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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
Contribution
Profit Volume Analysis
Limiting Factor/key factor
Break Even Analysis
Profit Volume Chart
Management
Decision
Making

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
volume of out put by which aggregate
costs are changed if volume of output
is increased or decreased by one unit”
1 Manufacture 100 radio
Variable costs Rs150 p u
Fixed cost Rs 5000
2 If Manufacture 101 radios
inal Cost 100 x150= 15000
Cost = 5000
total 20000
Marginal cost 150 x101=15150
Fixed Cost = 5000
TOTAL 20150
1
2
additional Cost=Rs 150

Marginal Costing
“marginal costing is ascertainment ofmarginal costing is ascertainment of
marginal cost by differentiating betweenmarginal cost by differentiating between
fixedfixed andand variablevariable costscosts
and of theand of the effecteffect
ofof changes in volumechanges in volume or type of outputor type of output””

Marginal Costing
What Could be effects ofWhat Could be effects of
ChangesChanges
In volumeIn volume
oror
Type of outputType of output

Marginal Costing
ChangesChanges
In volumeIn volume
oror
1 lakh units
To
2 lakh units

Marginal Costing
ChangesChanges
In volumeIn volume
oror
From One
Model of
Car to
Another
From One
Size of
product to
another

Marginal Costing ---Characteristics
Fixed & Variable
Costs
MC Costs as
Products Costs
Fixed Costs as
Period Costs
Inventory
Valuation
Contribution
Pricing
Marginal Costing
&
Profit

Segregation
Fixed & Variable
Costs
Semi-variable costs
are segregated
into fixed &
variable
Semi-variable costs
are segregated
into fixed &
variable

Marginal Costs
as
Products Costs
Only Variable costs
are charged
to products
Only Variable costs
are charged
to products

Fixed Costs as
Period Costs
Fixed costs treated
Period costs
Charged to costing
P & L Account
Fixed costs treated
Period costs
Charged to costing
P & L Account

Inventory
Valuation
WIP & F goods are
Valued at
Marginal Cost
WIP & F goods are
Valued at
Marginal Cost

Contribution
S-V=C
Profitability judged on
Contribution made
S-V=C
Profitability judged on
Contribution made

Pricing
Pricing is based on
Contribution &
Marginal Costs
Pricing is based on
Contribution &
Marginal Costs

Marginal Costing
&
Profit
A B C Total
Sales - - - ----
Less VC - - - ----
Contribution - - - ----
Fixed Cost ----
Profit -----

Marginal Costing --- Marginal Costing Profit
Sales of A
Marginal cost
Of A
Contribution of
A
Total
Contribution of
A,B& C
Total Fixed
Cost
Sales of B
Marginal cost
Of B
Contribution of
B
Sales of C
Marginal cost
Of C
Contribution of
C
less
=
less less
= =
less
= Profit/loss

Absorption Costing
“Absorption cost is a total cost techniqueAbsorption cost is a total cost technique
Under which total cost i.e.Under which total cost i.e. fixed & variablefixed & variable
is charged to production.is charged to production.
Inventory is also valued at total cost.Inventory is also valued at total cost.

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

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

Valuation
Of stock
WIP & FS
at
Marginal
Cost
Total Cost

Measurement
Of
Profitability
C=S-V P=S-V-F

Marginal Costing
Months
1 2 3 Total
Rs Rs Rs Rs
Absorption Costing
Months
1 2 3 Total
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
Months
1 2 3 Total
Rs Rs Rs Rs
Absorption Costing
Months
1 2 3 Total
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

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……….

Sales =Rs 12,000
V Cost=RS 7,000
F Cost=Rs 4,000
C=S-V
=12,000-7000=5000
P=C-F
=5,000-4000
=Rs 1,000
PROFIT ?
S=C+V
=5,000+7,000
=Rs 12,000
SALES?

Sales =Rs 12,000
V Cost=RS 7,000
F Cost=Rs 4,000
F=C-P
=5,000-1,000
=Rs 4,000
F COST?
V=S-C
=12,000-5000
=Rs 7,000
V Cost?

Profit –Volume Ratio (PV Ratio)
(Expresses the relation of Contribution to sales)
P/V Ratio =Contribution = C/S =S-V/S
Sales
C = S XP/V Ratio
C
S = --------
P/V Ratio
Sales= Rs 10,000
V Cost=Rs 8,000
P/V Ratio=c/s
=S-V/S
=10,000-8000/10,000
=20%

When PV
Ratio is
Given
C= SXPV Ratio
C= 10000X20%
=Rs 20,000

Another Method
Change in Contribution
P/V Ratio = ---------------------------------
Change in Sales
Change in profit
= -----------------------
Change in Sales
1600-1000
=-------------------x 100
22000-20000
600
= -----------x100=30%
2,0000
Year sales net profit
2005 20,000 1000
2006 22,000 1600

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

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

What Could be the Limiting Factors ?
Labour
Materials
Power
Sales
Capacity
Machines
………….

Cost- Volume- Profit
Analysis
Cost Of Production
Selling Prices
Volume Produced /Sold

Analysis
Break Even Analysis
Profit Volume Chart

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

Analysis
Break Even Analysis
Methods
Algebraic Method
Graphic Method

Analysis ALGEBRAIC
METHODFixed Cost
BEP (Units) = --------------- = F
Contribution PU S-V
Fixed Cost
BEP (Rs ) = ----------------- x Sales
Contribution
Fixed Cost
BEP (Rs) = ------------------
P/V Ratio

Analysis ALGEBRAIC
METHODFixed Cost
BEP (Units) = --------------- = F
Contribution PU S-V
Fixed Cost
BEP (Rs ) = ----------------- x Sales
Contribution
Fixed Cost
BEP (Rs) = ------------------
P/V Ratio
F Cost=Rs 12000
S Price=Rs12 pu
V Cost =Rs 9 pu
Find BEP

Analysis
Other Uses
Profit at diff. Sales Vol.
Sales at Desired Profit
F Cost=Rs 12000
S Price=Rs12 pu
V Cost =Rs 9 pu
Profit when sales are
a) Rs 60,000
b) Rs 1,00,000

Analysis
Profit at diff. Sales Vol.
C
P/V Ratio= ----- = 3/12=25%
S
WHEN SALES=Rs 60,000
contribution=salesxp/vratio
=60000x25%
=Rs 15000
Profit =contribution-fixed cost
=15000-12000
=Rs3000
F Cost=Rs 12000
S Price=Rs12 pu
V Cost =Rs 9 pu
Profit when sales are
a) Rs 60,000
b) Rs 1,00,000

Analysis
Other Uses
F Cost +Desired Profit
Sales= -------------------------------
P/V Ratio
F Cost=Rs 12000
S Price=Rs12 pu
V Cost =Rs 9 pu
Sales if desired profit
a) Rs 6000
b) Rs 15,000

Analysis
F Cost +Desired Profit
Sales= -------------------------------
P/V Ratio
12,000+6000
a)Sales= ---------------
25%
=Rs 72,000
F Cost=Rs 12000
S Price=Rs12 pu
V Cost =Rs 9 pu
Sales if desired profit
a) Rs 6000
b) Rs 15,000

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

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

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)

Break-Even Analysis
Costs/Revenu
e
Output/Sales
Initially a firm
will incur fixed
costs, these do
not depend on
output or sales.
FC
Q1

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

Break-Even Analysis
Costs/Revenue
Output/Sales
FC
VC
TCTR
Q1
If the firm chose
to set price higher
than Rs2 (say
Rs3) the TR curve
would be steeper
– they would not
have to sell as
many units to
break even
TR
Q2

Break-Even Analysis
Costs/Revenue
Output/Sales
FC
VC
TCTR
Q1
If the firm chose
to set prices lower
it would need to
sell more units
before covering
its costs
TR)
Q3

Break-Even Analysis
Costs/Revenue
Output/Sales
FC
VC
TCTR
Q1
Loss
Profit

Break-Even Analysis
Costs/Revenue
Output/Sales
FC
VC
TCTR
Q1 Q2
Assume
current sales
at Q2
Margin of Safety
Margin of
safety shows
how far sales can
fall before losses
made. If Q1 =
1000 and Q2 =
1800, sales could
fall by 800 units
before a loss
would be made
TR
Q3
A higher
price would
lower the
break even
point and the
margin of
safety would
widen

Costs/Revenue
Output/Sales
FC
VC
TR
High initial FC.
Interest on debt
rises each year –
FC rise therefore
FC 1
Losses get
bigger!

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
and elasticity
• Market Skimming – ‘high’ price ‘low’
volumes – fewer sales to break even

Break-Even
Analysis
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?

0 5000 10000 15000 20000
Sales Rs
Fixed Cost
Rs
2000
4000
5000
6000
8000
8000
6000
5000
4000
2000
Profit
Rs
BEP

0 5000 10000 15000 20000
Sales Rs
Fixed Cost
Rs
2000
4000
5000
6000
8000
8000
6000
5000
4000
2000
Profit
Rs
BEP
Loss
Area
Profit
Area
--------------------------
Margin of Safety

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

Effect Of Change in Profit- 10% decrease in V Cost
New V Cost= 10000- 10%=Rs9000
New PV Ratio=20000-9000
20000
Fixed Cost
New BEP = PV Ratio
= 5000/55%
=Rs 9090 Appx
New Profit=S-F-V
=20000-5000-9000
=Rs 6000
=55%

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

Effect Of 5% Decrease in Selling Price
0 5000 10000 15000 20000
Sales Rs
Fixed Cost
Rs
2000
4000
5000
6000
8000
8000
6000
5000
4000
2000
Profit
Rs
New BEP
Loss
Area
Profit
Area

ATTENTION COMMERCE
STUDENTS
ACCOUNTING(FINANACIAL & COST) OF
ICMAP STAGE 1,2,3,4 (NEW CLASSES)
CA..MODULE B,C,D
PIPFA (FOUNDATION,INTERMEDIATE,FINAL)
ACCA-F1,F2,F3
BBA,MBA
B.COM(FRESH),M.COM
MA-ECONOMICS..O/A LEVELS
KHALID AZIZ…..0322-3385752
cost-accountants@yahoogroups.com

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