MARGINAL COSTING

Marginal costing is a
technique where only the variable costs are considered while
computing the cost of a product. The fixed costs are met against the total fund arising
out the excess of selling price over total variable cost. This fund is
known as
contribution' in marginal costing. According to the Chartered Institute of
Management Accountants, London, marginal costing is a technique where '"only the
variable costs are charged to cost units, the fixed costs attributable
full
being written off in
against the contribution for that period".
This will be clear with the help of the
following illustration.
 MARGINAL COST
The technique of Marginal Costing is concerned with
naressary that the term "Marginal Cost" is "Marginal Cost". It is, therefore, very
Institute of Management Accountants, London, the
correctly understood. According to the Chartered
term "Marginal Cost" means "the
amount at any given volume of output by which
of output is increased or decreased by one unit'. Onaggregate
costs are changed if the volume
analysing this definition we can conclude
that the term "Marginal Cost" refers to increase or decrease in
the amount of cost on account
of increase or decrease of production by a
single unit. The unit may be a single article or a
batch of similar articles. This will be clear from the
following example.
Example 1. A factory produces 500 fans per annum. The varable cost
per fan is Rs. 50. The fixed
expenses are Rs. 10,000 per annum. Thus, the cost sheet of 500 fans will appear as follows:
Variable Cost (500 x Rs. 50) Rs. 25,000
Fixed Cost 10,000
Rs. 35,000
If production is increased by one unit, i.e., it becomes 501 fans per annum, the cost sheet
will then appear as follows:
Variable cost (501 x Rs. 50) Rs. 25,050
Fixed Cost 10,000
Total Cost Rs. 35,050
Rs. 50.
Marginal cost per unit is, therefore,
 COST VOLUME PROFIT ANALYSIS
Cost Volume Profit (CVP) Analysis is an important tool of profit planning. t provide
information about thefollowing matters:
1. The behaviour of cost in relation to volume.
 C.178
ManagementtAccounting
2. Volume of production or
sales, where the business will break even.
3. Sensitivity of profits due to variation in
4. Amount of profit for a output.
projected sales volume.
5. Quantity of production and sales for a
target profit level.
Cost-volume-profit analysis may therefore be defined as a managerial tool
showing the relationship between various ingredients of profit planning, viz., cost
(both fixed and variable), selling price and volume of activity,etc.
Such an analysis is useful to the Finance Manager inthefollowing respects:
() It helps him in forecasting the profit fairly accurately.
(ii) It is helpful in setting up flexible budgets, since on the basis of this
relationship, it can ascertain the cost, sales and profits at different levels of
activity.
(ii) It also assists him in performance evaluation for purposes of management
Control.
(io) R helps in formulating price policy by projecting the effect which different
price structures will have on cost and profits.
(o) It helps in determining the amount of overhead cost to be charged at various
levels of operations, since overhead rates are generally pre-determined on the
basis of a selected volume of production.
Thus, cost-volume-profit analysis is an important media which the
through
management can have an insight into effects on profit on account of variations in costs
(both fixed and variable) and sales (both volume and value) and take appropriate
decisions.
 ONS.
Plate

BREAK-EVEN ANALYSIS
Break-even analysis is a
widely used technique to study cost-volume- prof
relationship. The narrower interpretation of the term break-even analysis refersprofit
system of determination of that level of activity where total cost
toto:
equals total selli.
price
price. The broader interpretation refers to that system of analysis which ng
determin
probable profit any level of activity. It portrays the relationshiP between ines
at
cost o
production, volume of production and the sales value. of
It may be added here that CVP
analysis is also popularly, although not ver
correctly, designated as "Break-even Analysis". The difference between the two term
is very narrow. CVP
analysis
break-enen analysis is one of the
includes the entire gamut of profit
planning, while
techinques used in this process. However, as stated
above, the technique of break-even analysis is so
that the two terms are used as popular for studying CVP Analysis
synonymous terms. For the purposes of this study, we
have also not made any distinction between these two terms.
In order to understand the
concept of break even analysis, it will be useful to know
about certain basic terms as given below:
1. Contribution
This refers the excess of selling
to
price over the variable cost. It is also known as,
"gross margin". The amount of profit (loss) can be ascertained by
cost from contribution. In other deducting the fixed
words, fixed cost plus profit is equivalent to
contribution. It can be expressed by the following formula:
Contribution = Selling Price (-) Variable Cost
or
Fixed Cost (+) Profit
Profit Contribution - Fixed Cost
 ofit Plannin
al
Costing
and
C.179
Margin

Variable Cost Rs. 50,000

Example2 .
Fixed Coost Rs. 20,000
Selling Price Rs 80,000
Contribution Selling Price - Variable Cost
= Rs. 80,000- Rs.50,000
Rs. 30,000
Profit = Contribution Fixed Cost
= Rs. 30,000 Rs. 20,000
= Rs. 10,000
exceeds fixed cost and, therefore, the profit is of the magnitude of Rs.
Jance, Contribution
H
000. Suppose the fixed cost is Rs. 40,000 then the position shall be
Fixed cost
-
Profit =

Contribution
Rs. 30,000- Hs. Rs. 40,000 (-) Rs. 10,000
=

of 10,000 represents the extent of loss since the fixed costs are more than
The amount and no loss. The
At the level of fixed cost of Rs. 30,000, there shall be no profit
he Contribution.

ncept of the break-even analysis emerges out of this theory.

Ratio (P/V Ratio)

2.Profit/Volume Profit
for studying the profitablity of operations of a business,
This term is important contribution and the sale value.
establishes a relationship between the
volume ratio formula can be expressed
shown in the form of a percentage also. The
The ratio can be
thus:
Contribution Sales -Variable Cost
P/VRatio= Sales Sales
Variable Costs
or C/S orl- Sales ratio. This ratio c a n also be
This ratio can also be called 'Contribution/Sales'
in sales or change in profit
known by comparing the change in contribution to change
m e a n increase in profit only
increase in contribution would
due to change in sales. Any Thus,
to be constant at all levels of production.
because fixed costs are assumed
Change in Contribution o Change in Profit
Ratio
P/V Ratio Change in Sales Change in Sales

constant at different levels

of production since variable costs as

This ratio would remain

constant at various levels.
a proportion to sales remain
Rs. 2,00,000
Example 3. Sales
Variable Costs 1,20,000
Fixed Costs 40,000
Rs. 2,00,000-RS. 1,20,000 0.4 or 40%
P Ratio Rs. 2,00,000
and for the
determination of the
desired level of output or profit
The ratio is useful for the can be expressed as under:
for volume of sales. The vañable cost
calculation of variable costs any
VC S(1 - PV Ratio)

In the above example the variable cost can be computed as

and sales beforehand,
If we know the P/W Ratio
follows:
.06, i.e., 60% of sales
04
Variable costs =1 -

of Rs. 2,00,000)
= Rs. 1,20,000 (60%
Alternatively, by the formula
Since P/VRatio =
S - V= Sx PW ratio
 C.180
Management Accouns
or
or
V= S-Sx PV
= S (1-P/WRatio)
Ratio untdng
The following are the special features of P/V Ratio:
(i) It helps the management in ascertaining the total amount
nt of
of con
contribution
a given volume of sales.
(ii) Itremains constant so long the selling price and the variable oo
remainconstant or so long they fluctuate in the same proportionst per
(iii) It remains unaffected by any change in the level of activity. In o unit
volume otheractivu
wotd,
PV ratio for a product will remain the same whether the
1,000 units or 10,000 units. of
(io) The ratio also remains unaffected by any variation in the fixed
latter are not at all considered while calculating the PV ratio.
In case of a multi-product organisation, PV ratio
ince the
is of vital importanca
management to find out which product is more profitable. Management the
increase the value of this ratio by reducing the variable costs or
by increae
selling price. Sing the
3. Break-even Point
The point which breaks the total cost and the selling price evenly to show
sales which the level t
output or at there shall be neither profit nor loss, is
regarded as breakeva
point. At this point, the income of the business exactly equals ita
expenditure.
production is enhanced beyond this level, profit shall accrue to the business,
decreased from this level, loss shall be and if itis
suffered
It will be proper here to understand different
by the business.

break-even point before proceeding further. This has concepts regarding marginal cost and
been explained below:
Marginal Cost Total Variable Cost
or
Total Cost- Fixed Cost
=
Direct Material + Direct Labour + Direct
Variable Overheads Expenses (Variable)+
Contirbution =
Selling Price Variable cost
-

Profit Contribution - Fixed Cost

Fixed Cost =
Contribution Profit -

Contribution =
Fixed Cost + Profit
Profit/ Volume Ratio
(P/V Ratio) Contribution per unit
Selling price per unit
or Total Contribution
Total Sales
In case P/W
ratio is to be expressed as a percentage of sales, the from
the formulae as
given above should be multiplied by 100. figure derVed
Break-even Point (of output) Fixed Cost
Break-even Point (of sales) Contribution per unit
Fixed Cost x Selling Price per unit
Contribution per unit
Fixed Cost
otal Contribution X Total Sales
 and Profit Planning C.181
Costing
Marginninal

Fixed Coost Fixed Cost

P/V Ratio
Variable cost per unit
unit
Selling price per desired
hreak-even point
the profit is zero. In case the volume of output or sales
for a 'desired profit', the amount of 'desired profit'
should be added
computed
tob ne formulae given above. For example:
c o s t in the
Fixed Desired Profit
to
profit FIxed Cost +
for a desired
=

Units Contribution per unit

=Ked Cost + Desired Profit

desired profit
Sales for a P/V Ratio

This will be
clear from the following illustrations.
500
machines has the capacity to produce
4.8. A factory manufacturing sewing is Rs. 200 and each
uustration cost of each machine
annum. The marginal (variable)
machines per annum. Calculate the
Rs. 12,000 per
Rs. 250. Fixed overheads are
machine is sold forfor and sales and show what profit will result if output is 90% of
output
hreak-even points
capacity?

Solution: Rs. 200 Rs. 50

Rs. 250
Contribution per machine is
Break-even Point for Output
contribution' equal to fixed costs Rs. 12,000).
Output which will give Total Fixed Cost
BEP (tor output) Contribution per unit

12,000= 240 machines

50

Break-even Point for Sales unit

= OutputxSelling price per
240 x Rs. 250 = Rs. 60,000.
the following
with the help of any of
Break-even point for sales can also be calculated

formulae: Total Fixed Cost

) BEP Variable Cost per unit
1 unit
Selling Price per
12,000
200
1-250
12,000 Rs. 60,000
15
p e r unit
Selling Price
Cost x
Total FixedContribution per unit
i) BEP
12,000 x 250 Rs. 60,000
50

Total Fixed Cost

Cii) BEP P/V Ratio
 C.182
Management Accounting
12,000
20%
= Rs. 60,000

PV Ratio = Contribution
Sales
100=125,000
25,000
1,25.000
x 100 = 20%

Profit at 90% of the capacity has been calculated as follow:

Capacity 500 machines
Output at 90% of capacity 450 machines
Break-even point of output 240 machines
Since fixed overheads will be recovered in full at the break-even point, the entire contribution
beyond the break-even point will be the profit. The profit on 450 units, therefore, will be:
=Rs. 50 x (450 -240) Rs. 10,500.
=
C.186 Management Accounting
Solution:
COMPUTATION OF BREAK-EVEN POINT (BEP) FOR EACH
(a)
FACTORY INDIVIDUALLY
Factory X Factory Y
Rs. 2,00,000 Rs. 3,00,000
Fixed Cost
Contribution per unit 10 15
Fixed Cost 20,000 units 20,000 units
BEP Contribution per unit
(b) Which factory is more profitable will depend on the level of production. If the
production is 20,000 units only at each factory both are equally profitable', since both
have their break-even points at this level. If output is less than 20,000 units, factory X
will give a lower loss, Rs.10 per unit of the shortfall below the break-even point.
whereas the loss will be Rs. 15 per unit in case of factory Y. Production in excess of
20,000 units will make factory Ymore profitable since each extra unit produces a profit
of Rs. 15 per unit as compared to Rs.10 per unit in case of factory X.
However in case choice is to be made as to whose capacity is to be utilised, first
choice should be for Ysince it gives a higher contribution per unit.
(c) Computation of Cash Break-even Point (BEP) for each factory individually:
Cash fixed cost Rs. 1,60,000 Rs. 2,70,000
Contribution per unit 10 15
BEP= Cash fixed costs 16,000 units 18,000 units
Contribution per unit
(d) Computation of Break-even Point (BEP) for the company as a whole, assuming the
present product mix, i.e., 3:2.
Combined contribution (3/5 x Rs. 10)+(2/5 x 15) Rs. 12
Fixed cost Rs. 5,00,000
Combined BEP 5,00,000 = 41,667 units
12
(e) Break-even Point for the company as a whole, assuming that the product mix can be
altered as desired, has been call calculated as follows:
Factory Y gives a higher contribution, hence Factory Y to be used fully, ie., 30,000 units.
This will give a contribution of Rs. 4,50,000 Balance Rs.150,000 of fixed cost should be met
by producing 5,000 units in Factory X, since there is a contribution of Rs.10 per unit.
Break-even point will, therefore, be at a production of 35,000 units (i.e., 5,000 units of
Xand 30,000 units of Y)
() Consequences on profits if product mix is changed:
Profit as at present: Rs. Rs
Factory X: Total contribution on
30,000 units Rs. 10 3,00,000
Fixed cost 1,00,000
2,00,000
Factory Y: Total contribution on
20,000 unitsRs.15 3,00,000
Fixed cost 3,00,0000
Total profit 1.00.000
Profit in the new situation:
Factory X: Total contribution on
20,000 units 2,00,000
Fixed cost 2,00,000
Factory YTotal contribution on
30,000 units 4,50,000
Fixed cost 1,50,00
3,00,000
1,50,00
 will be the same wiieu
defective units in a batch is more than 250
batch if the minimum
percentage of

4. Margin of safety
is known as the 'ma.
Total sales minus the
sales at break-even point margin of satey
Thus, the formula is: = T.S. - B.E.S
M.S. = Total Sales- Break-even Sales.
Margin of Safety also be computed according to the following form.o
mula:
Margin of safety can
Net Profit
Margin of Safety P/V Ratio
also be expressed as a percentage of sales:
Margin of safety can Margin of Safety 100
Total Sales

Example 4. Rs. 1,50,000

Total Sales 75,000
Variable Costs 50,000
Fixed Costs
as follows:
The margin of safety can be computed
Fixed Cost
Break-even Sales P/V Ratio
50,000 Rs. 1,00,000
50%
= Contribution Fixed Cost
Net Profit = Rs. 75,000 - Rs. 50,000 = Rs. 25,000

Margin of Safety = Rs. 1,50,000 Rs.1,00,000

= Rs. 50,000
Net Profit
P/V Ratio
25,000 Rs. 50,000
50% Mh
If the margin of safety is large, it is a sign of soundness of the
business sinceeve
substantial reduction in sales, profit shall be earned by the business. If the mard aG
reduction in sales, even to a small extent may affect the profit position very adversey ari S a ninocd

reduction of sales value may even result in losses. Thus, margin of satety serve>
to the strength of the business.
can
In order to rectify the unsatisfactory margin of safety, the manageme
the following steps: affect the dema
ue
(i) Selling prices may be increased, but it should not affect
adversely otherwise the net sales revenue shall stand reduced.
(ii) Fixed or the variable cost may be reduced.
(i) Production may be enhanced, but it should be at a lower cost.
(iv) Unprofitable products may be substituted by profitable ones.
 C.189
Costing
and Profit Planning
al
Marginal

KEY FACTOR
activities of an
is that factor which limits the volume of output or level of
ator influence must be
Key
aking at a particular point of time or over a period. The extent of its the decision
to maximise the profits. Generally on the basis of contribution,
first so as
that matters,
It is not the maximisation of total contribution
ing product mix is taken. for relative profitability.
terms of the key factor that is to be compared
he contribution infactor or the goveming factor or principal budget
factor. If sales cannot
hut is the limiting is limited,
Thus, sales is regarded as the key factor, if production capacity
ed a given quantity, in terms of output, has to be computed. If r a w
material is in short
ribution per unit, i.e.,
relation to per unit of raw material required.
c contribution has to be expressed in is to be known.
labour shortage and in such a case contribution per labour hour
r may be
contribution machine hour is tò be considered
for
per
machine capacity is limitation,
a
can be measured by:
Thus, profitability
Dropriate decision making.
PPro
Contribution
Key Factor
illustrations would clearly show how key factor affects the relative
The following
of different products.
Pprofitability records of a factory.
are obtained from costing
lustyatíon 4.16. The following particulars ProductA Product B
(per unit) (per unit)
Rs. Rs.
200 500
Selling Price 40 160
Material (Rs. 20 per litre) 50 100
Labour (Rs. 10 per hour) 20 40
Variable Overhead
Fixed Overheads- Rs. 15,000.
TotalComment each product when:
on the profitability of

(a) raw material is in short supply;

production capacity is limited;
(b)
(c) sales quantity is limited;
(d) sales value is limited; total and
material is available for both the products in
(e) only 1,000 litres of raw

maximum sales quantity ofeach product is 300 units.

Solution: Product B
Product A
Particulars (per unit)
(per unit)
Rs. Rs
200 500
Selling Price
Less: Variable Costs 160
40
Materials 50 100
Labour 110 40 300
Variable Overhead 20 200
90
Contribution per unit
)(6) PV Ratio Contribution 100
90
200 100 200100
500
=Sales 45% 40%
Rs.90 Rs.200
i) Contribution per litre 2 litre 8 litres
= Rs. 45 = Rs. 25

Rs.90 Rs.200
(ri) Contribution 5 hrs. 10 hrs.
per hOur = Rs. 200
Rs.18
 C.190
Management Accounting
(a) When raw material is in short
supply, contribution per litre of product A is higher ans
hence product A is more and
profitable.
(b) When production capacity is limited, contribution per hour of product B is
hence product B s more profitable. higher ane
nd
(c) When sales quantity is limited, contribution per unit of product B is higher and hena
product Bis more profitable.
(d) When sales value is limited, the PV Ratio of product A is higher and hence product
is more profitable.
(e) When raw material as well as sales quantity both are limited, the raw materials shoult
first be
used for maximum number of units of product A, ie., for 300 units. Thiswi
consume 600 litres of material and balance 400 litres shall be utilised for
the
producing 50 units (.e., 400/8) of product B.
The profit in such a case would be:
Contribution from 300 units of product A (300 x 90)
Rs
27,000
Contribution from 50 units of product B (50 x 200) 10,000
Total Contribution 37(000
Less: Fixed Overheads 15,000
Maximum Profit 22,000
SOlution,

As explained earlier, break-even point is 'point of no-profit no-loss' The point

will, therefore, be
data are plotted on the
there where total costs are equal to total sales. In other words, if the two
line and the total sales line
graph paper, at the break-even point, the two lines, i.e., the total cost we need at least twO
will intersect each other. However, for plotting the data on the graph paper,
the total sales line. It will
points-one for plotting the total cost line and the other for plotting
as shown below:
therefore, be necessary to presume different levels of output and sales,
Variable Costs Fixed Costs Total Costs Sales
Output Rs.
(Units) Rs. Rs. Rs.
10,000 20,000 20,000 40,000 25,000
20,000 40,000 20,000 60,000 50,000
30,000 60,000 20,000 80,000 75,000
40,000 80,000 20,000 1,00,000 1,00,000
50,000 1,00,000 20,000 1,20,000 1,25,000
60,000 1,20,000 20,000 1,40,000 1,50,000

The data can now be plotted on the graph paper as follows:

Costs and Revenue
(in thousand Rs.)>
N
 n 7%age c a p a c r t y )

ASSUMPTIONS UNDERLYING CVP

The following assumptions are common to ANALYSIS/BREAK-EVEN CHARTS
(i) Fixed costs remain both Break-even Charts and CVP
constant at every level and Analysis.
decrease with change in they do not increase or
(ii) Variable cost fluctuates output.
per unit of output. In other words,
same proportion in which they vary in the
the volume of output or sales varies.
(iii) All costs are capable of being
(iv) Selling price remains bifurcated into fixed and variable elements.
constant even when the volume of
changes. production or sales
(v) Cost and revenue depend only on
(vi) Production and sales
volume and not on any other factor.
at the
figures are either identical changes or in the
inventory
beginning and at the end of the accounting period are not
significant.
(vii) Either the sales mix is constant or
only one product is manufactured.
 UTILITY OF CVP ANALYSIS
CVP analysis has great utility in the following areas of managerial decision making:
(1) Fixation of selling price. CVP analysis helps in fixing the selling price of the
products. The cost of the product and the desired profitability are two important
factors which govern fixation of selling price of a new product.

Illustration. 4.23. The overall PAW ratio of ABC Ltd., is 60%. The marginal cost of product Xis
estimated at Rs. 50. Determine the selling price for product X.

Solution:
lf selling price is Rs. 100, variable cost will be Rs. 40 and contribution Rs. 60.

Thus, the selling price of a product having a marginal cost of Rs. 40 is Rs. 100.
The selling price of a product having a marginal cost of Rs. 50 should be
100 x 50 125
40
director that only
Illustration 4.24. An enthusiastic marketing manager suggests to his managing
he would be able to achieve a
if he is permitted to reduce the selling price of a product by 20%,
cent increase in sales volume. The managing director, finding that the sales volume
30 per
 See

aintaining a desired level of

2
to time on account of
profit.industry has to cut prices of its products
The
time
from t i m e
competition, govemment regulations and other compeng
on. The contribution per unit on account of such cutting is reduced while the industry
S
herested in maintaining a minimum level of profit. In case the demand for the company s
nroducts is elastic, the minimum level of profit can be maintained by pushing up the sales.
The volume of such sales can be found out the by marginal costing technique.
Illustration 4.26. The sales turnover and profit during two periods were as follows.
Period 1 Sales Rs. 20 lakhs Profit Rs. 2 takhs
Period 2 Sales Rs. 30 lakhs Profit Rs. 4 lakhs
Calculate:
(i) PVRatio,
(i) Sales required to earn a profit of Rs. 5 lakhs, and
(ii) Profit when sales are Rs. 10 lakhs.
Solution:
(i) Calculation of PN Ratio:
Period Period Increase in period
1 2 2 over period 1
Sales Rs.20,00,000 30,00,000 10,00,000
Profit 2,00,000 .00,000 2,00,000
Increase in Costs 8,00,000
Since, fixed costs are constant, the increase in costs is increase in variable cost in tune with
increase in sales volume. As such variable costs are 80% of sales.
Therefore PV Ratio is 100 80% = 20%
(i) Calculation of sales required to earn a profit of Rs. 5 lakhs:
= Contribution - Net Profit
Fixed Expenses
20% of 30,00,000 -4,00,000 = Rs. 2,00,000
Fixed Expenses+Desired Profit
Required Sales =
P/VRatio
2,00,000+5,00,000x 100 =Rs. 35,00,000.
20
Verification:
Sales Rs. 35,00,000
28,00,000 (80%)
Marginal Cost of sales 7,00,000 (20%
Contribution
Fixed Expenses 2,00,000
Profit 5,00,000
(ii) Profit at Sales of Rs. 10 lakhs:
= Sales x PV Ratio Fixed Expenses
-

= Rs. 10 lakhs x 20% Rs. 2,00,000

-

= Rs. 2,00,000 Rs. 2,00,000 =Nil.

Verification:
Sales Rs. 10,00,000
Marginal Cost of sales 8,00,0000 (80%)
Contribution 2,00,000 (20%)
Fixed Expenses 2,00,000
Profit Nil
 .

3.Accepting of price less than the total cost. Sometimes prices have to
below the total cost of theproduct. This becomes necessary to meet the be be fiwed
siha
arising during trade depression. It will be enough in such period if the
recovered. The selling price may be fixed at a level above this cost marginale situation
though it mayay nnot be
enough to cover the total cost. This is because in such
periods any materal
contribution towards recovery of fixed cost is good
enough rather than not to havea
contribution at all. e anv
A price less than the total cost but above marginal cost may be
specific order has been received and it shall not adversely affect the acceptable
home
whena
additional sales revenue should be compared with the additional market. The
costs
generally only marginal costs) and if the net revenue is greater, the order(which a
accepted. In ca_e the market is competitive and there is a fear of adverse should anbe
existing sales even in the long run, the decision should be taken after due andimpact
carehu
thought.
Similar is the situation when order for
a price above the
exports is received by a concern. Exports at
marginal cost but below the total cost may be made since
exports will
not interfere in any way with the sales in
the home market.
Selling at marginal cost or even below the marginal cost may be recommended n
extraordinary situations like the following:
(i) When it is desired to eliminate weak
competitors.
(ii) When the production is to be kept continued because otherwise there is a danger
of heavy losses on account of shutdown.
(iii) When goods are likely to be perished
by the passage
(iv) When a new product is to be introduced in the
of timne.
market or an existing one i to
be made more popular.
(v) When the product can be sold with profit in combination with some other ct.
produ
4. Decisions involving alternative choices. The technique of marginal costing helps
in making decisions involving alternative choices, viz, discontinuance of a product
line, changes of sales mix, make or buy, own or lease, expand or contract, etc. These
decisions are generally made by applying the technique of differential costing whichis
as a matter of fact an extension of the technique of marginal costing. The conceptsof
differential cost and differential costing have already been explained in thischapter
However, the practical application of this technique in decisions involvingaltermative
choices is being explained in the next chapter.
 DETERMINATION OF SALES MIX

will remain unaffected, decision regarding

Presuming that fixed costs
contribution per unit of each product.
taken on the basis of the
sales/production mix is
contribution should be given the highest priority
The product which gives the highest should be given the least priority. A
contribution is the least,
and the product whose discontinued o r given up unless
contribution should be
product giving a negative
there are other reasons to continue its production.
from the cost records of United
information has been made available
llustration 5.1. Following
Automobiles Ltd., manufacturing spare parts: Per unit
Direct Materials Rs. 8
6

Direct Wages 24 hours 25 paise per hour

X 16 hours@ 25 paise per hour
Y 150% of direct wages
Variable Overheads Rs. 750
Fixed Overheads (total)
.228
Management Accounting
Slling Price
X
Y Rs. 25
The directors want to be Rs. 20
acquainted with the desirability of adopting any one of the following
alternative sales mixes in the budget for the next period.
(a) 250 units of X and 250 units of Y
(b) 400 units of Y only
(c) 400 units of X and 100 units of Y
(d) 150 units of X and 350 units of Y.
State which of the alternative sales mixes
you would recommend to the managment.
Solution:
MARGINAL COST STATEMENT (PER UNIT)
Particulars Products
Y
Rs Rs.
Direct Materials 6
Direct Wages 4
Variable Overheads 9
Marginal Cost 23 16
Contribution 2 4
Selling Price 25 20

Selection of Sales Alternative

(a) 250 units of X and 250 units of Y
Contribution:
Product X 250 units x 2 Rs. 500
Product Y 250 units x 4 1,000
1,500
Less: Fixed Overheads 750
Profit 750
(b) 400 units of product Y only
Contribution 400x4 Rs. 1,600
Less: Fixed Overheads 750
Profit 850
(c) 400 units of Xand 100 units of Y
Contribution: Rs.
Product X 400 x 2 800
Product Y 100x 4 400
1,200
Less: Fixed Overheads 750
Profit 450
(d) 150 units of X and 350 units of Y
Contribution:
Product X 150 x 2 300
Product Y 350 x 4 1,400
1,700
Less: Fixed Overheads 750
Profit 950
The alternative (d) is most profitable since it gives the maximum profit of Rs. 950.
 EXPLORING NEW MARKETS
Decision regarding selling goods in a new market (whether Indian or
be taken after considering the
foreigm) shojk
following factors:
(i) Whether the firm has surplus capacity to meet the new demand?
(ii) What price is being offered by the new market? In any case, it should
higher than the variable cost of the product plus any additional expenditue
to be incurred to meet the specific
requirements of the new market.
(ii) Whether the sale of goods in the new market will affect the present
for the goods? It is particularly true in case of sale of
marke
goods in a foreig
market at a price lower than the domestic market price. Before acceptingsu
an order from a
foreign buyer, it must be seen that the goods are not dumpe
in the domestic market itself.
 ldll etltseT.

Wlustration 5.4. A company annually manufactures 10,000 units of a product at a cost of

Rs. 4 n
unit and there is home market for volume of
consuming the entire production the sale
at
Rs. 4.25 per unit. In the year 1997, there is a fall in the demand for home market which can price o
consuma
10,000 units only at a sale price of Rs. 3.72 per unit. The analysis of the cost per 10,000 units is:
Materials Rs.15,000
Wages 11,000
Fixed overheads 8,000
Variable overheads 6,000
The foreign market is explored and it is found that this market can consume 20.000 units of
the product if offered at a sale price of Rs. 3.55 per unit. It is also discovered that for
additional
10,000 units of the product (over initial 10,000 units) that fixed overheads will increase by10per
cent. Is it worthwhile to try to capture the foreign market?
(M.Com., Madras,1980)
Solution:
STATEMENT SHOWING THE ADVISABILITY OF SELLING GOODS IN FOREIGN MARKET

Particulars Year 1996 Year 1997

Home Home Foreign Total
Market Market Markat Market
10,000 units 10,000 units 20,000 units 30,000 units
Rs. Rs. Rs. Rs
Materials 15,000 15,000 30,000 45,000
Wages 11,000 11,000 22,000 33,000
Overheads:
Fixed 8,000 8,000 1,600 9,600
Variable 6,000 6,000 12,000 18,000
Total cost 40,000 40,000 65,600 1,05,600
(2,800) 5,400 2,660
Profit (Loss) 2,500
42,500 37,200 71,000 7,08,200
Sales
 From the above it is clear that it is advisable to sell goods in the foreign market. t wil
Compensate not only for the loss on account of sale in domestic market but will also result in
an overall profit of Rs. 2,600.
 DISCONTINUANCE OF A PRODUCT LINE
The following factors should be considered before
taking a decision about the
discontinuance of a product line:
(i) The contribution given by the
product. The contribution is different from
profit. Profit is arrived at after deducting fixed cost from contribution. Fixed
costs are apportioned over different products on some reasonable basis
which may not be very much correct. Hence, contribution gives a better idea
about the profitability of a product as compared to profit.
The capacity utilisation, whether
ie., the firm is
working or below
to full capacity
normal capacity. In case a firm is having idle capacity, the production of any
product which can contribute towards the recovery of fixed costs canbe justified.
(ii) The availability of product to replace the product which the firm wants to
discontinue and which is already accounting for a significant proportion of
total capacity.
 oisions Involving Alternative Choices
Decisic

C.233
i)Thelong-term prospects in the market for
() The effect on sale of other the product.
products.
product may result in heavy decline in In some cases the
sales of other discontinuance the
of one
overall profitability of the firm. products affecting
etratlon 5.7. A manufacturer is
and replace it with another. Belowthinking
are
whether he should drop one item
from his product
ine
Product
given his present cost and output data:
Price
Variable Cost Percentage
per unit of Sales
Book shelfs Rs Rs
Tables
60 40 30%
100
Beds 60 20%
otal Fixed Costs per year 200 120 50%
Sales last year Rs. 75,50,000
Rs. 25,00,000
The change under consideration consists in dropping the line of tables in
this dropping and change is made favour of cabinets.
the manufacturer forecasts the following cost
Product Price
data: output
Variable Cost Percentage
per unit of Sales
Rs Rs
Bookshelfs 60
Cabinets 40 50%
160 60
Beds
200 10%
120 40%
TOtal Fixed Costs per year Rs. 7,50,000
Sales this year
Rs. 26,00,000
Is this proposal to be accepted? Comment. (M. Com., Rajasthan, 1980)
Solution:
COMPARATIVE PROFIT STATEMENT
Existing Situation Proposed Situation
Book Tables Beds Total Book Cabinets Beds Total
shelfs shelfs
Sales 750,000 5,00,000
12,50,000 25,00,000
Less:Variable Costs 5,00,0003,00,000 7,50,000 15,50,000 13,00,000
8,66,667
2,60,000 10,40,000
97,500 6.24,000
26,00,000
15,88,167
Less. Fixed Cost
2,50,000 2,00.000 5,00,000 9,50,000 4,33,333 1,62,500 4,16,000 10,11,833
7,50,000 7,50,000
2,00,000 2.61.833
The above analysis shows that the manufacturer will stand to
gain in case he drops the
production of tables in preference to cabinets. However, the demand for cabinets should be of a
permanent nature.
Working Notes:
Exlsting Situation:
COMPUTATION OF SALES AND VARIABLES COSTS
Sales Variable Costs

Books shelfs 25,00,000x

30
Rs. 7,50,000 7,50,0000
40
= Rs. 5,00.000
60

Tables 25,00,000x
20
Rs. 5,00,000 5,00,000 x
60
0
Rs. 3,00,000
100
Beds 50
25,00,000 x Rs.12,50,000 12,50.00000RS. 7,50:000
100 200
C.234
Management Accounting
Proposed Situation:
COMPUTATION OF SALES AND VARIABLE COSTS
Sales Variable Costs
50 13,00,000 40 8,66,667
Book shelfs 26,00,000x Rs. 13,00,000
60
Cabinets 26,00,000x Rs. 2,60,000 2,60,000 x 160 Rs. 97,500
Beds 26,00,000x 10
Rs. 10,40,000 10,40,000x120 Rs. 6,24,000
 MAKE OR BUY DECISIONS
A firm may be manufacturing product by itself. It may
a receive an
offer from an
outside supplier to supply that product. The decision in such a case will be made by by
comparing the price that has to be paid and the saving that can be effected on cost. The
saving will be only in terms of marginal cost of the product since generally no savings
can be effected in fixed costs.
Similarly, a firm may be buying a product from outside, it may be considering to
manufacture that product in the firm itself. The decision in such a case will be made by
comparing the price being paid to outsiders and all additional costs that will have to be
incurred for manufacturing the product. Such additional costs will comprise not only
direct materials and direct labour but also salaries of additional supervisors engaged,
rent for premises if required and interest on additional capital employed. Besides that
the firm must also take into account the fact that the firm will be losing the opportunity
of using surplus capacity for any other purpose in case it decides to manufacture the
product by itself.
In case a firm decides to get a product manufactured from outside, besides the
savings in cost it must also take into account the following factors:
(i) Whether the outside supplier would be in a position to maintain quality of
the product?
(ii) Whether the supplier would be regular in his supplies?
(ii) Whether the supplier is reliable? In other words, he is financially and
technically sound.
In case the answer is "No" to any of these questions it will not be advisable tor the

firm to buy the product from outside.

lustration 5.10. The Managing Director of A Pvt. Ltd., asks for your assistance in ariving ata
decision as to continue manufacturing a component X; or to buy it from an outsidesupplier.in
componentX is used in the finished products of the company. The following data are suppliedr
1. The annual requirement of component X is 10,000 units. The lowest quotation from a
outside supplier is Rs. 8.00 per unit.
Decii

2. The component X is manufactured in the machine shop. If the

component X is or tne
out, certain machinery will be sold at its book value and the residual capacitybougnt
machine shop will remain idle.
3. The total expenses of the Machine Shop for the year ending 31.3.1998 are as follows
During that year the Shop manufactured 10,000 units of X
Rs.
Material 1,35,000
Direct Labour 1,00,000
Indirect Labour 40,000
Power and Fuel 6,000
Repairs and Maintenance 11,000
Rate, Taxes and Insurance 16,000
Depreciation 20,000
Other Overhead Expenses 29,600
of component X
4. The following expenses of the Machine Shop apply to Manufacturing
Rs.
Materialss 35,000
Direct Labour 56,000
Indirect Labour 12,000
Power and Fuel 600
Repairs and Maintenance 1,000
X would reduce.
The sale of machinery used for the manufacture of component
Depreciation by Rs. 4,000
and Insurance by Rs. 2,000
additional expenses would be incurred:
5. If the component X is bought out, the following
Freight Re. 1.00 per unit
Inspection Rs.10,000 per annum.
of
a to the Managing Director showing the comparison
report
You are required to prepare when bought out
expenses of Machine Shop () when the component X is made, and (i) (AIMA, January, 1983)

Solution:
COMPARATIVE STATEMENT OF COST

To make To buy
Particulars Component Component
X
X
Rs.
Rs.
35,000
Direct Material 56,000
Direct Labour 12,000
Indirect Labour 600
Power and Fuel 1,000
Repair and Maintenance 4,000
Depreciation 2,000
Insurance 1,.10,600
Total Variable Cost 11.06 8.00
Variable Cost per unit 1.00
Purchase Price per unit 1.00
reight Charge per unit 10.00
spection Charge per unit T1.06
Cost per unit
because the variable cost
to make it in the shop,
than remain
to buy component X since fixed costs would
S preferableRs.1.06. Only variable cost is to be considered,
Sess by
C.238
Management Accounting
the sameunder both the circumstances. Even if the production of component Xis discontinued,
fixedcost cannot be saved. Moreover, the capacity, which would remain idle on acount of
buying this component from the market, can be utilised for some other purpose in the near future.
Ldntll
(i) Determination of sales mix;
(ii) Exploring new markets;
line;
(ii) Discontinuance of a production
(iv) Make or buy decisions; decision;
(v) Equipment replacement
(vi) Investement in asset;
(vii) Change versus status quo;
(vii) Expand or contract;
(ix) Shut down or continue. IOC SALES M-