2. Marginal Costing
Marginal Cost is an increase in total cost that results
from a one unit increase in output. It is defined as:
"The cost that results from a one unit change in the
production rate".
Marginal cost comes from the cost of production.
This includes both fixed and variable costs. In the
case of fixed costs, these are only calculated in
marginal cost if these are required to expand
production. Variable costs by contrast are always
included in marginal cost.
3. • For example, the total cost of producing one pen is Rs.5 and the total
cost of producing two pens is Rs.9, then the marginal cost of expanding
output by one unit is Rs.4 only (9 - 5 = 4).
The marginal cost of the second unit is the difference between the total
cost of the second unit and total cost of the first unit. The marginal cost
of the 5th unit is Rs.5. It is the difference between the total cost of the
6th unit and the total cost of the, 5th unit
4. Income Statement of Marginal Costing
Amount
Sales
Less:
Variable production cost:
Direct Material cost
Direct labor cost
Variable Factory overheads
Cost of goods manufactured
Add: Opening Inventory
Cost of goods available for sale
Less: Closing Inventory
Cost of goods sold
Marginal Contribution (Sales- COGS)
Less:
Fixed manufacturing Overhead
Variable selling and administrative expenses
Fixed selling and administrative expenses
Net Income
XX
X
X
XXXXX
XX
XX
XX
XX
XX
xxx
Xx
Xx
Xx
XXXX
5. In first year of business, he produces and sells 10 motorbikes for
Rs.100,000, which cost him Rs.50,000 to make. In his second year, he goes
on to produce and sell 15 motorbikes for Rs.150,000, which cost Rs.75,000
to make.
Change in Total cost= 75000-50000=25000
Change in quantity= 15-10=5
25000/5= Rs.5000
6. BREAK
EVEN POINT
BEP can be defined as the point or sales level
at which profits are zero and there is no loss.
At this point total costs are equal to total sales
revenue.
At the BEP profit being zero, contribution is
equal to the fixed cost.
If the actual volume of sales is higher than the
break-even volume, there will be a profit.
Formula
Break even Sales (Units)= Fixed cost / Contribution margin per
unit
Break Even Sales (Volume)= Fixed Cost / PV ratio
or
= Total fixed expenses / 1-Total variable expenses/Total sales
volume
Cash break even point (Units) = Cash fixed cost / cash
contribution per unit
8. Q.
Selling Price per unit = Rs. 20
Variable cost per unit= Rs 10
Total Fixed cost= Rs. 1,00,000
Find out the BEP.
Solution:
Selling Price per unit = Rs. 20
Less: Variable cost per Unit =Rs. 10
Contribution = Rs. 10
BEP Volume = 1,00,000 / 10
= 10,000 Units
9. Margin of Safety
Margin of safety is difference between sales and the break even point. If
the distance is relatively short, it indicates that a small drop in production
or sales will reduce profits considerably. If the distance is long, it means
that the business can still make profits even after a serious drop in
production.
Margin of Safety = Profit
P/V ratio
Or
Margin of safety = P𝑟𝑜𝑓𝑖𝑡 ÷ 𝑃/𝑉 𝑟𝑎𝑡𝑖𝑜
Sales − 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡
The Profit Volume (P/V) Ratio is the measurement of the rate of change of
profit due to a change in volume of sales.
𝑃𝑉 𝑟𝑎𝑡𝑖𝑜 =
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛
𝑆𝑎𝑙𝑒𝑠
Q. X Ltd has earned contribution of Rs. 2,00,000 and net profit of Rs.
1,50,000 on sales Rs. 8,00,000. What is its margin of safety?
10. Alternative choice decision cover situation with two or more alternative
courses of action from which the manager must select the best
alternatives. A decision involving ore than two alternatives is called multi
alternative choice decision.
Some examples are: make or buy, Add or Drop, own or lease, retain or
replace, now or later etc.
ALTERNATIVE CHOICE DECISION
11. 1.Make or Buy
Make or buy decisions arise when a company with unused production capacity
consider the following alternatives:
a. To buy certain raw materials or subassemblies from outside suppliers .
b. To use available capacity to produce the items within the company.
12. Absorption costing
Absorption costing refers to a method of costing to account for all the
costs of manufacturing. The management uses this method to absorb
the costs incurred on a product. The costs include direct costs and
indirect costs. Direct costs include materials, labour used in
production. Indirect costs include factory rent, administration costs,
compliance, and insurance.
13. • The costs observed under absorption costing include variable costs,
fixed costs, and semi-variable costs. Variable costs increase or decrease
in the proportion of the goods produced. Fixed costs do not alter
irrespective of the quantity of production. Semi-variable costs increase
or decrease in batches.
• Absorption costing is part of accounting methods and procedures.
Absorption costing determines the cost of the inventory at the end of
an accounting period. The closing inventory also consists of fixed costs,
thus increasing the value of the inventory. This method of inventory
valuation increases the profit of the company.
14. Absorption costing—also referred to as “full absorption costing" or "full
costing"—is an accounting method designed to capture all of the costs that go into
manufacturing a specific product. Absorption costing is necessary to file taxes and
issue other official reports. Regardless of whether every manufactured good is
sold, every manufacturing expense is allocated to all products. In other words, the
company’s products absorb all the company’s costs.
Some of these costs include:
Labor: The direct factory labor used to manufacture a product. This cost is directly
associated with wages paid during production.
Raw materials: The materials used to construct a finished product are calculated
as well.
Variable manufacturing overhead: The costs necessary to run a production
facility. They are variable costs because they vary with the volume of production.
Examples of variable manufacturing overhead are electricity, utilities and supplies
used by the manufacturing equipment.
Fixed manufacturing overhead: The costs associated with operating a production
facility that remain fixed, regardless of production volume. Examples include
insurance and rent.
15. How to calculate absorption costing
Here are some steps for calculating and assigning absorption costing:
1. Develop cost pools
First, determine the costs associated with the production of a product and then
assign them to different cost pools. A cost pool groups expenses by activity. You
might group marketing, customer service and research and development into
different cost pools. As you spend money, you will assign costs to the cost pool that
best describes it.
2. Determine usage for each cost
Next, go through every activity and figure out the amount each was used during
production. You will need to determine usage for activities such as the number of
hours spent on labor or equipment usage throughout the manufacturing process.
3. Calculate the costs
Lastly, calculate the allocation rate, which tells you the cost per unit. You can do this
by following this formula:
Absorption cost per unit = (Direct Material Costs + Direct Labor Costs +
Variable Manufacturing Overhead Costs + Fixed Manufacturing Overhead
Costs) / Number of units produced
16. Advantages of Absorption costing
• Accounting for all production costs
• Tracking profits
• Suitable for smaller companies
• Suitable for changing demands
Disadvantages of Absorption costing
• Over-assigning overhead costs
• Overproduction to cut costs
• Incomplete data
• Uninformed profitability
17. Parameters Absorption Costing Marginal Costing
Definition
This method is used for
finding the manufacturing
cost.
This method is used for
finding the total cost
changing.
GAAP Complaint Yes No
Advantages
It takes care of all the
production costs.
It is less complicated.
Disadvantages
It is difficult to compare
the cost of control.
They have long-term
pricing, and they ignore
market pricing
