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INTRODUCTION
Under the process of Marginal Costing, from the cost components, fixed costs are excluded.
The difference which arises between the variable costs incurred for activities and the revenue
earned from those activities is defined as the gross margin or contribution. It may relate to
total sales or may relate to one unit.
Helps the company to identify their financial position by which the company
can increase or decrease the total cost of production.
It also helps the company to identify and offer a minimum rate of product
price according to the expectations of the customer so that the company’s sales
level will get increased.
The study covering a period of five years 2018-2021. The study of performance is
compared within this period.
To understand the role of the Marginal Costing.
The study is focused to analysis the weaker position of the firm.
RESEARCH METHODOLOGY:
SOURCES OF DATA:
1. Primary Data
2. Secondary Data
1. Primary Data: The information regarding primary data is collected by visiting the
company frequently and the other relevant information was collected by personal
discussion with the concern department head and their subordinates.
2. Secondary Data: The secondary data is collected from the various sources of the
company manual and company’s annual reports for the study period.
LIMITATIONS OF THE STUDY:
Introduction:
It is a process whereby costs are classified into fixed and variable and with
such a division so many management decisions are taken. The essential feature of
marginal costing is division of total costs into fixed and variable, without which this
could not have existed. Variable costs vary with volume of production or
output, whereas fixed costs remains unchanged irrespective of charges in the volume
of output. It is to be understood that unit variable cost remains same at different levels
of output and total cost changes in direct proportion with the number of units. On
the other hand, total fixed cost remains same disregard of changes in units,
while is inverse relationship between the fixed cost per unit and the number of units.
Marginal Cost is defined as “the amount at any given volume of output by which
aggregate costs are changed if the volume of output is increased or decreased by
one unit.” Marginal Cost also means Prime Cost Plus Variable Overheads.
Marginal Cost is a constant ratio which may be expressed in terms of an amount per
unit of output. On the other hand, fixed cost which is not normally traceable to
particular unit denotes a fixed amount of expenditure incurred during an accounting
period. Fixed cost is, therefore, also called time cost, period cost, standby cost,
capacity cost, or constant cost. Variable cost or marginal cost is also termed as direct
cost, activity cost, volume cost or out-of-pocket cost.
From the above definition and analysis of marginal cost, we can understand that is
the cost which varies according to the variations in the volumes of output. However,
by definition marginal cost is the change in the total cost for addition of one unit. It is
to be noted that for an economist marginal cost and variable cost would be different.
But for an accountant both marginal cost and variable cost are same and are
interchangeably used. Therefore, for our study, we use marginal cost and variable cost
synonymously.
Appropriate and accurate division of total cost into fixed and variable by
picking out variable portion of semi variable costs also.
Valuation of stocks such as finished goods, work-in-progress is valued at variable
costs only.
The fixed costs are written off soon after they are incurred and do not find
place in product cost or inventories.
Prices are based on Marginal Cost and Marginal contribution.
It combines the techniques of cost recording and cost reporting.
Marginal costing can be a useful tool for evaluating some types of decision. Here
are some of the most common scenarios where marginal costing can provide the most
benefit:
Automation Investments:
Marginal costing is useful to determine how much a firm stands to gain or lose by
automating some function. The key costs to take into consideration are the incremental
labour cost of any employees who will be terminated versus the new costs incurred
from equipment purchase and subsequent maintenance.
Cost reporting:
Marginal costing is very useful for controlling variable costs, because you can create
a variance report that compares the actual variable cost to what the variable cost per unit
should have been.
Customer profitability:
Marginal costing can help determine which customers are worth keeping and which
are worth eliminating.
Marginal costing is useful for plotting charges in profit levels as sales volume. It is
relatively simple to create a marginal costing table that points out the volume levels at
which additional marginal costs will be incurred, so that management can estimate the
amount of profit at different levels of corporate activity.
Outsourcing:
In recent years, there has been a widespread interest in marginal costing, Still,
very few have adopted it as method of accounting for cost. Main points of
criticism are:
It is not proper to disregard fixed cost for product cost determination and inventory
valuation.
Marginal costing is especially useful in short profit planning and decision-
making, for decision of far reaching importance, one is interested in special
purpose cost rather than variability of costs.
Marginal costing technique disregards the use of recovering fixed cost through
product pricing. For long run continuity of business, it is not good assets have to
be recovered of cost.
Exclusion of fixed cost from inventory valuation does not confirm to accept
according practice.
The income tax authorities do not recognize the marginal cost for
inventory valuation. This necessitates keeping of separate books
for separate purpose.
a) Contribution:
In common parlance, contribution is the reward for the efforts of the entrepreneur
or owner of a business concern. From this, one can get in his mind that
contribution means profit. But it is not so. Technically or in Costing
terminology, contribution means not only profit but also fixed cost. That is
why; it is defined as the amount recovered towards fixed cost and profit.
Under marginal costing, the difference between sales and marginal cost of sales is
found is found out. This difference is technically called contribution. Contribution
provides for fixed cost and profit. Excess of contribution over fixed cost is profit
emphasis remains here on increasing total contribution. Variable cost is that part of
total cost, which changes directly in proportion with volume. Total variable cost
changes with change in volume of output. Variable costs are very sensitive in
nature and are influenced by a variety of factors.
Main aim of Marginal Costing is to help management in controlling variable cost
because this is an area of cost which lends itself to control by management.
b) Fixed Cost:
It represents the cost which is incurred for a period, and which within
certain output and turnover limits tends to be unaffected by fluctuation in the
levels of activity (output or turnover). Examples are rent, rates, insurance and
executives’ salaries.
c) Variable Cost:
Variable cost are those costs which vary directly with the level of output. They
represent payment output- related inputs such as raw materials, direct labour, fuel
and revenue-related costs such as commission. A distinction is often made
between Direct variable cost and Indirect variable and Indirect variable costs.
Direct variable costs are those which can be directly attributable to the production of
particular product or service and allocated to a particular cost center. Raw materials
and the wages those working on the production line are good example. Indirect
variable costs cannot be directly attributable to production but they do vary with
output. These include depreciation (where it is calculated related to output e.g.
machine hours), maintenance and certain labour costs.
Whilst the distinction between fixed and variable costs is a convenient way of
categorizing business costs, in reality there are some costs which are fixed in
nature but which increase when output reaches certain levels. These are largely
related to the overall Scale and complexity of the business.
P = Profit
From (1) and (2) above, we may deduce the following equation called
Fundamental Equation of Marginal Costing i.e.
We find that product having more contribution is more profitable. However, when
there is a limitation on any input factor, the profitability of the product cannot simply
be determined by finding out the contribution of the unit, but it can be found out by
ascertaining the contribution per unit of that factor of production which is limited in
the given situation. Such factor of production which is limited in the question
is called key factor or limiting factor.
First of all, a ratio is a statistical or mathematical tool with the help of which a
relationship can be established between the variables of the same kind. Further, it may
be expressed in different forms such as fractional form, quotient, percentage, decimal
form, and proportional form.
P/V ratio or contribution ratio is association of two variables. From this, one may
assume that it is the ratio of profit and sales. But it is not so. It is the ratio of
Contribution to Sales.
Contribution
Symbolically, P/V ratio = * 100
Sales
When someone asks a layman about his business he may reply that it is
alright. But a technical man may reply that it is break even. So, Break Even means
the volume of production or sales where there is no profit or loss. In other words, Break
Even Point is the volume of production or sales where total costs are equal to revenue. It
helps in finding out the relationship of costs and revenues to output. In understanding
the breakeven point, cost, volume and profit are always used. The break-even analysis is
used to answer many questions of the management in day to day business.
Definition:
Relevant range is the range of an activity over which fixed cost will remain
fixed in total and the variable cost per unit will remain constant
Total fixed cost are assumed to be constant in total
Total variable cost will increase with increasing number of units produced
Total revenue will increase with the increasing number of units produced
Breakeven analysis assumes that fixed cost, variable costs and sales revenue behave
in liner manner. However, overhead costs may be stepped in nature. The straight
sales revenue line and total cost line tent to curve beyond level of production.
It is assumed that all production is sold, the break-even chart does not take
the changes in stock level into account.
Break-even analysis can information for small and relatively simple companies that
produce same product. It is not useful for the companies producing multiple
products.
g) Margin of Safety:
It is the sales point beyond the breakeven point. Margin of safety can be obtained
by subtracting break even sales from Total sales. It is useful to determine financial
soundness of business enterprise. If margin of safety is high, then the financial position
of the enterprise is sound.
Margin of Safety = Total Sales – Break Even Sales
The point in the ongoing operation of a business at which sales revenue equals to
fixed and variable costs and cash flow is neither positive nor negative.
When break-even point is calculated only with those fixed costs which are
payable in cash, such a break- even point is known as cash break-even point. This
means that depreciation and other non- cash fixed costs are excluded from the fixed
costs in computing cash break-even point.
Its formula is, Cash break-even point = Cash fixed costs / Contribution per unit.