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# Marginal costing synopsis notes

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### Marginal costing synopsis notes

1. 1. Notes by Prof. M. B. Thakoor MARGINAL COSTING SYNOPSIS(1) INTRODUCTION OF IMPORTANT TERMS 1) Marginal Cost 2) Marginal Costing 3) Fixed Cost 4) Variable Cost 5) Semi Variable / Semi Fixed Cost(2) TECHNIQUES OF COSTING 1) Absorption Costing 2) Marginal Costing(3) CONCEPT OF BREAK EVEN POINT(4) CONCEPT OF PROFIT VOLUME RATIO(5) PRACTICAL APPLICATIONS OF MARGINAL COSTING TECHNIQUES 1) Pricing of Product 2) Make or buy decision 3) Operate or shutdown 4) Decision of Product Mix 5) Key or Limiting Factor a) Labour Shortage b) Material Shortage c) Machine Capacity constraint (Capacity Utilisation)(6) PROFIT PLANNING(7) EXPANSION AND DIVERSIFICATION(8) ACCEPT, REJECT SPECIAL OFFER AND SUBCONTRACTING.(1) Notes by Prof. M. B. Thakoor
2. 2. Notes by Prof. M. B. Thakoor Marginal Costing also known as Direct Costing or Variable Costing. The word Marginal Costing is common in the U.K. and other Countries of the Continent, while the expression “Direct Costing” or “Variable Costing” is preferred in the U.S.A. “Marginal Cost” is derived from the word “Margin” and is well known concept of Economic theory. Thus quite in the Economic Connotation of the term, it is described in simple words as “the cost which arises from the production of additional increment of output and it does not arise in case the additional increments are not produced.” "The amount at given volume of output by which aggregate cost are changed if the volume of output is increased or decreased by one unit.” Marginal Costing is the ascertainment of Marginal Cost by differentiating the cost between fixed cost and variable cost and finding its effect on the profit of changes in volume or type of output. Marginal Costing necessitates Analysis of cost into fixed and variable. Even semi variable costs have to be closely and critically analysed into Fixed and variable.INTRODUCTION:“Marginal Cost” is derived from the word “Margin” and is well known concept ofEconomic theory. Thus quite in tune with the Economic connotation of the term, it isdescribed in simple words as “Cost which arises from the production of additionalincrement of output and it does not arrive in case the additional increments are notproduced.”Q.1 What is Marginal Cost?A. Marginal Cost is the amount at any given volume of output by which the aggregate cost change, if the output is increased or decreased by 1 unit.(2) Notes by Prof. M. B. Thakoor
3. 3. Notes by Prof. M. B. ThakoorQ.2 What is Marginal Costing?A. Marginal Costing is a technique of costing which ascertains the effect of change in volume on the profits of the company, by dividing the cost into fixed and variable.Q.3 What is Fixed Cost?A. Fixed Cost is a cost which remains fixed irrespective of the level of production. Fixed Cost remain fix in total but changes per unit.Q.4 What is Variable Cost?A. Variable Cost is a cost which varies as per the level of production. Variable Cost remain fixed per unit but it varies in total.Q.5 What is Semi-Fixed / Semi-Variable Cost?A. Semi-Fixed / Semi-Variable Cost are basically fixed cost upto a certain level of activity specified and they vary after certain level. Ex. Maintenance expenditure to a certain level is fixed if production do not fluctuate widely. And if production rises beyond a fixed limit additional maintenance expenditure is required though such additional expense may not vary directly with production. Eg. Telephone Expenses.Q.6 What is the basic theme of Marginal Costing ?A. The concept of Marginal Costing is based on the important distinction between product cost which is related to volume of production and period cost which is related to period of time and not volume of production. This it is based on making a distinction of cost into variable and fixed.(3) Notes by Prof. M. B. Thakoor
5. 5. Notes by Prof. M. B. Thakoor ABSORPTION COSTING MARGINAL COSTING 2. DATA PRESENTATION Data is presented in the form of Vertical Data is presented in the form of vertical Statement. One of them being Cost Sheet statement known as Marginal Cost where Net Profit of each product is Statement where the cost data presented determined after subtracting Fixed Cost highlights the contribution of each along with the Variable Cost. product and the fixed cost is deducted from the total contribution to get profit. The Simple principle used = Cost + Profit = Selling price The Simple principal used = Sales – Cost = Profit. 3. TYPE OF COST Both Fixed and Variable Cost are considered Only Variable Costs are considered for to find the cost of the product. finding the Marginal Cost. 4. INVENTORY VALUATION Under Absorption Costing Inventory is Under Marginal Costing inventory is valued at Factory Cost which include factory valued at Variable Cost and no part of overheads both Fixed and Variable. A part Fixed Cost is applied to the inventory. of production overhead is therefore carried to the next accounting period along with W.I.P. and finished goods. 5.IMPACT OF INVENTORY VALUATION ON PROFIT a) No opening and no closing stock i.e. Production = Sale Profit is same as Marginal Costing. Profit is same as absorption Costing b) When Closing Stock is more than Opening Stock. Profit will be more than Marginal Costing Profit will be less than Absorption Costing. Logic: Because Under Absorption Costing a portion of fixed cost is charged to the closing stock and the same is deducted from cost so cost decreases hence profit increases. c) When Closing Stock is less than Opening Stock. Profit will be less than Marginal Costing Profit will be more than Absorption Costing. Logic: Under Absorption Costing a portion of fixed cost is charged to opening stock which is added to cost and its impact is greater than closing stock. So cost increases and profit decreases of the Business organizations. 6. AID IN DECISION MAKING As both Fixed are variable cost are As it classify cost as per variability it do considered and it do not recognize the help in decision making considering the difference between Fixed Cost and Variable Relevance of certain cost and Cost it do elaborately explain past profit / irrelevance of certain cost. losses but do not help when it comes to tomorrows result. It considers all cost are Relevant Cost.(5) Notes by Prof. M. B. Thakoor
6. 6. Notes by Prof. M. B. Thakoor RECONCILIATION OF RESULTS OF ABSORPTION COSTING AND MARGINAL COSTINGWhen results of Absorption Costing and Marginal Costing are compared it is necessary tomake adjustments for under absorbed overhead and / or over Absorbed overheads.Because under absorption costing fixed overhead rate is predetermined based on normallevel of activity.When actual activity level is different from normal activity level, a situation of underabsorption or over absorption of fixed cost arises.(1) Under Absorbed = Normal Prod. – Actual Prod X Fixed Overhead Fixed Overhead Level Level rate per unitThe above amount is reduced from profit under Absorption Costing or the above amountis added to the cost under Absorption Costing before comparing profit with MarginalCosting.(2) Over Absorbed = Actual Prod. – Normal Prod X Fixed Overhead Fixed Overhead Level Level rate per unitThe above amount is added to profit under Absorption Costing or the above amount isdeducted from the cost of production under absorption costing before comparing profitwith Marginal Costing.Conclusion:Process of Marginal CostingFirst find the difference between sale and variable cost i.e. Excess of sale over variablecost and this difference is known as contribution. The excess of contribution over FixedCost is profit. The emphasis is on increasing the total contribution.Sales – Variable Cost = ContributionContribution – Fixed Cost = Profit(6) Notes by Prof. M. B. Thakoor
7. 7. Notes by Prof. M. B. ThakoorProblems:Q.1: Following cost data is given for a production of N & Co. Ltd. Particulars Per Unit (Rs.) Sale Price 10 Variable Cost 6 Fixed Cost 2 Normal Production 26,000 units Following additional data are given for the four consecutive periods. Particulars Period I Period II Period III Period IV (Units) (Units) (Units) (Units)Opening Stock - - 6,000 2,000Production 26,000 30,000 24,000 30,000Sales 26,000 24,000 28,000 32,000Closing Stock 6,000 2,000 -Prepare a statement showing the profit for different period under both Marginal CostingMethod and Absorption Costing Method.Q.2: Sale Price Rs. 5.00 per unit Variable Cost Rs. 3.00 per unit Fixed Cost Rs. 1.00 per unit Normal Production 15,000 units Total Fixed Cost for the year Rs. 15,000Following statement shows the position of opening and closing stock. Particulars Period I (Units) Period II (Units)Opening Stock - 3,000Production 17,000 14,000Sale 14,000 16,000Closing Stock 3,000 1,000Prepare statement showing the figure of comparative profit by both the methods,Marginal Costing method and Absorption Costing Method.Q.3: The data below relate to Venus Ltd. Which makes and sell computerParticulars March AprilSales 5,000 Units 10,000 UnitsProduction 10,000 Units 5,000 UnitsSale Price per unit Rs. 100 Rs. 100Variable cost per unit Rs. 50 Rs. 50Fixed Production Overheads incurred Rs. 1,00,000 Rs. 1,00,000Fixed Production overheads cost per unit being Rs. 10 Rs. 10the predetermined overhead Absorption rateAdministration, Selling and Distribution Rs. 50,000 Rs. 50,000Overheads (Fixed)You are required to prepare comparative profit statement for each month using(1) Absorption Costing (2) Marginal Costing(7) Notes by Prof. M. B. Thakoor
8. 8. Notes by Prof. M. B. ThakoorSteps for Problems i.e. Q.1. Q.2. Q.3.(I) Find the Units sold by the following formula Quarter I Quarter II Quarter III Quarter IV (Units) (Units) (Units) (Units)Opening Stock XXX XXX XXX XXXAdd: Production XXX XXX XXX XXX XXX XXX XXX XXXLess: Closing Stock XXX XXX XXX XXXUnits Sold XXX XXX XXX XXX(II) Under Absorption Costing: Quarter I Quarter II Quarter III Quarter IV (Units) (Units) (Units) (Units)Sales (Units Sold X S.P.) XXX XXX XXX XXXLess: 1. Variable Cost XXX XXX XXX XXX(Units Sold x V.C. Per Unit) 2. Fixed Cost XXX XXX XXX XXX(Units Sold x F.C. Per Unit)Profit [Sale – (V.C. + F.C.)] XXX XXX XXX XXXAdd: Over absorption XXX XXX(Actual Prodn. – NormalProdn.) X Overhead rate XXX XXX XXX XXXLess: Under Absorption XXX XXX(Normal Prodn. – ActualProdn.) X Overhead rateFinal Profit XXX XXX XXX XXX(III) Under Marginal Costing Quarter I Quarter II Quarter III Quarter IV (Units) (Units) (Units) (Units)Sales (Units Sold X S.P.) XXX XXX XXX XXXLess: Variable Cost XXX XXX XXX XXX(Units Sold x V.C. Per Unit)Contribution XXX XXX XXX XXXLess: Fixed Cost XXX XXX XXX XXX(For Normal Prodn. OrFixed Amount Given butnot the absorption rate)Profit XXX XXX XXX XXX(8) Notes by Prof. M. B. Thakoor
9. 9. Notes by Prof. M. B. Thakoor RECONCILIATION Quarter I Quarter II Quarter III Quarter IV (Units) (Units) (Units) (Units)Profit XXX XXX XXX XXXUnder Absorption Costing XXX XXX XXX XXXUnder Marginal Costing XXX XXX XXX XXXFor ReconciliationTake for Each year(Closing Stock – Opening Stock) X Predetermined Overhead RatesIf Closing Stock > Opening Stock it will be positive and to that extent profit will be morein ABSORPTION COSTING.If (Closing Stock – Opening Stock) X Predetermined Overhead RateIf Closing Stock < Opening Stock it will be negative and to that extent profit will be lessin Absorption Costing (or More in Marginal Costing)(9) Notes by Prof. M. B. Thakoor
10. 10. Notes by Prof. M. B. Thakoor Marginal CostingQ. 1 What is Marginal Cost?Ans. Marginal Cost is the amount at any given volume of output by which the aggregate cost change, if the output is increased or decreased by 1 unit.Q. 2 What is Marginal Costing?Ans. Marginal Costing is a technique of costing which ascertains the effect of change in volume on the profits of the company, by dividing the cost into fixed and variable.Q. 3 What is Fixed Cost?Ans. Fixed cost is a cost which remains fixed irrespective of the level of production. Fixed cost remain fix in total but changes per unit.Q. 4 What is Variable Cost?Ans. Variable cost is a cost which varies as per the level of production variable cost per unit always remain the same.MARGINAL COST STATEMENTSales xxxLess : Variable Cost xxx ----Contribution xxxLess : Fixed Cost xxx -----Profit xxx ===Sales : Variable cost = ContributionContribution – Fixed Cost = Profit∴Contribution = Fixed Cost + Profit∴Contribution = Sales Price – Variable CostOr Contribution = Fixed Cost + Profit(10) Notes by Prof. M. B. Thakoor
11. 11. Notes by Prof. M. B. ThakoorQ.5 What is Break Even Point?Ans. Break Even Point is a point where the company or Business earns no profit or incurs no loss. It is the point where the sale revenue = Total Cost or A point of no profit no loss. Fixed CostBreak Even Point (in Units) = ---------------- Contribution per unit Fixed CostBreak Even Point (in Rupees) = -------------- P/V. RatioQ.6 What is Profit Volume Ratio or P/V. Ratio ?Ans. This Ratio expresses the relationship between Contribution and Sales. It is expressed as a % and indicates the relative profitability of different product. CP/V Ratio = ---- x 100 S Sales – V. C. OR ----- ---------- x 100 Sales F.C. + Profit OR = --------------- x 100 SalesThe higher the P/V. Ratio the more profitable is the product.Q. 7 What is Margin of Safety (M/S) ?Ans. Margin of Safety is the excess of Actual Sale over Break Even Sales Margin Safety = Actual Sale – Break Even SaleLarger the Marginal Sale more sound is the business.(11) Notes by Prof. M. B. Thakoor