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Marginal costing- Management Accounting.
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- 2. What is MarginalCosting Marginal cost is the incremental cost of producing one additional unit of a product/service. Therefore, Marginal cost = Change in Total Cost Change in Quantity What is Marginal Costing? – ICMAI defines it as “the ascertainment of marginal costs and of the effect on profit of changes in volume or type of output by differentiating between fixed costs and variable costs.”
- 3. Marginal Cost Equation Sales– Variable cost = Contribution Contribution – Fixed cost = Profit Sales – Variable cost = Fixed cost + Profit
- 4. Key Characteristics ofMarginal Costing All costs are analysed into fixed and variable, semi variable are also classified into fixed and variable costs The variable costs are assigned to the product and fixed costs to the period. Fixed costs are charged to P&L Under this type of costing, the value of finished goods and WIP is made up of variable costs. Variable Selling and Distribution costs and fixed costs are excluded from stock valuations Prices are determined by analysing the variable costs and contribution margin Profitability is determined with reference to contribution margin
- 5. Advantages of MarginalCosting Easy to make pricing decisions Avoids over/under recovery of overheads Realistic profit, as WIP and stocks are at marginal costs and fixed costs are written off. Helps in production planning Helps in controlling expenditure Managerial decision making Make or buy Determination of selling price Expansion of business Diversification
- 6. Applications of MarginalCosting Decisions regarding optimum product mix Decision regarding utilisation of scarce resource Decision regarding Pricing Earn maximum contribution At least break-even Recover at least the marginal costs Decision regarding Make or Buy
- 7. Break-Even Analysis Break-evenpoint is the point where there is No Profit and No Loss BEP (in units) = Fixed Cost Contribution Per Unit This calculation helps organisation analyse the volume- profit relationship
- 8. Margin of Safety The sales after break – even sales are called margin of safety sales At margin of safety sales, fixed costs are zero MOS sales = Actual sales – Break even sales Profit = Margin of Safety x PVR Larger MoS indicates a stronger business. Such businesses can continue to earn profits, even after sales decrease, e.g. During recessions Companies can improve the MoS by Increasing volume of sales or price of sales or selling products with higher PVR Reducing fixed costs or variable costs
- 9. Absorption Costing Absorptioncosting, sometimes called “full costing,” is a method of adding all costs incurred in the process of production and then calculating price per unit. Both fixed and variable costs are charged to individual products, process or contracts. It has certain limitations, like Charges fixed costs to products, due to which unit costs varies from one year to another depending on volume in each year, making comparison between two periods difficult Includes fixed costs in closing stocks, ignoring the revenue-cost matching principle which states that costs of one period should not be carried forward to another period. Arbitrary absorption of fixed costs, giving a misleading picture. This is especially true when the company is producing multiple products, but fixed cost is charged on unit basis. Ignores the cost-volume-profit relationship and cannot show the effect of change in volume on costs and profits
- 11. Difference between Marginaland Absorption Costing Marginal Costing Absorption Costing • Only variable costs are considered for product and inventory costing • Profitability (PVR) is not affected by Fixed costs • Cost data shows the contribution product wise • Stocks do not affect the unit cost of production • The cost per unit remains same irrespective of the production as it is valued at variable cost • Both fixed and variable costs are considered for product and inventory costing • Profitability is affected by Fixed costs • Cost data highlights net profit of each product • The difference between opening and closing stocks affects the unit cost • The cost per unit changes as production changes
- 12. Affect of Stockon Profits Change in Stock Difference in Profit No opening and closing stock Marginal Costing = Absorption Costing Opening stock = Closing stock Marginal Costing = Absorption Costing Closing stock > Opening stock Absorption Costing > Marginal Costing Opening stock > Closing stock Marginal Costing > Absorption Costing