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Chapter 5 Marginal Costing

Class presentation for Marginal Costing of Cost Accounting. Covers concepts of Absorption cost, Marginal Costing, CVP analysis etc.

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Suku Thomas Samuel
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303 views36 pages

Chapter 5 Marginal Costing

Class presentation for Marginal Costing of Cost Accounting. Covers concepts of Absorption cost, Marginal Costing, CVP analysis etc.

Uploaded by

Suku Thomas Samuel
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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CHAPTER 5

MARGINAL COSTING

BY

PROF. SUKU THOMAS SAMUEL


DEPARTMENT OF MANAGEMENT
METHODS OF COSTING

• Used for the ascertainment of cost of production.


• Important for estimation of production.
• Essential for fixing the price of the product.
• Needed for deciding the profit margin.
• Depends on the manufacturing process and nature of the industry.
METHODS OF COSTING
Some of the methods of costing are as follows:

1. Historical Costing: determination of cost post occurrence of


activities based on the cost incurred.
2. Standard Costing: determination of cost based on the set industry
standards.
3. Absorption Costing: total fixed cost and variable cost are absorbed
to the products or services.
4. Marginal Costing
TYPES OF COST
Important types of cost associated with manufacture:
FIXED COST
• Cost that remains the same
• Does not change with the level of production
• Example: rent, interest on loan etc.

VARIABLE COST
• Changes with the level of production
• Higher level of production – less is the VC (scale of economies)
• Example: raw material, wages etc.
MARGINAL COSTING
Marginal costing is “the ascertainment of marginal costs and of the
effect on profit of changes in volume or type of output by differentiating
between fixed costs and variable costs.”

• Production costs are classified into fixed and variable.


• Managerial decisions are taken based on the differentiation.
• Relation between cost, volume and profit is established.
• Control measures are taken based on the relation.
• Also known as ‘variable costing’.
ABORPTION COSTING
Absorption costing is a managerial accounting method for capturing all
costs associated with manufacturing a particular product.

• It is also called as full absorption costing.


• Direct and indirect costs are accounted.
• All the cost involved are considered for product costing.
• Allocates fixed overhead costs to a product.
MARGINAL COSTING VS. ABSORPTION COSTING

• In Marginal Costing only variable costs are considered for product


costing.
• In Absorption Costing the total cost is considered for product
costing.
MARGINAL COSTING VS. ABSORPTION COSTING

• According to Marginal Costing, fixed costs are not product costs but
period cost.
• According to Absorption Costing, fixed costs are part of the product.
MARGINAL COSTING – FEATURES
The features of Marginal Costing are:
• Combines the techniques of cost recording and cost reporting.
• Division of total cost into fixed and variable cost.
• Fundamental principle whereby variable costs are charged to cost
units.
• Fixed cost are recovered from profit.
MARGINAL COSTING:
ADVANTAGES AND LIMITATIONS
MARGINAL COSTING – ADVANTAGES
The Advantages of Marginal Costing are:
• Overcoming difficulty of allocation and absorbing the overheads.
• No requirements of classification into production and service cost
centers.
• Helps to establish the relationship between production and variable
costs.
• Helps in taking ‘make or buy’ decisions.
• Helps in strategizing for profit maximization.
• More accurate method of costing.
• Price benefit is passed onto the end consumer.
MARGINAL COSTING – LIMITATIONS
The limitations of Marginal Costing are:
• Segregation of cost into fixed and variable may be difficult.
• Danger of encouraging short sightedness about profit planning.
• Misinterpretation of investments with capital expenditure.
• Application difficulty in industries with high inventory levels.
MARGINAL COSTING EQUATION
MARGINAL COSTING EQUATION
Marginal Costing Equation explains the relationship between Sales, Costs
and profit.
S -V = F + P

S: Sales | V:Variable cost | F: Fixed Cost | P: Profit | C: Contribution

F+P=C

S -V = C
MARGINAL COSTING EQUATION
CONTRIBUTION:
• A pool of amount from which total fixed costs will be deducted to
arrive at the profit or loss.
• Includes fixed cost and profit.
• Contribution concept is used in managerial decision making.
PROFIT VOLUME RATIO
PROFIT VOLUME RATIO
• In brief, referred to as P/V ratio.
• Also known as contribution ratio or marginal ratio.
• Explains the relationship between contribution and sales.
• Measurement of the rate of change of profit due to change in volume
of sales.
Contribution S −V
P/V Ratio = | Or | P/V Ratio =
Sales Sales
Or

F+P
P/V Ratio =
Sales
BREAK EVEN POINT
BREAK EVEN POINT
Break Even Point in short is referred to as BEP.
• Refers to the revenue level necessary to cover a company's total
amount of fixed and variable expenses.
• It is with respect to an activity or during a specified period.
• BEP level corresponds to sales volume of neither profit nor loss.
• BEP can be estimated by applying:
i. Algebraic method
ii. Graphic representation
BREAK EVEN POINT
Algebraic method of calculation:

Total Fixed cost


BEP =
Contribution per unit

OR

Total Fixed cost


BEP =
PV Ratio
MARGIN OF SAFETY
MARGIN OF SAFETY
• Margin of safety is a financial ratio.
• Measures the amount of sales that exceeds the break-even point.
• Revenue earned after meeting the fixed and variable costs.
• Helps in managerial decisions.
• Evaluation of impact of lost sales or increased costs the company can
absorb.
MARGIN OF SAFETY
• Margin of Safety = Actual sales – Break Even Sales
• Margin of Safety = Profit / PV Ratio
• Margin of Safety = Profit / Contribution per unit
NUMERICAL
Question:
Given the total fixed cost is Rs 25,000; Selling price per unit Rs 5;
Variable cost per unit Rs 2
Calculate:
i. Break Even point in units and amount
ii. P/V ratio
NUMERICAL
Question:
Selling price per unit is Rs 12, Variable cost per unit is Rs 8, Fixed cost
Rs 40,000.
Calculate:
i. Break Even Point
ii. Profit when sales is Rs 3,00,000
iii. Margin of safety when sales is Rs 3,00,000
NUMERICAL
Question:
ABC Company Ltd, Rs 80,000 is the fixed cost. Variable cost is Rs 20/
unit and the selling price is Rs 40/ unit.
Calculate the
i. BEP in units
ii. BEP in amount
iii. PV ratio
iv. Sales when profit is Rs 20,000
v. Sales when profit is Rs 30,000
NUMERICAL
Question:
Given the following details about ABC company:
– Fixed cost Rs 1,00,000
– Variable cost Rs 10/ unit
– Selling price Rs 15/unit
Calculate the following details:
i. Number of units to be sold to break even.
ii. Sales earn a profit of Rs 10,000
iii. Sales earn a profit of Rs 15,000
NUMERICAL
Questions:
– Selling price per unit is Rs 25
– Variable cost includes manufacturing cost of Rs 12/unit and selling
price of Rs 3/unit.
– Fixed cost comprises of Rs 1,00,000 and selling price of Rs 50,000.

Calculate the breakeven sales and sales needed to earn Rs 50,000 as the
profit.
NUMERICAL
Questions:
From the following information, calculate the
i. Contribution
ii. PV ratio
iii. BEP in unit and rupees.
iv. What is the selling price if the BEP is brought down to 25,000 units?

Fixed cost: Rs 25,000


Variable cost/ unit: Rs 10
Selling/ unit: Rs 15
COST VOLUME ANALYSIS
CVP
COST VOLUME ANALYSIS
• Logical extension of Marginal Costing.
• Used of business decision makers.
• Applied to maximize the firms' profit.
• Examines the relationship of cost to volume to maximize the profit.
• Evaluate the impact of change of level of production on profit.
CVP - OBJECTIVES
The main objectives of CVP analysis are:
• Helps to forecast profit accurately.
• Helps in setting up flexible budgets.
• Helps in formulation of price and price policies.
• Evaluation of cost control measure implemented.
PV RATIO

Change in profit
P/V Ratio =
Changes in sales
Assuming the cost NUMERICAL
structure and selling
price remains the same
in period, calculate:
i. PV ratio
ii. Fixed cost Period Sales Profit
iii. BEP for sales
I 1,20,000 9,000
iv. Profit when sales is
Rs 1,00,000 II 1,40,000 13,000
v. Sales required to
earn a profit of Rs
20,000
vi. Margin of safety at a
profit of Rs 15,000
MARGINAL COSTING
BY

PROF. SUKU THOMAS SAMUEL


DEPARTMENT OF MANAGEMENT
KRISTU JAYANTI COLLEGE (AUTONOMOUS)
MARGINAL COSTING

CVP ANALYSIS

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