lalit narayan mithila university, darbhanga class : - m.b.a ... 3 marginal...marginal costing and...
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Lalit Narayan Mithila University, Darbhanga
Topic : - MARGINAL COSTING (PART-2)By-DR. PRABHAT KUMARGUEST FACULTY, MANAGEMENT PROGRAMMEPH.D, M.COM, JRF-UGC NET
Class : - M.B.A. 2ND SEMESTER
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Marginal Costing and Absorption CostingAbsorption costing charges all the costs i.e., both the fixed and variable fixed to the products,
jobs, processes, and operations. Marginal costing technique charges variable cost. Absorption
is not any specific method of costing. It is common name for all the methods where the total
cost is charged to the output.
Absorption Costing is defined by I.C.M.A, England as βthe practice of charging all costs,
both fixed and variable to operations, processes, or productsβ
Absorption Costing Marginal Costing
1. Total cost technique is the practiceof charging all cost, both variable andfixed to operations, process or products.2. It values stock at the cost whichincludes fixed cost also.3. It is guided by profit which is theexcess of sales over the total costs insolving managerial problems4. In total cost technique, there is aproblemof apportionment of fixedcosts which may result in under or over recovery ofexpenses.
1. Marginal costing charges only variable cost toproducts, process, or operations and excludes fixedcost entirely.2. It values stock at total variable costonly. This results in higher value of stock underabsorption costing than in marginal costing.3. It focuses its attention onContribution which is excess of sales over variablecost.4. It excludes fixed cost. Therefore, there is noquestionof arbitrary apportionment.
Distinction between Absorption Costing and Marginal Costing
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Marginal Costing and Absorption CostingExample: Cost of Production (10000 Units)
Per Unit (Rs. P) Total (Rs.)
Variable Cost 1.5 15,000 Sale 5000 units at Rs. 1,25000
Fixed Cost 0.25 2,500 Closing Stock 5000 units at Rs.1.75
Total Cost 17,500 Rs. 8,750
Absorption Costing Marginal Costing
Sales 12,500
Closing Stock 8,750
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21,250
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Less: Total Cost 17,500
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Profit 3,750
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Sales 12,500
Less: Marginal Cost of
5000 units (5000 x 1.50) 7,500
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5,000
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Less: Fixed Cost 2,500
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Profit 2,500
---------Closing stock will be valued at Rs. 7,500 only at
marginal cost.
Profit Calculation under Absorption Costing and Marginal Costing
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Decision Making IndicatorsProfit Volume Ratio (PV Ratio)
Break-even point (BEP)
Marginal of Safety (MOS)
Indifference Point
Shut Down Point
Profit Volume Ratio (PV Ratio) : The Profit Volume Ratio (PV Ratio) is the
relationship between Contribution and Sale Value (C/S). It is also termed as
Contribution to Sales Ratio (CSR)
Alternative Formula: PV Ratio=πΆβππππ ππ πΆπππ‘ππππ’π‘πππ
πΆβππππ ππ πππππ x =
πΆβππππ ππ ππππππ‘
πΆβππππ ππ πππππ x 100
Contribution =Sales- Variable Cost
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Decision Making Indicators Break Even Point (BEP): It is the level of Sales at which there is neither a Profit
nor a Loss to the Firm (Total Revenue = Total Costs). In other words, at this point,
the Total Contribution equals Fixed Costs.
β’ BE Point (Sale)=FC/PV Ratio
β’ BE Point (Qty)=
FC/Contribution per unit
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Decision Making IndicatorsMargin of Safety (MOS): It represents the difference between the Sales at Break
Even Point and the Total Sales.
Margin of Safety (in Rs) = Total Sales of Less BE Sales (or) Profit/PV Ratio
Margin of Safety (Qty) = Total Sales (Q) β BEP (Q) ) (or) Profit/Contribution per unit
Shut Down Point: Shut Down indicates the level of operations (Sales), below
which it is not justifiable to pursue production.
Shut Down Point (in Rs) = Avoidable Fixed Costs / PV Ratio
Shut Down Point (Qty) = Avoidable Fixed Costs /Contribution per unit
Where Avoidable Fixed Costs= Total Fixed Cost less Minimum (Unavoidable Fixed Costs.
Indifference Point: Indifference Point is the level of sales at which Total Costs /
Total Profit of tow option are equal. The decision market is indifferent as to option
chosen, since both option will result in the same amount of profit/cost.
Indifference Point (in Rs) =π·πππππππππ ππ πΉππ₯ππ πΆππ π‘
π·πππππππππ ππ ππππππππ πΆππ π‘ π ππ‘ππor
π·πππππππππ ππ πΉππ₯ππ πΆππ π‘
π·πππππππππ ππ π π π ππ‘ππ
Indifference Point (Qty) =π·πππππππππ ππ πΉππ₯ππ πΆππ π‘
π·πππππππππ ππ ππππππππ πΆππ π‘ π πor
π·πππππππππ ππ πΉππ₯ππ πΆππ π‘
π·πππππππππ ππ πΆπππ‘ππππ’π‘πππ ππ
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Application of Marginal Costing Cost Control
Profit Planning
Fixation of Selling Price
Make or Buy
Closing down of a department or
discontinuing a product
Selection of a Product / Sale Mix
Evaluation of Performance
Limiting Factor
Helpful in taking Key Managerial
Decisions
Cost Control: Marginal costing divides total cost into fixed and variable cost. Fixed
cost can be controlled by the Top Management to a limited extent and Variable costs
can be controlled by the lower level of Management. Marginal costing by
concentrating all efforts on the variable costs can control total cost.
Profit Planning: It helps in short-term profit planning by making a study of
relationship between cost, volume and Profits, both in terms of quantity and graphs.
An analysis of contribution made by each product provides a basis for profit-
planning in an organisation with range of products.
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Application of Marginal Costing Fixation of Selling Price: Generally prices are determined by demand and supply of
products and services. But under special market conditions marginal costing is helping in
deciding the prices at which management should sell. When marginal cost is applied to
fixation of selling price, it should be remembered that the price cannot be less than marginal
cost. But under the following situation, a company shall sell its products below the marginal
cost:
To maintain production and to keep employees occupied during a trade depression.
To prevent loss of future orders.
To dispose of perishable goods.
To eliminate competition of weaker rivals.
To introduce a new product.
To help in selling a co-joined product which is making substantial profit.
To explore foreign market
Make or Buy : Marginal costing helps the management in deciding whether to make a
component part within the factory or to buy it from an outside supplier. Here, the decision is
taken by comparing the marginal cost of producing the component part with the price quoted
by the supplier. If the marginal cost is below the supplierβs price, it is profitable to produce
the component within the factory. Whereas if the supplierβs price is less than the marginal
cost of producing the component, then it is profitable to buy the component from outside.
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Application of Marginal Costing Closing down of a department or discontinuing a product: The firm that has several
departments or products may be faced with this situation, where one department or product
shows a net loss. Should this product or department be eliminated? In marginal costing, so for
as a department or product is giving a positive contribution then that department or product
shall not be discontinued. If that department or product is discontinued the overall profit is
decreased.
Selection of a Product / Sales Mix: The Marginal costing technique is useful for deciding
the optimum product/sales mix. The product which shows higher P/V ratio is more profitable.
Therefore, the company should produce maximum units of that product which shows the
highest P/V ratio so as to maximize profits.
Evaluation of Performance: The different products and divisions have different profit
earning potentialities. The Performance of each product and division can be brought out by
means of Marginal cost analysis, and improvement can be made where necessary.
Limiting Factor: When a limiting factor restricts the output, a contribution analysis based on
the limiting factor can help maximizing profit. For example, is machine availability is the
limiting factor, then machine hour utilisation by each product shall be product which gives
highest contribution.
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Application of Marginal Costing Helpful in taking Key Managerial Decisions: In addition to above, the following are the
important areas where managerial problems are simplified by the use of marginal costing:
Analysis of Effect of change in Price
Maintaining a desired level of profit.
Alternative methods of production.
Diversification of products.
Alternative course of action etc.