PAN African eNetwork

Project
Masters of Business Administration (IB)
Accounting and Finance
Semester - I
Dr. N N Sen Gupta
Copyright Amity University

MARGINAL
COSTING

Marginal Cost
According to the Terminology of Cost Accountancy of the Institute of
Cost And Management Accountant, London, Marginal Cost
represents the amount of any volume of given output by which
aggregate cost are changed if the volume of output is increased by
one units.
In practice, it is measured by the total variable costs attributable to
one unit.
For example, the cost of production of 1,000 units of radios is Rs. 2,
00, 000 and that of 1001 units is Rs. 2, 00, 150 the marginal cost is
Rs. 150, i.e., 2, 00, 150 2, 00, 000.

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Marginal Costing
The Institute of Cost and Management, London,
has defined Marginal costing as the
ascertainment of marginal costs and of the
effects on profit of changes in volume or type of
output by differentiating between fixed costs and
variable costs. In this technique of costing only
variable costs are charged to operational
process or products, leaving all indirect cost to
be written off against profit in the period in which
they arise.

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Marginal Costing
Thus, marginal costing is not a system of
costing such as process costing, job
costing, operating costing, etc. but a
technique which is concerned with the
changes in costs and profits resulting from
changes in the volume of output. Marginal
costing is also known as variable costing.

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 It

FEW CHARACTERISTICS OF MARGINAL

COSTING

is a technique of analysis and presentation of cost which help

management in making many managerial decision and is no an
independent system of costing such as job costing or process costing.
All elements of cost- production, administration and selling and distribution
are classified into variable and fixed components. Even semi-variable costs
are analysed into fixed and variable.
The variable cost (marginal costs) are regarded as the cost of the products.
Fixed costs are treated as period costs and are charged to profit and loss
account for the period for which they are incurred.
The stocks of finished goods and work-in-process are valued at marginal
cost only.
Prices are determined on the basis of marginal cost by adding contribution
which is the excess of sales and selling price over marginal cost of sales.

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Distinction between marginal and absorption costing

Marginal costing

Absorption costing

1.

Only variable costs are considered for Both fixed and variable costs are
product costing and inventory considered for product costing and
valuation.
inventory valuation.

2.

Fixed costs are regarded as period Fixed costs are charged to the cost of
costs. The Profitability of different production. Each product bears a
products is judged by their P/V ratio.
reasonable share of fixed cost and thus
the profitability of a product is influenced
by the apportionment of fixed costs.

3.

Cost data presented highlight the total Cost data are presented in conventional
contribution of each product.
pattern. Net profit of each product is
determined after subtracting fixed cost
along with their variable costs.

4.

The difference in the magnitude of The difference in the magnitude of opening

opening stock and closing stock does stock and closing stock affects the unit
not affect the unit cost of production.
cost of production due to the impact of
related fixed cost.

MARGINAL COST EQUATION

FOR THE SAKE OF CONVINIENCE, A MARGAL COST EQUATION CAN BE
DERIVED AS FOLLOWS:-

Or,
Or,
Or,
Or,

Sales Variable cost = contribution.

Sales Variable cost + contribution.
Sales = Variable cost + Fixed cost Profit / Loss.
Sales - Variable cost = Fixed cost Profit / Loss.

Where

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S
V
F
P

stands for Sales.

stands for Variable cost.
stands for Fixed cost.
stands for Profit / Loss.

Profit / Volume Ratio (P/V Ratio or C/S Ratio)

Contribution
P/V Ratio

Sales

Cost-Volume-Profit Analysis
Cost-Volume-Profit analysis is a technique for studying the
relationship between cost volume and profit. Profits of an
undertaking depends upon a large number of factors. But the
most important of these factors are the cost of manufacture,
volume of sales and the selling price of the products. In words
of Herman C. Heiser,the most significant single factor in profit
planning of the average business is the relationship between
volume of business, cost and profits. The CVP relationship is
an important tool used for profit planning of a business.
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BREAK EVEN CHART

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Numerical 1
A manufacturing company finds that while the
cost of making a component No. 0.51 in its own
workshop is Rs. 8.00 each, the same is available
in market at Rs. 6.50 with an assurance of
continious supply. Give your suggestion whether
to make or buy this component. Give also your
views in case the supplier reduces the price from
Rs. 6.50 to Rs. 5.50. The cost of data follows:-

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Materials

3. 00

Direct Labor

2. 00

Other Variable
Expenses.
Depriciation And
Other Fixed Expenses.

-1. 00

Total .

8. 00

2. 00

NUMERICAL 2
From the following information calculate the
break-even point in units and in sales value:
Output
Selling Price per unit
Variable Cost per unit
Total Fixed Cost

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=
=
=
=

3, 000 units.
Rs.
30.
Rs.
20.
Rs. 20, 000.

NUMERICAL - 3
From the following particulars, calculate:
i.
ii.

Break-even point in terms of sales value and in units.

Number of units that must be sold to earn a profit of Rs. 90,000.
Fixed Factory Overhead cost
=
Rs. 60,000.
Fixed Selling Overhead cost
=
Rs. 12,000.
Variable Manufacturing Cost per Unit
=
Rs.
12.
Variable Selling Cost per unit
=
Rs.
3.
Selling Price per unit
=
Rs.
24.

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NUMERICAL - 4
From the following data, you are required to calculate:
a. P/V ratio.
b. Break-even sales with the help of P/V ratio.
c.
Sales required to earn a profit of Rs. 4, 50, 000.
Fixed Expenses
Variable cost per unit:
Direct Material
Direct Labour
Direct Overhead
Selling Price per unit

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Rs. 90, 000.

=
=
=
=

Rs. 5.
Rs. 2.
100% of Direct abour.
Rs. 12.

Differential cost
It may be defined as the increase or decrease in total
cost or the change in specific elements of cost that result
from any variation in operations. It represents an
increase or decrease in total cost resulting out of :
(a) producing or distributing a few more or few less of
the products;
(b) a change in the method of production or of
distribution;
(c) an addition or deletion of a product or a territory; and
(d) selection of an additional sales channel.

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Incremental cost
It is defined as, the additional costs of a change
in the level or nature of activity. As such for all
practical purposes there is no difference
between incremental cost and differential cost.
However, from a conceptual point of view,
differential cost refers to both incremental as
well as decremental cost. Incremental cost and
differential cost calculated from the same data
will be the same.

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Multiple Choice Questions

The main difference between marginal costing and absorption costing is regarding the treatment of
a.
Prime cost
b.
Fixed overheads
c.
Direct materials
d.
Variable overheads

Contribution is defined as
a.
Difference between sales revenue and profit
b.
Difference between sales revenue and fixed costs
c.
Difference between sales revenue and variable costs
d.
None of the above

When production exceeds sales (in units) then profit under

a.
Marginal costing is higher than that of absorption costing
b.
Marginal costing is lower than that of absorption costing
c.
Marginal costing is equal to that of absorption costing
d.
None of above

Profit-volume ratio is an indicator of

a.
The rate of profit
b.
The rate at which goods are sold
c.
The volume of profit
d.
The volume of sales

If margin of safety is 45% of sales then what about the remaining 55% of sales
a.
Profit
b.
Break-even sales
c.
Fixed cost
d.
None of the above

Question
A
Which financial
statement is
used to show
what the firm Income
owns?
statement

Which of the
following
describes a
record of the
transactions?

Statement of
retained
Balance Sheet earnings

Income
General ledger statement

Balance sheet

Cash flow
statement

Journal

Which of the following

equations represents
the balance sheet

Assets + Liabilities =
Shareholders' equity

A revenue

Is a decrease or an
Is a decrease in
increase in
has no impact on Is an increase in
shareholders' equity shareholders' equity. shareholders' equity shareholders' equity

Assets - Liabilities =
Shareholders' equity

Assets = Liabilities Shareholders' Equity

Assets = Liabilities +
Shareholders' equity

What is the ration

between current
assets and current
Return on
liabilities called? Return on assets Investment

Current Ratio

Which of the
following is not
a current
Accounts
asset?
receivable

Inventory of raw
materials
Land

Inventory of
finished
products

Cash ratio

What is the final

stage of the
accounting
process?
Journal

Financial
statement

Ledger

Trial balance

What is the process

called, where costs
of an intangible
asset are allocated
over its useful life? Depletion

Impairment

Depreciation

Amortization

In practice, what
are the two
methods for
recording
Perpetual and
Daily and anuual
inventory
periodic inventory inventory
movements?
systems.
systems.
Which procedure is applied
when goods withdrawn are
valued batch by batch in
the reverse order from the
one they followed when
entering inventory?
FIFO

Commercial and
manufacturing
inventory
systems.

Weighted average cost

method

Continuous and
discontinuous
inventory
systems.

First our First in

LIFO

Which of the
following items is
not a subcategory of
shareholders'
equity?
Share capital

Retained earnings Dividends payable Share premium

Which of the
following
equations is
correct?

Share premium Share premium Share premium

= Issue price - = Issue price / = Issue price x
Par value
Par value
Par value

Share
premium =
Issue price +
Par value

Sale returns
appearing in the
trial balance are
deducted from Capital

Sales

Purchases

None of the
three

Drawings are
deducted from Sales

Purchases

Expenses

Capital

Debit balance

None of the
Negative balance above

Commission
received in
advance has a

Credit balance

What is the
order in which
the accounting
transactions
and events are
recorded in the
books:

Journal,
subsdiary
books, P/L A/c
and Ledger

Ledger, Journal
Balance sheet,
and Profit and
loss A/c

Journal, ledger,
P/L A/c, and
balance sheet

P/L A/c, ledger

and balance sheet

Bills receivable
is a
Current asset

Fixed asset

Tangible asset

Intangible asset

Personal
Bank account is account

Intangible real
account

Nominal account Both (b) and (c)

The degree of
honesty with
which accounting The capital
work has been invested in
done
business

Profit earned or
loss suffered by
the firm

Gross profit is the

difference
Sales and
between
purchases

Sales and cost of Sales and total

sales
expenses

None of the
three

P & L account
is prepared for
a period of one
year by
Consistency
following
concept

Conservatism
concept

Cost Concept

The Profit and

loss account
shows

The financial
position of the
concern

Time Peiod
Concept

Payments
received in
advance from a
customer for a
contract can be

Shown as a
deduction from
contract work-inprogress on asset
Shown as a liability Shown as an asset
side

Either (a) or (b)

Which of the
following is an
example of
personal
account?

Machinery

Cash

Creditor / Salary

Debit purchase a/c;

credit A a/c

Debit Stock a/c;

Credit purchase a/c

Rent

Purchase of goods on
credit from A is
Debit purchases a/c; Debit A a/c; Credit
recorded as
Credit cash a/c
purchases a/c

When fixed assets The total assets

are sold
are sold

The total liabilities The total assets will There is no change

will increase
decrease
in the total assets

Purchase of
raw materials
for cash

Increases total
liabilites

Increase total
assets

Withdrawal of
goods from stock
by the owner of the
business for
personal use
Drawings account
should be recorded and crediting cash
by debting
accounting

Leaves total
Increases total
assets unchanged fixed assets

Drawings account
and crediting
Capital account
Purchases account
purchases
and crediting
and crediting
accounting
drawings account drawings account

Prime costs +
Cost of
other
production is manufacturing
equat to
costs

Production
costs
+Administratio
n expenses

Works cost +
Administration
costs + Selling None of the
expenses
above

Answer Key

Question No.
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30

Answer
B
D
D
D
C
D
B
D
A
D
C
B
B
D
A
C
C
A
A
D
D
B
C
D
D
C
D
C
B
D

Thank You
Please forward your query
To: Nnsengupta@gmail.com
CC: manoj.amity@panafnet.com