Marginal Costing

Marginal Costing and Absorption CostingThere are mainly two techniques of

determining cost and profit:-Marginal CostingAbsorption Costing

These are not methods of costing like job costing or process costing.

Marginal Costing:CIMA defines marginal costing as “the

accounting system in which variable costs are charged to the cost units and fixed costs of the period are written-off in full against the aggregate contribution.

ABSORPTION COSTING Absorption costing is a costing technique,

which does not recognise the difference between fixed costs and variable costs, all the manufacturing costs are absorbed in the cost of the products produced.Absorption costing is a traditional approach and is also known as ‘Conventional Costing’.

Characteristics of Marginal CostingSegregation of Costs into fixed and variable

elements.Marginal Costs as products costs.Fixed costs as period costs.Valuation of inventory(on the basis of

variable manufacturing cost only)Contribution (sales – variable cost ).

Variable CostsVariable costs are costs such as raw

materials, direct labor, direct expenses and energy, commission on sales units etc, that vary or change directly with the amount of product produced and sold.

Differences between Marginal Costing and Absorption CostingMarginal costing differs from absorption

costing on the ground of difference in valuation of closing stock. Marginal costing techniques values closing stock at marginal cost where as it is valued at total cost of production in absorption costing techniques.

Uses of Marginal Costing in Decision making:

Helps in Fixation of selling price Helps in selecting a suitable produce mix for

maximum profit. Determining Break – Even point. Choosing from the available alternative

method of production the one which gives highest contribution or contribution per limiting factor.

Make or buy decision on the basis of higher contribution

Taking a decision as regard to adding a new product in the market.

Decisions Based on Marginal CostingTo plan their operations, manufacturing firms

must decide:How many units they expect to sellHow many units to produceHow much to spend to produce and sell these

unitsAt what price they must sell the units to make

the profit they wantTo make these decisions, firms may calculate

the break-even point.

Break-Even PointThe break-even point is the point at which

income from sales equals the total cost of producing and selling goods.

It is the point at which the business will neither make a profit nor suffer a loss.

When sales exceed the break-even point, there is a profit.

When sales are less than the break-even point, there is a loss.

Finding the Break-Even PointTo find the break-even point, you need to

know three things:Fixed costs for manufacturing the productVariable costs for manufacturing each unit of

the productExpected selling price of each unit of the

product

Break-Even Point in Rs.= Break-Even Point in Units × Sales Price per Unit

orFixed cost P/V ratio

Break Even point in unitsBreak Even point in units

= Fixed Cost Contribution per unit

Marginal cost equation

S – V = F ± P Where S = Sales V = Variable cost

F = Fixed cost P = profit

Break-Even (or cost volume profit) Analysis It establishes the relationship of costs,

volume and profit in broader sense break even analysis is one which determines the profit earned at any point or level of output. In narrow sense it is to determine the break even point (no-profit, no-loss) from where profits accrue.

Contribution and P/V ratio

Contribution - The amount contributed towards fixed expenses and profit i.e., sales less variable cost.

Profit / Volume ration (P/V Ratio) - Studies the profitability of operations of a business and establishes the relationship between contribution and sales.

To improve the P/V

- Reduce variable costs - Increase the selling price - Produce products having higher P/V ratio

Margin of Safety It is the level of sale over and above the

break even point.MoS = Sales - BEP

decrease in selling price results in Reduction in sales volume Reduction in contribution Reduction in P/V ratio Increase in break-even sales volume Shortening of margin of safety

List of Formulae:

1) Variable expenses per unit = change in cost

change in output 2) Marginal cost equation Sales – Variable Cost = Fixed cost ± profit /loss

3) Contribution = Sales – variable cost. 4) P/V ratio = contribution ( x 100 if or

percentage)

sales

Continue5) Variable Cost = Sales x (1- P/V ratio) 6) Profit = (Sales x P/V ratio) – Fixed cost 7) Sales to earn desired profit =

Fixed expenses + Desired profit Selling price per unit – Variable cost per unit

Continue10) Margin of safety = Actual sales – Break

Even sales or profit

P/V ratio 11) P/V ratio =

change in profit ( x 100 for %)

change in sales

Break Even Chart:

It provides pictorial view of the relationship between costs, volume & profit, it shows the Break even points and also indicates the estimated profit / loss at various levels of output. Break – Even chart is a point at which the total cost line and the total sales line intersect. Profit volume chart:

It represent profit volume relationship, it shows profit/loss at different volumes of sales