Marginal costing synopsis notes

Notes by Prof. M. B. Thakoor

MARGINAL COSTINGSYNOPSIS

(1) INTRODUCTION OF IMPORTANT TERMS1) Marginal Cost2) Marginal Costing3) Fixed Cost4) Variable Cost5) Semi Variable / Semi Fixed Cost

(2) TECHNIQUES OF COSTING1) Absorption Costing2) Marginal Costing

(3) CONCEPT OF BREAK EVEN POINT

(4) CONCEPT OF PROFIT VOLUME RATIO

(5) PRACTICAL APPLICATIONS OF MARGINAL COSTING TECHNIQUES1) Pricing of Product2) Make or buy decision3) Operate or shutdown4) Decision of Product Mix5) Key or Limiting Factor

a) Labour Shortageb) Material Shortagec) Machine Capacity constraint

(Capacity Utilisation)

(6) PROFIT PLANNING

(7) EXPANSION AND DIVERSIFICATION

(8) ACCEPT, REJECT SPECIAL OFFER AND SUBCONTRACTING.

(1) Notes by Prof. M. B. Thakoor


Marginal Costing also known as Direct Costing or Variable Costing. The

word Marginal Costing is common in the U.K. and other Countries of the

Continent, while the expression “Direct Costing” or “Variable Costing” is

preferred in the U.S.A.

“Marginal Cost” is derived from the word “Margin” and is well known

concept of Economic theory. Thus quite in the Economic Connotation of the

term, it is described in simple words as “the cost which arises from the production

of additional increment of output and it does not arise in case the additional

increments are not produced.”

"The amount at given volume of output by which aggregate cost are

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

Marginal Costing is the ascertainment of Marginal Cost by differentiating

the cost between fixed cost and variable cost and finding its effect on the profit of

changes in volume or type of output.

Marginal Costing necessitates Analysis of cost into fixed and variable.

Even semi variable costs have to be closely and critically analysed into Fixed and

variable.

INTRODUCTION:

“Marginal Cost” is derived from the word “Margin” and is well known concept of

Economic theory. Thus quite in tune with the Economic connotation of the term, it is

described in simple words as “Cost which arises from the production of additional

increment of output and it does not arrive in case the additional increments are not

produced.”

Q.1 What is Marginal Cost?

A. Marginal Cost is the amount at any given volume of output by which the

aggregate cost change, if the output is increased or decreased by 1 unit.



Q.2 What is Marginal Costing?

A. Marginal Costing is a technique of costing which ascertains the effect of change in

volume on the profits of the company, by dividing the cost into fixed and variable.

Q.3 What is Fixed Cost?

A. Fixed Cost is a cost which remains fixed irrespective of the level of production.

Fixed Cost remain fix in total but changes per unit.

Q.4 What is Variable Cost?

A. Variable Cost is a cost which varies as per the level of production. Variable Cost

remain fixed per unit but it varies in total.

Q.5 What is Semi-Fixed / Semi-Variable Cost?

A. Semi-Fixed / Semi-Variable Cost are basically fixed cost upto a certain level of

activity specified and they vary after certain level.

Ex. Maintenance expenditure to a certain level is fixed if production do not

fluctuate widely. And if production rises beyond a fixed limit additional

maintenance expenditure is required though such additional expense may not vary

directly with production. Eg. Telephone Expenses.

Q.6 What is the basic theme of Marginal Costing ?

A. The concept of Marginal Costing is based on the important distinction between

product cost which is related to volume of production and period cost which is

related to period of time and not volume of production.

This it is based on making a distinction of cost into variable and fixed.



TECHNIQUES OF COSTING

ABSORPTION COSTING MARGINAL COSTING

1. FORMAT OF STATEMENTCost Statement / Cost Sheet

for the year endedMarginal Cost Statement

Raw Material Cost xxx Sales Revenue xxxAdd: Direct Labour Less: Variable Cost of Goods

SoldAdd: Direct Expenses xxx 1. Direct Material xxxPRIME COST xxx 2. Direct labour xxxAdd: Works Overhead xxx 3.Direct Expenses xxxGROSS WORKS COST xxx 4. Variable Fy. OH

(if any) xxxAdd: Opening W.I.P. xxx 5. Variable Admn. OH (if

any) xxxxxx 6.Variable S/D. OH xxx xxx

Less: Closing W.I.P. xxx CONTRIBUTION xxxxxx Less: Fixed Cost

Less: Sale of Scrap xxx 1. Factory OH. xxxNET WORKS COST xxx 2.Office & Admn. xxxAdd: Office & Administration overheads

3. Selling & Dis.OH xxxxxx

a) Fixed expenses xxx PROFIT xxxb) Variable expenses xxx xxxCOST OF PRODUCTION OR COST OF GOODS PRODUCED

xxx

Add: Op. Stock of F.G. xxxxxx

Less: Closing Stock of F.G. xxxCOST OF GOODS PRODUCED AND SOLD

xxx

Add: Selling & Distribution overheadsa) Fixed Exp. Xxxb) Variable Exp. Xxx xxxCOST OF SALE xxxAdd : PROFIT xxxSale xxx



ABSORPTION COSTING MARGINAL COSTING

2. DATA PRESENTATIONData is presented in the form of Vertical Statement. One of them being Cost Sheet where Net Profit of each product is determined after subtracting Fixed Cost along with the Variable Cost.

The Simple principle used = Cost + Profit = Selling price

Data is presented in the form of vertical statement known as Marginal Cost Statement where the cost data presented highlights the contribution of each product and the fixed cost is deducted from the total contribution to get profit.

The Simple principal used = Sales – Cost = Profit.

3. TYPE OF COSTBoth Fixed and Variable Cost are considered to find the cost of the product.

Only Variable Costs are considered for finding the Marginal Cost.

4. INVENTORY VALUATIONUnder Absorption Costing Inventory is valued at Factory Cost which include factory overheads both Fixed and Variable. A part of production overhead is therefore carried to the next accounting period along with W.I.P. and finished goods.

Under Marginal Costing inventory is valued at Variable Cost and no part of Fixed Cost is applied to the inventory.

5.IMPACT OF INVENTORY VALUATION ON PROFITa) No opening and no closing stock i.e. Production = Sale Profit is same as Marginal Costing. Profit is same as absorption Costingb) When Closing Stock is more than Opening Stock.Profit will be more than Marginal Costing Profit will be less than Absorption

Costing.Logic: Because Under Absorption Costing a portion of fixed cost is charged to the closing stock and the same is deducted from cost so cost decreases hence profit increases.c) When Closing Stock is less than Opening Stock.Profit will be less than Marginal Costing Profit will be more than Absorption

Costing.Logic: Under Absorption Costing a portion of fixed cost is charged to opening stock which is added to cost and its impact is greater than closing stock. So cost increases and profit decreases of the Business organizations.

6. AID IN DECISION MAKINGAs both Fixed are variable cost are considered and it do not recognize the difference between Fixed Cost and Variable Cost it do elaborately explain past profit / losses but do not help when it comes to tomorrows result. It considers all cost are Relevant Cost.

As it classify cost as per variability it do help in decision making considering the Relevance of certain cost and irrelevance of certain cost.



RECONCILIATION OF RESULTS OF ABSORPTION COSTING AND

MARGINAL COSTING

When results of Absorption Costing and Marginal Costing are compared it is necessary to

make adjustments for under absorbed overhead and / or over Absorbed overheads.

Because under absorption costing fixed overhead rate is predetermined based on normal

level of activity.

When actual activity level is different from normal activity level, a situation of under

absorption or over absorption of fixed cost arises.

(1) Under Absorbed = Normal Prod. – Actual Prod X Fixed Overhead

Fixed Overhead Level Level rate per unit

The above amount is reduced from profit under Absorption Costing or the above amount is added to the cost under Absorption Costing before comparing profit with Marginal Costing.

(2) Over Absorbed = Actual Prod. – Normal Prod X Fixed Overhead

Fixed Overhead Level Level rate per unit

The above amount is added to profit under Absorption Costing or the above amount is deducted from the cost of production under absorption costing before comparing profit with Marginal Costing.

Conclusion:

Process of Marginal Costing

First find the difference between sale and variable cost i.e. Excess of sale over variable

cost and this difference is known as contribution. The excess of contribution over Fixed

Cost is profit. The emphasis is on increasing the total contribution.

Sales – Variable Cost = Contribution

Contribution – Fixed Cost = Profit



Problems:

Q.1: Following cost data is given for a production of N & Co. Ltd.

Particulars Per Unit (Rs.)Sale Price 10Variable Cost 6Fixed Cost 2Normal Production 26,000 units

Following additional data are given for the four consecutive periods.

Particulars Period I (Units)

Period II (Units)

Period III (Units)

Period IV (Units)

Opening Stock - - 6,000 2,000Production 26,000 30,000 24,000 30,000Sales 26,000 24,000 28,000 32,000Closing Stock 6,000 2,000 -Prepare a statement showing the profit for different period under both Marginal Costing Method and Absorption Costing Method.

Q.2: Sale Price Rs. 5.00 per unitVariable Cost Rs. 3.00 per unitFixed Cost Rs. 1.00 per unitNormal Production 15,000 unitsTotal Fixed Cost for the year Rs. 15,000

Following statement shows the position of opening and closing stock.

Particulars Period I (Units) Period II (Units)Opening Stock - 3,000Production 17,000 14,000Sale 14,000 16,000Closing Stock 3,000 1,000Prepare statement showing the figure of comparative profit by both the methods, Marginal Costing method and Absorption Costing Method.

Q.3: The data below relate to Venus Ltd. Which makes and sell computerParticulars March April

Sales 5,000 Units 10,000 Units

Production 10,000 Units 5,000 Units

Sale Price per unit Rs. 100 Rs. 100

Variable cost per unit Rs. 50 Rs. 50

Fixed Production Overheads incurred Rs. 1,00,000 Rs. 1,00,000



Fixed Production overheads cost per unit being the predetermined overhead Absorption rate

Rs. 10 Rs. 10

Administration, Selling and Distribution Overheads (Fixed)

Rs. 50,000 Rs. 50,000

You are required to prepare comparative profit statement for each month using

(1) Absorption Costing (2) Marginal Costing

Steps for Problems i.e. Q.1. Q.2. Q.3.

(I) Find the Units sold by the following formula

Quarter I (Units)

Quarter II (Units)

Quarter III (Units)

Quarter IV (Units)

Opening Stock XXX XXX XXX XXX

Add: Production XXX XXX XXX XXX

XXX XXX XXX XXX

Less: Closing Stock XXX XXX XXX XXX

Units Sold XXX XXX XXX XXX

(II) Under Absorption Costing:

Quarter I (Units)

Quarter II (Units)

Quarter III (Units)

Quarter IV (Units)

Sales (Units Sold X S.P.) XXX XXX XXX XXX

Less: 1. Variable Cost (Units Sold x V.C. Per Unit)

XXX XXX XXX XXX

2. Fixed Cost(Units Sold x F.C. Per Unit)

XXX XXX XXX XXX

Profit [Sale – (V.C. + F.C.)] XXX XXX XXX XXX

Add: Over absorption(Actual Prodn. – Normal Prodn.) X Overhead rate

XXX XXX

XXX XXX XXX XXX

Less: Under Absorption(Normal Prodn. – Actual Prodn.) X Overhead rate

XXX XXX

Final Profit XXX XXX XXX XXX

(III) Under Marginal Costing

Quarter I (Units)

Quarter II (Units)

Quarter III (Units)

Quarter IV (Units)

Sales (Units Sold X S.P.) XXX XXX XXX XXX

Less: Variable Cost (Units Sold x V.C. Per Unit)

XXX XXX XXX XXX



Contribution XXX XXX XXX XXX

Less: Fixed Cost(For Normal Prodn. Or Fixed Amount Given but not the absorption rate)

XXX XXX XXX XXX

Profit XXX XXX XXX XXX

RECONCILIATION

Quarter I (Units)

Quarter II (Units)

Quarter III (Units)

Quarter IV (Units)

Profit XXX XXX XXX XXX

Under Absorption Costing XXX XXX XXX XXX

Under Marginal Costing XXX XXX XXX XXX

For Reconciliation

Take for Each year

(Closing Stock – Opening Stock) X Predetermined Overhead Rates

If Closing Stock > Opening Stock it will be positive and to that extent profit will be more in ABSORPTION COSTING.

If (Closing Stock – Opening Stock) X Predetermined Overhead Rate

If Closing Stock < Opening Stock it will be negative and to that extent profit will be less in Absorption Costing (or More in Marginal Costing)



Marginal Costing

Q. 1 What is Marginal Cost?

Ans. Marginal Cost is the amount at any given volume of output by which the

aggregate cost change, if the output is increased or decreased by 1 unit.

Q. 2 What is Marginal Costing?

Ans. Marginal Costing is a technique of costing which ascertains the effect of change

in volume on the profits of the company, by dividing the cost into fixed and

variable.

Q. 3 What is Fixed Cost?

Ans. Fixed cost is a cost which remains fixed irrespective of the level of production.

Fixed cost remain fix in total but changes per unit.

Q. 4 What is Variable Cost?

Ans. Variable cost is a cost which varies as per the level of production variable cost

per unit always remain the same.

MARGINAL COST STATEMENTSales xxxLess : Variable Cost xxx

----Contribution xxxLess : Fixed Cost xxx

-----Profit xxx

===

Sales : Variable cost = Contribution

Contribution – Fixed Cost = Profit

Contribution = Fixed Cost + Profit

Contribution = Sales Price – Variable Cost

Or Contribution = Fixed Cost + Profit



Q.5 What is Break Even Point?Ans. Break Even Point is a point where the company or Business earns no profit or

incurs no loss. It is the point where the sale revenue = Total Cost or A point of

no profit no loss.

Fixed Cost Break Even Point (in Units) = ----------------

Contribution per unit

Fixed CostBreak Even Point (in Rupees) = --------------

P/V. Ratio

Q.6 What is Profit Volume Ratio or P/V. Ratio ?

Ans. This Ratio expresses the relationship between Contribution and Sales. It is

expressed as a % and indicates the relative profitability of different product.

CP/V Ratio = ---- x 100

S

Sales – V. C. OR ----- ---------- x 100

Sales

F.C. + ProfitOR = --------------- x 100

Sales

The higher the P/V. Ratio the more profitable is the product.

Q. 7 What is Margin of Safety (M/S) ?

Ans. Margin of Safety is the excess of Actual Sale over Break Even Sales

Margin Safety = Actual Sale – Break Even Sale

Larger the Marginal Sale more sound is the business.


Marginal costing synopsis notes

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