6. marginal costing
TRANSCRIPT
Marginal Costing
Break Even & CVP analysis
Marginal Costing
• Marginal cost is same as variable cost. It is opposite of Total costing / absorption costing.
• The cost which would vary in proportion to the volume of production or sales.
• Isolate the cost that can be saved when one less unit is produced under a given level.
• Marginal Cost of production = Variable cost of manufacturing• Marginal Cost of sales = Variable cost including variable selling &
distribution cost.• Contribution (C)=Sales Value (SV) – Marginal Cost (MC)
Marginal Costing
• Marginal costing considers fixed cost as period cost. It strongly believe that fixed cost are for business and need not be apportioned. Hence period cost in totality are reduced from Total contribution to arrive at Net Profit. The result (total net profit) would be the same both in Total costing & marginal costing only the presentation style differs.
• Semi variable or semi fixed costs are required to be classified in the individual components of fixed cost and variable cost
BEP
• Break Even Point (BEP) – Situation of no profit no loss. i.e.
when contribution is just enough to cover fixed costs i.e.
Contribution = Fixed Costs.
In terms of quantity = Fixed costs
Contribution per unit
In terms of amount = Fixed cost
P/V ratio
P/V Ratio
• Profit Volume or P/V Ratio or C/S ratio = Contribution to Sales x 100 or as % of
Changes in profits
Changes in sales i.e.
Sales x P/V ratio = Contribution i.e. Contribution = Sales
P/V ratio
Margin of Safety
• Sales beyond break even point. • A high margin of safety = Much below BEP than actual
sales• A low margin of safety with high fixed costs & high P/V
ratio = efforts are required to reduce fixed cost or increase sales volume
• A low margin of safety with low P/V ratio = Efforts are required to reduce variable cost or increase selling price
• Margin of Safety = Sales – BEP• Margin of Safety = Profit P/V Ratio
CVP Analysis
Illustration 1
Assume the selling price of product Rs.20/-per unit and variable cost per unit Rs.10/- and the fixed cost Rs.1000/- Find out the break even point.
Illustration 1
Sales Rs.20/-Variable Cost Rs.10/-Contribution Rs 10/-Fixed Cost Rs.1000/-Profit (-) Rs. 990
• Break Even Point (Units)=
• Fixed Cost / Contribution Margin Per Unit
= Rs.1000 / Rs.10
= 100units
• PV Ratio Method
• BEP(Rs)= Fixed Cost / PV ratio
= 1000 / (10/20)%
= Rs. 2000 sales
Illustration 2
• Calculate Break Even Point from the following particulars
Fixed Cost Rs.3,00,000Variable Cost Per Unit Rs.20/-Selling Price Per Unit Rs.30/-
Answer
30000 units or Rs. 9 lakhs
Illustration 3
• Calculate Break Even Point from the following particulars
Fixed Cost Rs.12,000Variable Cost Per Unit Rs.9/-Selling Price Per Unit Rs.12/-
Answer
• P/V Ratio = 25%
• BEP in Units = 4000 units
• BEP in Rs. = 48,000/-
Illustration
Month Jan A B C Total
Units sold (lakhs) 1 2 3
Sales price per unit 100 50 60
Total Sales (Rs. Lakhs) 100 100 180 380
Variable cost per unit 55 30 30
Contribution per unit (Rs.) 45 20 30
Total Contribution (Rs. Lakhs) 45 40 90 175
Total fixed cost of business (Rs. Lakhs) 75
Total profit of the business (Rs. Lakhs) 100
P/V ratio 45% 40% 50% 46%
BEP (Rs. Lakhs) 163
MS (Rs. Lakhs) 217
Illustration
Month Jan A B C Total
Units sold (lakhs) 3 1 2
Sales price per unit 100 50 60
Total Sales (Rs. Lakhs) 300 50 120 470
Variable cost per unit 55 30 30
Contribution per unit (Rs.) 45 20 30
Total Contribution (Rs. Lakhs) 135 20 60 215
Total fixed cost of business (Rs. Lakhs) 75
Total profit of the business (Rs. Lakhs) 140
P/V Ratio 45% 40% 50% 46%
BEP (Rs. Lakhs) 163
MS (Rs. Lakhs) 307
Practical Application of Marginal Costing
• Evaluation of performance – of any department or product or a branch and so on. Loss making operation / product can be closed down or visa versa.
• Profit Planning – P/V ratio enables the management to plan the activities in such a way that the profits can be maximized. Refer earlier illustration or profits can be maintained
• Fixation of prices – The prices can be fixed in such a way that at least variable cost is covered especially in short run or depression period, disposal of substandard products, price quote for export market especially at entry level.
Practical Application of Marginal Costing - continued
• Make or buy decision – Whether a component or a product to make in house or buy from an outside source of course before finalising the decision the other factors like reliability of supplier, availability of manufacturing capacity, quality, etc. should be considered.
• Optimising Product Mix – Various products a company needs to sell can be decided based on the mix which gives the maximum contribution.
• Cost control – Marginal costing is basically the classification of costs into fixed and variable. So Variable costs can be controlled by lower and middle level management and Fixed costs can be controlled by
top management.• Flexible Budget preparation – When the costs are divided into fixed
and variable, it facilitates budget preparation
Problem of key factor
• Under marginal costing profit is maximized when maximum volumes are sold of products with high P/V ratio. But in practice, there may be some factors which act as hindrance like unavailability of raw materials, limited market, etc. Such factors are called as limiting or key factors.
• A product generating maximum contribution per unit of key factor is the maximum profitable product
• Multiplicity of key factors is a complex situation which is handled with more advanced techniques like linear programming.
Limitations of marginal costing
• Classification of fixed and variable cost is difficult. Some cost like Direct labour cost though variable, but especially in India where workers have legal protection, labour cost is not variable in nature.
• In today’s era of automation, fixed costs are sizable in nature. In such case ignoring them completely is not wise many a times.
• It does not provide any standard for evaluation like standard or budgetary costing
• Fixation of selling price or profitability analysis based on marginal costing is useful in short terms only.