marginal costing

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Why do we study Marginal Costing?

What do we study in 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? 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 1 2 volume of out put by which aggregate costs are changed if volume of output is increased or decreased by one unit” 1 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 cost by differentiating between “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 What Could be effects of Changes In volume or From One Model of Car to Another What Could be effects of Changes In volume or Type of output From One Size of product to another

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

Profitability judged on Marginal Costing ---Characteristics Contribution S-V=C Profitability judged on Contribution made

Marginal Costing ---Characteristics Pricing Pricing is based on Contribution & Marginal Costs

Marginal Costing ---Characteristics & Profit A B C Total Sales - - - ---- Less VC - - - ---- Contribution - - - ---- Fixed Cost ---- Profit -----

Marginal Costing --- Sales of A Sales of B Sales of C less less less Marginal Costing Profit Sales of A Sales of B Sales of C less less less Marginal cost Of A Marginal cost Of B Marginal cost Of C = = = Contribution of A Contribution of B Contribution of C Total Contribution of A,B& C less Profit/loss Total Fixed Cost =

Absorption Costing “Absorption cost is a total cost technique Under which total cost i.e. fixed & variable is charged to production. Inventory is also valued at total cost.

Valuation Of stock Absorption-Marginal Costing--differences Fixed & Measurement Of Profitability Valuation Of stock Fixed & Variable Costs

Absorption-Marginal Costing--differences Fixed & Variable Costs Absorption Costing Both F & V Costs Are charged Marginal Costing Only variable cost FC charged to P/L

Valuation Of stock Total Cost Absorption-Marginal Costing--differences Valuation Of stock WIP & FS at Marginal Cost Total Cost

C=S-V P=S-V-F Absorption-Marginal Costing--differences Measurement Of Profitability C=S-V P=S-V-F

Comparative Cost Statement Marginal Costing Months 2 3 Total Rs Rs Rs Rs Absorption Costing Months 2 3 Total Rs Rs Rs Rs (A) Sales 2,00,000 1,65,000 2,35,000 6,00,000 2,00,000 1,65,000 2,35,000 6,00,000 Opening Stock 84,000 84,000 1,05,000 2,73,000 1,08,000 1,08,500 1,35,625 3,52,625 Add V Cost 1,20,000 1,20,000 1,20,000 3,60,000 1,20,000 1,20,000 120,000 3,60,000 F Cost _ _ _ _ 35,000 35,000 35,000 1,05,000 Total Cost 2,04,000 2,04,000 2,25,000 6,33,000 2,63,000 2,63,000 2,90,625 8,17,625 Less C Stock 84,000 1,05,000 84,000 2,73,000 1,08,000 1,35,625 1,08,500 3,52,625 (B) COGS 1,20,000 99,000 1,41,000 3,60,000 1,55,000 1,27,875 1,82,125 4,65,000 Contribution (A-B)c 80,000 66,000 94,000 2,40,000 _ _ _ _ ( D) F Cost 35000 35,000 35,000 1,05,000 _ _ _ _ Profit (C-D) 45,000 31,000 59,000 1,35,000 (A-B) 45,000 37,125 52,875 1,35000

Comparative Cost Statement Marginal Costing Months 2 3 Total Rs Rs Rs Rs Absorption Costing Months 2 3 Total Rs Rs Rs Rs (A)Sales 2,00,000 1,65,000 2,35,000 6,00,000 2,00,000 1,65,000 2,35,000 6,00,000 Opening Stock 84,000 84,000 1,05,000 2,73,000 1,08,000 1,08,500 1,35,625 3,52,625 Add V Cost 1,20,000 1,20,000 1,20,000 3,60,000 1,20,000 1,20,000 120,000 3,60,000 F Cost _ _ _ _ 35,000 35,000 35,000 1,05,000 Total Cost 2,04,000 2,04,000 2,25,000 6,33,000 2,63,000 2,63,000 2,90,625 8,17,625 Less C Stock 84,000 1,05,000 84,000 2,73,000 1,08,000 1,35,625 1,08,500 3,52,625 (B) COGS 1,20,000 99,000 1,41,000 3,60,000 1,55,000 1,27,875 1,82,125 4,65,000 Contribution (A-B)c 80,000 66,000 94,000 2,40,000 _ _ _ _ ( D) F Cost 35000 35,000 35,000 1,05,000 _ _ _ _ Profit (C-D) 45,000 31,000 59,000 1,35,000 (A-B) 45,000 37,125 52,875 1,35000

Comparative Cost Statement Marginal Costing Months 2 3 Total Rs Rs Rs Rs Absorption Costing Months 2 3 Total Rs Rs Rs Rs (A)Sales 2,00,000 1,65,000 2,35,000 6,00,000 2,00,000 1,65,000 2,35,000 6,00,000 Opening Stock 84,000 84,000 1,05,000 2,73,000 1,08,000 1,08,500 1,35,625 3,52,625 Add V Cost 1,20,000 1,20,000 1,20,000 3,60,000 1,20,000 1,20,000 120,000 3,60,000 F Cost _ _ _ _ 35,000 35,000 35,000 1,05,000 Total Cost 2,04,000 2,04,000 2,25,000 6,33,000 2,63,000 2,63,000 2,90,625 8,17,625 Less C Stock 84,000 1,05,000 84,000 2,73,000 1,08,000 1,35,625 1,08,500 3,52,625 (B) COGS 1,20,000 99,000 1,41,000 3,60,000 1,55,000 1,27,875 1,82,125 4,65,000 Contribution (A-B)c 80,000 66,000 94,000 2,40,000 _ _ _ _ ( D) F Cost 35000 35,000 35,000 1,05,000 _ _ _ _ Profit (C-D) 45,000 31,000 59,000 1,35,000 (A-B) 45,000 37,125 52,875 1,35000

Concept Of Contribution

Contribution =sales-variable cost C= S-V 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

If any 3 factors in the equation are known The 4th could be found out 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 ? SALES? C=S-V P=C-F S=C+V =5,000+7,000 =Rs 12,000 Sales =Rs 12,000 V Cost=RS 7,000 F Cost=Rs 4,000 C=S-V =12,000-7000=5000 P=C-F =5,000-4000 =Rs 1,000 S=C+V =5,000+7,000 =Rs 12,000

F COST? V Cost? F=C-P =5,000-1,000 =Rs 4,000 V=S-C =12,000-5000 Sales =Rs 12,000 V Cost=RS 7,000 F Cost=Rs 4,000 F=C-P =5,000-1,000 =Rs 4,000 V=S-C =12,000-5000 =Rs 7,000

Profit –Volume Ratio (PV Ratio) (Expresses the relation of Contribution to sales) Sales= Rs 10,000 V Cost=Rs 8,000 P/V Ratio =Contribution = C/S =S-V/S Sales 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) Another Method Change in Contribution P/V Ratio = --------------------------------- Change in Sales Change in profit = ----------------------- 1600-1000 =-------------------x 100 22000-20000 600 = -----------x100=30% 2,0000 Year sales net profit 20,000 1000 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

a factor in the activities of an undertaking 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 Labour Materials Power Sales Capacity Machines 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 don’t 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 ALGEBRAIC METHOD Fixed Cost BEP (Units) = --------------- = F Contribution PU S-V BEP (Rs ) = ----------------- x Sales Contribution BEP (Rs) = ------------------ P/V Ratio

Cost- Volume- Profit Analysis ALGEBRAIC METHOD Fixed Cost BEP (Units) = --------------- = F Contribution PU S-V BEP (Rs ) = ----------------- x Sales Contribution BEP (Rs) = ------------------ P/V Ratio F Cost=Rs 12000 S Price=Rs12 pu V Cost =Rs 9 pu Find BEP

Cost- Volume- Profit Analysis F Cost=Rs 12000 S Price=Rs12 pu V Cost =Rs 9 pu Profit when sales are Rs 60,000 Rs 1,00,000 Other Uses Profit at diff. Sales Vol. 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 Rs 60,000 Rs 1,00,000 Profit at diff. Sales Vol. C P/V Ratio= ----- = 3/12=25% S WHEN SALES=Rs 60,000 contribution=salesxp/vratio =60000x25% =Rs 15000 Profit =contribution-fixed cost =15000-12000 =Rs3000

Cost- Volume- Profit Analysis F Cost=Rs 12000 S Price=Rs12 pu V Cost =Rs 9 pu Sales if desired profit Rs 6000 Rs 15,000 Other Uses Sales at Desired Profit F Cost +Desired Profit Sales= ------------------------------- P/V Ratio

Cost- Volume- Profit Analysis F Cost=Rs 12000 S Price=Rs12 pu V Cost =Rs 9 pu Sales if desired profit Rs 6000 Rs 15,000 Sales at Desired Profit F Cost +Desired Profit Sales= ------------------------------- P/V Ratio 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=3000000—5% =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 FC Costs/Revenue Q1 Output/Sales Initially a firm will incur fixed costs, these do not depend on output or sales. FC Q1 Output/Sales

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

Break-Even Analysis TC VC FC Costs/Revenue Q1 Output/Sales TR Q2 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 TR VC FC Q2 Q1 Output/Sales

Break-Even Analysis TC VC FC Costs/Revenue Q1 Q3 Output/Sales TR) If the firm chose to set prices lower it would need to sell more units before covering its costs TR TC VC FC Q1 Q3 Output/Sales

Break-Even Analysis TC VC Profit Loss FC Costs/Revenue Q1 Output/Sales TR TC Costs/Revenue VC Profit Loss FC Q1 Output/Sales

Break-Even Analysis TC VC Margin of Safety FC Costs/Revenue Margin of safety shows how far sales can fall before losses made. If Q1 = 1000 and Q2 = 1800, sales could fall by 800 units before a loss would be made TR TR TC Costs/Revenue A higher price would lower the break even point and the margin of safety would widen VC Assume current sales at Q2 Margin of Safety FC Q3 Q1 Q2 Output/Sales

FC 1 FC Losses get bigger! TR VC Costs/Revenue Output/Sales High initial FC. Interest on debt rises each year – FC rise therefore Costs/Revenue 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 break-even Lower prices might encourage more customers but higher volume needed before sufficient revenue generated to break-even

Links of BE to pricing strategies and elasticity Break-Even Analysis Links of BE to pricing strategies and elasticity Penetration pricing – ‘high’ volume, ‘low’ price – more sales to break even

Links of BE to pricing strategies and elasticity Break-Even Analysis Links of BE to pricing strategies and elasticity Market Skimming – ‘high’ price ‘low’ volumes – fewer sales to break even

Links of BE to pricing strategies and elasticity 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 6000 5000 4000 2000 BEP Fixed Cost Rs Profit Rs 0 5000 10000 15000 20000 Sales Rs 2000 4000 5000 6000 8000

Construction Of PV Chart 8000 6000 5000 4000 2000 BEP Profit Area Fixed Cost Rs Profit Rs 0 5000 10000 15000 20000 Sales Rs Loss Area 2000 4000 5000 6000 8000 Margin of Safety --------------------------

New F Cost= 5000- 20%=Rs4000 Fixed Cost New BEP = PV Ratio = 4000/50% 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 5000 4000 2000 BEP Profit Area Fixed Cost Rs Profit Rs 0 5000 10000 15000 20000 Sales Rs Loss Area 2000 4000 5000 6000 8000

New V Cost= 10000- 10%=Rs9000 New PV Ratio=20000-9000 20000 =55% Effect Of Change in Profit- 10% decrease in V Cost New V Cost= 10000- 10%=Rs9000 New PV Ratio=20000-9000 20000 Fixed Cost New BEP = PV Ratio = 5000/55% =Rs 9090 Appx New Profit=S-F-V =20000-5000-9000 =Rs 6000 =55%

Construction Of PV Chart 8000 6000 5000 4000 2000 New BEP Profit Area Fixed Cost Rs Profit Rs 0 5000 10000 15000 20000 Sales Rs Loss Area 2000 4000 5000 6000 8000

Effect Of 5% Decrease in Selling Price 8000 6000 5000 4000 2000 Profit Area Fixed Cost Rs Profit Rs 0 5000 10000 15000 20000 Sales Rs Loss Area 2000 4000 5000 6000 8000 New BEP

ATTENTION COMMERCE STUDENTS ACCOUNTING(FINANACIAL & COST) OF ICMAP STAGE 1,2,3,4 (NEW CLASSES) CA..MODULE B,C,D PIPFA (FOUNDATION,INTERMEDIATE,FINAL) ACCA-F1,F2,F3 BBA,MBA B.COM(FRESH),M.COM MA-ECONOMICS..O/A LEVELS KHALID AZIZ…..0322-3385752