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1. Website Designing Company in
Gudgaon
By:
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2. 2
Marginal costing
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3. 3
January February March
$ $ $
Sales 100000 80000 110000
Less: Variable cost of good
sold ($35) 35000 28000 385500
Product contribution margin 65000 52000 71500
Less: Variable selling overhead4000 3200 4400
Total contribution margin 61000 48800 67100
Less: Fixed Expenses
Fixed factory overhead 30000 30000 30000
Fixed selling overheads 1000 1000 1000
Net profit 30000 32800 30100
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4. 4
Wk1:
Standard fixed overhead rate
= Budgeted total fixed factory overheads
Budgeted number of units produced
= $30000
1000 units
= $30 units
Wk 2:
Production cost per unit under absorption costing:
$
Direct materials 20
Direct labour 10
Fixed factory overhead absorbed 30
Variable factory overheads 5
65
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5. 5
Wk 3:
(Under-)/Over-absorption of fixed factory overheads:
January February March
$ $ $
Fixed overhead 30000 39000 27000
Fixed overheads incurred 30000 30000 30000
0 9000 (3000)
1000*$30 1300*$30 900*$30
Wk 4:
Variable production cost per unit under marginal costing:
$
Direct materials 20
Direct labour 10
Variable factory overhead 5
35
No fixed factory overhead
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6. 6
Difference between absorption
and marginal costing
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7. 7
Absorption costing Marginal costing
Treatment for
fixed
manufacturing
overheads
Fixed
manufacturing
overheads are
treated as product
costing. It is
believed that
products cannot be
produced without
the resources
provided by fixed
manufacturing
overheads
Fixed manufacturing
overhead are treated
as period costs. It is
believed that only the
variable costs are
relevant to decision-
making.
Fixed manufacturing
overheads will be
incurred regardless
there is production or
not
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8. 8
Absorption costing Marginal costing
Value of
closing stock
High value of
closing stock will be
obtained as some
factory overheads
are included as
product costs and
carried forward as
closing stock
Lower value of
closing stock that
included the variable
cost only
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9. 9
Absorption costing Marginal costing
Reported
profit
If the production = Sales, AC profit = MC Profit
If Production > Sales, AC profit > MC profit
As some factory overhead will be deferred as
product costs under the absorption costing
If Production < Sales, AC profit < MC profit
As the previously deferred factory overhead
will be released and charged as cost of goods
sold
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10. 10
Argument for absorption costing
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11. 11
• Compliance with the generally accepted accounting
principles
• Importance of fixed overheads for production
• Avoidance of fictitious profit or loss
– During the period of high sales, the production is small
than the sales, a smaller number of fixed manufacturing
overheads are charged and a higher net profit will be
obtained under marginal costing
– Absorption costing is better in avoiding the fluctuation of
profit being reported in marginal costing
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12. 12
Arguments for marginal costing
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13. 13
• More relevance to decision-making
• Avoidance of profit manipulation
– Marginal costing can avoid profit manipulation by
adjusting the stock level
• Consideration given to fixed cost
– In fact, marginal costing does not ignore fixed costs in
setting the selling price. On the contrary, it provides useful
information for break-even analysis that indicates whether
fixed costs can be converted with the change in sales
volume
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14. 14
Break-even analysis
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15. 15
Definition
• Breakeven analysis is also known as cost-
volume profit analysis
• Breakeven analysis is the study of the
relationship between selling prices, sales
volumes, fixed costs, variable costs and profits
at various levels of activity
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16. 16
Application
• Breakeven analysis can be used to determine
a company’s breakeven point (BEP)
• Breakeven point is a level of activity at which
the total revenue is equal to the total costs
• At this level, the company makes no profit
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17. 17
Assumption of breakeven point
analysis
• Relevant range
– The relevant range is the range of an activity over which
the fixed cost will remain fixed in total and the variable
cost per unit will remain constant
• Fixed cost
– Total fixed cost are assumed to be constant in total
• Variable cost
– Total variable cost will increase with increasing number of
units produced
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18. 18
• Sales revenue
– The total revenue will increase with the increasing
number of units produced
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19. 19
Total cost
Variable cost
Fixed cost
Cost $
Sales (units)
Sales revenue
Total Cost/Revenue $
Sales (units)
Total cost
Profit
BEP
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20. 20
Calculation method
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21. 21
Calculation method
• Breakeven point
• Target profit
• Margin of safety
• Changes in components of breakeven analysis
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22. 22
Breakeven point
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23. 23
Calculation method
• Contribution is defined as the excess of sales
revenue over the variable costs
• The total contribution is equal to total fixed
cost
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24. 24
Formula
Breakeven point
Fixed cost
Contribution per unit
Sales revenue at breakeven point
= Breakeven point *selling price
=
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25. 25
Alternative method:
Sales revenue at breakeven point
Contribution required to breakeven
Contribution to sales ratio
=
Breakeven point in units
Sales revenue at breakeven point
Selling price
=
Contribution per unit
Selling price per unit
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26. 26
Example
• Selling price per unit $12
• Variable cost per unit $3
• Fixed costs $45000
Required:
– Compute the breakeven point
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27. 27
Breakeven point in units = Fixed costs
Contribution per unit
= $45000
$12-$3
= 5000 units
Sales revenue at breakeven point = $12 * 5000 = $60000
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28. 28
Alternative method
Contribution to sales ratio $9 /$12 *100% = 75%
Sales revenue at breakeven point
= Contribution required to break even
Contribution to sales ratio
= $45000
75%
= $60000
Breakeven point in units = $60000/$12 = 5000 units
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29. 29
Target profit
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30. 30
Formula
No. of units at target profit
Fixed cost + Target profit
Contribution per unit
=
Required sales revenue
Fixed cost + Target profit
Contribution to sales ratio
=
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31. 31
Example
• Selling price per unit $12
• Variable cost per unit $3
• Fixed costs $45000
• Target profit $18000
Required:
– Compute the sales volume required to achieve the
target profit
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32. 32
No. of units at target profit
Fixed cost + Target profit
Contribution per unit
=
$45000 + $18000
$12 - $3
=
= 7000 units
Required to sales revenue = $12 *7000
= $84000
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33. 33
Alternative method
Required sales revenue
Fixed cost + Target profit
Contribution to sales ratio
=
$45000 + $18000
75%
=
= $84000
Units sold at target profit = $84000 /$12 = 7000 units
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34. 34
Margin of safety
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35. 35
Margin of safety
• Margin of safety is a measure of amount by
which the sales may decrease before a
company suffers a loss.
• This can be expressed as a number of units or
a percentage of sales
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36. 36
Formula
Margin of safety
= Margin of safety
Budget sales level *100%
Margin of safety
= Budget sales level – breakeven sales level
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37. 37
Sales revenue
Total Cost/Revenue $
Sales (units)
Total cost
Profit
BEP
Margin of safety
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38. 38
Example
• The breakeven sales level is at 5000 units. The
company sets the target profit at $18000 and
the budget sales level at 7000 units
Required:
Calculate the margin of safety in units and
express it as a percentage of the budgeted
sales revenue
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39. 39
Margin of safety
= Budget sales level – breakeven sales level
= 7000 units – 5000 units
= 2000 units
Margin of safety
= Margin of safety
Budget sales level
= 2000
7000
= 28.6%
*100 %
*100 %
The margin of safety indicates that the actual sales can fall by
2000 units or 28.6% from the budgeted level before losses are
incurred.
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40. 40
Changes in components of
breakeven point
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41. 41
Example
• Selling price per unit $12
• Variable price per unit $3
• Fixed costs $45000
• Current profit $18000
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42. 42
• If the selling prices is raised from $12 to
$13, the minimum volume of sales required
to maintain the current profit will be:
Fixed cost + Target profit
Contribution to sales ratio
=
$45000 + $18000
$13 - $3
= 6300 units
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43. 43
• If the fixed cost fall by $5000 but the variable
costs rise to $4 per unit, the minimum volume
of sales required to maintain the current profit
will be:
Fixed cost + Target profit
Contribution to sales ratio
=
$40000 + $18000
$12 - $4
= 7250 units
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44. 44
Limitation of breakeven point
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45. 45
Limitations of breakeven analysis
• Breakeven analysis assumes that fixed cost,
variable costs and sales revenue behave in
linear manner. However, some overhead costs
may be stepped in nature. The straight sales
revenue line and total cost line tent to curve
beyond certain level of production
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46. 46
• It is assumed that all production is sold. The
breakeven chart does not take the changes in
stock level into account
• Breakeven analysis can provide information
for small and relatively simple companies that
produce same product. It is not useful for the
companies producing multiple products
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