A full guide to Marginal Costing..

1. Marginal Costing
&
Its Impact on Profitability
Contents
• Introduction To Marginal • Decision Making
Costing
• Pricing Policy
• Break Even Point Analysis
• Case Studies
• Special Situations

2. Get Familiar With Terms……
 Variable Cost: Costs which vary with the output are referred to as Variable Cost.
Eg – Material Cost , Labour Cost, etc.
 Fixed Cost: Fixed Costs are independent of output. They are periodic costs.
Eg – Salary, Depreciation on machinery, rent, etc.
 Sunk Costs: Historical Cost incurred in the past are known as Sunk Costs. They play no
role in decision making in the current period.
For Eg – In a decision making related to replacement of a machine, the WDV of the
existing machine is a sunk cost and therefore not considered.
 Opportunity Cost: This cost refers to the value of sacrifice made or the benefit of
opportunity foregone in accepting an alternative course of action.
Eg: A firm financing its expansion plan by withdrawing money from its bank deposits. In
such a case , the loss of interest on the bank deposits is the opportunity cost for
carrying out the expansion plan.
 Contribution: Sales Less Variable Costs
Marginal Vs Absorption
Costing
What we do in day to day accounting ?
Vs
What we should do ?
Do not mix accounting and decision making!!!

3. Lets Illustrate
 A company manufactures 3 products, A, B and C
respectively. The segmental reports show that the
production of Product B is loss making and hence the
company should discontinue the same.
Particulars A B C
Sales 80,000 50,000 1,00,000
Less: Variable Cost (20,000) (30,000) (60,000)
Less: Fixed Costs allocated equally (30,000) (30,000) (30,000)
Segmental Profit 30,000 (10,000) 10,000
Profit (%) 37.5% - 10%
Now, Lets Think Like A Cost
Accountant….
 Recall that Fixed Costs are periodic costs and
will be incurred irrespective of production.
 Hence, Don’t you think we must exclude them
while calculating profitability to arrive at a
decision of whether or not to produce a
product?

4. Basis Of Decision Making…
Particulars Product A Product B Product C
Sales 80,000 50,000 1,00,000
Less: Variable Cost (20,000) (30,000) (60,000)
Contribution 60,000 20,000 40,000
Contribution (%) 75% 40% 40%
In the above computation, we observe that Product B is adding
to the Total Contribution by Rs 20,000.
Hence, is it right to discontinue the production of B ?
WHICH OTHER FACTORS SHOULD MANAGEMENT REVISIT ?
What Is Marginal Costing?
The principals of Marginal Costing are as follows:
a) For any given period of time, the fixed cost will remain the same, for
any volume of sales and production.
Therefore by selling an extra tem of product or service, the following
will happen:
 Revenues will increase by the sales value of the item sold
 Costs will increase by the variable cost per unit
 Profit will increase by the amount of contribution earned from the
item.

5. What Is Marginal Costing?
b) Profit measurement should be based on analysis of total
contribution. Since fixed cost relate to a period of time, and do
not change with increase or decrease in sales volume, it is
misleading to charge units of sale with the share of fixed cost.
c) When a unit of product is made, the extra cost incurred in its
manufacture are the variable production costs. Fixed cost are
unaffected and no extra fixed cost are incurred when output is
increased.
Marginal Costing Pro - Forma
Particulars Amount Amount
Sales Revenue XXX
Less: Marginal Cost of Sales
Opening Stock ( Valued at Marginal Cost) XXX
Add: Production Cost ( Valued at Marginal Cost) XXX
Less: Closing Stock ( Valued at Marginal Cost) (XXX)
Add: Selling Admin and Distribution Cost XXX
Marginal Cost of Sales (XXX)
Contribution XXX
Less: Fixed Cost (XXX)
Marginal Costing Profit XXX

6. Break Even Analysis
This analysis is also referred to as Break Even Analysis or
Contribution Margin Analysis or Cost Volume Profit Analysis and is
based on the following 3 presumptions.
a) Sales price per unit always remains constant
b) The variable cost per unit always remains constant
c) The fixed cost for the period always remains constant
Break Even Point
• It is the level of Sales that gives us the contribution
which is exactly equal to the amount of fixed cost. It is
a no profit, no loss situation.
Break Even Point ( units) = Fixed Cost / Contribution per
unit
Break Even Point ( Rs) = Fixed Cost / PV Ratio

7. Other Concepts
• PV Ratio : This is the relationship between sales and
contribution.
PV Ratio = Contribution / Sales x 100
• Margin of Safety : It is the actual difference between Actual
Sales and Break Even Sales. The more the amount of Margin of
Safety, the more should the company enjoy because, even if
the sales fall by the amount of margin of safety, the company
still would not make the losses.
Margin Of Safety
B
BEP
A
Volume of Sales
Sales Total Cost Fixed Cost
At which point you are safer? A or B? What is your margin of safety?

8. Example 1
 ABC Ltd manufactures a single product which it
sells for Rs 20 per unit. Fixed Costs are Rs 60,000
per annum. The contribution to the sales ratio is
40%. Calculate the Break even point.
Example 2
 ABC Ltd sells a single product for Rs 9 per unit.
The variable cost is Rs 6 per unit and the fixed
cost total Rs 54,000 per month. In a period
when the actual sales were Rs 1,80,000, find the
Margin of Safety, in units.

9. Example 3
 Product X generates a contribution to the sales
ratio of 30%. Fixed Cost directly attributable to X
amounts to Rs 75,000 per month. Calculate the
sales revenue required to achieve a monthly
profit of Rs 15,000.
Decision Making Process
When ever decision is to be taken, no matter what is the type of
proposal, we always calculate relevant revenues and relevant
costs, in respect of the decision and if the net result is a gain, then
we take the decision favorably.
(a) Relevant Revenue
Money to be received
Outflow to be avoided
(b) Relevant Cost
Money to be spent
Inflow to be lost
Net Gains (loss) a – b

10. Decision Making
Case Study 1
Decision Making
Case Study 2

11. Shut – Down Decisions
Case Study
Application To Pricing Decisions
• How would you price a new product to be launched in the market if
the product is a mass product?
• How would you price a new product to be launched in the market if
the product is a niche product?
• How would you re price an already existing product in the market?
• How would you price a product which had to be internally sold from
one department to another department?

12. Application To Pricing Decisions
Lets evaluate how various products
are priced…..
(Refer to the Chart)
Application To Pricing Decisions
Case Study 1

13. Application To Pricing Decisions
Case Study 2
Special Situations : Determination
Of A Profitable Mix
a) When there is No Limiting factor
Total fixed cost remaining constant, the product which offers more
contribution per unit is more profitable since it would maximize the total
contribution and therefore the net profit.
Particulars Product A Product B Product C
SP per unit 1000 800 600
Less: variable Cost per unit (500) (400) (500)
Contribution per unit 500 400 100
Priority of Production: A , B , C

14. Determination Of A Profitable Mix
b) When there is a limiting factor
 Some resources are required for products and are not adequately
available. These resources become Limiting Factors.
 If there are some limiting factors, then the product which offers
maximum contribution per unit may not give more amount of total
contribution because it may not make more profitable use of the limited
resources.
 Hence, we calculate the contribution per unit of the limiting factor and
the production priority is to be decided accordingly.
Determination Of A Profitable Mix
Continuing the previous example, let us say that labour hours is
a limiting factor.
Particulars Product A Product B Product C
SP per unit 1000 800 600
Less: Variable Cost per unit (500) (400) (500)
Contribution 500 400 100
Labour hours required per unit 10 hours 5 hours 1 hours
Contribution per unit of labour hour 50 80 100
( Contribution / Labour hour per unit)
Priority of Production: Product C, B and A.

15. Buy V/S Make Decision
• Very often, the management is faced with the problem as to
whether a product should be manufactured or purchased
from outside market. Under such circumstances, the following
factors are to be considered
a) Whether surplus capacity is available
b) The Marginal Cost
Buy v/s Make Decision
Case Study

16. Treatment Of Semi Variable
Costs
How would you treat Semi variable
Costs while calculating Break Even
Point?
Treatment of Semi Variable
Cost
Case Study

17. Application of Marginal Costing
to Material Procurement
• The cost already incurred should be completely ignored.
• We compare the resale value with the cost savings and select the
higher of the two.
• Sometimes, stock has no resale value or other use but we have to
incur some disposal cost if the raw material stock is not used. In
such cases, by using the stock for the proposal, we do not incur
any relevant costs but we avoid the outflow of disposal cost which
otherwise would occur and disposal cost to be avoided becomes
relevant revenue.
Application of Marginal Costing
to Material Procurement
Case Study

18. Q&A
Thank You…