Marginal Costing

 Meaning
 Objectives of Marginal costing
 Advantages of Marginal Costing
 CVP Analysis
 Managerial Application of Marginal costing/CVP
 Break Even Chart (Graph)
 Break Even Analysis (Problems Solving)
 Margin of Safety(Problem Solving)
 Key Factor (Problem Solving)
 Meaning of marginal cost-CIMA
defines;
Marginal Cost or Variable Cost

Amount at any given volume of output by which

aggregate costs are changed if volume of output is
increased or decreased by one unit .
 Meaning of marginal costing –A/C
to CIMA,
Marginal costing is the ascertainment of marginal cost
and of the effect on profit of changes in volume or type
of output by differentiating fixed cost &variable cost .
In this technique of costing only variable cost are
charged to operation ,processes or products leaving all
indirect cost to be written off against profits in period in
which they arise.
Objectives of Marginal Costing;
It is a method of recording costs and reporting profits;
All operating costs are differentiated into fixed and
variable costs;
Variable cost is “charged to product and treated as a
product cost”
Fixed cost treated as period cost and written off to the
profit and loss account
Features
All costs are categorized into fixed and variable
costs. Variable cost per unit is same at any level of
activity. Fixed costs remain constant in total
regardless of changes in volume.
Fixed costs are considered period costs and are
not included in product cost, only variable costs
are considered as product costs.
Stock of work-in-progress and finished goods are
valued at marginal cost of production.
In marginal process costing, products are
transferred from one process to another are
valued at marginal costs only.
Prices are determined with reference to marginal
cost and contribution margin.
Profitability of departments, products etc. is
determined with reference to their contribution
margin.
The overhead control account in the cost ledger
represents only the variable overhead. Fixed costs
are taken as expenses in the profit and loss
account and thus excluded from costs.
Presentation of data is oriented to highlight the
total contribution and contribution from each
product.
The difference in the magnitude of opening stock
and closing stock does not affect the unit cost of
production since all the product costs are variable
costs.
Advantages;
 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;
 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
LIMITATIONS;
 Technical difficulties.
 Time taken for completion of jobs is not given due attention.
 Less effective.
 Balance sheet will not exhibit true and fair view.
 Problem of apportionment of variable cost still arises.
 Difficulty to apply in contract or ship building industry.
 Does not provide any standard.
 General reduction in selling price and thus losses.
COST–VOLUME –PROFIT (CVP)
ANALYSIS
 APPLICATION OF MARGINAL COST & CVP
Analysis
1. Cost control.
2. Profit planning.
3. Evaluation of performance.
4. Decision making.
5. Fixation of selling price.
6. Key limiting factor.
7. Suitable product mix.
8. Continue or discontinue Product line
9. Selection of a Profitable product Mix
10. Make or Buy Decision
11. Accept a bulk order
12. Introduction of new product
13. Level of Activity
14. Desired level of Profit
15. Alternative methods of production
Assumptions;
Fixed cost remain static & marginal costs are
completely variable at all levels of output.
Selling prices are constant at all sales volume.
Factor prices are constant at all sales volume .
Efficiency and productivity remain unchanged. In a
multi product situation ,there is constant sales mix at
all level of sales.
Turnover level is only relevant factor affecting cost &
revenue.
Value of production is equal to volume of sales.
DIFFERENCE BETWEEN CONTRIBUTION
&PROFIT
CONTRIBUTION PROFIT
 Includes fixed cost & profit .  Does not include fixed cost.
 Based on marginal cost  Based on common man
concept. concept.
 Contribution above break even  Profit is expected only after
contributes to profit. covering variable and fixed
 Contribution analysis requires cost.
a knowledge of break even  Profit does not require any
concept. such concept.
ELEMENTS OF CVP (Important)
MARGINAL (VARIABLE) COST EQUATION

CONTRIBUTION MARGIN .

PROFIT /VOLUME RATIO (P/V Ratio)

BREAK EVEN POINT (Output & Sales) .

MARGIN OF SAFETY.

KEY FACTOR OR LIMITING FACTOR

Marginal Cost = Total Variable Cost

Marginal Cost = Direct Material +

Direct Labour + Direct Expenses
 Contribution is the difference between sales
And the marginal (Variable) cost

Contribution per Unit = Selling Price- Variable cost per Unit

Contribution (Total) =sales-variable cost

C= S-V
Contribution (Total) = Fixed Cost+ Profit
C= F+P
Therefore
Contribution (total) = S-V = F+P
Profit / Volume Ratio (P/V Ratio)
P/V Ratio = Contribution X 100
Sales
OR
P/V Ratio = Sales – Variable Cost X 100
Sales
OR
P/V Ratio = Change in Contribution X 100
Change in Sales
OR
P/V Ratio = Change in Profit X 100
Change in Sales
Break Even Point (B.E.P)
B.E.P (Units) = Fixed Cost
Contribution per Unit

B.E.P (Sales) = B.E.P (units) x Selling Price (S.P)

B.E.P (Sales) = Fixed Cost x Selling Price (S.P)

Contribution per Unit

B.E.P (Sales) = Fixed Cost

P/V Ratio
 Margin of Safety (M.O.S)
M.O.S (Units) = Total Sales(Units) – Break Even (Units)

M.O.S (Sales) = M.O.S (units) x Selling Price (S.P)

M.O.S ( Sales) = Total Sales (Rs) – Break Even Sales

OR
M.O.S (Units) = Profit
Contribution per Unit

M.O.S (Sales) = Profit

P/V Ratio
M.O.S (%) = M.O.S
 Total Sales
 Key Factor (Limiting Factor)
Profitability = Contribution
Key Factor
Key Factors can be:
Labour
Materials
Sales ( Quantity & Value)
Capacity
Power
Machines