2. Marginal costing is an alternative to absorption
costing
In Marginal costing, only variable costs are
charged as a cost of sale and a contribution is
calculated
Closing inventories of work in progress or
finished goods are valued at marginal (variable)
production cost
Fixed costs are treated as a period cost, and are
charged in full to the profit and loss account of
the accounting period in which they are
incurred
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3. An important measure in marginal costing
Is the difference between the sales value and the
marginal or variable cost of sales
Contribution may be defined as the profit
before the recovery of fixed costs
contribution goes toward the recovery of fixed
cost and profit, and is equal to fixed cost plus
profit (C = F + P).
In case a firm neither makes profit nor suffers
loss, contribution will be just equal to fixed cost
(C = F). this is known as break even point.
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4. The principles of marginal costing are as follows:-
(a) For any given period of time, fixed costs will be
the same, for any volume of sales and production
(provided that the level of activity is within the
‘relevant range’). Therefore, 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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5. (b) Similarly, if the volume of sales falls by one item,
the profit will fall by the amount of contribution
earned from the item.
(c) Profit measurement should therefore be based
on an analysis of total contribution. Since fixed costs
relate to a period of time, and do not change with
increases or decreases in sales volume, it is
misleading to charge units of sale with a share of
fixed costs.
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6. (d) When a unit of product is made, the extra costs
incurred in its manufacture are the variable
production costs. Fixed costs are unaffected, and no
extra fixed costs are incurred when output is
increased.
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7. The main features of marginal costing are as
follows:
1. Cost Classification
The marginal costing technique makes a
sharp distinction between variable costs
and fixed costs. It is the variable cost on the
basis of which production and sales policies
are designed by a firm following the marginal
costing technique.
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8. 2. Stock/Inventory Valuation
Under marginal costing, inventory/stock for
profit measurement is valued at marginal cost.
It is in sharp contrast to the total unit cost
under absorption costing method.
3. Marginal Contribution
Marginal costing technique makes use of
marginal contribution for marking various
decisions. Marginal contribution is the
difference between sales and marginal cost. It
forms the basis for judging the profitability of
different products or departments.
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9. Sales revenue xxx
Less Marginal cost of production:-
Opening stock (valued at marginal cost) xxx
Add production cost xxx
Less closing stock (valued at marginal cost) (xxx)
Marginal cost of production xxx
Add selling, distribution cost xxx
Marginal cost of sales (xxx)
Contribution xxx
Less Fixed cost (xxx)
Profit xxx
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10. Alpha makes a product, the marble, which has a variable
production cost of Rs 6 per unit and a sales price of Rs 10
per unit. At the beginning of Sept. 2000 there were no
opening inventories production during the month was
20,000 units. Fixed costs for the month were Rs 45,000.
There were no variable marketing costs.
Calculate the contribution and profit for Sept 2000,
using marginal costing principles if sales were as
follows:-
10,000 marbles
15,000 marbles
20,000 marbles 10
11. Based on your answer in the first part, calculate the
expected profit from the sale of 17,000 marbles
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13. In marginal costing, fixed production costs are treated
as period cost and are written off as they are incurred.
In absorption costing, all costs are absorbed into
production and thus operating statements do not
distinguish between fixed and variable costs.
The valuation of stock and work in progress contains
both fixed and variable elements.
Inventory values are therefore greater than those
calculated using marginal costing
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14. In a period 20,000 units of Z were produced and only
18,000 units were sold and 2,000 units were carried
forward as stock to the next period. Costs and
revenues were:
$
Sales 100,000
Production Costs:
Variable 35,000
Fixed 15,000
Administrative and selling overheads 25,000
Prepare profit statements based on marginal costing
and on absorption costing.
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16. The difference in profits reported under the two
costing systems is due to the different inventory
valuation method used.
If inventory levels increase between the
beginning and the end of the period,
absorption costing will report a higher profit.
This is because some of the fixed production
overhead incurred during the period will be
carried forward in closing inventory (which
reduces cost of sales) to be set against sales
revenue in the following period instead of being
written off in full against profit in the period
concerned.
If inventory levels decrease, absorption costing
will report the lower profit.
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17. Reconciliation of profit of ING Inc
Marginal costing profit 26,640
To calculate absorption costing profit given a change in
inventory level of 40,000 (280,000 – 240,000) and an
overhead absorption rate of Rs 1.25
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18. The overhead absorption rate for product X is Rs 10
per machine hour. Each unit of product X requires
five machine hours. Inventory of product X on 1
Jan was 150 units and on 31 Dec it was 100 units.
What is the difference in profit between results
reported using absorption costing and results
reported using marginal costing.
Hint- Difference in profit = change in inventory * fixed
overhead absorption per unit
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19. When opening inventories were 8,500 litres and
closing inventories were 6,750 litres, a company had a
profit of Rs 62,100 using marginal costing.
Assume that the fixed overhead absorption rate was Rs
3 per litres, what would be the profit using absorption
costing?
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20. What are the advantages and disadvantages of
marginal costing
What are the advantages and disadvantages of
absorption costing
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