP Sales  Margin of safety (in units) = Actual Sales (units) – BEP Sales (units)  Profit = Margin of safety * PV ratio ASCERTAINING MISSING FIGURES 1. CONTRIBUTION = Sales – Variable Cost = Fixed Cost + Profit = Sales * PV Ratio = (BE Sales in units * Contribution per units) + Profit = (BE Sales in value * PVR) + Profit = Fixed Cost + (MS in units * Contribution per unit) = Fixed Cost + (MS in value * PVR) = Profit / MS in % = Fixed Cost / BE sales in%
  26. 26. 26 2. PROFIT VOLUME RATIO (PVR) = Sales - Variable Cost / Sales * 100 = Contribution / Sales *100 = Fixed Cost + Profit / Sales *100 = Fixed Cost / BE Sales in value * 100 = Fixed Cost / BE Sales in units *100 / Selling price per unit = Profit / Margin of safety in value *100 = Profit / Margin of safety in units *100 / Selling price per unit = Change in profit / Change in sales *100 = 100 – Variable cost to sales ratio 3. BE SALES IN UNITS = Fixed Cost / Contribution per unit = BE Sales / Selling price = Fixed Cost / S.P. per unit – Variable cost P.U = Actual Sales per unit – Margin of safety in units 4. BE SALES IN VALUE = Fixed Cost / PVR = Actual Sales in value – Margin of safety in value = Fixed Cost / Contribution per unit * Selling price per unit = BE Sales in units * Selling price per unit = Fixed Cost / 1- Variable Cost / Sales = Fixed Cost / % of Contribution to sales 5. BE SALES IN % OF SALES = Fixed Cost / Contribution *100 = BE Sales / Actual Sales *100 = 100 – margin of safety (in %) 6. MARGIN OF SAFETY IN UNITS = Profit / Contribution per unit = Actual Sales in units – BE Sales in units
  27. 27. 27 7. MARGIN OF SAFETY IN VALUE = Profit / PV Ratio = Actual Sales in value – BE Sales in value = Profit / Contribution per unit * Selling price per unit = Margin of Safety in units * Selling price per unit 8. PROFIT = Sales – Total Cost = Sales – (Variable Cost + Fixed Cost) = Contribution – Fixed Cost = Margin of Safety in Value * PVR = Margin of Safety (% of sales) * Total Contribution = (Margin of Safety in % of Sales * Actual Sales) * PVR 9. SALES = Total Cost + Profit = Variable Cost + Fixed Cost + Profit = Variable Cost + Contribution = Contribution / PV ratio * 100 = BE Sales + Margin of Safety
  28. 28. 28 MARGINAL COSTING PRO-FORMA Sales Revenue xxxxx Less Marginal Cost of Sales Opening Stock (Valued @ marginal cost) xxxx Add Production Cost (Valued @ marginal cost) xxxx Total Production Cost xxxx Less Closing Stock (Valued @ marginal cost) (xxx) Marginal Cost of Production xxxx Add Selling, Admin & Distribution Cost xxxx Marginal Cost of Sales (xxxx) Contribution xxxxx Less Fixed Cost (xxxx) Marginal costing Profit xxxxx
  29. 29. 29 BROWNIES BASKET- SHOKOLADE FOUNDER: Ms. Anju Kumar OWNERSHIP STATUS: Sole proprietorship FUNCTIONING: Order based only Shokolade – which means Chocolate in German is based full-time in Mumbai but makes deliveries to places as far as Chennai, Delhi, Bangalore amongst others. And even though it is still a small set-up with only a few helpers and delivery boys, a total of 18 hours is all they need to ensure you get freshly made brownies at your doorstep. With no big investment or a special seed capital, Shokolade has grown from scratch with only such situations to learn from, the equity of Anju’s tremendous efforts and hard work combined with the sharp business and creative acumen of her husband and kids. Hence while the older son takes keen interest in developing new products, boxes and expansion strategies, the other members ensure that the brownies are packed and delivered on time. VISION: To spread the word and build up the customer base to as many as possible. It is word-of- mouth publicity that is being relied upon by the group to drive any food business. We plan to target and spread the word to as many people as possible so that our customer list keeps increasing. “We want our brownies to be bought and not sold” MISSION: To provide fresh high-quality homemade brownies to our clients and grow business by focusing on building long term relationships with our clients, vendors and other business partners.
  30. 30. 30 PRODUCTS: • Almond Brownie • Chocolate Brownie • Coffee Brownie • Ferrero Rocher Brownie • Nutella Brownie SERVICES: • Basket of love • Free delivery SUPPLIED TO: • Homes • Cafeterias • Caterers • Clubs • Restaurants
  31. 31. 31 MARGINAL COSTING CALCULATIONS OF BROWNIES BASKET- SHOKOLADE 2011-12 2012-13 2013-14 78900 units 90000 units 100000 units Particulars Cost per units Cost per units Cost per units Sales 3866100 49 4125000 45 4756000 47 Less: variable cost 3162681 40 3545612 39 4112331 41 Contribution 703419 9 579388 6 643669 6 Fixed cost Telephone charges 6000 6000 6000 Salaries 60000 126000 135000 Consultancy services 10000 10000 10000 Lighting & heating 18000 18000 18000 Fixed assets 330369 330369 330369 Total Fixed cost 424369 490369 499369 Total cost 3587050 4035981 4611700 PV. Ratio 18.19% 14% 13.53% BEP 2332398 47152 3502636 81728 3690828 83228 MOS 1533702 31748 622364 8272 1065172 16772
  32. 32. 32 WORKINGS 2011-12 2012-13 2013-14 Profit Volume Ratio (PV Ratio) (Contribution/Sales*100) 703419/3866100* 100 =18.19% 579388/4125000* 100 =14% 643669/4756000* 100 =13.53% BEP ( ) (Fixed Cost/ PV Ratio) 424369/18.19% =2332398 490369/14% =3502636 499369/13.53% =3690828 BEP (units) (Fixed Cost/ Contribution Per Unit) 424369/ 9 =47152 490369/6 =81728 499369/6 =83228 Margin of Safety(MOS) ( ) (Actual Sales – BEP Sales) 3866100-2332398 =1533702 4125000-3502636 =622364 4756000-3690828 =1065172 Margin of Safety (MOS) (units) [Actual Sales (in units) – BEP (in units)] 78900 – 47152 =31748 90000-81728 =8272 100000-83228 =16772
  33. 33. 33 CONCLUSIONS Marginal cost is the cost management technique for the analysis of cost and revenue information and for the guidance of management. The presentation of information through marginal costing statement is easily understood by all managers, even those who do not have preliminary knowledge and implications of the subjects of cost and management accounting. For the decision making purpose of management, better information about expected profit is obtained from the use of variable costs and contribution approach in the accounting system. Marginal costs depend not only upon the timing of a postulated change in output but also upon the timing of the decision to adapt to it. Marginal costs are forecasts, and forecasts are rarely accurate. However, all decisions are founded upon uncertain expectations about the future effects of current choices.
  34. 34. 34 BIBLOGRAPHY  Advanced Cost Accounting – Dr. Varsha Ainapure – Manan Prakashan  http: //  http: //  http: //      www.investopediacom