Marginal costing

The supreme goal of every manager is make profit . To achieve this management has to take
several decisions regarding the marginal unit, the product mix, pricing, make or buy. It has to
ascertain the cost which are controllable and establish a mechanism to control them. Marginal
costing is an effective technique applied by the management in taking several decisions and
controlling cost . The application of marginal is explained below.

(1) Decision Regarding The Marginal Unit

. It means a single additional unit or an additional block of units such as a batch of articles, an
order, a process, a department and so on. Management .Management has to frequently take
decisions regarding the additions or discontinuance of the Marginal Unit. Thus,
Management has to decide whether to
• increase or decrease the production of a single article
• continue or discontinue a batch of articles
• accept or reject a specific order
• continue or discontinue a specific process
• add or discontinue a department, and so on.
(2) Decision Regarding Optimum Product-mix
Marginal Costing helps the management in deciding the most profitable product-mix. The
Break- even Chart and the Profit- Volume Ratio for each product can be studied to decide
upon the quantity of each product to be produced so as to earn the maximum Contribution
and Profits. That Product-Mix which yields the maximum possible profits is the optimum
Product-Mix.
(3)Decision Regarding Utilisation of Scarce Resource
If any resources such as labour, machinery, raw material or finance are in short supply, the
Contribution in relation to the Key Factor can be worked out. The product which yields the
highest Contribution per unit of the scarce factor (Contribution per Labour Hour etc.) can be
produced in large quantities to derive the maximum profits possible.
(4) Decision Regarding Pricing
Marginal Costing helps the management in taking price decisions. In Absorption Costing, the
prices are fixed so as to cover the total costs which include Fixed Costs as well as
Variable Costs. In Marginal Costing, however, the price can be fixed on the basis of only
Variable Cost
Thus prices can be fixed so as to -
(a) Earn Maximum Contribution: Marginal Costing Techniques such as Profit Volume Ratio are
L_ for submitting quotations or tenders.
especially helpful in fixing the selling price
(b) At Least Break-even. i.e. earn just enough to cover the costs. Thus if the product is
perishable or seasonal, it is advisable to at least break even, i.e. sell on no profit no loss basis.
The technique of Break-even Charts is useful in deciding the break-even point. It assists in
deciding the minimum quantity to be sold or the minimum price to be charged in order to break-
even.
(a) Recover At Least the Marginal Costs, e.g. in the following circumstances -
(i) Depression: When there is trade depression, the concern must survive
somehow. Even if the production is stopped, the Fixed Costs will continue.
Hence it is better to continue the production so as to retain the trained
labour, staff and the consumers. The plant will also remain in working
condition. This will avoid the costs of closing down and re-starting again when
the trade conditions improve.

(11) Eliminate Competition: When the concern wants to eliminate competition, it may
initially sell at the Marginal Cost. Thereafter once the competition is eliminated, it will
enjoy monopoly, can charge higher prices and recover its losses.

(111) Establish New Product: When the concern wants to introduce or popularise a new
product, initially, it may sell at the Magrinal Cost. Once the product is established, it
can increase its prices and recover its losses. The same strategy can be applied in
case of a special order, or for an export order etc.
(5) Decision Regarding Make or Buy
Management has to decide whether it would be more profitable to manufacture a product
or a. component in-house rather than buying it from outside. Thus-
(1) The concern should make ail article itself if its Mar g inal Cost is lower than the
market price of the article. Thus,

Make Article A if Marginal Cost of A < Market Price of A

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(1) If theC7
making
making machinery
Article A thebeing used
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itself producing
makeanother article
the article (sayif B)
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Market diverted
Price of
article A is more than the total of the Marginal Cost of A + Contribution of Article B which will be
lost.
Make Article A if [Marginal Cost of A + Contribution of B] < Market Price of A

(6) Cost Control

Marginal
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hence are with Variable
not controllable Costs
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Thus, oncetothe
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amenable Costs,
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help the management in controlling the marginal costs. Break-even Charts C and PV Ratios also help
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the management in controlling cost and maximising the profits
Illustration 1 :
From the following data, calculate break-even point (BEP) in units as well as value.
Rs.
Selling price per unit 20
Variable cost per unit 15
Fixed overheads 20,000
If sales are 20% above BEP, determine the net profit.

Illustration 2:
(i) Find out contribution and BEP sales if Budgeted Output is 80,000 units. Fixed Cost is
Rs. 4,00,000, Selling Price per unit is Rs. 20. Variable Cost per unit is Rs. 10
(ii) Find out Margin of safety, if profit is Rs. 20,000 and PV Ratio is 40%.

Illustration 3:
From the following data, calculate:
(i) Break-even point expressed in amount of sales in rupees.
(ii) Number of units that must be sold to earn a profit of Rs. 1,60,000 per year.
Selling price Rs. 20 per unit
Variable manufacturing cost Rs. 11 per unit
Variable selling cost Rs. 3 per unit
Fixed factory overheads Rs. 5,40,000 per year
Fixed selling cost Rs. 2,52,000 per year

Illustration 4
Sales Rs. 1,00,000, Profit Rs. 10,000, Variable Cost 70%. Find out (a) PV ratio (b) Fixed cost and
(C) Sales to earn of profit Rs. 40,000.

Illustration 5:
Profit Volume Ratio of a company is 50%, while its margin of safety is 40%. It sales volume of the
company is Rs. 50 lakhs, find out its break-even point and net profit.

Illustration 6:
(1) Ascertain Profit, when Sales Rs. 2,00,000
Fixed Cost Rs. 40,000
BEP Rs. 1,60,000
(2) Ascertain Sales, when Fixed Cost Rs. 20,000
Profit Rs. 10,000
BEP Rs. 40,000

Illustration 7: (PVR, BEP, MS & New Sales)

S. Ltd. furnishes you the following information relating to the half year ending 30th Sept. 2003
Rs.
Fixed expenses 50,000
Sales value 2,00,000
Profit 50,000
During the second half of the same year the company, has projected a loss of Rs. 10,000.
Calculate -
(i) The P/V Ratio, break-even point and margin of safety for six months ending 30th
Sept., 2003.
(ii) Expected sales value for second half of the year assuming that selling price and
fixed expenses remain unchanged in the second half year also.
(iii) The break-even point and margin of safety for the whole year 2003-2004.

Illustration 8: (Ascertaining PVR, FC, BEP, New Sales, New Profit)

 Particulars Sales Profit
Rs. Rs.
Period 1 10,000 2,000
Period 2 15,000 4,000
You are required to calculate: -
(a) PV ratio, (b) Fixed Cost, (c) Break-even sales volume, (d) Sales to earn a profit of Rs. 3,000
and (e) Profit when sales are Rs. 8,000.

Illustration 9: (BEP - Amount & Units)

A company sells its product at Rs. 15 per unit. In a period if it produces and sells 8,000 units, it
incurs a loss of Rs. 5 per unit. If the volume is raised to 20,000 units it earns a profit of Rs. 4 per
unit. Calculate break-even point both in terms of rupees as well as in units.

Illustration 10: (Sales From BEP)

From the following data find out (i) sales and (ii) new break-even sales, if selling price is reduced
by 10%.
Particulars Rs.
Fixed Cost 4,000
Break-even sales 20,000
Profit 1,000
Selling price per unit 20

Illustration 11: (PVR & FC)

Calculate PV Ratio and Fixed expenses from the following:
Margin of Safety Rs. 80,000
Profit Rs. 20,000
Sales Rs. 3,00,000

Illustration 12: (Sales From PVR, BEP)

The ratio of variable cost to sales is 70%. The break-even point occurs at 60% of the capacity
sales. Find this capacity sales when fixed costs are Rs. 90,000. Also compute profit at 75% of the
capacity sales.

Illustration 1 : (Export Order)

The cost sheet of a product is as follows:
Particulars Rs.
per
unit
Direct Material 10.00
Direct Wages 05.00
Factory Overheads
Fixed 01.00
Variable 02.00
Administrative Expenses (fixed) 1.50
Selling and Distribution
Expenses:
Fixed 00.50
Variable 01.00
Cost of Sales 21.00
The selling price per unit is Rs. 25.00. The above cost information is for an output of
50,000 units, whereas the capacity of the firm is 60,000 units. A foreign customer is
desirous of buying 10,000 units at a price of Rs.19 per unit. The extra cost of
exporting the product is Rs. 0.50 per unit. You are required to advise the
manufacturer whether the order should be accepted?

Illustration 2: (Discontinue A Product)

A manufacturing company makes two product - Luxury and Delux. The results for
2009 were as under:
Particulars Luxury Delux
Rs. Rs.
Sales 2,00,000 1,60,000
Variable Cost 1,20,000 1,32,000
Fixed Cost 40,000 32,000
Profit/Loss 40,000 (-) 4,000
The managing director has suggested that Delux should be dropped. Should Delux
be dropped, if:
(1) His decision has no effect on sales of luxury; or
(2) By using the vacant factory space, sales of luxury could be increased by
Rs. 1,00,000 the extra production would lead to increase in the total fixed cost to
Rs. 76,000.
(3) If deluxe is discontinued fixed cost would be nil for the product.

Illustration 3 (Discontinue Division C)- XYZ Ltd. has three divisions each of which
makes a different product. The budgeted data for the next year are as follows:
A B C
Sales 1,12,000 56,000 84,000
Costs:
Direct material 14,000 7,000 14,000
Direct labour 5,600 7,000 22,400
Variable Overhead 14,000 7,000 28,000
Fixed costs 28,000 14,000 28,000
Total Costs 61,600 35,000 92,400
Profit/(Loss) 50,400 21,000 (8,400)
The management is considering to close down Division C. There is no
possibility of reducing fixed costs. Advise ‘whether or/not Division C
should be closed down?

Illustration 4 ( temporary cessations of operations/ shut down

point) - ABC Ltd. operates at normal capacity. It produces 20,000 units of
a product from plant 111. The unit cost of manufacturing at normal
capacity is as follows: (Rs.)
Direct materials 6.50
Direct labour 2.60
Variable 3.30
overhead
Fixed overhead 4.00

Each unit of the product is sold for Rs. 20 with variable selling and
administrative expenses of 60 paise per unit c product. The company
excepts that during the next year only 2,000 units can be sold.
Management plants to shut-down the plant, estimating that the fixed
manufacturing overhead can be reduced to Rs. 45,000 for the next year.
When the plant is operating the fixed overhead costs are incurred at a
uniform rate throughout the year. Additional costs of plant shut are
estimated at Rs. 15,000. Should the plant be shut-down? Show
computations. Calculate the shut down point.
Illustration 5 : ( selection of product mix )
From the following date you are required to present the best alternative

Particulars Product Per unit

Rs.
Direct Materials X 10.50
Direct Materials Y 8.50
Direct Wages X 3.00
Direct Wages Y 2.00
Variable expenses 100% of direct wages per product.
Fixed expenses (total) Rs. 800
Sales PriceX Rs. 20.50 and
Y Rs. 14.50
Suggested sales mixes:
Alternatives No of
Units
X y
A 100 200
B 150 150
C 200 100

Illustration 6 : ( Key Factors)

The following particulars are taken from the records of a company engaged in
manufacturing two products, A and B, from a certain material:
Particulars Product Product
A B
(per (per unit)
unit) Rs.
Rs.
Sales 2,500 5,000
Material cost (Rs. 50 per kg.) 500 1,250
Direct Labour (Rs. 30 per hour) 750 1,500
Variable overhead 250 500
Total Fixed Overhead: Rs.
10,00,000
Comment on the profitability of each product when:
(1) Total sale in value is limited and only one product to be sold.
(2) Raw materials is in short supply .Total availability of raw materials is
20,000 kg. and maximum sales potential of each product is 1,000 units, find the
product mix to yield maximum profits.
 (3) Labour is the limiting factor. Total availability of labour hours is 40,000
hours. and maximum sales potential of each product is 1,000 units, find the
product mix to yield maximum profits.

Illustration 7: (Key Factor : Raw Materials)

Vinak Ltd. which produces three products furnishes you the following data for 2003-
04:
Particulars Products
A B C
Selling Price per unit (Rs.) 100 75 50
Profit volume, ratio (%) 10 20 40
Maximum sales potential (Units) 40,000 25,000 10,000
Raw Material content as percentage of
variable costs (%) 50 50 50
The fixed expenses are estimated at 6,80,000. The Company uses a single raw
material in all the three products. Raw material is in short supply and the company
has a quota foe the supply of raw materials of the value of Rs. 18,00,000 for the
year 2003-04 for the manufacture of its products to meet its sales demand.
You are required to:
(1) Set a product mix which will give a maximum overall profit keeping the
short supply of raw materials in view.
(2) Compute that maximum profit.

Illustration 8: ( Key factor sums)

ABC Ltd. manufactures and sells three products X, Y and Z.

Budgeted sales X Y Z
demand 300 500 200
units units units
Unit sales price 16 18 14
Variable costs:
Materials 8 6 2
Labour 4 12 6 12 9 11
Contribution 4 6 3
All three products use the same dire materials and the same type of
direct labour, in the next year, the available supply of materials will be
restricted to Rs.4,800, and the a supply of labour to Rs. 6,600. What
would be the profit maximising budget?

Illustration 9- ( key factor sum) - A company manufactures four

products. The cost data per unit areas under:
A B C D
Selling price 9 71 100 86
Direct materials 0 20 40 40
Direct labour 3 18 30 12
Variable 0 9 15 6
overheads 2
 4
1
2
Fixed costs are estimated at Rs. 2,00,000 per month. The company
employs 250 direct workers, who work eight hours a day for 25 days a
month. The direct wage rate is Rs. 6 per hour. It is not possible for the
company to increase its operatives in the short run nor is it practicable to
work overtime. The company’s policy does not allow subcontracting of
work. The Marketing Director has forecast the following demands for a
month:
Produc Unit
t s
A 5,50
B 0
C 5,00
D 0
6,25
0
8,25
0
The management desires you to find out the most profitable product mix

Illustration 10: -‘Novelties Ltd. seeks your advice on production mix in

respect of the three products Super, Bright Fine. You have the following
information:
for standard costs per unit:
Particulars Supe Brigh Fin
r t e
Direct 320 240 160
materials
Variable 16 40 24
overhead
Direct labour:
Departme Rate per Supe Brigh Fine
nt (Rs./Hour) r t Hour
Hour Hour s
s s
A 8.00 6 10 5
B 16.00 6 15 11
From current budget, you have further details as below:
Supe Brigh Fine
r t

Selling price per unit 624 800 430

(Rs.)
Fixed overhead: Rs. 16,00,000
Sales department’s estimate of 6,000 8,000 12,00
maximumpossible sales in the 0
coming year (Nos.)
You are also to note that there is a constraint on supply of labour in
Department A 1,50,000 hours and its manpower cannot be increase
beyond its present level.
Suggest the best production and sales mix from the stand point of
maximum profitability. Prepare statement setting out the profit resulting
from the budgeted production and the best alternative suggested by you.

Illustration 11 : (Evaluate Alternative Responses to Price Changes)

The accounts of a company are expected to reveal a profit of Rs. 14,00,000 after
charging fixed costs of Rs. 10,00,000 for the year ended 31sf March, 2009. The
Selling price of the product is 95. 50 per unit and variable cost per unit is Rs. 20.
Market Selling Price Quantity Sold
investigations Reduced by Increases by
suggest the
following responses
to the price
changes:Alternative
I 5% 10%
II 7% 20%
III 10% 25%
Evaluate these alternatives and state which of the alternatives, on profitability,
consideration, should be adopted for the forthcoming year.

Illustration 12 :
Cookwell Ltd. manufactures pressure cookers the selling price of which is Rs. 300
per unit. Currently the capacity utilisation is 60% with sales turnover of Rs. 18 lakhs.
The company proposes to reduce the selling price by 20% but desires to maintain
the same profit position by increasing the output. Assuming that the increased
output could be made and sold, determine the level at which the company should
operate to achieve the desired objective.
The following further date are available:
(1) Variable cost per unit Rs. 60.
(2) Semi-variable cost (including a variable element of Rs. 10 per unit) Rs.
1,80,000.
(3) Fixed cost Rs. 3,00,000 will remain constant upto 80% level. Beyond this
an additional amount of Rs. 60,000 will be incurred.

Illustration 13:

Pioneer engineering company Ltd has just completed first of year of its operation as
31st March 2009and summarized result of the information is given below: Installed
capacity- 20,000 kg : production 14,000 kg.
Income and expenditure details :
Particulars Rs Rs
Income 28,00,000
Expenditure
Variable
Material 3,50,000
Labour 4,20,000
Overheads
Factory 2,80,000
Marketing 2,10,000 12,60,000
Contribution 15,40,000
Fixed cost 10,00,000
Profit 5,40,000

The Managing Director wishes to expand the operation for the year next
year and has asked you to prepare flexible budgets on capacity utilisation
levels of 80%, 90% and 100% based on the following estimate
(Rs. per kg.)
(a) Price at 80% level- 220
at 90% level- 210
at 100% level- 200
Whatever produced during the year is expected to be sold within the year.
(b) Increase in variable cost components.
Materials @ 12%
Labour @ 10%
Overheads:
Factory @ 15%
Marketing @ 20%
(a) Inflation rate applicable to fixed cost is 15%. Additionally, if the capacity
utilisation exceeds 80% fixed cost is expected to increase by 10% up to
100% capacity utilisation level.
Part 2: To avoid the incidence of increase in fixed cost for production levels beyond
80% capacity utilization the production manager has submitted the plan to sub-
contract the additional production of 4,000 kg to the party at cost of Rs 105 Kg
including marketing cost . You are requested to comment on this plan of sub
contracting with a view to maximize the profit of the company,

Illustration 14 - The following is the summarised trading account of a

manufacturing concern which makes two : X and Y.
Summarised trading account for the four months to 30th April, 2003.
Particulars X Y Total
Rs. Rs. Rs.
Sales 10,00 4,000 14,000
Less: Cost of sales 0
Direct costs*
Labour 3,00 1,00
Materials 0 0 2,000 6,500
1,50 4,500 1,00 2,000 7,500
Indirect costs 0 5,500 0
Variable expenses 1,000 3,000
2,000 1,000 4,500
Fixed expense 3,500
Common to both X 1,250 2,500
and Y 1,250
Net profit (-)250 2,000
2,250

Fixed costs tend to remain constant irrespective of the physical outputs of

X and Y.
It has been the practice of the concern to allocate these costs equally
between X and Y. The following proposals have been made by the Board
of Directors for your consideration as financial adviser:
1. Discontinue Product Y.
2. As an alternative to (1) reduce the price of Y, by 20 per
cent. (It is estimated that the demand will then increase by 40 per cent
3. Double the price of X. (It is estimated that this will
reduce the demand by the three-fifths).
You are required to recommend the proposals to be taken after
evaluating each of these three proposals.

Illustration 15 (pricing of the product) - ABC Ltd. manufactures a

product involving the assembly of some parts purchased and other
worked from raw-materials. The plant has been operating at an even rate
throughout the year on one eight hour shift producing 500 units per
month. The average annual cost for the past year was as follows:
(Rs.)
Raw materials 1,60,00
Purchase parts 0
Direct wages 1,00,00
Variable 0
overhead 3,00,00
Fixed overhead 0
Total 70,000

1,20,00
0
 7,50,00
0
At this point, sales department wanted to know the minimum price to be
quoted for an order of 3,000 additional units to be produced and
delivered at the rate of 250 units each month for the next twelve
‘months. No additional selling and’ administration expenses will be
incurred, if the order is accepted and the management wants a minimum
profit of 5% on the selling price.
Any additional raw-material purchase can be made at a saving of 5% of
cost of such materials, labour requirements above the present one shift
can be secured only at an increase of 10% over present rate. Total
variable overheads are expected to increase by 60% due to the increase
in volume and fixed production overheads will go up by Rs. 9,000 only.
Prepare a statement showing details of price calculation for new order.

Illustration 16 ( accept / reject order and sub contracting) - A

company currently operating at 80% capacity has the following
particulars:
Sales 32,00,00
Direct 0
Materials 10,00,00
Direct Labour 0
Variable
Overheads 4,00,000
Fixed 2,00,000
Overheads
13,00,00
0
An export order has been received that would utilise half the capacity of
the Factory. The order cannot be split. i.e., if has either to be taken in full
and executed at 10% below the normal domestic prices, or rejected
totally.
The alternatives available to the Management are:
1. Reject the export order and continue with the domestic sales only
(as at present), or
2. Accept the export order, split capacity between overseas and
domesectic sales and turn away excess domestic demand (operate
at 100%) or
3. Increase capacity so as to accept the export order and maintain the
present domestic sales by:
a) buying an equipment that will increase capacity by 10%. This
will result in an increase of Rs. 1,00000 in fixed costs, and
b) work overtime to meet balance of required capacity. In that
case labour will be paid at one and a half- times the normal
wage rate.
Prepare a comparative statement of profitability and suggest the best alterative.