Marginal costing synopsis

Notes by Prof. M. B. Thakoor

MARGINAL COSTING SYNOPSIS

(1) INTRODUCTION OF IMPORTANT TERMS

1) Marginal Cost 3) Fixed Cost2) Marginal Costing 4) Variable Cost5) Semi Variable / Semi Fixed Cost

(2) TECHNIQUES OF COSTING1) Absorption Costing 2) 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 Limited 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 as 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 Mat. 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 & Admn. 3. Selling & Dis.OH xxx

xxxa) Fixed expenses xxx PROFIT xxxb) Variable expenses xxx xxxCOST OF PRODUCTION xxxAdd: Op. Stock of F.G. xxx

xxxLess: Closing Stock of F.G. xxxCOST OF GOODS SOLD xxxAdd: Selling & Distn.a) Fixed Exp. xxxb) Variable Exp. xxx xxxCOST OF SALE xxxAdd : PROFIT xxxSale xxx



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 Costing

b) 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 Releyant 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.

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 if profit.

The emphasis is on increasing the total contribution.

Sales – Variable Cost = Contribution

Contribution – Fixed Cost = Profit



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.



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 unit

Variable Cost Rs. 3.00 per unit

Fixed Cost Rs. 1.00 per unit

Normal Production 15,000 units

Total 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 1,000

Prepare 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 computer

Particulars 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


Marginal costing synopsis

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