marginal costing

Why do we study Marginal Costing?

What do we study in Marginal Costing?

Marginal Cost
Marginal Costing
Direct Costing
Absorption Costing
Contribution
Profit Volume Analysis
Limiting Factor/key factor
Break Even Analysis
Profit Volume Chart
What do we study in Marginal Costing?
and
Why do we Study MC?
Marginal Cost
Marginal Costing
Direct Costing
Absorption Costing Management
Contribution Decision
Profit Volume Analysis Making
Limiting Factor/key factor
Break Even Analysis
Profit Volume Chart
 Marginal Cost

“Marginal cost is amount at any given

volume of out put by which aggregate
costs are changed…..

if volume of output
is increased or decreased by one unit”
 Marginal Cost

“Marginal cost is amount at any given 1

volume of out put by which aggregate
costs are changed if volume of output
is increased
inal Cost or decreased by one unit”
100 x150= 15000
Cost = 5000
total 20000

2
1 Manufacture 100 radio
Variable costs Rs150 p u
Fixed cost Rs 5000 Marginal cost 150 x101=15150
2 If Manufacture 101 radios Fixed Cost = 5000
TOTAL 20150
additional Cost=Rs 150
 Marginal Costing

“marginal costing is ascertainment of

marginal cost by differentiating betwee
fixed and variable costs

and of the effect

of changes in volume or type of output
 Marginal Costing

What Could be effects of

Changes

In volume
or
Type of output
 Marginal Costing

What Could be effects of

Changes
1 lakh units
In volume To
2 lakh units
or
Type of output
 Marginal Costing

From One
What Could be effects of Model of
Car to
Changes
Another

In volume
or From One
Type of output Size of
product to
another
 Marginal Costing ---Characteristics

Fixed & Variable Inventory

Costs Valuation

Marginal Costing
MC Costs as
Contribution &
Products Costs
Profit

Fixed Costs as
Pricing
Period Costs
 Marginal Costing ---Characteristics

Segregation Semi-variable costs

Fixed & Variable are segregated
Costs into fixed &
variable
 Marginal Costing ---Characteristics

Marginal Costs Only Variable costs

as are charged
Products Costs to products
 Marginal Costing ---Characteristics

Fixed costs treated

Fixed Costs as Period costs
Period Costs Charged to costing
P & L Account
 Marginal Costing ---Characteristics

WIP & F goods are

Inventory
Valued at
Valuation
Marginal Cost
 Marginal Costing ---Characteristics

Contribution S-V=C

Profitability judged on
Contribution made
 Marginal Costing ---Characteristics

Pricing is based on
Pricing Contribution &
Marginal Costs
 Marginal Costing ---Characteristics

A B C Total

Sales - - - ----
Less VC - - - ----
Marginal Costing
Contribution - - - ----
&
Profit
Fixed Cost ----

Profit -----
 Marginal Costing --- Marginal Costing Profit

Sales of A Sales of B Sales of C

less less less

Marginal cost Marginal cost Marginal cost
Of A Of B Of C
= = =
Contribution of Contribution of Contribution of
A B C

Total
Contribution of
A,B& C
less
Total Fixed = Profit/loss
Cost
 Absorption Costing

“Absorption cost is a total cost technique

Under which total cost ie fixed & variable
is charged to production.

Inventory is also valued at total cost.

Absorption-Marginal Costing--differences

Measurement
Valuation Of
Fixed & Profitability
Variable
Of stock
Costs
Absorption-Marginal Costing--differences

Marginal Costing Absorption Costing

Fixed &
Only variable cost Both F & V Costs
Variable
Are charged
Costs FC charged to P/L
Absorption-Marginal Costing--differences

Valuation
Of stock

WIP & FS
at
Marginal
Total Cost
Cost
 Absorption-Marginal Costing--differences

Measurement
Of
Profitability

C=S-V P=S-V-F
 Comparative Cost Statement

Marginal Costing Absorption Costing

Months Months
4 2 3 Total 4 2 3 Total
Rs Rs Rs Rs Rs Rs Rs Rs

(A)Sales 2,00,000 1,65,000 2,35,000 6,00,000 2,00,000 1,65,000 2,35,000

6,00,000
Opening Stock 84,000 84,000 1,05,000 2,73,000 1,08,000 1,08,500 1,35,625 3,52,625
Add V Cost 1,20,000 1,20,000 1,20,000 3,60,000 1,20,000 1,20,000 120,000 3,60,000
F Cost _ _ _ _ 35,000 35,000 35,000 1,05,000

Total Cost 2,04,000 2,04,000 2,25,000 6,33,000 2,63,000 2,63,000 2,90,625 8,17,625

Less C Stock 84,000 1,05,000 84,000 2,73,000 1,08,000 1,35,625 1,08,500 3,52,625

(B) COGS 1,20,000 99,000 1,41,000 3,60,000 1,55,000 1,27,875 1,82,125 4,65,000

Contribution (A-B)c 80,000 66,000 94,000 2,40,000 _ _ _ _

( D) F Cost 35000 35,000 35,000 1,05,000 _ _ _ _

Profit (C-D) 45,000 31,000 59,000 1,35,000

(A-B)
45,000 37,125 52,875 1,35000
 Comparative Cost Statement

Marginal Costing Absorption Costing

Months Months
4 2 3 Total 4 2 3 Total
Rs Rs Rs Rs Rs Rs Rs Rs

(A)Sales 2,00,000 1,65,000 2,35,000 6,00,000 2,00,000 1,65,000 2,35,000

6,00,000
Opening Stock 84,000 84,000 1,05,000 2,73,000 1,08,000 1,08,500 1,35,625 3,52,625
Add V Cost 1,20,000 1,20,000 1,20,000 3,60,000 1,20,000 1,20,000 120,000 3,60,000
F Cost _ _ _ _ 35,000 35,000 35,000 1,05,000

Total Cost 2,04,000 2,04,000 2,25,000 6,33,000 2,63,000 2,63,000 2,90,625 8,17,625

Less C Stock 84,000 1,05,000 84,000 2,73,000 1,08,000 1,35,625 1,08,500 3,52,625

(B) COGS 1,20,000 99,000 1,41,000 3,60,000 1,55,000 1,27,875 1,82,125 4,65,000

Contribution (A-B)c 80,000 66,000 94,000 2,40,000 _ _ _ _

( D) F Cost 35000 35,000 35,000 1,05,000 _ _ _ _

Profit (C-D) 45,000 31,000 59,000 1,35,000

(A-B)
45,000 37,125 52,875 1,35000
 Comparative Cost Statement

Marginal Costing Absorption Costing

Months Months
4 2 3 Total 4 2 3 Total
Rs Rs Rs Rs Rs Rs Rs Rs

(A)Sales 2,00,000 1,65,000 2,35,000 6,00,000 2,00,000 1,65,000 2,35,000

6,00,000
Opening Stock 84,000 84,000 1,05,000 2,73,000 1,08,000 1,08,500 1,35,625 3,52,625
Add V Cost 1,20,000 1,20,000 1,20,000 3,60,000 1,20,000 1,20,000 120,000 3,60,000
F Cost _ _ _ _ 35,000 35,000 35,000 1,05,000

Total Cost 2,04,000 2,04,000 2,25,000 6,33,000 2,63,000 2,63,000 2,90,625 8,17,625

Less C Stock 84,000 1,05,000 84,000 2,73,000 1,08,000 1,35,625 1,08,500 3,52,625

(B) COGS 1,20,000 99,000 1,41,000 3,60,000 1,55,000 1,27,875 1,82,125 4,65,000

Contribution (A-B)c 80,000 66,000 94,000 2,40,000 _ _ _ _

( D) F Cost 35000 35,000 35,000 1,05,000 _ _ _ _

Profit (C-D) 45,000 31,000 59,000 1,35,000

(A-B)
45,000 37,125 52,875 1,35000
Concept Of Contribution
Contribution is the difference between
sales
And the marginal (Variable) cost
Contribution =sales-variable cost
C= S-V
Contribution = Fixed Cost+ Profit
C= F+P
Therefore
S-V = F+P
Contribution is the difference between
sales
And the marginal (Variable) cost

S-V=F+P

If any 3 factors in the equation are known

The 4th could be found out

P=S-V-F
P=C-F
F=C-P
S=F+P+V
V=S-C……….
 PROFIT ? SALES?
C=S-V
Sales =Rs 12,000
=12,000-7000=5000 S=C+V

V Cost=RS 7,000 P=C-F

=5,000+7,000
F Cost=Rs 4,000 =5,000-4000 =Rs 12,000

=Rs 1,000
 F COST? V Cost?

Sales =Rs 12,000 F=C-P V=S-C

V Cost=RS 7,000
=5,000-1,000 =12,000-5000
F Cost=Rs 4,000 =Rs 7,000
=Rs 4,000
 Profit –Volume Ratio (PV Ratio)
(Expresses the relation of Contribution to sales)

Sales= Rs 10,000

V Cost=Rs 8,000
P/V Ratio =Contribution = C/S =S-V/S
Sales

C = S XP/V Ratio
P/V Ratio=c/s
C
=S-V/S
S = --------
=10,000-8000/10,000
P/V Ratio
=20%
 Profit –Volume Ratio (PV Ratio)

When PV
Ratio is
Given

C= SXPV Ratio

C= 10000X20%
=Rs 20,000
 Profit –Volume Ratio (PV Ratio)

Change in Contribution
P/V Ratio = --------------------------------- Another Method
Change in Sales

Change in profit
= -----------------------
Change in Sales
Year sales net profit

3 20,000 1000
1600-1000
=-------------------x 100
5 22,000 1600
22000-20000

600
= -----------x100=30%
2,0000
What Could be the Uses of PV Ratio?

Break Even Point

Profit at Given Sales

Vol required to earn given Profit

How Improvement in PV Ratio Could be Achieved?

Increasing Selling Price

Reducing Variable Cost

Changing Sales Mix

Limiting Or Key Factor

a factor in short supply

 Limiting Or Key Factor

a factor in the activities of an undertaking

which at a point of time or over a period
will limit the volume of out put
 Limiting Or Key Factor

What Could be the Limiting Factors ?

Labour
Materials
Power
Sales
Capacity
Machines
………….
Cost- Volume- Profit Analysis
Cost- Volume- Profit
Analysis

Cost Of Production

Selling Prices

Volume Produced /Sold

Cost- Volume- Profit
Analysis

Break Even Analysis

Profit Volume Chart

Cost- Volume- Profit
Analysis
Break Even Analysis

A point of no profit no loss

A point where revenue equals cost

What are BEP---assumptions

All costs are fixed or variable

VC remains Constant
Total FC remains Constant
Selling Price don’t change With Volume
Synchronisation of Prod & Sales
 No Change in Productivity per workers
Cost- Volume- Profit
Analysis
Break Even Analysis

Methods

Algebraic Method

Graphic Method
 Cost- Volume- Profit
Analysis ALGEBRAIC
Fixed Cost METHOD
BEP (Units) = --------------- = F
Contribution PU S-V

Fixed Cost
BEP (Rs ) = ----------------- x Sales
Contribution

Fixed Cost
BEP (Rs) = ------------------
P/V Ratio
 Cost- Volume- Profit
Analysis ALGEBRAIC
Fixed Cost METHOD
BEP (Units) = --------------- = F
Contribution PU S-V

Fixed Cost
BEP (Rs ) = ----------------- x Sales
Contribution
F Cost=Rs 12000
Fixed Cost S Price=Rs12 pu
BEP (Rs) = ------------------ V Cost =Rs 9 pu
P/V Ratio
Find BEP
 Cost- Volume- Profit
Analysis
F Cost=Rs 12000
Other Uses S Price=Rs12 pu
V Cost =Rs 9 pu

Profit when sales are

Profit at diff. Sales Vol. g) Rs 60,000

h) Rs 1,00,000

Sales at Desired Profit

 Cost- Volume- Profit
Analysis
F Cost=Rs 12000
S Price=Rs12 pu
Profit at diff. Sales Vol. V Cost =Rs 9 pu

Profit when sales are

C
P/V Ratio= ----- = 3/12=25% g) Rs 60,000
S h) Rs 1,00,000

WHEN SALES=Rs 60,000

contribution=salesxp/vratio
=60000x25%
=Rs 15000
Profit =contribution-fixed cost
=15000-12000
=Rs3000
 Cost- Volume- Profit
Analysis
Other Uses F Cost=Rs 12000
S Price=Rs12 pu
V Cost =Rs 9 pu

Sales at Desired Profit Sales if desired profit

f) Rs 6000
g) Rs 15,000

F Cost +Desired Profit

Sales= -------------------------------
P/V Ratio
 Cost- Volume- Profit
Analysis
Sales at Desired Profit F Cost=Rs 12000
S Price=Rs12 pu
V Cost =Rs 9 pu
F Cost +Desired Profit
Sales= ------------------------------- Sales if desired profit
P/V Ratio f) Rs 6000
g) Rs 15,000

12,000+6000
a)Sales= ---------------
25%

=Rs 72,000
 CVP Analysis -question

P ltd has earned a profit of Rs 1.80 lakh on sales of

Rs 30 lakhs and V Cost of Rs 21 lakhs.
work out

a)BEP
b)BEP When V Cost decreases by5%
c)BEP at present level when selling price reduced by5%
CVP Analysis -

S-V
P/V Ratio=--------
S
3000000-2100000
= ------------------------
3000000
=30%
Sales =VC+FC+P
3000000=2100000+FC+180000
FC =Rs 720000
7,20,000
BEP= -------------
30%

=Rs 2400000
CVP Analysis -question

b) When V Cost increases by 5%

New Variable Cost=2100000+5%

=22,05,000

PV Ratio 3000000-2205000
3000000
=26.5%

BEP =7,20,000/ 26.5%

=Rs 27,16,981
 CVP Analysis -question

c)When Selling Price reduced by 5%

New SP=3000000—5%
=Rs 28,50,000

Contribution=28,50,000-21,00,000
=Rs7,50,000

PV Ratio =7500000/2850000
=26.32%

FC+PROFIT
Desired Sales= ------------------ =
720000+1800000
PV Ratio 26.32%

=Rs 34,19,453( appx)

 BEP

Graphical Presentation
 Break-Even Analysis
Costs/Revenu
e Initially a firm
will incur fixed
costs, these do
not depend on
output or sales.

FC

Q1 Output/Sales
 Break-Even Analysis
The Break-even
Total revenue point
is
As
The output
lower
Initially is
a by the
firm
The
occurs total
where
determined coststotalthe
Costs/Revenu generated,
price, the
the less
TR TR TC will
revenue
therefore
price
firm
incur
equals
charged
will
fixed
incur
total
and
e VC costscosts,
steep –
(assuming
the the these
firm,
thecosts
quantity do
total
soldin –
variable
this not depend
example on
would –
again
accurate
revenue
these this
vary will
curve. be
directly
have output
to sell
determined orQ1sales.
to
bythe
forecasts!)
with
generate the is
amount
sufficient
expected
sum of
produced forecast
FC+VC
revenue
sales initially. its
to cover
costs.

FC

Q1 Output/Sales
 Break-Even Analysis
Costs/Revenue If the firm chose
TR TR TC to set price higher
VC than Rs2 (say
Rs3) the TR curve
would be steeper
– they would not
have to sell as
many units to
break even

FC

Q2 Q1 Output/Sales
 Break-Even Analysis
TR)
Costs/Revenue If the firm chose
TR
TC VC
to set prices lower
it would need to
sell more units
before covering
its costs

FC

Q1 Q3 Output/Sales
 Break-Even Analysis
TR
Costs/Revenue TC
Profit VC

Loss
FC

Q1 Output/Sales
 Break-Even Analysis
Margin of
TR TR
TC safety shows
Costs/Revenue A far
how higher
sales can
VC price
fall would
before losses
Assume
made. If Q1
lower the=
current
1000 and Q2 sales
=
break
1800,
even
at Q2sales could
point
fall by 800and the
units
margin
before a lossof
would
safetybe made
would
widen
Margin of Safety
FC

Q3 Q1 Q2 Output/Sales
 High initial FC.
Interest on debt
rises each year –
Costs/Revenue FC rise therefore
FC 1

FC
Losses get
bigger!
TR
VC

Output/Sales
 Break-Even Analysis

• Remember:
• A higher price or lower price does not
mean that break even will never be
reached!

• The BE point depends on the sales

needed to generate revenue to cover
costs
 Break-Even Analysis

• Importance of Price Elasticity of Demand:

• Higher prices might mean fewer sales to break-

even

• Lower prices might encourage more customers

but higher volume needed before sufficient
revenue generated to break-even
 Break-Even Analysis
• Links of BE to pricing strategies and
elasticity

• Penetration pricing – ‘high’ volume, ‘low’ price –

more sales to break even
 Break-Even Analysis
• Links of BE to pricing strategies and
elasticity

• Market Skimming – ‘high’ price ‘low’ volumes –

fewer sales to break even
 Break-Even Analysis
• Links of BE to pricing strategies and
elasticity

• Elasticity – what is likely to happen to sales

when prices are increased or decreased?
 Marginal Costing
Cost Volume Chart
 Construction Of PV Chart

1 select a scale on Horizontal axis---sales

2 Select a scale on Vertical axis- FC & Profit

3 Plot FC & Profit

4 Diagonal line crosses sales line at BEP

PV Chart Information

Fixed Cost =Rs 5000

Sales =Rs 20000(pu RS 20)
V Cost= Rs 10000(pu Rs10)

Find
PV Ratio, BEP, Profit?
 Construction Of PV Chart

8000

6000
BEP 5000
4000

2000
Fixed Cost
Rs
Profit
0 5000 10000 15000 20000 Rs
Sales Rs
2000

4000
5000
6000

8000
 Construction Of PV Chart

8000

6000
BEP 5000
4000

2000
Profit
Fixed Cost
Area Profit
Rs
0 5000 10000 15000 20000 Rs
Sales Rs
Loss
2000
Area
4000 Margin of Safety
5000
6000
--------------------------
8000
 Effect Of Change in Profit- 20% decrease in fixed Cost

New F Cost= 5000- 20%=Rs4000

Fixed Cost
New BEP = PV Ratio
= 4000/50%
=Rs 8000
New Profit=S-F-V
=20000-4000-10000
=Rs 6000
 Effect of Change in profit- 20% decrease in FC

8000
6000

BEP 5000
4000

2000
Profit
Fixed Cost
Area Profit
Rs
0 5000 10000 15000 20000 Rs
Sales Rs
Loss
2000
Area
4000
5000
6000

8000
 Effect Of Change in Profit- 10% decrease in V Cost

New V Cost= 10000- 10%=Rs9000

New PV Ratio=20000-9000 =55%
20000

Fixed Cost
New BEP = PV Ratio
= 5000/55%
=Rs 9090 Appx
New Profit=S-F-V
=20000-5000-9000
=Rs 6000
 Construction Of PV Chart

8000
6000
New BEP
5000
4000

2000
Profit
Fixed Cost
Area Profit
Rs
0 5000 10000 15000 20000 Rs
Sales Rs
Loss
2000
Area
4000
5000
6000

8000
 Effect Of 5% Decrease in Selling Price

8000
6000

5000
4000

2000
Profit
Fixed Cost
Area Profit
Rs
0 5000 10000 15000 20000 Rs
Sales Rs
Loss
2000
Area
4000
5000
6000
e w BEP
N
8000