marginal costing

Why do we study Marginal Costing?

What do we study in Marginal Costing?

Marginal CostMarginal CostingDirect CostingAbsorption CostingContributionProfit Volume AnalysisLimiting Factor/key factorBreak Even AnalysisProfit Volume Chart

What do we study in Marginal Costing?and Why do we Study MC?

Marginal CostMarginal CostingDirect CostingAbsorption CostingContributionProfit Volume AnalysisLimiting Factor/key factorBreak Even AnalysisProfit Volume Chart

ManagementDecisionMaking

Marginal Cost

“Marginal cost is amount at any given volume of out put by which aggregate costs are changed…..

if volume of output is increased or decreased by one unit”

Marginal Cost

“Marginal cost is amount at any given volume of out put by which aggregate costs are changed if volume of output is increased or decreased by one unit”

1 Manufacture 100 radioVariable costs Rs150 p uFixed cost Rs 50002 If Manufacture 101 radios

Marginal Cost 100 x150= 15000Fixed Cost = 5000 total 20000

Marginal cost 150 x101=15150Fixed Cost = 5000

TOTAL 20150

additional Cost=Rs 150

Marginal Costing

“marginal costing is ascertainment ofmarginal costing is ascertainment ofmarginal cost by differentiating betweenmarginal cost by differentiating betweenfixedfixed and and variablevariable costs costs

and of the and of the effecteffectof of changes in volumechanges in volume or type of output or type of output””

Marginal Costing

What Could be effects ofWhat Could be effects ofChangesChanges

In volume In volume or or Type of outputType of output

Marginal Costing

1 lakh unitsTo

2 lakh units

Marginal Costing

From OneModel of

Car toAnother

From OneSize of

product toanother

Marginal Costing ---Characteristics

Fixed & VariableCosts

MC Costs asProducts Costs

Fixed Costs asPeriod Costs

InventoryValuation

Contribution

Pricing

Marginal Costing&

Profit

SegregationFixed & Variable

Semi-variable costsare segregated

into fixed &variable

Semi-variable costsare segregated

into fixed &variable

Marginal Costs as

Products Costs

Only Variable costsare chargedto products

Fixed Costs asPeriod Costs

Fixed costs treatedPeriod costs

Charged to costingP & L Account

Fixed costs treatedPeriod costs

Charged to costingP & L Account

InventoryValuation

WIP & F goods areValued at

Marginal Cost

WIP & F goods areValued at

Marginal Cost

ContributionS-V=C

Profitability judged onContribution made

Pricing

Pricing is based onContribution &Marginal Costs

Marginal Costing&

Profit

A B C Total

Sales - - - ----Less VC - - - ----

Contribution - - - ----

Fixed Cost ----

Profit -----

Marginal Costing --- Marginal Costing Profit

Sales of A

Marginal costOf A

Contribution of A

TotalContribution of

A,B& C

Total FixedCost

Sales of B

Marginal costOf B

Contribution of B

Sales of C

Marginal costOf C

Contribution of C

less less

= Profit/loss

Absorption Costing

“Absorption cost is a total cost technique Absorption cost is a total cost technique Under which total cost ie Under which total cost ie fixed & variablefixed & variableis charged to production.is charged to production. Inventory is also valued at total cost. Inventory is also valued at total cost.

Absorption-Marginal Costing--differences

Fixed &Variable

MeasurementOf

ProfitabilityValuationOf stock

Fixed &Variable

Marginal Costing

Only variable cost

FC charged to P/L

Absorption Costing

Both F & V CostsAre charged

ValuationOf stock

WIP & FSat

MarginalCost

Total Cost

MeasurementOf

Profitability

C=S-V P=S-V-F

Marginal Costing

Months1 2 3 Total Rs Rs Rs Rs

Absorption Costing

(A)Sales 2,00,000 1,65,000 2,35,000 6,00,000 2,00,000 1,65,000 2,35,000 6,00,000Opening Stock 84,000 84,000 1,05,000 2,73,000 1,08,000 1,08,500 1,35,625 3,52,625Add V Cost 1,20,000 1,20,000 1,20,000 3,60,000 1,20,000 1,20,000 120,000 3,60,000 F Cost _ _ _ _ 35,000 35,000 35,000 1,05,000

Total Cost 2,04,000 2,04,000 2,25,000 6,33,000 2,63,000 2,63,000 2,90,625 8,17,625

Less C Stock 84,000 1,05,000 84,000 2,73,000 1,08,000 1,35,625 1,08,500 3,52,625

(B) COGS 1,20,000 99,000 1,41,000 3,60,000 1,55,000 1,27,875 1,82,125 4,65,000

Contribution (A-B)c 80,000 66,000 94,000 2,40,000 _ _ _ _

( D) F Cost 35000 35,000 35,000 1,05,000 _ _ _ _

Profit (C-D) 45,000 31,000 59,000 1,35,000 (A-B) 45,000 37,125 52,875 1,35000

Comparative Cost Statement

Marginal Costing

Absorption Costing

Total Cost 2,04,000 2,04,000 2,25,000 6,33,000 2,63,000 2,63,000 2,90,625 8,17,625

Less C Stock 84,000 1,05,000 84,000 2,73,000 1,08,000 1,35,625 1,08,500 3,52,625

(B) COGS 1,20,000 99,000 1,41,000 3,60,000 1,55,000 1,27,875 1,82,125 4,65,000

( D) F Cost 35000 35,000 35,000 1,05,000 _ _ _ _

Profit (C-D) 45,000 31,000 59,000 1,35,000 (A-B) 45,000 37,125 52,875 1,35000

Marginal Costing

Absorption Costing

Total Cost 2,04,000 2,04,000 2,25,000 6,33,000 2,63,000 2,63,000 2,90,625 8,17,625

Less C Stock 84,000 1,05,000 84,000 2,73,000 1,08,000 1,35,625 1,08,500 3,52,625

(B) COGS 1,20,000 99,000 1,41,000 3,60,000 1,55,000 1,27,875 1,82,125 4,65,000

( D) F Cost 35000 35,000 35,000 1,05,000 _ _ _ _

Profit (C-D) 45,000 31,000 59,000 1,35,000 (A-B) 45,000 37,125 52,875 1,35000

Concept Of Contribution

Contribution is the difference between salesAnd the marginal (Variable) cost

Contribution =sales-variable cost C= S-VContribution = Fixed Cost+ Profit C= F+PTherefore

S-V = F+P

Contribution is the difference between salesAnd the marginal (Variable) cost

S-V=F+P

If any 3 factors in the equation are knownThe 4th could be found out

P=S-V-F P=C-F F=C-P S=F+P+V V=S-C……….

Sales =Rs 12,000

V Cost=RS 7,000

F Cost=Rs 4,000

C=S-V =12,000-7000=5000

=5,000-4000

=Rs 1,000

PROFIT ?

=5,000+7,000 =Rs 12,000

SALES?

Sales =Rs 12,000

V Cost=RS 7,000

F Cost=Rs 4,000

=5,000-1,000 =Rs 4,000

F COST?

=12,000-5000 =Rs 7,000

V Cost?

Profit –Volume Ratio (PV Ratio)(Expresses the relation of Contribution to sales)

P/V Ratio =Contribution = C/S =S-V/S Sales

C = S XP/V Ratio C S = -------- P/V Ratio

Sales= Rs 10,000

V Cost=Rs 8,000

P/V Ratio=c/s=S-V/S=10,000-8000/10,000=20%

Profit –Volume Ratio (PV Ratio)

When PV Ratio isGiven

C= SXPV Ratio

C= 10000X20% =Rs 20,000

Profit –Volume Ratio (PV Ratio)

Another Method

Change in ContributionP/V Ratio = --------------------------------- Change in Sales

Change in profit = ----------------------- Change in Sales

1600-1000 =-------------------x 100 22000-20000

600 = -----------x100=30% 2,0000

Year sales net profit

2005 20,000 1000

2006 22,000 1600

What Could be the Uses of PV Ratio?

Break Even Point

Profit at Given Sales

Vol required to earn given Profit

How Improvement in PV Ratio Could be Achieved?

Increasing Selling Price

Reducing Variable Cost

Changing Sales Mix

Limiting Or Key Factor

a factor in short supply

a factor in the activities of an undertakingwhich at a point of time or over a period

will limit the volume of out put

What Could be the Limiting Factors ?

LabourMaterialsPowerSalesCapacityMachines………….

Cost- Volume- Profit Analysis

Cost Of Production

Selling Prices

Volume Produced /Sold

Break Even Analysis

Profit Volume Chart

Break Even Analysis

A point of no profit no loss

A point where revenue equals cost

What are BEP---assumptions

All costs are fixed or variableVC remains ConstantTotal FC remains ConstantSelling Price don’t change With VolumeSynchronisation of Prod & Sales No Change in Productivity per workers

Break Even Analysis

Methods

Algebraic Method

Graphic Method

Cost- Volume- Profit Analysis ALGEBRAIC

METHOD Fixed Cost BEP (Units) = --------------- = F Contribution PU S-V

Fixed Cost BEP (Rs ) = ----------------- x Sales Contribution

Fixed Cost BEP (Rs) = ------------------ P/V Ratio

Cost- Volume- Profit Analysis ALGEBRAIC

METHOD Fixed Cost BEP (Units) = --------------- = F Contribution PU S-V

Fixed Cost BEP (Rs ) = ----------------- x Sales Contribution

Fixed Cost BEP (Rs) = ------------------ P/V Ratio

F Cost=Rs 12000S Price=Rs12 puV Cost =Rs 9 pu

Find BEP

Other Uses

Profit at diff. Sales Vol.

Sales at Desired Profit

Profit when sales are

a) Rs 60,000b) Rs 1,00,000

Profit at diff. Sales Vol.

CP/V Ratio= ----- = 3/12=25% S

WHEN SALES=Rs 60,000

contribution=salesxp/vratio =60000x25% =Rs 15000Profit =contribution-fixed cost =15000-12000 =Rs3000

Profit when sales are

a) Rs 60,000b) Rs 1,00,000

Other Uses

F Cost +Desired ProfitSales= ------------------------------- P/V Ratio

Sales if desired profita) Rs 6000b) Rs 15,000

F Cost +Desired ProfitSales= ------------------------------- P/V Ratio

12,000+6000a)Sales= --------------- 25%

=Rs 72,000

Sales if desired profita) Rs 6000b) Rs 15,000

CVP Analysis -question

P ltd has earned a profit of Rs 1.80 lakh on sales ofRs 30 lakhs and V Cost of Rs 21 lakhs.work out

a)BEPb)BEP When V Cost decreases by5% c)BEP at present level when selling price reduced by5%

CVP Analysis -

S-VP/V Ratio=-------- S 3000000-2100000 = ------------------------ 3000000 =30%Sales =VC+FC+P3000000=2100000+FC+180000 FC =Rs 720000 7,20,000 BEP= ------------- 30%

=Rs 2400000

b) When V Cost increases by 5%

New Variable Cost=2100000+5% =22,05,000

PV Ratio 3000000-2205000 3000000 =26.5%

BEP =7,20,000/ 26.5%

=Rs 27,16,981

c)When Selling Price reduced by 5%

New SP=3000000—5% =Rs 28,50,000

Contribution=28,50,000-21,00,000 =Rs7,50,000

PV Ratio =7500000/2850000 =26.32%

FC+PROFITDesired Sales= ------------------ = 720000+1800000 PV Ratio 26.32%

=Rs 34,19,453( appx)

Graphical Presentation

Break-Even Analysis

Costs/Revenue

Output/Sales

Initially a firm will incur fixed costs, these do not depend on output or sales.

Break-Even Analysis

Costs/Revenue

Output/Sales

Initially a firm will incur fixed costs, these do not depend on output or sales.

As output is generated, the firm will incur variable costs – these vary directly with the amount produced

The total costs therefore (assuming accurate forecasts!) is the sum of FC+VC

Total revenue is determined by the price charged and the quantity sold – again this will be determined by expected forecast sales initially.

TRThe lower the price, the less steep the total revenue curve.

The Break-even point occurs where total revenue equals total costs – the firm, in this example would have to sell Q1 to generate sufficient revenue to cover its costs.

Break-Even Analysis

Costs/Revenue

Output/Sales

VCTCTR

If the firm chose to set price higher than Rs2 (say Rs3) the TR curve would be steeper – they would not have to sell as many units to break even

Break-Even Analysis

Costs/Revenue

Output/Sales

VCTCTR

If the firm chose to set prices lower it would need to sell more units before covering its costs

Break-Even Analysis

Costs/Revenue

Output/Sales

Profit

Break-Even Analysis

Costs/Revenue

Output/Sales

Assume current sales at Q2

Margin of Safety

Margin of safety shows how far sales can fall before losses made. If Q1 = 1000 and Q2 = 1800, sales could fall by 800 units before a loss would be made

A higher price would lower the break even point and the margin of safety would widen

Costs/Revenue

Output/Sales

High initial FC. Interest on debt rises each year – FC rise therefore

Losses get bigger!

Break-Even Analysis

• Remember:• A higher price or lower price does not

mean that break even will never be reached!

• The BE point depends on the sales

needed to generate revenue to cover costs

Break-Even Analysis

• Importance of Price Elasticity of Demand:

• Higher prices might mean fewer sales to break-even

• Lower prices might encourage more customers but higher volume needed before sufficient revenue generated to break-even

Break-Even Analysis

• Links of BE to pricing strategies and elasticity

• Penetration pricing – ‘high’ volume, ‘low’ price – more sales to break even

Break-Even Analysis

• Market Skimming – ‘high’ price ‘low’ volumes – fewer sales to break even

Break-Even Analysis

• Elasticity – what is likely to happen to sales when prices are increased or decreased?

Marginal CostingCost Volume Chart

Construction Of PV Chart

1 select a scale on Horizontal axis---sales

2 Select a scale on Vertical axis- FC & Profit

3 Plot FC & Profit

4 Diagonal line crosses sales line at BEP

PV Chart Information

Fixed Cost =Rs 5000Sales =Rs 20000(pu RS 20)V Cost= Rs 10000(pu Rs10)

Find PV Ratio, BEP, Profit?

0 5000 10000 15000 20000 Sales Rs

Fixed Cost Rs

400050006000

600050004000

ProfitRs

0 5000 10000 15000 20000 Sales Rs

Fixed Cost Rs

400050006000

600050004000

ProfitRs

LossArea

ProfitArea

--------------------------Margin of Safety

Effect Of Change in Profit- 20% decrease in fixed Cost

New F Cost= 5000- 20%=Rs4000

Fixed CostNew BEP = PV Ratio = 4000/50% =Rs 8000New Profit=S-F-V =20000-4000-10000 =Rs 6000

Effect of Change in profit- 20% decrease in FC

0 5000 10000 15000 20000 Sales Rs

Fixed Cost Rs

400050006000

ProfitRs

LossArea

ProfitArea

80006000

50004000

Effect Of Change in Profit- 10% decrease in V Cost

New V Cost= 10000- 10%=Rs9000New PV Ratio=20000-9000 20000

Fixed CostNew BEP = PV Ratio = 5000/55% =Rs 9090 AppxNew Profit=S-F-V =20000-5000-9000 =Rs 6000

0 5000 10000 15000 20000 Sales Rs

Fixed Cost Rs

400050006000

80006000

50004000

ProfitRs

New BEP

LossArea

ProfitArea

Effect Of 5% Decrease in Selling Price

0 5000 10000 15000 20000 Sales Rs

Fixed Cost Rs

400050006000

80006000

50004000

ProfitRs

New BEP

LossArea

ProfitArea

marginal costing

price rs12 pu

fixed cost rs

cost total cost

marginal costing

fixed cost bep

profit volume ratio

sales contribution bep

fixed

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