Marginal Cost; & -OSting q CVP Analy ee sting system is not a method of ¢ of costing like oF operating costing job of bate ne cin ating ting which are used for top ich costing or process cost or services. Marginal costing is a techei UrpOSe of calcu ae rice. Mi costing contented culating the costo guid the managers for taking short term decisions natn wt of special order, etc. It is also us like sales mi purposes Sed by the manager costs behave differently with the increase sts change proportionately with the change 1s st inal costing system, only variable cos " ss peri cos and charged to he Prof cod haa ein te ion Fino marginal costing system, fixed costs ae excluded from unit ost mainly fortwo aso costs which are not affected by the numberof units produced duiny spon ut of the machinery, etc. are not dependent For example, rent and taxes, insurance, lease reu in the units produced. Same amount is payable if production is zero unit or 10,000 ‘units or 15,000 units or more. i) Fixed cost per unit will be more if number of units produced is less. Similarly, fixed cost per unit will be less if number of units produced are more. The variation in fixed cost per unit may distort the cost calculation for decision making in the short run. Therefore, it is better not to consider fixed cost for cost calculation. | : Marginal costing system seeks to remove any potential difficulty, which might be caused by the facors discussed above. Peerase i ied or otherwise) na marginal costing system, all variable costs (direct, indirect, ences of eae Gn cluded in the cost of sales lS eer lic edt 0 recov ulated in the above manner) is treated as contribution. pane ‘The following cost statement ‘ted cost for the period. Ifthere is any surplus, its treated will make the matter clear ; ate Scanned with CamScannerig and CVP Analysis pinnae Marginal Cost Statement : Particulars jes Revenue : Marginal Cost of Sales Opening Stock (valued @ marginal cost) Add: Production Cost (valued @ marginal cost) Total Production Cost Less: Closing Stock (valued @ marginal cost) Marginal Cost of Production : Add: Variable Selling, Admin. & Distribution Cost (C) Contribution (A - B) (D)_ Less: Fixed Cost (E)_ Profit (C - D) Definition of Marginal Costing The official terminology of CIMA, UK, has defined marginal costing as "4 principi ‘marginal costs of cost units are ascertained. Only variable costs are charged to coy jr ‘fixed costs attributable to a relevant period being written off in full against the contibuig that period." Jor Marginal Cost The official terminology of CIMA, UK, has defined marginal Cost as "The amount a any volume of output by which aggregate costs are changed ifthe volume of output i incraey decreased by one unit." a i : very of production", For examples manufacturing company produces X unit ata ind X+ 1 units at a cost of & 2,100. The cost of an additional unit will be& 100 which X~1 units comes to 1,900, the cost of m Features of Marginal Co Following are the (1) In marginal costing gy it cost, Scanned with CamScannerCost and and Management Accounting - I 5.3 arial coming ster, cow daa presente onthe bas io ti Rese calculated ae taking al arable cone 4 Ses ae ' CORO . dire penses, variable production, selling and administrative over oe ets Sit venue and is ea id cost of sales is d cor ie see cat les is called contribution. Fixed costs are a ages of Marginal Costing System yer jeosting system has the following advantages sil 8 ginal Cost system is very useful for internal purposes ~ decision making, planning and “oat "gn fs of ales unde magia coming system is simple owner sarginal costing system is very simple to operate as it does not require complex apportion- OF pnents OF ‘overheads. a Marginal costing syst xy rate ig The {epartmental performance can be evaluated more scientifically by using marginal costing system. Fixed costs are kept outside the evaluation process as the department has no role to play fr the incurrence of common fixed costs. (6 Iteliminates the problem of over / under absorption of overheads. (7) Theeffects of change in selling prices, variable costs can be more readily available and quick decisions can be taken in time. (8) avoids the illogical camry forw: stock. Limitations of Marginal Costing System inal costing system, however, has the following limitations : (}) Marginal costing system is not very useful in situations where a very small proportion of total cost is variable cost. For example, in telec cation business, majority portion of the total cost is depreciation ¢ rk, rates and taxes,ctc. which are fixed in nature; marginal costing 8} f iable costs into fixed element and variable 1 costing system may give mis- tem avoids the problem of selecting a suitable basis for overhead recov- ard of current year's fixed cost to next period in the form of al cost is not acceptable for external its stock at marginal cost as it is not ‘manufacturing stock is build up Inthis situation, profit ge in stock level and sales. fixed or variable. Marginal xed cost. Pricing based on ituation, any deci- Scanned with CamScannerAN sion based on marginal costing system (where itis assumed that there ig M0 change in Price, labour cost or selling prices) may not be useful at all, in (7) Valuation of stock, WIP at marginal cost may not show the true profit OF the organ also violates the Generally Accepted Accounting Principles and distort tye and f the financial statements, (8) Income tax authority do not accept the valuation of stock at marginal cost, Contribution Contribution is the difference between the sales revenue and variable cost of SUCH sales ki Surplus after all variable costs (manufacturing as well as non-manufacturing) have ibe isa Contribution is the amount available to cover fixed costs and then to provide profit for the Peat Variable cost consists of direct material, direct labour, direct; expenses, variable production oe variable selling and distribution overhead and variable administrative overhead (ifany), a, ‘Therefor, itis fundamental to classify and segregate those costs which tend to remain AX different level of output and are termed as fixed costs, and those costs which tend ot” broportionately with changes in output and are termed a variable costs, Calculation ofcontibuse does not involve fixed cost Itis to be noted that contribution is used first to cover fixed costs and then wi towards profit. If the contribution is not sufficient to cover fixed cost, 54 Marginal Costing and CVP Analysis "ation, vig +hatever: Temains then a loss occu Irs for Period. Since fixed expenses are covered, te profit will increase by the unit contribution for = additional unit sold, The relationship of contribution, fixed equati Costs and profit can be shown with the help of the following L 3. Role of Contribution Contribution plays.a very importantrole in marginal itis safe to use contribution than profit per unit as it only be shared arbitrarily between products, The amount of contribution ‘Per unit will have a! to take to improve profits. For example, the gre is the amount thata company will be ready to spe on this logic, high unit contribution car manufi heavily, while low unit contribution products etc.) tend to spend much less for advert ‘ing. Contribution can be expressed Per unit or in t i steps a company is ready for a product, the greater les unto Scanned with CamScannerr J Cont a nd Management Acconny unting - It $.s onl tats ot ts) Total 1s ge Costs } Per Unit * variable 10.00, 6 veto [liom | 10 __L_ 0 p00 ; cot os —— _volume Ratio (P/V Ratio) / Contri 1 bution ~ Sales Ratio ( ; poole ratio is the contribution divided by sales. It re i ato iS normally expressed as a percentage and is al tow known as contribut ‘rate at which each rupee sales available to cover acne PW ratio o C/S ratio Costs and provide for profit t ne formula for calculating P/V Ratio (C/S Ratio) is as ; 'S Ratio) can be computed using ei ig either unit f the above example, the P/V Ratio (Gavin figures. ae computed as follows CIS Ratio) = 50.908 6 pv Ratio (C/S Ratio) ~ 7 69,000 x 100 = 37.5% or = x 100 = 37.5% b ‘be noted that when selling price and variable cost are constant, enties | ‘tribution and P/V Iris to ati will also be constant. me nyo the above logic the PIV ratio can also be calculated as follows : pw Ratio (C' aking data © Given an estimate of total sales re ‘The formula for calculating ratio is very useful for calculating break: is calculated after considering total tions where the sales revenue can c hhaving higher P/V ratio is to be 0 of X - 40% and that of Y - 30%. The company ‘will prefer to push Scanned with CamScanneri Cost a nd Management Accounting - 11 $,9 Notes: xing, Not wort of Goods Sold (1 OP inect Materials (8 000) pirect labour %0 production Overhead (Variable + Fixed) 0 Total | overheads consist of both i |, gelling ovetheads consist of both variable and fi 2 sen 00) ined costs (ie., © 30,000 + # 1.25,900 «) administrative overheads consist of both variable 0) 95,000) And fixed cost (i.e., € 20,000 + # 75,000 qutorial Notes: 1) Under marginal costing format, fixed cost is treated as Period cost ‘ valuation of closing stock. and it is not included in the (2) AS-2 "Inventories; does not support marginal costing format. (3) Marginal costing format is useful for internal purposes. Cost Volume Profit (CVP) Analysis according to CIMA (Chartered Institute of Management Accountant, UK) terminology ‘CVP Analysis is "The study of the effects on future profit of changes in fixed cost, variable cost, sales price, quantity and mix". There are often a number of alternatives open to management. CVP analysis is one Of the most powerful tools used by the management for taking many short term decisions. \t helps them to understand the inter-relationship among the following elements : 1. Fixed Cost 2. Variable Cost 3. Sales Price 4. Quantity / Volume 5. Product Mix Analysis of CVP data helps the . What sales volume is . What sales volume is the answers to the following questions: have neither a profit nor a loss) ? In CVP analysis, all costs —m nufacturing (¢.g., selling, administrative, etc.) are segregated into their f 2 Before any formulae are given or nalysis must be stated. Without these ‘These assumptions are : short-run). (although, in practice, it might be Scanned with CamScanner“osting and CVP Analys 3. Variable cost per unit and selling price per unit will r 4. There is no change in technology, production process and efficiency 5. Stocks are valued at marginal cost only. There is no change in stock level 6. Total variable cost will change in linear fashion with the change in activity, A single produet or constant product mix is to be considered. 8. The analysis is applicable only to a short-term period. 1, Break-even Computation The break-even point is the volume of activity where organisation's total revenue js qual 1p cost. At this level, there is no profit, no loss, t breaks evert. CIMA has defined break-even i "the level of activity at which there is neither a profit nor a loss”. The management tent organisation is interested to know the break-even point so that they can formulate different stay? for growth and survival. An organisation with lower break-even point will be able to handle Teesin in better manner than an organization with higher break-even point. For example, during the as Ford Motors, General Motors suf many Indian automobile companie point. ara The break-even point can be computed by using any of the following two methods - 1. Contribution Method 2. Equation Method Contribution Method Under this method, contribution (discussed earlier) per unit is taken into consideration. We cach unit sold provides a certain amount of contribution to recover the fixed costs, To clogs break-even point, total fixed cost is divided by the contribution per unit. Sometimes, management prefers that the break-even point should be expressed in terms of Sle Revenue rather than Units. Break-even point in sales revenue is calculated as follows: Scanned with CamScannerON Cost and Management A = menting - 1h $9 " sthod, computation of break-ev is point is based on Jon the profit equation ols can be used to represent the various item in the above equation Fein 9 vi Profit Mf ws old U Number of units to be sold to earn a profit of € 10,000 : Fixed Cost + Target Profit _ 50,000 + 10,000 = Ip 7 6,000 Units be Sold = —Gontribution per Unit No.of Units tO when number of units sold = 7,000 units re (Number of units sold * Contribution Per Unit) ~ Fixed Cost = (7,000 x & 10) ~¥ 50,000 = % 20,000. “Alternatively : : profit = (Sales * PIV ratio) — Fixed Cost = (7,000 x % 20% #50%) — ¥ 50,000 = 70,000 ~€ 50,000 = € 20,000. Contribution per Unit 99 — 2 100 _ Selling Price per Unit Profit iv) “ Profit Sales to NP = Px-(@* bx) Where, NP =Net Profit =0 (at break- P= Selling price per unit = (to Scanned with CamScannerNn Method oF Equation w, out evious eth Dunne Men in 00 PIONS MAHON hate? my > fei use aay method for sving the pope se ny, aes e oT the problems reen solved by usin, .. aan xaminatn the ey safety Computation ton mother Mowers nasty | a ya safety OF AN CHEESE ig the an art aren ye break-even sales revenie. pig f Sales #8 € 6.00.00. The margin of safer mes X Lid weaicates the amount BY Which sales can ye 190.000 (8 fg ses et ian ict enterprise, Margin of safety ig the er eT losses bey n° 9.90.50 the ex -even sales unit CESS Of budg ted sal or calculating af margin of safety is as follow fargin of Safety (in Sales Revenugy= 7. the budgeted (oF actual) Sales Revenue — eernatively. Break-even Sales Revenue Profit Margin oF SSI = P7V Ratio G/S Rata) |, Margin of Safety (in Units) = The bud y enterprises prefer to express margin of safe M ne ty in percentage terms vied by dividing margin of safety in sales revenue by weet bugged (er carah On cu ; or actual) sales (7g. Margin of Safety P entage = = =a sii -d (or Ac “ring data from the above example, the margin of safety _ 4,00,000 yargn of Safety Percentage = 7>o5 555 X 100 = 40% Percentage will be as follows before slippit tion 3 f : < ara (P) Ltd. operates a chain of bakery shops, with each shop baking es own tet ne management accountant of the company is reviewing a proposal to open a new shop at Darjeeling The estimates for the new shop are as follows : - . |. Estimated price and variable costs per W Be ict 5 — (7) per loaf "| (1) per loaf Electricity 2 f Contribution: Scanned with CamScanner