1Marginal Costing
Introduction
Meaning Of Marginal Costing
Separation of costs into fixed and variable (marginal) is of special interest and importance. Under marginal costing, cost of a product is estimated without considering fixed cost. This method allocates only variable costs (direct material, direct labour, direct expenses, and variable overheads) to production. It is also
known as ‘variable costing’.
Marginal Cost = Variable Cost = Direct Labour + Direct Material + Direct Expenses + Variable Overheads
Meaning Of Absorption Costing
It refers to the conventional technique of costing under which the total costs (fixed and variable) are charged to products. It is considered to have only a limited application today.
Meaning Of Breakeven Point
Breakeven point represents that volume of production where total cost equal total revenue resulting into a no-profit no-loss situation. If output falls below that point, there is loss and if output exceeds the point there is profit. Therefore at breakeven point.
Formulas
Statement Of Profit Under Marginal Costing
Particulars
Amount
Sales
***
Less:-Variable cost
***
Contribution
***
Less:- Fixed cost
***
Profit
***
Sales = Total cost + Profit = Variable cost + Fixed cost + Profit
Total Cost = Variable cost + Fixed cost
Variable cost = It changes directly in proportion with volume
Sales – Variable cost = Fixed cost + Profit
Contribution = Sales * P/V Ratio
Profit Volume Ratio [P/V Ratio]:-
{Contribution / Sales} * 100
{Contribution per unit / Sales per unit} * 100
{Change in profit / Change in sales} * 100
{Change in contribution / Change in sales} * 100
Break Even Point [BEP]:-
Fixed cost / Contribution per unit [in units]
Fixed cost / P/V Ratio [in value] (or) Fixed Cost * Sales value per unit
(Sales – Variable cost per unit)
Margin of safety [MOS]:-
Actual sales – Break even sales
Net profit / P/V Ratio
Sales unit at Desired profit = {Fixed cost + Desired profit} / Cont. per unit
Sales value for Desired Profit = {Fixed cost + Desired profit} / P/V Ratio
At BEP, Contribution = Fixed cost
Indifference Point = Point at which two Product sales result in same amount of profit
= Change in fixed cost (in units)
Change in variable cost per unit
= Change in fixed cost (in units)
Change in contribution per unit
= Change in Fixed cost (in `)
Change in P/Ratio
= Change in Fixed cost (in `)
Change in Variable cost ratio
MARGINAL COSTING V/S ABSORPTION COSTING
MARGINAL COSTING
ABSORPTION COSTING
Costs considered
Only variable costs are considered for product costing and inventory
valuation.
Both fixed and variable costs are
considered for product costing and inventory valuation.
Judgement about profitability
The Profitability of different products is judged by their P/V ratio.
Each product bears a
reasonable share of fixed cost and thus
the profitability of a product is influenced
by the apportionment of fixed costs.
Impact of Changes in Stock
The difference in the magnitude of opening stock and closing stock does not affect the unit cost of production.
The difference in the magnitude of opening stock and closing stock affects the unit cost of production due to the
impact of related fixed cost.
Cost per unit
In case of marginal costing the cost
per unit remains the same,
irrespective of the production as it is
valued at variable cost
In case of absorption costing the cost per
unit reduces, as the production increases
as it is fixed cost which reduces, whereas,
the variable cost remains the same per
unit.
Is there any difference in respects of profits computed under the two approaches?
The above two approaches will compute the different profit because of the difference in the stock valuation. This difference is explained as follows in different circumstances.
1. No opening and closing stock: In this case, profit / loss under absorption and marginal costing will be equal.
2. When opening stock is equal to closing stock: In this case, profit / loss under two approaches will be equal provided the fixed cost element in both the stocks is same amount.
3. When closing stock is more than opening stock: In other words, when production during a period is more than sales, then profit as per absorption approach will be more than that by marginal approach. The reason behind this difference is that a part of fixed overhead included in closing stock value is carried forward to next accounting period.
4. When opening stock is more than the closing stock: In other words when production is less than the sales, profit shown by marginal costing will be more than that shown by absorption costing. This is because a part of fixed cost from the preceding period is added to the current year’s cost of goods sold in the form of opening stock.
Income Statement under the two approaches
1. Absorption Costing
Sales XXXXX
Production Costs:
Direct material consumed XXXXX
Direct labour cost XXXXX
Variable manufacturing overhead XXXXX
Fixed manufacturing overhead XXXXX
Cost of Production XXXXX
Add: Opening stock of finished goods XXXXX
(Value at cost of previous period’s production)
Less: Closing stock of finished goods XXXXX
(Value at production cost of current period) .
Cost of Goods Sold XXXXX
Add: (or less) Under (or over) absorption of fixed
Manufacturing overhead XXXXX
Add: Selling and distribution costs XXXXX
Administration costs XXXXX
Total Cost XXXXX
Profit (Sales – Total cost) XXXXX
Income Statement (Marginal costing)
Sales XXXXX
Variable manufacturing costs:
– Direct material consumed XXXXX
– Direct labour XXXXX
– Variable manufacturing overhead XXXXX
Cost of Goods Produced XXXXX
Add: Opening stock of finished goods XXXXX
(Value at cost of previous period)
Less: Closing stock of finished goods
(Value at current variable cost XXXXX
Cost of Goods Sold XXXXX
Add: Variable adm., selling and dist. Overhead XXXXX
Total Variable Cost XXXXX
Add: Selling and distribution costs
Contribution (Sales – Total variable costs) XXXXX
Less: Fixed costs (Production, adm., selling and dist.) XXXXX
Net Profit XXXXX
REVISION QUESTION ( MARGINAL V/S ABSORPTION COSTING)
XY Ltd. has a production capacity of 2,00,000 units per year. Normal capacity utilisation is reckoned as 90%. Standard variable production costs are `11 per unit. The fixed costs are
`3,60,000 per year. Variable selling costs are `3 per unit and fixed selling costs are`2,70,000 per year. The unit selling price is `20.
In the year just ended on 30th June, 2006, the production was 1,60,000 units and sales were 1,50,000 units. The closing inventory on 30th June was 20,000 units. The actual variable
production costs for the year were `35,000 higher than the standard.
(i) Calculate the profit for the year
(a) by absorption costing method and
(b) by marginal costing method.
(ii) Explain the difference in the profits.
ANSWER
Profit under absorption costing = 2,59,375
Profit under marginal costing = 2,39,375
Reconciliation of profits
Reasons for Difference in Profit: Rs.
Profit as per absorption costing 2,59,375
Add :Op. stock under –valued in marginal costing
(Rs.1,30,000 – 1,10,000) 20,000
2,79,375
Less :Cl. Stock under –valued in marginal closing
(Rs.2,64,375 – 2,24,375) 40,000
Profit as per marginal costing 2,39,375
IMPORTANT POINTS FOR PRACTICAL QUESTIONS
1. MOS * P/V RATIO = PROFITS
It implies that since the fixed costs have been covered at the level of Break even sales, therefore all contribution on excess sales is simply profit.
2. BREAK EVEN POINT FOR MULTIPRODUCT COMPANY
In units:
BEP = Fixed Costs
Wtd. Average contr. p.u.
In sales or rupees(`) :
BEP = Fixed Costs
wtd. Average p/v ratio
3. When data for 2 years is given in the question, p/v ratio can be computed as follows:
p/v ratio = Change in profit * 100
Change in sales
It is to be kept in mind that Variable cost per unit, contribution per unit and fixed costs should remain constant.
4. Computation of cost Break even point
It is the production level at which production cost is same irrespective of the alternative adopted.
Cost B.E.P. = Difference in fixed costs
Difference in variable costs
5. Step up costs
Such costs change in equal range. Treat step up cost as Fixed cost for Break even point. Find Break even point using hit and trial as shown in the illustration below:
Revision illustration
Fixed cost( other than supervision) = `20000
Supervision charges = one supervisor for every 100 candidates at the rate of `50 per day
Contribution per candidate = `20 per candidate
Find the break even number of candidates assuming supervisor is required for 4 days.
Answer
Break even (excluding supervision) = 20000/20
=1000 candidates
Thus we can conclude that the total break even shall always exceed 1000 candidates.
Supervision charges for candidates between:
? CASE I:
1000-1100 = `(11*200) = `2200
Total fixed cost ( if supervision included)
= `20000 + `2200 = `22200
New BEP = 22200/20 = 1110 candidates ;
Which is not in the range assumed .
? CASE II:
1100-1200 = `(12*200) = `2400
Total fixed cost ( if supervision included)
= `20000 + `2400 = `22400
New BEP = 22400/200 = 1120 candidates;
Which falls in the range assumed and thus BEP
is 1120 candidates.
6. In the decision of setting up a new company or a company for a special product only both fixed and variable costs related to that product are to be considered in make v/s buy decision.
7. In deciding about whether to make or buy a particular component of product, depreciation and fixed costs are irrelevant as they can be allocated on remaining components.
Make v/s Buy costs
Make cost is associated with self manufacturing of the product and buy cost relates to purchasing the product from outside. Manufacturer shall prefer the alternative in which the cost is lower.
Concept of key factor
Key factor or Limiting factor is a factor which at a particular time or over a period limits the activities of an undertaking. It may be the level of demand for the products or services or it may be the shortage of one or more of the productive resources, e.g., labour
hours, available plant capacity, raw material’s availability
Key factor
Basis of evaluation
1. Sales quantity
Contribution per unit
2. Sales volume
Contribution per rupee of sales or p/v ratio
3. Material
Contribution per unit( or kg) of material consumed
4. Labour time
Contribution per labour hour
5. Machine time
Contribution per machine hour
In general:
? Contribution per unit = Contribution per key factor
Key factor
Revision illustration for comprehensive revision of the chapter
A company has fixed cost of Rs. 90,000, Sales Rs. 3,00,000 and Profit of Rs. 60,000.
Required:
(i) Sales volume if in the next period, the company suffered a loss of Rs. 30,000.
(ii) What is the margin of safety for a profit of Rs. 90,000?
Answer
(i) Rs. 1,20,000
(ii) Rs. 1,80,000
Additional problems for practice
Question 1
A company produces single product which sells for Rs. 20 per unit. Variable cost is Rs. 15 per unit and Fixed overhead for the year is Rs. 6,30,000.
Required:
(a) Calculate sales value needed to earn a profit of 10% on sales.
(b) Calculate sales price per unit to bring BEP down to 1,20,000 units.
(c) Calculate margin of safety sales if profit is Rs. 60,000.
Answer
(a) Rs. 42,00,000
(b) Rs.20.25
(c) 25%
Question 2
An Automobile manufacturing company ‘Bharti’ produces different models of cars.
The budget in respect of model 1000 for the month of September, 2011 is as under:
Budgeted output 40,000 units
Variable Costs: (Rs. Lakhs)
Materials 264
Labour 52
Direct expenses 124
Fixed costs:
Specific fixed costs 90.00
Allocated fixed costs 112.50
Total costs 642.50
Add: Profit 57.50
Sales 700.00
Calculate:
(i) Profit with 10% increase in selling price with a 10% reduction in sales volume.
(ii) Volume to be achieved to maintain the original profit after a 10% rise in material costs, at the originally budgeted selling price per unit.
Answer
(i) 94.50 lakhs
(ii) 44521 units
