Professional Documents
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ACCOUNTING
“MARGINAL COSTING”
Submitted by :
Shivani Jain(0043)
Shruti Pal(0076)
Sunmeet kaur (0060)
Apoorva Chhabra (
Ashna Banga (
B.B.S. III semester
To :
Ms. Aanchal Garg
Department of Business Studies
We sincerely thank Ms. Aanchal Garg and our friends for the help extended by them
for the successful completion of the project report.
Date:
Countersigned
Signature
(Ms. Aanchal Garg) (Sunmeet Kaur)
Signature
(Shruti Pal)
Signature
(Shivani Jain)
Signature
(Apoorva Chhabra)
Signature
(Ashna Banga)
TABLE OF
CONTENTS
S.no Topic Page no
1 Introduction
2 Meaning of SWOT
7 Simple Rules
8 How to do a SWOT ?
10 Generating Strategies
13 Example.1
14 Example.2
Bibliography
Marginal costing may be defined as the technique of presenting cost data wherein
variable costs and fixed costs are shown separately for managerial decision-making. It
should be clearly understood that marginal costing is not a method of costing like
process costing or job costing. Rather it is simply a method or technique of the
analysis of cost information for the guidance of management which tries to find out an
effect on profit due to changes in the volume of output.
MARGINAL COST
The marginal cost of a product –“ is its variable cost”. This is normally taken to be;
direct labour, direct material, direct expenses and the variable part of overheads.
Marginal cost means the cost of the marginal or last unit produced. It is also defined
as the cost of one more or one less unit produced besides existing level of production
The marginal cost varies directly with the volume of production and marginal cost per
unit remains the same. It consists of prime cost, i.e. cost of direct materials, direct
labor and all variable overheads. It does not contain any element of fixed cost which
is kept separate under marginal cost technique.
The term ‘contribution’ mentioned in the formal definition is the term given to the
difference between Sales and Marginal cost. Thus
Marginal costing technique has given birth to a very useful concept of contribution
where contribution is given by: Sales revenue less variable cost (marginal cost)
Contribution may be defined as the profit before the recovery of fixed costs. Thus,
contribution goes toward the recovery of fixed cost and profit, and is equal to fixed
cost plus profit (C = F + P). In case a firm neither makes profit nor suffers loss,
contribution will be just equal to fixed cost (C = F). this is known as break even point.
The concept of contribution is very useful in marginal costing. It has a fixed relation
with sales. The proportion of contribution to sales is known as P/V ratio which
remains the same under given conditions of production and sales.
Theory of Marginal Costing
The theory of marginal costing as set out in “A report on Marginal Costing”
published by CIMA, London is as follows:
1. If the volume of output increases, the cost per unit in normal circumstances
reduces. Conversely, if an output reduces, the cost per unit increases. If a factory
produces 1000 units at a total cost of $3,000 and if by increasing the output by one
unit the cost goes up to $3,002, the marginal cost of additional output will be $.2.
2. If an increase in output is more than one, the total increase in cost divided by the
total increase in output will give the average marginal cost per unit. If, for example,
the output is increased to 1020 units from 1000 units and the total cost to produce
these units is $1,045, the average marginal cost per unit is $2.25. It can be described
as follows:
Additional cost = $ 45 = $2.25
Additional units 20
a. For any given period of time, fixed costs will be the same, for any volume of sales
and production (provided that the level of activity is within the ‘relevant range’).
Therefore, by selling an extra item of product or service the following will happen:
b. Similarly, if the volume of sales falls by one item, the profit will fall by the amount
of contribution earned from the item.
d. When a unit of product is made, the extra costs incurred in its manufacture are the
variable production costs. Fixed costs are unaffected, and no extra fixed costs are
incurred when output is increased.
1. Cost Classification
The marginal costing technique makes a sharp distinction between variable costs and
fixed costs. It is the variable cost on the basis of which production and sales policies
are designed by a firm following the marginal costing technique.
2. Stock/Inventory Valuation
Under marginal costing, inventory/stock for profit measurement is valued at marginal
cost. It is in sharp contrast to the total unit cost under absorption costing method.
3. Marginal Contribution
Marginal costing technique makes use of marginal contribution for marking various
decisions. Marginal contribution is the difference between sales and marginal cost. It
forms the basis for judging the profitability of different products or departments.
4. The effects of alternative sales or production policies can be more readily available
and assessed, and decisions taken would yield the maximum return to business.
5. It eliminates large balances left in overhead control accounts which indicate the
difficulty of ascertaining an accurate overhead recovery rate.
Disadvantages
1. The separation of costs into fixed and variable is difficult and sometimes gives
misleading results.
2. Normal costing systems also apply overhead under normal operating volume and
this shows that no advantage is gained by marginal costing.
3. Under marginal costing, stocks and work in progress are understated. The exclusion
of fixed costs from inventories affect profit, and true and fair view of financial affairs
of an organization may not be clearly transparent.
4. Volume variance in standard costing also discloses the effect of fluctuating output
on fixed overhead. Marginal cost data becomes unrealistic in case of highly
fluctuating levels of production, e.g., in case of seasonal factories.
5. Application of fixed overhead depends on estimates and not on the actuals and as
such there may be under or over absorption of the same.
7. In practice, sales price, fixed cost and variable cost per unit may vary. Thus, the
assumptions underlying the theory of marginal costing sometimes becomes
unrealistic. For long term profit planning, absorption costing is the only answer.
ABSORPTION COSTING
Absorption costing means that all of the manufacturing costs are absorbed by the
units produced. In other words, the cost of a finished unit in inventory will include
direct materials, direct labor, and both variable and fixed manufacturing overhead. As
a result, absorption costing is also referred to as full costing or the full absorption
method.
According to this method, the cost of a product’ is determined after considering both
fixed and variable costs. The variable costs, such as those of direct materials, direct
labour, etc. are directly charged to the products, while the fixed costs are apportioned
on a suitable basis over different products manufactured during a period. Thus, in case
of Absorption Costing all costs are identified with the manufactured products.
Marginal Costing versus Absorption
Costing
The net profits in Marginal Costing and Absorption Costing are not same because of
the following reasons:
(b) There are no apportionments, which are frequently done on an arbitrary basis, of
fixed costs. Many costs, such as the marketing director's salary, are indivisible by
nature.
(c) Fixed costs will be the same regardless of the volume of output, because they are
period costs. It makes sense, therefore, to charge them in full as a cost to the period.
(d) The cost to produce an extra unit is the variable production cost. It is realistic to
value closing inventory items at this directly attributable cost.
(f) Marginal costing provides the best information for decision making.
(g) Fixed costs (such as depreciation, rent and salaries) relate to a period of time and
should be charged against the revenues of the period in which they are incurred.
(h) Absorption costing may encourage over-production since reported profits can be
increased by increasing inventory levels.
Arguments in favour of absorption costing
(a) Fixed production costs are incurred in order to make output; it is therefore 'fair' to
charge all output with a share of these costs.
(b) Closing inventory values, include a share of fixed production overhead, and
therefore follow the requirements of the international accounting standard on
inventory valuation.
(c) Absorption costing is consistent with the accruals concept as a proportion of the
costs of production are carried forward to be matched against future sales.
(e) In a job or batch costing environment (see section 5 below), absorption costing is
particularly useful in the pricing decision to ensure that the profit markup is sufficient
to cover fixed costs.
3. To assess the present-day value of Marginal Costing, the changes occurring in the
business world must be analyzed more closely.
First, cost planning takes precedence over cost control. The effort involved in
planning and monitoring costs is increasingly being seen as excessive.
Second, cost accounting must be employed as a tool for cost control at an early stage.
The relative significance of traditional cost accounting as a management accounting
tool will decline as it is applied mainly to fields where costs cannot be heavily
influenced. More significant than influencing the current costs of production with cost
center controlling and authorized-actual comparisons of the cost of goods
manufactured is timely and market-based authorized cost management. The greatest
scope for influencing costs is at the early product development phase and when
setting up the production processes.
4. The shift in the purposes of cost accounting is being accompanied by a shift in the
main applications of standard costing. Costing solutions for market-oriented
profitability management and life-cycle-based planning and monitoring should be
developed further. They should be implemented both in indirect areas and at the
corporate level. In addition, cost accounting must be integrated into performance
measurement.
While top management benefits most from financial success indicators that it
examines in monthly or longer intervals and that can consist of multidimensional
aggregate figures, lower management must necessarily be concerned mainly with
nonfinancial, operational, and very short-term data at the day or shift level. In
concrete terms, measures in the categories of time, quantity, and quality--such as
equipment downtime, lead time, response time, degree of utilization (ratio of actual
output quantity to planned output quantity), sales orders, and error rate--are becoming
increasingly significant for controlling business processes.
• MARGIN OF SAFETY
Formula :
Sales
Significance of PV Ratio
• It is considered to be the basic indicator of profitability of business.
• The higher the PV Ratio, the better it is for the business. In the case of the firm
enjoying steady business conditions over a period of years, the PV Ratio will
also remain stable and steady.
• If PV Ratio is improved, it will result in better profits.
Improvement of PV Ratio
• By reducing the variable costs.
• By increasing the selling price
• By increasing the share of products with higher PV Ratio in the overall sales
mix. (where a firm produces a number of products)
Use of PV Ratio
• The Break – Even Point is the point or a business situation at which there is
neither a profit nor a loss to the firm. In other words, at this point, the total
contribution equals fixed costs. The break-even point is the intersection of the
total sales and the total cost lines. This point determines the number of units
produced to achieve breakeven.
• A break-even chart is constructed with a horizontal axis representing units
produced and a vertical axis representing sales and costs. Represent fixed costs
by a horizontal line since they do not change with the number of units
produced. Represent variable costs and sales by upward sloping lines since
they vary with the number of units produced and sold. The break-even point is
the intersection of the total sales and the total cost lines. Above that point, the
firm begins to make a profit, but below that point, it suffers a loss. It depicts
the following:
• CVP analysis involves the analysis of how total costs, total revenues and total
profits are related to sales volume, and is therefore concerned with predicting
the effects of changes in costs and sales volume on profit. It is also known as
'breakeven analysis'.
a) Budget planning. The volume of sales required to make a profit (breakeven point)
and the 'safety margin' for profits in the budget can be measured.
c) Sales mix decisions, to determine in what proportions each product should be sold.
d) Decisions that will affect the cost structure and production capacity of the company
4. Margin of Safety
Margin of Safety (MOS) represents the difference between ‘the actual total sales and
sales at break-even point.’ It can be expressed as a percentage of total sales, or in
value, or in terms of quantity.
SIGNIFICANCE
• Upto Break even point the contribution earned is sufficient only to recover
fixed costs. However beyond the Break even point. The contribution is called
profit (since fixed costs are fully recovered by then)
• Profit is nothing but contribution carried out of Margin of Safety Sales.
• The size of the margin of safety shows the strength of the business.
• If the margin of safety is small, it may indicate that the firm has large fixed
expenses and is more vulnerable to changes in sales.
• If the margin of safety is large, a slight fall in sales may not affect the business
very much but if it is small even a slight fall in sales may adversely affect the
business.
5. SHUT DOWN POINT
Shut Down Point indicates the level of operations (sales), below which it is not
justifiable to pursue production. For this purpose fixed costs of a business are
classified into
(a) Avoidable or Discretionary Fixed Costs and
(b) Unavoidable or Committed Fixed Costs.
A firm has to close down if its contribution is insufficient to recover the avoidable
fixed costs.The focus of shutdown point is to recover the avoidable fixed costs in the
first place. By suspending the operations, the firm may save as also incur some
additional expenditure. The decision is based on whether contribution is more than the
difference between the fixed expenses incurred in normal operation and the fixed
expenses incurred when plant is shut down.
KEY FACTOR: