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WHAT IS MARGINAL COST Marginal cost : Cost of the marginal or last unit produced, also defined as the cost of one more or one less unit produced besides existing level of production Example: if a firm produces ‘X’ unit at a cost of $ 300 ‘X+1’ units at a cost of $ 320, Then the cost of an additional unit will be $ 20 which is ‘marginal cost’
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WHAT IS MARGINAL COST Mathematically expressed as : Where: TC : total cost Q : quantity produced
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WHAT IS MARGINAL COST Marginal costing : Defined as the technique of presenting cost data wherein variable costs and fixed costs are shown separately for managerial decision-making Technique of the analysis of cost information for the guidance of management which tries to find out an effect on profit due to changes in the volume of output
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ABSORPTION COSTING Absorption costing It is costing system which treats all manufacturing costs including both the fixed and variable costs as product costs
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PRINCIPLE OF MARGINAL COSTING By selling an extra item of product or service the following will happen : Revenue will increase by the sales value of the item sold Costs will increase by the variable cost per unit Profit will increase by the amount of contribution earned from the extra item
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If the volume of sales falls by one item, the profit will fall by the amount of contribution earned from the item Profit measurement should therefore be based on an analysis of total contribution When a unit of product is made, the extra costs incurred in its manufacture are the variable production costs
Contribution margin Contribution Margin = Marginal Profit per unit sale Can be used as a measure of operating leverage
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Contribution/Sales Ratio or Profit/Volume Ratio Contribution = C = S – V Sales S S P/V Ratio in % = C x 100 S P/V ratio = Change in Contribution Change in Sales = Change in Profit Change in Sales
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Break even point (BEP) BEP (in units) = Total Fixed Cost = F Contribution per unit C BEP (in Rs.) = F = F x S P/V Ratio C P/V Ratio = F BEP
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Calculation of Sales to breakeven or earn a given Profit Calculation of Sales = F + Profit to earn a given Profit C (per unit) (in units) Calculation of Sales = F + Profit to earn a given Profit P/V Ratio (in Rs.)
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Sales at which two companies earn the same amount of Profit Sales at which two companies earn the = Difference in Fixed Cost same amount of Profit Difference in P/V Ratio
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Margin of Safety Margin of Safety = Actual Sales – Breakeven Point (M/S) M/S Ratio = Actual Sales – BEP Actual Sales M/S = Profit P/V Ratio
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Margin of Safety Profit = Margin of Safety x P/V Ratio Profit = Actual Sales x M/S Ratio x P/V Ratio
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ADVANTAGE Marginal costing is simple to understand It helps in short-term profit planning by breakeven and profitability analysis Practical cost control is greatly facilitated, efforts can be concentrated on maintaining a uniform and consistent marginal cost, which is useful to various levels of management
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Helpful in Decision Making : - Make or Buy Decision Capturing the foreign Markets Change of Product Mix Sales Price in Normal Condition Determination of Minimum Price Temporary /permanent closure of production ADVANTAGE
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DISADVANTAGES Normal costing systems also apply under normal operating volume and this shows that no advantage is gained by marginal costing Under marginal costing, stocks and work in progress are understated, the exclusion of fixed costs from inventories affect profit
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Marginal cost data becomes unrealistic in case of highly fluctuating levels of production, e.g., in case of seasonal factories For long term profit planning, absorption costing is the only answer DISADVANTAGES
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