A Case Study on

Application of Marginal Costing in

Managerial Decision Making of
N M CREATIONS
Submitted by:-

Abbas Chitalwala 03
Abhee Parmar 04
Bhawin Saraiya 29
Jagruti Patti 54
Arun Mishra 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

PREFACE

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Through this Case Study of APPLICATION OF MARGINAL COSTING IN
MANAGERIAL DECISION MAKING 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; clarity of theoretical concepts is very
crucial to understand what the purpose of the calculations is.
Keeping that in mind our group will first explain the concepts
of overhead costing and later; through the company in light,
help understand how the concepts are converted into the
required format by accountants for the purpose of maintaining
Books of Accounts. A brief overview of the company is also
provided though much focus is given to our project related
aspect. To conclude we share a common yet critical view of this
topic that most managers would agree with and find relevant.

N M Creations is a Manufacturing company that has been in

business for over 4 years. Their clients include many famous
brands of India.

ACKNOWLEDGEMENT

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We would like to express our sincere gratitude to Prof. L. N.
Chopde for giving us the opportunity to work on such an
informative project which proved to be a very good learning
experience. We would also like thank him for his valuable
expertise and for guiding us throughout our project.

Our sincere thanks to Mr. Hamir Merchant of n m creations for

allowing us to study this topic with practical examples.

We would also like to thank the MET Library staff for allowing
us to use the library for our reference purpose.

Finally, we would like to thank all those who have directly and
indirectly helped us throughout our project and motivated us
for its successful completion.

EXECUTIVE SUMMARY

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We begin our project by throwing light on the various concepts
of Marginal Costing including Contribution, Profit and
Breakeven Analysis. Marginal Costing also helps in
understanding the Margin of Safety and desired profit.

This followed by a brief introduction of the company n m

creations and their profile.

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. These are followed
by notes to explain the items included in the Fixed and Variable
Costs and the basis for calculation.

In conclusion we talk about the impact of Marginal Costing

while taking Managerial Decision for the company specially
reducing costs and project expansions.

Our most relevant source for content was the company n m

creations followed by the theory taught by Prof. Chopde and
various books as well.

CONTENTS

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SERIAL TOPIC PAGE NO.
NO.
1 About N M Creations 6

2 Introduction 7

3 Marginal Costing 10
Concepts
5 Marginal Costing 12
Analysis
6 Marginal Costing & 14
Decision Making
7 Conclusion 15

8 Bibliography 16

N M CREATION
11B GIRI KUNJ , N.S.PATKAR MARG, MUMBAI 400 007.

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We introduce ourselves as Manufacturers of full range of Garments
which include Sportswear, 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. A special emphasis is given
to the comfort of the wearer as per the pattern and specification laid
down by the customer.

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, 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. We appreciate if the undersigned is given an opportunity to
present our credentials and display the workmanship of our products.

INTRODUCTION

The costs that vary with a decision should only be included in decision analysis. For
many decisions that involve relatively small variations from existing practice and/or
are for relatively limited periods of time, fixed costs are not relevant to the decision.

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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.
Suppose a business occupies premises to carry out its activities. 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, cheaper premises. Does this mean that the
business will sell its old premises and move on to new ones overnight? Clearly, it
cannot happen. 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, let us say, delicate equipment to be moved. Apart from external
constraints on the speed of move, the management may feel that the downturn
might not be permanent. Thus, it would be reluctant to take such a dramatic step. It
would mean to deny itself an opportunity of benefit from a possible revival of trade.
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. So, what we really see is that more than the fixed cost, what really influences
decision making in the short-run is the variable cost which is actually synonymous
with the marginal cost.
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.

It is also a technique where only variable cost or direct cost will be charged to the
cost unit produced. Marginal costing shows the effect on profit of changes in volume
or type of output by differentiating between fixed and variable costs. The analysis is
segregated into short and long-run cases.

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At each level of production and time period being considered, marginal costs include all
costs which vary with the level of production, 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

Its provide better information hence is a useful managerial decision making tool
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 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, 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. In the long run, management must consider the total costs not only the
variable portion

Difficulty to classify properly variable and fixed cost perfectly, hence stock valuation
can be distorted if fixed cost is classify as variable

Marginal Costing Concepts

FORMULA:
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1. Marginal Cost Equation:

SV=F+P

Where,

S = Sales F = Fixed Cost

V = Variable P = Profit

2. P/V Ratio :

P/V Ratio = Contribution x 100

Sales

Contribution = Sales Variable

3. Break Even Sales:

Break even point = Total Fixed Cost

Contribution per unit

Break even point = Total Fixed Cost

PV Ratio

4. 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. 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

FINANCIAL STATEMENT
N M CREATION
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 Trading and P/L Account for the year ending March 2008
Particulars Amount (Rs) Particulars Amount(Rs)
To opening stock 18092527 By sales 82,806,180
To purchases 55841336
By closing stock 18,085,527
DIRECT EXPENSES
To warehouse charges 280,713
To consultancy expenses 63,000
To process charges 4,234,278
To transport charges 276,420
To yarn dyeing charges 1,864,938
To twisting charges 1,170,763
To weaving charges 12,946,768
To warping charges 479,600

To gross profit 5,641,364

100,891,707 100,891,707

INDIRECT EXPENSES
To audit fees 13,500
To advertisement expenses 9,600 By gross profit 5,641,364
To bank int & charges 22,779 By disc.rec. 7,000
To brokerage on sales 430,990
To comp maintainance 3,000
To int on o/d 223,204
To depreciation 923,851
To electricity exp. 915,324
To int on loan 1,598,306
To petrol & diesel exp. 237,069
To professional fees 7,500
To salary & bonus 610,000
To telephone exp. 44,446
To misc.exp. 12,000
To int on partners cap 479,278
To insurance charges 30,000
To car exp. 21,810
To loan processing charges 4,500

To net profit 61,207

5,648,364 5,648,364

Classification of Costs
Fixed Costs Amount(Rs.) Variable Costs Amount(Rs.)

(Rs)

warehouse charges 280,713 process charges 4,234,278

consultancy expenses 63,000 transport charges 276,420

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to audit fees 13,500 yarn dyeing charges 1,864,938

bank int & charges 22,779 twisting charges 1,170,763

comp maintainance 3,000 weaving charges 12,946,768

int on o/d 223,204 warping charges 479,600

Depreciation 923,851 advertisement expenses 9,600

int on loan 1,598,306 brokerage on sales 430,990

professional fees 7,500 electricity exp 915,324

salary 610,000 petrol & diesel exp 237,069

int on partners cap 479,278 telephone exp 44,446

insurance charges 30,000 misc.exp 12,000

loan processing charges 4,500 car exp. 21,810

Purchase 55841336

4,259,631 78485342

MARGINAL COSTING ANALYSIS

Particulars Rs.

SALES 82,806,180

less VARIABLE COSTS 78485342

CONTRIBUTION 4320838

less FIXED COSTS 4,259,631

PROFIT 61207

P/V RATIO = CONTRIBUTION/SALES 5.22 %

BEP (Rs.) = FIXED COSTS/PV RATIO Rs. 81602126

MARGIN OF SAFETY =

ACTUAL SALES - BEP SALES Rs.1204054

Marginal Costing in Decision Making

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CASE - During the month of May 2008 n m creations was approached by Vivid
Impex. They offered to Import worth Rs.A . This contract would give nm creations
entry into European markets which was much needed as a Strategic Expansion Plan.

If nm creations were to accept the order then it would increase their plant utilisation
to 100% from the existing 80%. However Marginal Costing Analysis helped
understand the profitability of the deal better. It is shown as follows:

Existing Sales: Rs. 82,806,180

Import Order worth Rs. A

Percentage increase in F.C on account of Import assignment : x %

Percentage increase in V.C on account of Import assignment : y %

Revised Sales: Rs. 82,806,180 + A

Revised Variable Cost : 78485342 + y %

Revised Contribution : (82,806,180 + A) - (78485342 + y %) = B

Revised Fixed Cost : 4,259,631+ x %

Revised Profit : B (4,259,631 + x %) = C

Existing Profit : Rs.61207

Comparing the revised profit i.e. Profit arising after accepting the Import assignment
(C) with the original profit i.e. Profit prevalent after rejecting the Import
assignment, we can see that Marginal Costing enables us to reach a conclusion and
make a Managerial Decision.

If C > Existing Profit then the manager will accept the import assignment.

If C < Existing Profit then the manager will reject the import assignment.

Thus Marginal Costing is practically applicable and beneficial to the

management.

N.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.

CONCLUSION

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As managers it is important to understand how the application of
marginal costing helps in managerial decision making. 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. Making sales is more exciting than
conserving expenses, but both are essential functions of the every
business manager. Overhead costs, just like sales levels and direct
expenses, should be examined on a consistent, routine basis. Allocating
overhead costs to departments within the firm or to products within
departments can assist the manager in identifying unprofitable aspects
of the business. Break-even analysis can help a manager understand the
implications of their overhead costs on their required sales volume, sales
price or production structure.

If business activity was stable and predictable, applying overhead costs

to individual product units would be straight forward. The dynamic and
uncertain business environment facing most firms has led to a variety of
methods of matching overhead costs with individual products. These
methods range from direct costing in which only variable costs are
associated with individual products, to various absorption costing
which allocate overhead costs. Consider the following example in which
a manager attempts to establish product cost in light of a special order
opportunity.

BIBLIOGRAPHY

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Books:

Cost Accounting and Financial Management, 2001

Samir Kumar Chakravarty
New Age International Pvt. Ltd

Advanced Cost Accounting, 1987

B.M. Lall, Nigam
Himalaya Publication

Sites:
Wikipedia
http://en.wikipedia.org/wiki/marginal_cost
Google
http://www.google.com/
www.accountingcoach.com
http://www.referenceforbusiness.com/encyclopedia/Oli
-Per/costingmethods.html

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