A Case Study on
Application of Marginal Costing in Managerial Decision Making of
N M CREATIONS
Submitted by:• Abbas Chitalwala • Abhee Parmar • Bhawin Saraiya • Jagruti Patti • Arun Mishra 03 04 29 54 24
A report submitted to the institute as part of the project required for the subject Financial and Cost Accounting for the year 2011-2013.
Under the guidance of: Prof L. N. Chopde
Mumbai Educational Trust
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Keeping that in mind our group will first explain the concepts of overhead costing and later. help understand how the concepts are converted into the required format by accountants for the purpose of maintaining Books of Accounts. clarity of theoretical concepts is very crucial to understand what the purpose of the calculations is. Their clients include many famous brands of India. To conclude we share a common yet critical view of this topic that most managers would agree with and find relevant.
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. A brief overview of the company is also provided though much focus is given to our project related aspect.PREFACE
Through this ‘Case Study of
APPLICATION OF MARGINAL
in n m creations’ we hope we have successfully managed to explain the concepts and processes with practical examples. While concepts of accounting principles are best understood only by actually applying them in practical purpose. through the company in light.
COSTING IN MANAGERIAL DECISION MAKING
N M Creations is a Manufacturing company that has been in business for over 4 years.
Finally. N. Our sincere thanks to Mr. We would also like thank him for his valuable expertise and for guiding us throughout our project. We would also like to thank the MET Library staff for allowing us to use the library for our reference purpose. Hamir Merchant of n m creations for allowing us to study this topic with practical examples.ACKNOWLEDGEMENT
We would like to express our sincere gratitude to Prof. L.
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. Chopde for giving us the opportunity to work on such an informative project which proved to be a very good learning experience. we would like to thank all those who have directly and indirectly helped us throughout our project and motivated us for its successful completion.
Profit and Breakeven Analysis. This followed by a brief introduction of the company n m creations and their profile.EXECUTIVE SUMMARY
We begin our project by throwing light on the various concepts of Marginal Costing including Contribution. Marginal Costing also helps in understanding the Margin of Safety and desired profit. In conclusion we talk about the impact of Marginal Costing while taking Managerial Decision for the company specially reducing costs and project expansions. Chopde and various books as well.
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. Our most relevant source for content was the company n m creations followed by the theory taught by Prof. These are followed by notes to explain the items included in the Fixed and Variable Costs and the basis for calculation. Then through a detailed Profit and Loss Account of the Company for year ended 31st March 2008 we will explain the various elements listed and their relevance.
About N M Creations Introduction Marginal Costing Concepts Marginal Costing Analysis Marginal Costing & Decision Making Conclusion Bibliography
6 7 10 12 14 15 16
2 3 5 6 7 8
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SERIAL NO. 1 TOPIC PAGE NO.
N. Industrial wear. n m creations has been in business for more than 4 years with the Proprietor drawing valuable experience and training from the 3rd generation family business of textiles with personalized attention from Selection of Mill Made Fabric to Finishing.N M CREATION
11B GIRI KUNJ . MUMBAI 400 007. We appreciate if the undersigned is given an opportunity to present our credentials and display the workmanship of our products.
We introduce ourselves as Manufacturers of full range of Garments which include Sportswear. BOSINI & NIKE)
At n m creations our Paramount concern is to maintain the highest standards of Quality at Competitive rates and provide the Maximum comfort.
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. A special emphasis is given to the comfort of the wearer as per the pattern and specification laid down by the customer.S. Our clients include: MODISCH (suppliers & exporters of Garments to GAP n Wrangler Jeans) SAH SAFARI ( Brand : INTERNATIONAL NEWS & KKNY ) V N S TEXTILES ( supplier & exporter to ZEEMAN.PATKAR MARG.
cheaper premises. This is partly because it is not usually possible to find a buyer for the premises at a very short notice and it may be difficult to move premises quickly where there is. what we really see is that more than the fixed cost. It would mean to deny itself an opportunity of benefit from a possible revival of trade. Marginal costing is a technique of costing which analyses and presents costing information to the management in such a manner that the right decision is taken on managerial problems. There is a downturn in demand for the service which the business provides and it would be possible to carry on the business from smaller. it would be reluctant to take such a dramatic step. delicate equipment to be moved. Suppose a business occupies premises to carry out its activities.The costs that vary with a decision should only be included in decision analysis. it cannot happen. It is also a technique where only variable cost or direct cost will be charged to the cost unit produced. Does this mean that the business will sell its old premises and move on to new ones overnight? Clearly. For many decisions that involve relatively small variations from existing practice and/or are for relatively limited periods of time. Thus. So. fixed costs are not relevant to the decision. This is because either fixed costs tend to be impossible to alter in the short term or managers are reluctant to alter them in the short term. Apart from external constraints on the speed of move. The business premises may provide an example of an area of one of the more inflexible types of cost but most of the fixed costs tend to be broadly similar in this context. let us say. The analysis is segregated into short and long-run cases. Marginal costing shows the effect on profit of changes in volume or type of output by differentiating between fixed and variable costs. what really influences decision making in the short-run is the variable cost which is actually synonymous with the marginal cost. the management may feel that the downturn might not be permanent.
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and other costs are considered fixed costs.
Features of Marginal Costing System:
• • • •
It is a method of recording costs and reporting profits All operating costs are differentiated into fixed and variable costs Variable cost charged to product and treated as a product cost whilst Fixed cost treated as period cost and written off to the profit and loss account Closing stock is valued on marginal cost
Advantages of Marginal Costing:
It is simple to understand re: variable versus fixed cost concept A useful short term survival costing technique particularly in very competitive environment or recessions where orders are accepted as long as it covers the marginal cost of the business and the excess over the marginal cost contributes toward fixed costs so that losses are kept to a minimum Its shows the relationship between cost. price and volume Under or over absorption do not arise in marginal costing
Stock valuations are not distorted with present years fixed costs Page | 8
.At each level of production and time period being considered. marginal costs include all costs which vary with the level of production.
fixed costs may become variable Its oversimplified costs into fixed and variable as if it is so simply to demarcate them It is not a good costing technique in the long run for pricing decision as it ignores fixed cost.•
Its provide better information hence is a useful managerial decision making tool It concentrates on the controllable aspects of business by separating fixed and variable costs The effect of production and sales policies is more clearly seen and understood
Disadvantages of Marginal Costing:
Marginal cost has its limitation since it makes use of historical data while decisions by management relates to future events It ignores fixed costs to products as if they are not important to production Stock valuation under this type of costing is not accepted by the Inland Revenue as it ignores the fixed cost element It fails to recognize that in the long run. hence stock valuation can be distorted if fixed cost is classify as variable
• • • •
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. management must consider the total costs not only the variable portion Difficulty to classify properly variable and fixed cost perfectly. In the long run.
Margin of Safety: Margin of safety = Actual Sales – Break even Sales % of Margin of safety = Margin of safety x 100 Actual Sales Margin of safety = Profit P/V Ratio
5.Marginal Costing Concepts
FORMULA: 1. Break Even Sales: Break even point = Total Fixed Cost Contribution per unit
Break even point = Total Fixed Cost PV Ratio
4. Marginal Cost Equation: S–V=F+P Where. S = Sales V = Variable F = Fixed Cost P = Profit
2. P/V Ratio : P/V Ratio = Contribution x 100 Sales Contribution = Sales – Variable 3. Find Profit when Sales are given: Profit = Contribution – Fixed Cost
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6. Sales required to earn profit: Sales required = Desired Contribution P/V Ratio which is: Sales required = Fixed Cost + Desired Profit PV Ratio
N M CREATION
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278 30.000 44.364
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.851 915.069 7.527
INDIRECT EXPENSES To audit fees To advertisement expenses To bank int & charges To brokerage on sales To comp maintainance To int on o/d To depreciation To electricity exp.648.000 479. To loan processing charges To net profit
13.324 1.085.Trading and P/L Account for the year ending March 2008
Particulars To opening stock To purchases DIRECT EXPENSES To warehouse charges To consultancy expenses To process charges To transport charges To yarn dyeing charges To twisting charges To weaving charges To warping charges To gross profit Amount (Rs) 18092527 55841336 Particulars By sales By closing stock 280.207 5.420 1.648.364
By gross profit By disc.170.000
5.641.713 63.364 7.779 430.000 223.600 5.234.364 100. To int on partners cap To insurance charges To car exp.768 479.rec.891.446 12.000 21.204 923.990 3.306 237.810 4.278 276.641.500 9.938 1.891. To professional fees To salary & bonus To telephone exp.806.598.864.180 18.707 100.000 4.500 610.500 61.
5.600 22. To misc.946.exp.707 Amount(Rs) 82.763 12. To int on loan To petrol & diesel exp.
Classification of Costs
Fixed Costs Amount(Rs . 81602126
MARGIN OF SAFETY = ACTUAL SALES .306 7.000 479.000 13.000 21.22 %
BEP (Rs.810 55841336 78485342
MARGINAL COSTING ANALYSIS
Particulars SALES less VARIABLE COSTS CONTRIBUTION less FIXED COSTS PROFIT
Rs.500 process charges transport charges yarn dyeing charges twisting charges weaving charges warping charges advertisement expenses brokerage on sales electricity exp petrol & diesel exp telephone exp misc.631 61207
P/V RATIO = CONTRIBUTION/SALES
5.BEP SALES Rs.069 44.600 9.259.713 63.420 1.) = FIXED COSTS/PV RATIO
Rs.500 610.180 78485342 4320838 4.500 22.170.1204054
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.600 430.exp car exp.806.990 915. ) (Rs) warehouse charges consultancy expenses to audit fees bank int & charges comp maintainance int on o/d Depreciation int on loan professional fees salary int on partners cap insurance charges loan processing charges 280.779 3.864.000 223.) Variable Costs Amount(Rs. 82.234.768 479.851 1.446 12.631 4.204 923.946.000 4.938 1.763 12. Purchase 4.278 30.598.278 276.259.324 237.
It is shown as follows: Existing Sales: Rs.259.(78485342 + y %) = “B” Revised Fixed Cost : 4. we can see that Marginal Costing enables us to reach a conclusion and make a Managerial Decision.806. They offered to Import worth Rs. Thus Marginal Costing is practically applicable and beneficial to the management. If nm creations were to accept the order then it would increase their plant utilisation to 100% from the existing 80%.”A” .631 + x %) = “C” Existing Profit : Rs. Profit arising after accepting the Import assignment (“C”) with the original profit i. “A” Percentage increase in F.e.C on account of Import assignment : x % Percentage increase in V.259.180 + A Revised Variable Cost : 78485342 + y % Revised Contribution : (82.e.During the month of May 2008 n m creations was approached by Vivid Impex. 82. 82.631+ x % Revised Profit : “B” – (4. If “C” > Existing Profit then the manager will accept the import assignment.806.Marginal Costing in Decision Making
CASE .180 + A) .180 Import Order worth Rs.C on account of Import assignment : y % Revised Sales: Rs. However Marginal Costing Analysis helped understand the profitability of the deal better.806.
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. If “C” < Existing Profit then the manager will reject the import assignment. Profit prevalent after rejecting the Import assignment.61207 Comparing the revised profit i. This contract would give nm creations entry into European markets which was much needed as a Strategic Expansion Plan.
should be examined on a consistent. Consider the following example in which a manager attempts to establish product cost in light of a special order opportunity.
As managers it is important to understand how the application of marginal costing helps in managerial decision making.B: We have made assumptions regarding the amounts (figures) of the import assignment as the figures are confidential and the organization could not disclose them. Overhead costs. but both are essential functions of the every business manager. Making sales is more exciting than conserving expenses. sales price or production structure. just like sales levels and direct expenses.N. to various “absorption” costing which allocate overhead costs. Allocating overhead costs to departments within the firm or to products within departments can assist the manager in identifying unprofitable aspects of the business.
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. routine basis. The dynamic and uncertain business environment facing most firms has led to a variety of methods of matching overhead costs with individual products. applying overhead costs to individual product units would be straight forward. These methods range from “direct costing” in which only variable costs are associated with individual products. There are several ways to reduce marginal costing some can be:• • • • • Decreasing working capital Implementing total quality management Controlling sales costs Studying maintenance costs Decreasing transportation expenses
Overhead costs are the indirect and sometimes invisible costs associated with producing a product or service. Break-even analysis can help a manager understand the implications of their overhead costs on their required sales volume. If business activity was stable and predictable.
wikipedia.google.com • http://www.referenceforbusiness.com/
• www. Ltd
Advanced Cost Accounting. Nigam Himalaya Publication
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.M. 2001 Samir Kumar Chakravarty
New Age International Pvt.org/wiki/marginal_cost
• Google http://www.BIBLIOGRAPHY
Cost Accounting and Financial Management. 1987 B.com/encyclopedia/ Oli-Per/costingmethods.