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MARGINAL COSTING

Revenues

Costs By-
Rima Agarwal
Swati Saraswat
Yamini Devpura

Common Cost Behavior Patterns

A. Variable Costs
B. Fixed Costs
C. Discretionary versus Committed Fixed
Costs
D. Mixed Costs
E. Step Costs

Types of Costs

Variable

Fixed

Mixed

Minutes Talked . Total Long Distance Your total long distance Telephone Bill telephone bill is based on how many minutes you talk.Total Variable Cost Total variable costs change when activity changes.

10 cents per minute. Minutes Talked . For example. The cost per long Telephone Charge distance Per Minute minute talked is constant.Variable Cost Per Unit Variable costs per unit do not change as activity increases.

Your monthly basic Telephone Bill Monthly Basic telephone bill probably does not change when you make more Number of Local Calls local calls.Total Fixed Cost Total fixed costs remain unchanged when activity changes. .

Example: monthly electric utility charge Fixed service fee Variable charge per kilowatt hour used . Mixed Costs Contain fixed portion that is incurred even when facility is unused & variable portion that increases with usage.

Mixed Costs Total Utility Cost ost d c Variable i xe l m Utility Charge o ta T Fixed Monthly Utility Charge Activity (Kilowatt Hours) .

Marginal Costing Introduction:  Marginal costing is a technique of costing fully oriented towards managerial decision making and control. Marginal Costing being a technique can be used in conjunction with any method of cost ascertainment. It can be used in combination with other techniques such as budgeting and standard costing. . departments. processes and cost centers.  Marginal costing is helpful in determining the profitability of products.

M.Definition of Marginal Cost  Marginal cost is the additional cost of producing an additional unit of a product.A. Marginal Cost = Prime cost+ Total variable overheads (or) Total cost – Fixed cost.  According to I. . this is measured by the total variable cost attributable to one unit.C. London as ”the amount to any given volume of output by which aggregate costs are changed if the volume of output is increased or decreased by one unit”. In practice.  Thus.

C.M. as “the ascertainment of marginal cost and of the effect on profit of changes in volume or type of output by differentiating between fixed costs and variable costs.A. .Definition Marginal Costing: Marginal costing is defined by. I.

Under marginal costing the total cost is classified as fixed and variable cost. Fixed costs are treated as period cost and charged to profit and loss a/c for the period for which they are incurred.Marginal costing is a technique of control or decision making. 6. 3. Prices are determined on the basis of marginal cost. 5. The stock of finished goods and work-in-progress are valued at marginal costs only. 4. .Features of Marginal Costing 1. 2. The Variable costs are regarded as the costs of the products.

7. Profit planning. Cost control and cost reduction. Simplicity 2. Meaningful reporting 4. 8. Stock valuation 3.Advantages of Marginal Costing 1. Pricing policy. Helpful to management. Production Planning 10. 6. 9. Fixation of Selling Price 5. Make or Buy Decisions .

Under valuation of stock 5. 7. Not suitable for external reporting. Not applicable in all types of business. 8. Production aspect is ignored. Automation – Lack of Advancement 6. Classification of cost 2. 4.Limitations of Marginal Costing 1. 3. Misleading picture -Assumptions . Lack of long-term perspective.

but remain constant per unit  Level of efficiency of operations is uniform  Product risk remains unaltered. unless specified otherwise.  Selling price remains constant at different levels of activity. .Assumptions of Marginal Costing  All costs can be classified into two categories – Fixed and Variable  Fixed costs remain constant at all levels of activity  Variable costs vary in total.

Thus  MARGINAL COST =Variable Cost (Direct Labour +Direct Material+direct Expense+ Variable Overheads)  CONTRIBUTION = Sales . The meaning is usually clear from the context. and profits. costs.  The term ‘contribution’ mentioned in the formal definition is the term given to the difference between Sales and Marginal cost.Cost-Volume-profit analysis  CVP analysis looks at the relationship between selling prices. .Marginal Cost The term marginal cost sometimes refers to the marginal cost per unit and sometimes to the total marginal costs of a department or batch or operation. sales volumes.

MARGINAL COST STATEMENT  Particulars Rs Rs Sales   xxxxx Less: Variable Expenses   (xxxx)                                 Contribution   xxxxx Less Fixed Cost   (xxxx)                                Marginal Costing Profit   xxxxx .

Assumptions of CVP Analysis Expenses can be classified as either variable or fixed. . and total fixed expenses will not vary within the relevant range. unit variable cost. CVP relationships are linear over a wide range of production and sales. Sales prices.

Inventory levels will be unchanged.Assumptions of CVP Analysis Volume is the only cost driver. . The sales mix remains unchanged during the period. The relevant range of volume is specified.

management should know not only the budgeted profit.Breakeven Analysis  Introduction  To assist planning and decision making. without a loss being incurred (the margin of safety) . but also:  the output and sales level at which there would neither profit nor loss (break-even point)  the amount by which actual sales can fall below the budgeted sales level.

.Cost-Volume-Profit (C-V-P) Relationship  CVP is a management accounting tool that expresses relationship among sale volume. Some of the questions are as follows:  What is the breakeven revenue of an organization?  How much revenue does an organization need to achieve a budgeted profit?  What level of price change affects the achievement of budgeted profit?  What is the effect of cost changes on the profitability of an operation?  Cost-volume-profit analysis can also answer many other “what if” type of questions. Although it is a simple yet a powerful tool for planning of profits and therefore. of commercial operations. cost and profit.profit analysis can answer a number of analytical questions. Cost-volume-profit analysis is one of the important techniques of cost and management accounting. It provides an answer to “what if” theme by telling the volume required producing. Cost-volume. CVP can be used in the form of a graph or an equation.

Objectives of Cost-Volume-Profit Analysis In order to forecast profits accurately. Cost-volume-profit analysis is helpful in setting up flexible budget which indicates cost at various levels of activities. . it is essential to ascertain the relationship between cost and profit on one hand and volume on the other. Such analysis may assist management in formulating pricing policies by projecting the effect of different price structures on cost and profit. Cost-volume-profit analysis assists in evaluating performance for the purpose of control.

. (4) (or)  Contribution = Sales x P/V ratio....... (3) P/V Ratio (or C/S Ratio) =Contribution/Sales..(1) Fixed cost + Profit = Contribution ......(2) Sales – Marginal cost = Fixed cost + Profit.(6) ....... (5) (or)  Sales = Contribution/ P/V Ratio....Breakeven Analysis Equations Sales – Marginal cost = Contribution ........

Break Even Point (Units) = Fixed Cost/ Contribution Break Even Point (Sales)= Fixed Cost/ P/V Ratio 4. Contribution = Sales (Volume/Per unit) – Variable Cost. Profit-Volume Ratio= Contribution/ Sales (or) P/V Ratio= Change in Profit/Change in Sales 3. Fixed Cost = Contribution . Profit for given Sales= Contribution-Fixed Cost Contribution= Given Sales x P/V Ratio 7. 2.Profit .Important Formula… 1. Sales for required profit= Fixed Cost + Required Profit P/V Ratio 6. Margin of safety = Actual Sales – Break Even Sales 5.

000.000 = = 3. F +0 $360.000 BEP in sales $ = = CMR (P − V ) / P ($200 − $80) / $200 $360.000 units $120 / unit F +0 = F $360. The variable costs per briefcase are $80.000 BEP in units = = P − V $200 / unit − $80 / unit $360. and the total fixed costs are $360. Find the BEP in units and in sales $ for this company. Breakeven Point Calculations Bill’s Briefcases makes high quality cases for laptops that sell for $200.000 = = $600.000 60% .

Profit at 4100 units = TR $120 x 4100 . What is the pretax profit if Bill sells 4100 briefcases? If he sells 2200 briefcases? Recall that P = $200.$360.000 More easily: 4100 units is 1100 units past BEP. V = $80.000. units 2200 3000 4100 . 2200 units is 800 units before BEP.$360.000 $1000s TC $600 Profit at 2200 units = $120 x 2200 . so loss = $120 x 800 units. CVP Graph Draw a CVP graph for Bill’s Briefcases.000. $360 -$96. so profit = $120 x 1100 units.000. and F = $360. $132.

000 F $200/unit $200/unit==$1. course. Units needed to F + Profit $360.000units unitsxx Sales $ required F + $240. too. CVP Calculations How many briefcases does Bill need to sell to reach a target pretax profit of $240. so this is stillaa unit.000 valuable valuableformula. and F = $360.5. 60% formula.000? What level of sales revenue is this? Recall that P = $200.000 5.000 per per unit. $1.000.000 reach target = P − V = $120 / unit pretax profit = 5.000. so this is still = = $1. V = $80.000.000.000. to reach target = = too.000. CMR (P − V ) / P But Butsometimes sometimesyou you pretax profit only know the CMR only know the CMR and andnot notthe theselling sellingprice price $600.000 + $240.000 units Of Ofcourse. .

3) Units needed to $360.CVP Calculations How many briefcases does Bill need to sell to reach a target after-tax profit of $319.200 Pretax profit = = = $456.000 reach target = = 6. First convert the target after-tax profit to its target pretax profit: After-tax profit $319.800 units pretax profit $120 / unit Sales $ needed $360.000.000 to reach target = = $1.200 if the tax rate is 30%? What level of sales revenue is this? Recall that P = $200.360.000 pretax profit 60% .000 + $456.000 + $456. and F = $360.000 (1 − Tax rate) (1 − 0. V = $80.

Determine the highest level that his variable costs can so that he can make his target.000 units V = $75/unit If Bill can reduce his variable costs to $75/unit.000 $170/unit − V = = $95/unit 6.000 + $210. he can meet his goal.000 Q = 6.Using CVP to Determine Target Cost Levels Suppose that Bill’s marketing department says that he can sell 6. but solve for V: $360.000 briefcases if the selling price is reduced to $170. Recall that F = $360.000.000 + $210. Use the CVP formula for units.000 units = $170/unit − V $360.000. . Bill’s target pretax profit is $210.

.Margin of safety The difference between budgeted sales revenue and break-even sales revenue. The amount by which sales can drop before losses begin to be incurred Excess of expected sales over breakeven sales.

or plans to operate. = actual or estimated in Rs.  Margin of safety in % = Or Margin of safety in units Actual or estimated units Margin of safety in $ = Actual or estimated sales $ .Margin of safety The margin of safety is a measure of how far past the breakeven point a company is operating. .BEP in units  Margin of safety in Rs. It can be measured 3 ways:  Margin of safety in units= actual or estimated activity .

000 units.Margin of safety  Suppose that Bill’s Briefcases has budgeted next year’s sales at 5. and the BEP in sales $ = $600.000 = 40% $ 200 *5000 . that P = $200.000.000 units = 2.000 units – 3. V = $80.$600.  margin of safety in units = 5.000.000 . the BEP in units = 3.000.000 units  margin of safety in $ = $200 x 5.000  margin of safety percentage = 2000 units 5000 units = $ 400. F = $360.000 = $400. Compute all three measures of the margin of safety for Bill.