MARGINAL COSTING

Revenues

Costs By-
Rima Agarwal
Swati Saraswat
Yamini Devpura
Common Cost Behavior Patterns

A. Variable Costs
B. Fixed Costs
C. Discretionary versus Committed Fixed
Costs
D. Mixed Costs
E. Step Costs
Types of Costs

Variable

Fixed

Mixed
Total Variable Cost

Total variable costs change

when activity changes.
Total Long Distance

Your total long distance

Telephone Bill

telephone bill is based

on how many minutes
you talk.

Minutes Talked
Variable Cost Per Unit

Variable costs per unit do not change

as activity increases.
The cost per long

Telephone Charge
distance

Per Minute
minute talked is
constant.
For example, 10
cents per minute.

Minutes Talked
Total Fixed Cost

Total fixed costs remain unchanged

when activity changes.
Your monthly
basic
Telephone Bill
Monthly Basic

telephone bill
probably
does not change
when
you make more
Number of Local Calls local calls.
 Mixed Costs
Contain fixed portion that is incurred even
when facility is unused & variable portion
that increases with usage.
Example: monthly electric utility charge
Fixed service fee
Variable charge per kilowatt hour used
Mixed Costs
Total Utility Cost

ost
d c Variable
i xe
l m Utility Charge
o ta
T
Fixed Monthly
Utility Charge
Activity (Kilowatt Hours)
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
 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
(or)
Total cost – Fixed cost.
Definition

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
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
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
1. Classification of cost
2. Not suitable for external reporting.
3. Lack of long-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
 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

 CVP analysis looks at the relationship between selling prices,

sales volumes, costs, and profits.
 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 Cost

The 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
 Particulars Rs Rs
Sales   xxxxx
Less: Variable Expenses   (xxxx)
                                Contribution   xxxxx
Less Fixed Cost   (xxxx)
                               Marginal Costing Profit   xxxxx
Assumptions of CVP Analysis

Expenses can be classified as either

variable or fixed.
CVP relationships are linear over a wide
range of production and sales.
Sales prices, unit variable cost, and total
fixed expenses will not vary within the
relevant range.
Assumptions of CVP Analysis

Volume is the only cost driver.

The relevant range of volume is specified.
Inventory levels will be unchanged.
The sales mix remains unchanged during
the period.
Breakeven Analysis

 Introduction
 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
 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

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

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)
(or)
 Contribution = Sales x P/V ratio...... (5)
(or)
 Sales = Contribution/ P/V Ratio......(6)
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
P/V Ratio
6. Profit for given Sales= Contribution-Fixed Cost
Contribution= Given Sales x P/V Ratio
7. Fixed Cost = Contribution - Profit
 Breakeven Point Calculations
Bill’s Briefcases makes high quality cases for laptops that sell for $200.
The variable costs per briefcase are $80, and the total fixed costs are
$360,000. Find the BEP in units and in sales $ for this company.

F +0 $360,000
BEP in units = =
P − V $200 / unit − $80 / unit
$360,000
= = 3,000 units
$120 / unit

F +0 = F $360,000
BEP in sales $ = =
CMR (P − V ) / P ($200 − $80) / $200
$360,000
= = $600,000
60%
 CVP Graph
Draw a CVP graph for Bill’s Briefcases. What is the pretax profit if Bill
sells 4100 briefcases? If he sells 2200 briefcases? Recall that P =
$200, V = $80, and F = $360,000.

Profit at 4100 units =

TR
$120 x 4100 - $360,000.
$132,000
$1000s
TC

$600 Profit at 2200 units = $120 x 2200 - $360,000.

$360 -$96,000 More easily: 4100 units is 1100 units past BEP,
so profit = $120 x 1100 units; 2200 units is 800
units before BEP, so loss = $120 x 800 units.

units
2200 3000 4100
 CVP Calculations
How many briefcases does Bill need to sell to reach a target pretax
profit of $240,000? What level of sales revenue is this? Recall that P =
$200, V = $80, and F = $360,000.

Units needed to F + Profit $360,000 + $240,000

reach target = P − V = $120 / unit
pretax profit
= 5,000 units
Of
Ofcourse,
course,5,000
5,000units
unitsxx
Sales $ required F + $240,000 F
$200/unit
$200/unit==$1,000,000,
$1,000,000,
too.
to reach target = = too.
CMR (P − V ) / P But
Butsometimes
sometimesyou you
pretax profit only know the CMR
only know the CMR
and
andnot
notthe
theselling
sellingprice
price
$600,000 per
per unit, so this is stillaa
unit, so this is still
= = $1,000,000 valuable
valuableformula.
60% formula.
CVP Calculations
How many briefcases does Bill need to sell to reach a target after-tax
profit of $319,200 if the tax rate is 30%? What level of sales revenue is
this? Recall that P = $200, V = $80, and F = $360,000.

First convert the target after-tax profit to its target pretax profit:

After-tax profit $319,200

Pretax profit = = = $456,000
(1 − Tax rate) (1 − 0.3)
Units needed to
$360,000 + $456,000
reach target = = 6,800 units
pretax profit $120 / unit

Sales $ needed
$360,000 + $456,000
to reach target = = $1,360,000
pretax profit 60%
Using CVP to Determine Target
Cost Levels
Suppose that Bill’s marketing department says that he can sell 6,000
briefcases if the selling price is reduced to $170. Bill’s target pretax
profit is $210,000. Determine the highest level that his variable costs
can so that he can make his target. Recall that F = $360,000.

Use the CVP formula for units, but solve for V:

$360,000 + $210,000
Q = 6,000 units =
$170/unit − V
$360,000 + $210,000
$170/unit − V = = $95/unit
6,000 units

V = $75/unit

If Bill can reduce his variable costs to $75/unit, he can meet his goal.
Margin of safety

The difference between budgeted sales

revenue and break-even sales revenue.
The amount by which sales can drop
before losses begin to be incurred
Excess of expected sales over breakeven
sales.
Margin of safety
The margin of safety is a measure of how far past the breakeven
point a company is operating, or plans to operate. It can be
measured 3 ways:
 Margin of safety in units= actual or estimated activity
- - BEP in units
 Margin of safety in Rs. = actual or estimated in Rs.

 Margin of safety in % = Or

Margin of safety in units

Actual or estimated units

Margin of safety in $
=
Actual or estimated sales $
Margin of safety
 Suppose that Bill’s Briefcases has budgeted next year’s sales at
5,000 units. Compute all three measures of the margin of safety
for Bill. that P = $200, V = $80, F = $360,000, the BEP in units =
3,000, and the BEP in sales $ = $600,000.

 margin of safety in units = 5,000 units – 3,000 units = 2,000 units

 margin of safety in $ = $200 x 5,000 - $600,000 = $400,000
 margin of safety percentage = 2000 units
5000 units
= $ 400,000 = 40%
$ 200 *5000