MARGINAL COST OR VARIABLE COST OR DIRECT COST Marginal ... file13.11.2014 · manufacturing cost are...
Transcript of MARGINAL COST OR VARIABLE COST OR DIRECT COST Marginal ... file13.11.2014 · manufacturing cost are...
MARGINAL COST OR VARIABLE COST OR DIRECT COST
Marginal cost is the variable cost of one more unit of a product or service. As such, it arises from additional increments
of output. The accountants' concept of marginal cost differs from economists' concept of marginal cost. Economists
define marginal cost as additional cost of producing one additional unit. This shall include an element of fixed cost also.
To ascertain the marginal cost, we need the following elements of cost.
Direct Materials
Direct Labour
direct expenses,
variable portion of overhead (usually variable portion of manufacturing overheads)
Consequently the cost of a unit of product in inventory or cost of goods sold under this method does not contain any
fixed overhead cost. Thus variable cost is charged with cost units and fixed costs of the periods are written off in full
against the contribution .
That is, Marginal cost or variable cost = Prime cost + Total Variable Overheads (usually variable portion of
manufacturing overheads)
Or
Marginal Cost or variable cost = Total cost - Fixed Cost
MARGINAL COST contd.
A factory produces 500 bicycles per annum. The variable cost per by cycle is US$ 100. the fixed expenses are US$ 10000
per annum.
The cost sheet of bicycle will appear as follows:
US $
Variable cost (500 X US$ 100) 50000
Fixed cost 10000___
60000___
If production is increased by one unit i.e. if it becomes 501 bicycles per annum, the cost sheet will appear as follows :
US $
Variable cost (501 X US$ 100) 50100
Fixed cost 10000___
60 100___
The marginal cost is therefore US$ 100
MARGINAL or VARIABLE or DIRECT COSTING
Marginal costing is an improvement over absorption costing. It considers only variable cost ( those costs of production
that vary with output) in calculating the cost of the product while fixed costs are charged against the revenue (sales) of
the product. The revenue arising from the sales over variable costs is technically known as Contribution under marginal
costing. Thus, here variable costs are treated as product cost and fixed costs are not treated as product cost. Fixed
manufacturing cost are part of part of period cost.
Marginal costing is considered superior to absorption costing
so far as managerial decision making is considered. It
identifies only such costs with the jobs or products which
directly vary with the level of output. Thus the uncertainty
and irrationality associated with apportionment of fixed cost
in traditional costing is thus avoided.
According to marginal costing, variable cost would usually
include direct materials, direct labour direct expenses, and
variable portion of manufacturing overhead.
DIFFERENCE BETWEEN ABSORPTION COSTING AND VARIABLE (MARGINAL COSTING)
Recovery of Overheads: In case of absorption costing, both fixed and variable overheads are charged to productionwhile in case of marginal costing only variable overheads are charged to production.
Valuation of stocks: Absorption costing of stocks of work-in-progress and finished goods are valued at work cost andtotal cost of production respectively. Work cost and cost of production is defined to include fixed overheads too. Whilein marginal costing, only variable costs are considered while computing the value of work-in-progress or finishedgoods. Thus, closing stock is undervalued in marginal costing as compared to absorption costing.
CONTRIBUTION and PROFIT
Contribution is the difference between selling price and variable cost. It is sum of fixed cost and profit.
Contribution or Gross Margin = Selling Price (total revenue) – Variable Cost (marginal cost)
Contribution= (Variable cost + Fixed cost + Profit) – variable cost
Contribution= Fixed cost + Profit
Or, Profit = Contribution – Fixed cost
Or, Fixed cost = Contribution – profit
Let us take an example.
Variable cost Rs 5000
Fixed cost Rs. 2000
Selling Price Rs 8000
Contribution = Selling price – variable cost
= Rs 8000 – Rs 2000
= Rs 3000
Profit = Contribution – fixed cost
= Rs 3000 – Rs 2000
= Rs 1000
As contribution exceeds fixed cost, there is a profit of Rs.
1000.
If fixed cost is assumed as Rs 4000, the position
will change as:
Contribution – fixed cost = Negative Profit (loss)
= Rs 3000 – Rs 4000
= Rs 1000
The sum of Rs 1000 represents the extent of loss
since the fixed costs are more than the
contribution. At the level of foxed cost of Rs 3000,
there shall be no profit and no loss. The concept of
break-even analysis arises out of this basic fact.
CONTRIBUTION or GROSS MARGIN contd.
Example 1: Tripura Ltd is manufacturing three product : A, B, C. the cost of manufacture are as follows
A B C
Direct Material per unit Rs 3 Rs 4 Rs 5
Direct labour per unit Rs 2 Rs 3 Rs 3
Selling price per unit Rs 10 Rs 15 Rs 20
Output 1000 units 1000 units 1000 units
The total overhead costs are Rs.12000 out of which Rs. 9000 are fixed and the rests are variable. It is decided to
apportion these costs over different products in the ratio of output. From the above data, prepare a statement
of cost and profit according to Marginal Costing.
Example 1: solution
Statement showing Profit And Cost (Marginal Costing )
Product A_____ _____Product _B _____ ____Product C _____
Per unit Rs
TotalRs
Per unit Rs
TotalRs
Per unit Rs
TotalRs
Direct material Direct labour
Variable Overheads
Total Marginal CostContribution (Sales – MC)Selling price
32
1
30002000
1000
43
1
40003000
1000
54
1
50004000
1000
64
60004000
87
80001000
1010
1000010000
10 10000 15 15000 20 20000
Example 1: solution contd.
Total profit under marginal costing would be: Contribution Rs.
Product A 4000Product B 7000Product C 10000
Total Contribution 21000Less: Fixed Cost
Product A 3000Product B 3000Product C 3000 9000
Profit 12000
Example 2: Tripura Ltd is manufacturing three product : A, B, C. the cost of manufacture are as follows
A B C
Direct Material per unit Rs 3 Rs 4 Rs 5
Direct labour per unit Rs 2 Rs 3 Rs 3
Selling price per unit Rs 10 Rs 15 Rs 20
Output 1000 units 1000 units 1000 units
The total overhead costs are Rs.12000 out of which Rs. 9000 are fixed and the rests are variable. It is decided toapportion these costs over different products in the ratio of output. Prepare a statement showing the cost and profit ofeach product according to marginal costing.
Calculate amount of profit and profit and loss made by Tripura Ltd in the first two years of its existence, presumingthati. In the first year, it manufactures 1000 units of each product A, B, C but fails to effect any sales.ii. In the second year, it does not produce anything but sells the entire stock carried forward from the first year.iii. What fallacious conclusions can be drawn from the results.
Solution : Example2
Tripura Limited Profit and loss Account of 1st Year (as per marginal costing)
Rs Rs
Direct material ABC
Direct labour ABC
Overhead: variables
A 1000B 1000C 1000
Fixed -----
300040005000___ 12000
200030004000___ 9000
30009000 _12000__
___33000_
SalesClosing Stock Loss
-----24000
9000
___________33000_
Solution : Example 2 contd.
Tripura Limited Profit and loss Account of 2nd Year (as per marginal costing)
Rs Rs
Opening Stock Fixed overhead
Profit
240009000
12000
_______45000__
SalesA BC
100001500020000_ 45000
______45000_
The above Profit and Loss accounts shows that the company suffered a loss of Rs.9000 in the first year because of non-recovery of fixed overheads while in the second year it makes a profit of Rs. 12000. It may be seen from the profit and lossaccount that the fixed cost of one year has been carried forward to the next year. Thus, the profit and loss account givesthe correct picture according to marginal costing.
Example 3: Tripura Ltd is manufacturing three product : A, B, C. the cost of manufacture are as follows
A B C
Direct Material per unit Rs 3 Rs 4 Rs 5
Direct labour per unit Rs 2 Rs 3 Rs 3
Selling price per unit Rs 10 Rs 15 Rs 20
Output 1000 units 1000 units 1000 units
The total overhead costs are Rs.12000 out of which Rs. 9000 are fixed and the rests are variable. It is decided to
apportion these costs over different products in the ratio of output. From the above data, prepare a statement
of cost and profit according to Marginal Costing.
Compute the amount of profit under absorption costing and marginal costing in case units of goods sold of
products A, B, C are 900 each.
Example 3: solution
Statement showing Profit And Cost (Absorption Costing )
Product A_____ _____Product _B _____ ____Product C _____
TotalRs
TotalRs
TotalRs
Direct material Direct labour Variable OverheadsTotal Marginal (variable) CostAdd: Fixed Overheads
Total cost of production Less: Closing Stock Cost of goods sold Profit
300020001000
400030001000
500040001000
60003000
80003000
100003000
9000900
110001100
130001300
8100900
99003600
117006300
Sales 9000 13500 18000
Total profit under absorption costing is
Total Profit Rs._______
Product A 900 Product B 3600 Product C 6300 Rs 10800
Example 3: solution contd.
Example 3: solution
Statement showing Profit And Cost (Marginal Costing )
Product A_____ _____Product _B _____ ____Product C _____
TotalRs
TotalRs
TotalRs
Total Marginal CostLess: Closing Stock Cost of goods sold Contribution (Sales – MC)Sales
6000600
8000800
100001000
54003600
72006300
90009000
9000 13500 18000
Example 3: solution contd.
Total profit under marginal costing would be:
Total Contribution Rs.
Product A 3600Product B 6300Product C 9000 18900
Less: Fixed Cost Product A 3000
Product B 3000Product C 3000 9000
Profit Rs. 9900
BREAK -EVEN ANALYSIS
Break –even Analysis refer to a system of determination of activity where total cost equals total selling price. It is also
known as cost-volume- profit analysis. The analysis is a tool of financial analysis whereby the impact on profit of the
changes in volume, price, costs and product mix can be estimate d with reasonable accuracy.
Break even analysis is useful for a manger in the following way.
It helps him in forecasting the profit fairly accurately
It is helpful in setting up flexible budget , since on the basis of cost-volume-profit relationship, one can ascertain the
costs, sales and profits at different levels of activity.
It is helpful in formulating price policy by projecting the effect of different price structures on costs and profits
It helps in determining the amount of overheads costs to be charged at various levels of operations since overheads
are generally pre-determined on the basis of selected volume of operations.
BREAK-EVEN POINT
. Break-even-point is a point where the total sales (total revenue or income) are equal to total cost. Break-even-point
is equilibrium point or balancing point of no-profit no loss. This is a point after which loss ceases and profit begins.
Hence, if production is increased beyond this point, profit shall accrue and if it is reduced below this level, loss will be
suffered. Break-even-point can be determined by the following formula:
Break even point in output = Fixed cost ÷ contribution per unit
Break even point in sales = (Fixed cost ÷ contribution per unit) x Selling price per unit
= Fixed cost ÷ (1 - variable cost per unit ÷ selling price per unit)
= (Fixed cost ÷ contribution per unit) x Total sales
= (Fixed cost ÷ P/V ratio)
To break even point, profit is zero. To calculate volume of output and sales for a desired profit, the amount of desired
should be added to fixed costs as given bellow.
Units for a desired profit = (Fixed cost + desired profit )÷ contribution per unit
Sales for a desired profit = (Fixed cost + desired profit )÷ P/V ratio
Example 4: From the following information, you are required to compute break-even point Variable cost per unit
- Rs. 12; Fixed cost- Rs. 60000; Selling price per unit- Rs. 18.
Solution:
Contribution = Selling Price - Variable Cost
= Rs. 18 - Rs. 12 = Rs. 6
B.E.P. in Units = Fixed Cost ÷ Contribution per Unit
= Rs. 60000 ÷ Rs. 6 = 10000 Units
Break Even Point Sales = Rs. 18 X 10000 Units = Rs. 180000
Example 5: A company estimates that next year it will earn a profit of Rs. 50000. The budgeted fixed costs and
sales are Rs. 250000 and 993000 respectively. Find out the break-even point for the company
Solution:
Contribution = Fixed Cost + Profit = Rs. 250000 + Rs. 50000 = Rs. 300000
B.E.P. (in Units) = (Fixed Cost X Sales) ÷ Contribution
= (Rs. 250000 X Rs. 993000) ÷ Rs. 300000 = Rs. 827500