Marginal Costing : Marginal Costing Introduction:
Marginal costing is a technique of costing fully oriented towards managerial decision making and control. Marginal Costing being a technique can be used in conjunction with any method of cost ascertainment. It can be used in combination with other techniques such as budgeting and standard costing.
Marginal costing is helpful in determining the profitability of products, departments, processes and cost centers. Definition of Marginal Cost : Definition of Marginal Cost Marginal cost is the additional cost of producing an additional unit of a product.
According to I.C.M.A. London as ”the amount to any given volume of output by which aggregate costs are changed if the volume of output is increased or decreased by one unit”. In practice, this is measured by the total variable cost attributable to one unit.
Thus, Marginal Cost = Prime cost+ Total variable overheads
Total cost – Fixed cost. Slide 3: Marginal Costing:
Marginal costing is defined by, I.C.M.A. as “the ascertainment of marginal cost and of the effect on profit of changes in volume or type of output by differentiating between fixed costs and variable costs. Features of Marginal Costing : Features of Marginal Costing 1.Marginal costing is a technique of control or decision making.
2. Under marginal costing the total cost is classified as fixed and variable cost.
3. Fixed costs are treated as period cost and charged to profit and loss a/c for the period for which they are incurred.
4. The Variable costs are regarded as the costs of the products.
5. The stock of finished goods and work-in-progress are valued at marginal costs only.
6. Prices are determined on the basis of marginal cost. Advantages of Marginal Costing : Advantages of Marginal Costing 1. Simplicity
2. Stock valuation
3. Meaningful reporting
4. Fixation of Selling Price
5. Profit planning.
6. Cost control and cost reduction.
7. Pricing policy.
8. Helpful to management.
9. Production Planning
10. Make or Buy Decisions Limitations of Marginal Costing : Limitations of Marginal Costing 1. Classification of cost
2. Not suitable for external reporting.
3. Lack of log-term perspective.
4. Under valuation of stock
5. Automation – Lack of Advancement
6. Production aspect is ignored.
7. Not applicable in all types of business.
8. Misleading picture -Assumptions Assumptions of Marginal Costing : Assumptions of Marginal Costing All costs can be classified into two categories – Fixed and Variable
Fixed costs remain constant at all levels of activity
Variable costs vary in total, but remain constant per unit
Level of efficiency of operations is uniform
Product risk remains unaltered, unless specified otherwise.
Selling price remains constant at different levels of activity. Cost-Volume-profit analysis : Cost-Volume-profit analysis The term ‘contribution’ mentioned in the formal definition is the term given to the difference between Sales and Marginal cost. Thus
MARGINAL COST =VARIABLE COST DIRECT LABOUR+DIRECT MATERIAL+DIRECT EXPENSE+VARIABLE OVERHEADS
CONTRIBUTION SALES - MARGINAL COSTThe term marginal cost sometimes refers to the marginal cost per unit and sometimes to the total marginal costs of a department or batch or operation. The meaning is usually clear from the context. MARGINAL COST STATEMENT : MARGINAL COST STATEMENT Breakeven Analysis : Breakeven Analysis Introduction
In this lesson, we will discuss in detail the highlights associated with cost function and cost relations with the production and distribution system of an economic entity.
To assist planning and decision making, management should know not only the budgeted profit, but also:
the output and sales level at which there would neither profit nor loss (break-even point)
the amount by which actual sales can fall below the budgeted sales level, without a loss being incurred (the margin of safety) Cost-Volume-Profit (C-V-P) Relationship : Cost-Volume-Profit (C-V-P) Relationship CVP is a management accounting tool that expresses relationship among sale volume, cost and profit. CVP can be used in the form of a graph or an equation. Cost-volume- profit analysis can answer a number of analytical questions. Some of the questions are as follows:
What is the breakeven revenue of an organization?
How much revenue does an organization need to achieve a budgeted profit?
What level of price change affects the achievement of budgeted profit?
What is the effect of cost changes on the profitability of an operation?
Cost-volume-profit analysis can also answer many other “what if” type of questions. Cost-volume-profit analysis is one of the important techniques of cost and management accounting. Although it is a simple yet a powerful tool for planning of profits and therefore, of commercial operations. It provides an answer to “what if” theme by telling the volume required producing. Objectives of Cost-Volume-Profit Analysis : Objectives of Cost-Volume-Profit Analysis In order to forecast profits accurately, it is essential to ascertain the relationship between cost and profit on one hand and volume on the other.
Cost-volume-profit analysis is helpful in setting up flexible budget which indicates cost at various levels of activities.
Cost-volume-profit analysis assists in evaluating performance for the purpose of control.
Such analysis may assist management in formulating pricing policies by projecting the effect of different price structures on cost and profit. Breakeven Analysis Equations : Breakeven Analysis Equations Sales – Marginal cost = Contribution ......(1)
Fixed cost + Profit = Contribution ......(2)
Sales – Marginal cost = Fixed cost + Profit...... (3)
P/V Ratio (or C/S Ratio) =Contribution/Sales.....(4)
Contribution = Sales x P/V ratio...... (5)
Sales =Contribution/ P/V Ratio......(6) Important Formula… : Important Formula… 1. Contribution = Sales (Volume/Per unit) – Variable Cost.
2. Profit-Volume Ratio= Contribution/ Sales
(or) P/V Ratio= Change in Profit/Change in Sales
3. Break Even Point (Units) = Fixed Cost/ Contribution
Break Even Point (Sales)= Fixed Cost/ P/V Ratio
4. Margin of safety = Actual Sales – Break Even Sales
5. Sales for required profit= Fixed Cost + Required Profit
6. Profit for given Sales= Contribution-Fixed Cost
Contribution= Given Sales x P/V Ratio
7. Fixed Cost = Contribution - Profit