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 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

Marginal Cost 100 x150= 15000 Fixed Cost = 5000 total 20000

2 1 Manufacture 100 radio Variable costs Rs150 p u Fixed cost Rs 5000 2 If Manufacture 101 radios

Marginal cost 150 x101=15150 Fixed Cost = 5000 TOTAL 20150

additional Cost=Rs 150

Marginal Costing

marginal costing is

ascertainment of marginal cost by differentiating between 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 In volume or Type of output

1 lakh units To 2 lakh units

Marginal Costing
From One Model of Car to Another From One Size of product to another

What Could be effects of Changes In volume or Type of output

Marginal Costing ---Characteristics

Fixed & Variable Costs

Inventory Valuation

MC Costs as Products Costs

Contribution

Marginal Costing & Profit

Fixed Costs as Period Costs

Pricing

Marginal Costing ---Characteristics

Segregation Fixed & Variable Costs

Semi-variable costs are segregated into fixed & variable

Marginal Costing ---Characteristics

Marginal Costs as Products Costs

Only Variable costs are charged to products

Marginal Costing ---Characteristics

Fixed Costs as Period Costs

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

Marginal Costing ---Characteristics

Inventory Valuation

WIP & F goods are Valued at Marginal Cost

Marginal Costing ---Characteristics

S-V=C

Contribution
Profitability judged on Contribution made

Marginal Costing ---Characteristics

Pricing

Pricing is based on Contribution & Marginal Costs

Marginal Costing ---Characteristics

A Sales Less VC Contribution Fixed Cost Profit -

B -

C -

Total ----------------Marginal Costing & Profit

Marginal Costing ---

Marginal Costing Profit

Sales of A

Sales of B

Sales of C

less Marginal cost Of A = Contribution of A

less Marginal cost Of B = Contribution of B

Total Contribution of A,B& C less Total Fixed Cost =

less Marginal cost Of C = Contribution of C

Profit/loss

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

Fixed & Variable Costs

Valuation Of stock

Measurement Of Profitability

Absorption-Marginal Costing--differences

Marginal Costing

Absorption Costing

Fixed & Variable Costs

Only variable cost FC charged to P/L

Both F & V Costs Are charged

Absorption-Marginal Costing--differences

Valuation Of stock
WIP & FS at Marginal Cost

Total Cost

Absorption-Marginal Costing--differences

Measurement Of Profitability

C=S-V

P=S-V-F

Comparative Cost Statement

Marginal Costing
1 Rs
(A)Sales Opening Stock Add V Cost F Cost Total Cost Less C Stock (B) COGS Contribution (A-B)c ( D) F Cost Profit (C-D) (A-B) Months 2 Rs

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

3 Rs

2,00,000 1,65,000 84,000 84,000 1,20,000 1,20,000 _ _ 2,04,000 2,04,000 84,000 1,20,000 80,000 35000 45,000 1,05,000 99,000 66,000 35,000 31,000

2,35,000 6,00,000

2,00,000

1,65,000

2,35,000 6,00,000

1,05,000 2,73,000 1,08,000 1,08,500 1,35,625 3,52,625 1,20,000 3,60,000 1,20,000 1,20,000 120,000 3,60,000 _ _ 35,000 35,000 35,000 1,05,000 2,25,000 6,33,000 2,63,000 2,63,000 84,000 2,73,000 1,08,000 1,35,625 1,55,000 _ _ 2,90,625 8,17,625 1,08,500 3,52,625

1,41,000 3,60,000 94,000 2,40,000 35,000 1,05,000 59,000 1,35,000

1,27,875 1,82,125 4,65,000 _ _ _ _ _ _

45,000

37,125

52,875

1,35000

Comparative Cost Statement

Marginal Costing
1 Rs
(A)Sales Opening Stock Add V Cost F Cost Total Cost Less C Stock (B) COGS Contribution (A-B)c ( D) F Cost Profit (C-D) (A-B) Months 2 Rs

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

3 Rs

2,00,000 1,65,000 84,000 84,000 1,20,000 1,20,000 _ _ 2,04,000 2,04,000 84,000 1,20,000 80,000 35000 45,000 1,05,000 99,000 66,000 35,000 31,000

2,35,000 6,00,000

2,00,000

1,65,000

2,35,000 6,00,000

1,05,000 2,73,000 1,08,000 1,08,500 1,35,625 3,52,625 1,20,000 3,60,000 1,20,000 1,20,000 120,000 3,60,000 _ _ 35,000 35,000 35,000 1,05,000 2,25,000 6,33,000 2,63,000 2,63,000 84,000 2,73,000 1,08,000 1,35,625 1,55,000 _ _ 2,90,625 8,17,625 1,08,500 3,52,625

1,41,000 3,60,000 94,000 2,40,000 35,000 1,05,000 59,000 1,35,000

1,27,875 1,82,125 4,65,000 _ _ _ _ _ _

45,000

37,125

52,875

1,35000

Comparative Cost Statement

Marginal Costing
1 Rs
(A)Sales Opening Stock Add V Cost F Cost Total Cost Less C Stock (B) COGS Contribution (A-B)c ( D) F Cost Profit (C-D) (A-B) Months 2 Rs

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

3 Rs

2,00,000 1,65,000 84,000 84,000 1,20,000 1,20,000 _ _ 2,04,000 2,04,000 84,000 1,20,000 80,000 35000 45,000 1,05,000 99,000 66,000 35,000 31,000

2,35,000 6,00,000

2,00,000

1,65,000

2,35,000 6,00,000

1,05,000 2,73,000 1,08,000 1,08,500 1,35,625 3,52,625 1,20,000 3,60,000 1,20,000 1,20,000 120,000 3,60,000 _ _ 35,000 35,000 35,000 1,05,000 2,25,000 6,33,000 2,63,000 2,63,000 84,000 2,73,000 1,08,000 1,35,625 1,55,000 _ _ 2,90,625 8,17,625 1,08,500 3,52,625

1,41,000 3,60,000 94,000 2,40,000 35,000 1,05,000 59,000 1,35,000

1,27,875 1,82,125 4,65,000 _ _ _ _ _ _

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 ? C=S-V
Sales =Rs 12,000 V Cost=RS 7,000 F Cost=Rs 4,000 =12,000-7000=5000

SALES? S=C+V =5,000+7,000 =Rs 12,000

P=C-F
=5,000-4000 =Rs 1,000

F COST? F=C-P =5,000-1,000 =Rs 4,000

V Cost? V=S-C
=12,000-5000 =Rs 7,000

Sales =Rs 12,000 V Cost=RS 7,000 F Cost=Rs 4,000

Profit Volume Ratio (PV Ratio)

(Expresses the relation of Contribution to sales)

Sales= Rs 10,000
P/V Ratio =Contribution Sales = C/S =S-V/S V Cost=Rs 8,000

C = S XP/V Ratio C S = -------P/V Ratio P/V Ratio=c/s =S-V/S =10,000-8000/10,000 =20%

Profit Volume Ratio (PV Ratio)

When PV Ratio is Given

C= SXPV Ratio

C= 10000X20% =Rs 20,000

Profit Volume Ratio (PV Ratio)

P/V Ratio =

Change in Contribution --------------------------------Change in Sales Change in profit ----------------------Change in Sales

Another Method

Year 2005

sales 20,000

net profit 1000

1600-1000 =-------------------x 100 22000-20000 600 = -----------x100=30% 2,0000

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

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 dont 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

Fixed Cost BEP (Units) = --------------Contribution PU
ALGEBRAIC METHOD

= F S-V

Fixed Cost BEP (Rs ) = ----------------x Sales Contribution Fixed Cost = -----------------P/V Ratio

BEP (Rs)

Cost- Volume- Profit Analysis

Fixed Cost BEP (Units) = --------------Contribution PU
ALGEBRAIC METHOD

= F S-V

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

BEP (Rs)

Cost- Volume- Profit Analysis

Other Uses
F Cost=Rs 12000 S Price=Rs12 pu V Cost =Rs 9 pu Profit when sales are

Profit at diff. Sales Vol.

a) Rs 60,000 b) Rs 1,00,000

Sales at Desired Profit

Cost- Volume- Profit Analysis

F Cost=Rs 12000 S Price=Rs12 pu V Cost =Rs 9 pu Profit when sales are C P/V Ratio= ----- = 3/12=25% S a) Rs 60,000 b) Rs 1,00,000

Profit at diff. Sales Vol.

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 if desired profit a) Rs 6000 b) Rs 15,000

Sales at Desired Profit

F Cost +Desired Profit Sales= ------------------------------P/V Ratio

Cost- Volume- Profit Analysis

Sales at Desired Profit
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

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=30000005% =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/Revenue
Initially a firm will incur fixed costs, these do not depend on output or sales.

FC

Q1

Output/Sales

Break-Even Analysis
Costs/Revenue

TR

TR

TC

VC

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

FC

Q1

Output/Sales

Break-Even Analysis
Costs/Revenue
TR
TR

TC

VC

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

FC

Q2

Q1

Output/Sales

Break-Even Analysis
Costs/Revenue
TR)
TR

TC

VC

If the firm chose to set prices lower it would need to sell more units before covering its costs

FC

Q1

Q3

Output/Sales

Break-Even Analysis
Costs/Revenue
TR

TC Profit VC

Loss FC

Q1

Output/Sales

Break-Even Analysis
Costs/Revenue
TR
TR

TC VC

Margin of safety shows A higher how far sales price can fall before would lower Assume losses the made. breakIf current Q1 = 1000sales and even point Q2 1800, sales at = Q2 andfall the could by 800 units beforeof a margin loss would be safety would made

widen

Margin of Safety FC

Q3

Q1

Q2

Output/Sales

Costs/Revenue

High initial FC. Interest on debt rises each year 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 breakeven 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

BEP

6000 5000 4000 2000

Fixed Cost Rs

5000

10000

15000 Sales Rs

20000

Profit Rs

2000

4000 5000 6000

8000

Construction Of PV Chart

8000

BEP

6000 5000 4000

Fixed Cost Rs

Profit Area
0 5000 10000

2000 20000

2000

Loss Area

15000 Sales Rs

Profit Rs

4000 5000 6000

8000

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

8000 6000

BEP

5000 4000

Fixed Cost Rs

Profit Area
0 5000 10000

2000

2000

Loss Area

15000 Sales Rs

20000

Profit Rs

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

Fixed Cost Rs

Profit Area
0 5000 10000

2000 20000

2000

Loss Area

15000 Sales Rs

Profit Rs

4000 5000 6000

8000

Effect Of 5% Decrease in Selling Price

8000 6000 5000 4000

Fixed Cost Rs

Profit Area
0 5000 10000

2000 20000

2000

Loss Area

15000 Sales Rs

Profit Rs

4000 5000 6000

8000