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Marginal Costing[1]

# Marginal Costing[1]

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12/01/2010

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# Marginal Costing & Cost-Volume-Profit Analysis

Dr Smita Sahoo

Two Approaches to Compute Profits
Conventional income statement Conventional income statement Contribution margin income statement Contribution margin income statement

Dr. Smita Sahoo

Conventional Income Statement
Cost of = Goods Sold Gross Margin

Sales

Gross Margin
Dr. Smita Sahoo

Operating = Expenses

Net Income

Contribution Margin Income Statement
Sales – Variable Contribution = Overhead Margin

Contribution – Margin
Dr. Smita Sahoo

Net Income

Breakeven Point (BEP) BEP for a business is the output level( units produced or services provided) at which the income from sales is just enough to cover all costs.
Dr. Smita Sahoo

BEP Calculation – an Example
• • • • • Assume selling price is Rs.35 per unit. Variable expense is Rs.21 per unit. Fixed cost is Rs.7,000. What is the breakeven point? BEP( in Units)

F ix ed C o sts BEP = C o n trib u tio n p er U n it
Dr. Smita Sahoo

Breakeven Point
40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 Rs.

Breakeven sales point
e Sa l s

Rupees

n e ve r

u

line e

l Tota

e st lin Co

Fixed Cost line
300 500 Units 1000

Dr. Smita Sahoo

Margin of Safety (MOS)
Margin of Safety is the difference between the expected level of sales and the BEP. The larger the margin of safety , the more likely it is that a profit will be made. MOS= Projected sales – BEP Profit= MOS X Contribution per unit
Dr. Smita Sahoo

P/V or C/S Ratio
C ontribution per U nit P/V R atio = X 100 Selling price per U nit
Fixed C osts B E P in sales value=   P/V R atio

Dr. Smita Sahoo

Example-I
Selling price per unit DM DL Variable overhead Fixed overhead Profit per unit
Rs/Unit Rs/Unit

22 16 14 18

100

70 30

Fixed overhead absorption rate is based on the normal capacity of 2000 units per month. Assume that FC per month will remain same through out the year. Budgeted sales for the next month are 3,500 units. Dr. Smita Sahoo

You are required to calculate:
I. The breakeven point in sales units per month; II. Margin of safety for the next month; III. Budgeted profit for the next month; IV. The sales required to achieve a profit of Rs.108,000 in a month.

Dr. Smita Sahoo

Limitations of BEP/CVP Analysis
i. ii. iii. iv. Costs are assumed to behave in a linear fashion. Sales revenues are assumed to be constant for each unit sold. It is assumed that there is no changes in stocks. It is assumed that activity is the only factor affecting costs, and factors such as inflation are ignored. This limits BEP analysis to short-term decision making.

Dr. Smita Sahoo

Limiting factor decision-making
A limiting factor is any factor which is in scarce supply and which stops the organisation from expanding its activities further. Decision rule can be stated as ‘ maximising the contribution per unit of limiting factor’.

Dr. Smita Sahoo

Example : Profit Statement using Marginal Costing & Absorption Costing
A company produces & sells one product only which sells for Rs50 per unit. There were no stocks at the end of May & other information are as follows. Standard cost per unit: Direct Material 18.00 Direct Labour 4.00 Variable production overhead 3.00 Budgeted & actual costs per month: Fixed production overhead 99,000 Fixed selling exp. 14,000 Fixed admn. Exp. 26,000 Variable selling exp. 10% of Sales value
Dr. Smita Sahoo

Rs.

Example : Profit Statement using Marginal Costing & Absorption Costing
Normal Capacity is 11,000 units per month. The number of units produced & sold was: June Units 12,800 14,000 July Units 11,000 10,200

Sales Production
Dr. Smita Sahoo

Reconciliation of profit
June Marginal Costing profit 117,000 Adj. for fixed overhead in stock: Stock increase( 1200 X9) 10,800 Stock decreases (800 X 9) Absorption costing profit 127,800 July 81,000

(7,200) 73,800

Note: If stocks↑ then Absorption costing profit will be more & if stocks↓ marginal costing profit will be higher.
Dr. Smita Sahoo

Relevant & Non-relevant Costs
Relevant costs are those which will be affected by the decision being taken. If a cost will remain unaltered regardless of the decision being taken, then it is called a non-relevant cost.

Dr. Smita Sahoo

Examples of non-relevant costs
• Sunk or past costs • Absorbed fixed overhead • Future Expenditure • Historical cost • Notional Costs

Dr. Smita Sahoo

Opportunity Costs
“The value of the benefit sacrificed when one course of action is chosen, in preference to an alternative . The opportunity cost is represented by the forgone potential benefit from the best rejected course of action.” An opportunity cost is a special type of relevant cost.
Dr. Smita Sahoo

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