ASSIGNMENT-3

Q1. How marginal costing is different from Absorption costing and direct costing? Discuss
the advantages of marginal costing.
Ans-
Basis Marginal Costing Absorption Costing Direct Costing
1.Meaning Marginal costing is a Absorption costing is Direct costing,
costing method that a costing method that similar to marginal
calculates the cost of allocates both costing, considers
a product by variable and fixed only variable costs
considering only its manufacturing costs when calculating
variable costs and to products. It is product costs. Fixed
treats fixed costs as primarily used for costs are treated as
period costs. It is external financial period costs. It is
often used for reporting and follows also used for internal
internal decision- the matching decision-making.
making. principle.
2. Cost Recognition Marginal costing Absorption costing Direct costing,
considers only allocates both similar to marginal
variable costs (direct variable and fixed costing, considers
and variable manufacturing costs only variable costs
manufacturing costs) to products. This when calculating the
when determining means that fixed cost of a product.
the cost of a product. costs are absorbed Fixed manufacturing
Fixed manufacturing into the cost of goods costs are treated as
costs are treated as sold and inventory. period costs.
period costs and are
not allocated to
products.
3. Income The income The income The income
Statement statement prepared statement prepared statement under
under marginal under absorption direct costing
costing separates costing includes both separates costs into
costs into fixed and variable and fixed fixed and variable
variable components. manufacturing costs components, making
This provides a as part of the cost of it easier to analyze
clearer view of how goods sold. This can the impact of sales
changes in sales result in fluctuations volume changes on
volume impact in reported profits as profitability.
profitability. sales volumes change
4. Contribution It focuses on In absorption It also focuses on
Margin calculating the costing, the calculating the
contribution margin contribution margin contribution margin
per unit, which is the is not explicitly per unit to assess
difference between calculated as it is in product profitability.
the sales price and marginal costing.
variable cost per Instead, absorption
unit. This helps in costing focuses on
 assessing the the gross profit,
profitability of which is the
individual products difference between
and making total sales revenue
decisions on and the total cost of
production and goods sold
pricing. (including both
variable and fixed
manufacturing
costs).
5. Decision Making Marginal costing is Absorption costing Direct costing is
often used for may not provide valuable for internal
internal decision- accurate information decision-making,
making, such as for short-term particularly for short-
pricing decisions, decision-making term decisions where
discontinuing since it can allocate a variable costs are
product lines, or significant portion of more relevant than
choosing between fixed costs to fixed costs. It can
different production products, potentially help in pricing,
methods. leading to product
suboptimal discontinuation, and
decisions. production decisions.

Advantages of Marginal Costing:

1. Simplified Costing: Marginal costing simplifies the cost allocation process by

considering only variable costs as product costs. This makes it easier to understand
and analyze the cost structure of products, particularly in situations where fixed costs
are unrelated to production volume.
2. Contribution Margin Analysis: Marginal costing calculates the contribution margin
(the difference between sales and variable costs) for each product. This helps in
assessing the profitability of individual products and making informed decisions
regarding pricing, product mix, and resource allocation.
3. Break-Even Analysis: Marginal costing is instrumental in conducting break-even
analysis. By knowing the contribution margin and the fixed costs, a company can
determine the level of sales needed to cover all fixed costs and start generating profit.
4. Decision Making: Marginal costing provides relevant cost information for short-term
decision-making, such as whether to accept a special order, discontinue a product line,
or make pricing decisions. It helps in identifying the most profitable choices.
5. Cost-Volume-Profit (CVP) Analysis: It facilitates CVP analysis, allowing businesses
to explore various scenarios and understand how changes in sales volume, selling
prices, or costs affect profits. This is crucial for planning and decision-making.

Q2. Explain the Break-Even analysis along with its assumptions and utility.
Ans- Break-even analysis is a financial tool used by businesses to determine the point at
which total revenues equal total costs, resulting in neither profit nor loss. At the break-even
point, there is no net income, but it provides valuable insights into the minimum level of sales
or production needed for a business to cover its costs.

Break-even point can be ascertained by using the following formula:

Assumptions of Break-Even Analysis:

1. Fixed and Variable Costs: Break-even analysis assumes that costs can be classified
into fixed costs and variable costs. Fixed costs remain constant regardless of the level
of production or sales, while variable costs vary directly with production or sales
volume.
2. Linear Relationship: It assumes that both fixed and variable costs change linearly
with production or sales volume. In reality, cost behavior can be more complex.
3. Sales Prices Remain Constant: The analysis assumes that the selling price per unit
remains constant regardless of the production or sales volume. In some cases,
businesses may use different pricing strategies.
4. Production Equals Sales: It assumes that all units produced are sold. This may not
always be the case, as there can be variations in inventory levels.
5. No Changes in External Factors: Break-even analysis assumes that external factors
such as market conditions, competition, and demand remain constant. In reality, these
factors can change.

Utility of Break-Even Analysis:

1. Determining Profitability: The primary utility of break-even analysis is to determine

the level of sales or production at which a business neither makes a profit nor incurs a
loss. This information is crucial for assessing the financial viability of a product,
service, or business as a whole.
2. Setting Sales Targets: Break-even analysis helps businesses set realistic sales targets.
It provides a clear understanding of the minimum sales volume required to cover
costs, which can inform sales and marketing strategies.
3. Cost Control: By identifying fixed and variable costs, break-even analysis helps
businesses analyze their cost structure. This knowledge can aid in cost control efforts
and efficiency improvements.
4. Pricing Decisions: It assists in making pricing decisions by helping businesses
understand the relationship between price, costs, and profitability. Businesses can
determine whether price adjustments are necessary to achieve their profit goals.
5. Capital Budgeting: Break-even analysis is useful in evaluating investment decisions.
It helps in assessing the payback period and risk associated with different investment
options.