Management Accounting: Marginal Costing & Cost Volume Profit Analysis

Meaning of Management Accounting

According to Anglo-American Council of Productivity -: It is the presentation of accounting information in such a way as to assist management in the creation of policy and the day to day operation of the undertaking.

Management Accounting and Financial Accounting

Financial Accounting Objective To maintain account to determine financial position of business Nature It deals with historical data. Management Accounting Objective To help management to formulate policies and plan Nature It deals with projection of data for the future.

Continues.
Subject matter F.A assess the result of the whole business Subject matter M.A deals separately with different units, deptts.etc. Compulsion Compulsion Preparation of M.A is Preparation of F.A is not necessary by law compulsory by law Precision Precision It records exact figures of It considers approximate figures the transactions

Cost Accounting and Management Accounting

Cost Accounting 1. It records the quantitative aspect of a transaction 2. Records the cost of producing a product and providing service 3. It only deals with cost ascertainment Management Accounting 1. it records both qualitative and quantitative aspect of a transaction 2. Provides information to management for planning and co-ordination 3. It is wider in scope as it includes F.A, budgeting, Tax, Planning.

Continue..
Cost Accounting 4. It uses both past and present figures 5. Its development is related to industrial revolution 6. It follows certain principles and procedures for recording costs of different products Management Accounting 4. It is concerned with the projection of figures for future. 5. It develops in accordance to the modern business world 6. It does not follow any specific rules and regulations.

MARGINAL COSTING

Marginal Cost
According CIMA, London, Marginal Cost represents the amount of any volume of given output by which aggregate cost are changed if the volume of output is increased by one units. In practice, it is measured by the total variable costs attributable to one unit. For example, the cost of production of 1,000 units of radios is Rs. 200000 and that of 1001 units is Rs. 200150 the marginal cost is Rs. 150, i.e., 200150 200000.

Marginal Costing
The Institute of Cost and Management, London, has defined Marginal costing as the ascertainment of marginal costs and of the effects on profit of changes in volume or type of output by differentiating between fixed costs and variable costs.

Marginal Costing
In this technique of costing only variable costs are charged to operational process or products, leaving all indirect cost to be written off against profit in the period in which they arise.

Marginal Costing
Is not a system of costing such as process costing, job costing, operating costing, etc. A technique which is concerned with the changes in costs and profits resulting from changes in the volume of output. It is also known as variable costing.

FEW CHARACTERISTICS OF MARGINAL COSTING

It is a technique of analysis and presentation of cost which
help management in making many managerial decision.

All

elements of are classified into variable and fixed components. Even semi-variable costs are analysed into fixed and variable. the products.

The variable cost (marginal costs) are regarded as the cost of Fixed costs are treated as period costs and are charged to
profit and loss account for the period for which they are incurred. at marginal cost only.

The stocks of finished goods and work-in-process are valued

Distinction between Marginal and Absorption Costing

Marginal costing
1.

Absorption costing

Only variable costs are considered for Both fixed and variable costs are product costing and inventory considered for product costing and valuation. inventory valuation. Fixed costs are regarded as period Fixed costs are charged to the cost of costs. The Profitability of different production. Each product bears a products is judged by their P/V ratio. reasonable share of fixed cost and thus the profitability of a product is influenced by the apportionment of fixed costs. Cost data presented highlight the total Cost data are presented in conventional contribution of each product. pattern. Net profit of each product is determined after subtracting fixed cost along with their variable costs.

2.

3.

MARGINAL COST EQUATION

FOR THE SAKE OF CONVINIENCE, A MARGAL COST EQUATION CAN BE DERIVED AS FOLLOWS:Sales Variable cost = contribution. Sales = Variable cost + contribution. Sales = Variable cost + Fixed cost Profit / Loss. Sales - Variable cost = Fixed cost Profit / Loss. SV=FP

Or, Or, Or, Or,

Where

S V F P

stands for Sales. stands for Variable cost. stands for Fixed cost. stands for Profit / Loss.

Profit / Volume Ratio (P/V Ratio or C/S Ratio)

Contribution P/V Ratio = Sales C S-V = ---- = -----S S Profit volume ratio is the ratio of contribution denoting the difference between sales and variable cost. Since in the short term fixed cost does not change, Profit/volume ratio also measures the rate of change of profit due to change in the volume of sales. If the sales price increases without corresponding increase in marginal cost the contribution increases and the Profit volume ratio improves. Similarly if the marginal cost is reduced with sale price remaining same Profit/Volume ratio improves.

Cost-Volume-Profit Analysis
 Is a technique for studying the relationship between cost, volume and profit.  Profits of an undertaking depends upon a large number of factors. But the most important of these factors are the cost of manufacture, volume of sales and the selling price of the products.  In words of Herman C. Heiser,the most significant single factor in profit planning of the average business is the relationship between volume of business, cost and profits.  The CVP relationship is an important tool used for profit planning of a business.

BREAK EVEN CHART

Break Even Point

Break even point represents that volume of production where total cost equal total revenue resulting into a no-profit no-loss situation. If output falls below that point, there is loss and if output exceeds the point there is profit. Therefore at break even point Revenue = Total Cost Sales(S) = Cost (C) = Fixed Cost + Variable Cost Sales - variable Cost = Contribution = Fixed Cost At break even point the contribution earned just covers the fixed cost and at levels below the point contribution earned is not adequate to match the fixed cost and at levels above the point contribution earned more than recovers the fixed cost. BEP = Fixed Cost/ PV Ratio

Margin of Safety
Margin of safety is the difference between the sales or production at a particular level of activity and the break even sales a production.
M/S Ratio = ASR-BESR ASR M/S Ratio = margin of safety ratio, ASR = Actual Sales Revenue, BESR = Break Even Sales Revenue

A large margin of safety indicates the soundness of the business and correspondingly a small margin of business indicates a not toosound position. Margin of safety can be improved by lowering the fixed cost and variable costs, increasing the volumes of sales and production, increasing the selling prices or changing the product mix resulting into a better overall Profit/Volume ratio. Profit Margin of safety = ----------------------Profit/Volume ratio

You are given the following data for the year 2007 of B Co. Ltd: Variable cost 60000 60% Fixed cost 30000 30% Net profit 10000 10% Sales 100000 100% Find out (a)Break-even point (b)P/V ratio (c)Margin of safety

S  V 1,00,000  60,000 (a) P/V ratio ! S ! 1,00,000

! 40%

(b) BE point !

F P/V ratio

30,000 ! 40%

! Rs. 75,000

(c) Margin of safety = Actual Sales BE point = 1,00,000 75,000 = Rs. 25,000

(a) You are given the following data for the coming year for a factory. Budgeted output 800000 units Fixed expenses Rs. 4000000 Variable expenses/ unit Rs. 10 Selling price/ unit Rs. 20 Find the break-even point. (b) If price is reduced to Rs. 18, what will be the new break-even point? (a) Contribution = S V = Rs. 20 Rs. 10 = Rs. 10 per unit.

Fixed cost 4000000 B.E. oint ! ! ! 400000 units Contributi on per unit Rs. 10
(b) When selling price is reduced New selling price = Rs. 18 New Contribution = Rs. 18 Rs. 10 = Rs. 8 per unit. New

s. 4000000 . . Point ! ! 500000 units. s. 8

X Ltd. which is a multi product Company furnishes the following data for the current year Particulars Sales Total Cost First Half Year Rs 450000 Rs 400000 Second Half Year Rs 500000 Rs 430000

Assuming that there is no change in prices and variable cost and that the fixed expenses are incurred equally in the two half-year periods, calculate for the year (i) Profit volume ratio (ii) Fixed expenses (iii) Break even sales (iv) Margin of Safety Ratio

Sales Revenue Total Cost = Net Profit Rs. 450000 - Rs 400000 = Rs 50000(1st Half) Rs. 500000 - Rs 430000 = Rs 70000(2nd Half) On a differential basis, Sales Revenue- Total Cost= Net Profit 50000 30000 = 20000 Only VC changes with change in S, Total Cost = VC PV Ratio = (S-V)/S = (50000-30000)/50000 = 40% VV Ratio = V/S = 30000/50000=60% SR=FC + VC + NP 950000= FC + 0.60(950000) + 120000 FC = 950000 570000 120000 = Rs 260000 BEP = FC/PV Ratio = 260000/0.40 = Rs 650000 M/S Ratio = (950000-650000)/950000 = 31.58%

 A Ltd furnishes the following information:

Particulars A Selling Price/ Unit Profit as % of SP Units produced & sold Fixed costs Rs 10 25 10000 40000 Products B Rs 12 33.33 15000 45000 C Rs 20 20 5000 25000

During the year, variable costs are expected to increase by 10%. There will be no change in fixed costs, selling prices and units to be produced and sold. Prepare a statement showing P/V ratio, BEP & M/S for each of the products and company as a whole.

Year 1 Particulars Units produced & sold Selling Price/Unit Sales Revenue Less: Variable Cost Contribution Less: Fixed Cost Operating Profit P/V Ratio (%) BEP Margin of Safety A
10000 10 100000 35000 65000 40000 25000 65

Year 2 COMBINED A
10000 10 100000 38500 61500 40000 21500 61.5

B
15000 12 180000 75000 105000 45000 60000 58.33

C
5000 20 100000 55000 45000 25000 20000 45

B
15000 12 180000 82500 97500 45000 52500 54.17

C
5000 20 100000 60500 39500 25000 14500 39.5

COMBINED
30000 12.667 380000 181500 198500 110000 88500 52.24 210579 169421

30000 12.667 380000 165000 215000 110000 105000 56.58 194419 185581

Variable Cost = Sale Revenue - Fixed Cost - Net Profit For Product A For Product B For Product C
100000-40000-(0.25*100000) = 35000 (Y1) 180000-45000-(0.3333*180000) = 75000 (Y1) 100000-25000-(0.20*100000) = 55000 (Y1) Y2=35000*1.10 = 38500 Y2=75000*1.10 = 82500 Y2=55000*1.10 = 60500

MANAGERIAL APPLICATION OF MARGINAL COSTING

PRICING DECISION PROFIT PLANNING MAKE OR BUY DECISIONS KEY FACTORS OR LIMITING FACTORS SELECTION OF A SUITABLE SALES MIX EFFECT OF CHANGES IN SALES PRICE DETERMINATION OF OPTIMUM LEVEL OF ACTIVITY EVALUATION OF PERFORMANCE

PRICING DECISION
PRICING UNDER NORMAL CONDITION (Prices are based
on total cost of sales or marginal cost plus high margin on marginal cost)

SELLING PRICE BELOW THE MARGINAL COST

(Different circumstances such as introduction of new product, making a product popular, helping a joint product, goods are of perishable nature, the concern had already purchased huge quantities of raw materials and the prices of these materials is falling considerably in the market, to obviate shut-down costs, to capture future market, to capture foreign market)

PRICING DURING STIFF COMPETITION AND TRADE DEPRESSION (Some part of fixed cost to be covered, competitors
are to be eliminated from the market )

ACEPTING SPECIAL ORDERS,BULK ORDERS, ADDITIONAL ORDERS, EXPORT ORDERS AND EXPLORING NEW MARKETS (below normal market price to
utilise idle capacity)

PROFIT PLANNING

DESIRED SALES WITH DESIRED LEVEL OF PROFIT

DESIRED PROFIT WITH DESIRED LEVEL OF SALES

ILLUSTRATION
From the following particulars, calculate:
Break-even point in terms of sales value. Number of units that must be sold to earn a profit of Rs. 90,000. Fixed Factory Overhead cost = Rs. 60,000. Fixed Selling Overhead cost = Rs. 12,000. Variable Manufacturing Cost per Unit = Rs. 12. Variable Selling Cost per unit = Rs. 3. Selling Price per unit = Rs. 24. BEP = Fixed Cost/P/V Ratio Fixed Cost = Fixed Factory Overhead + Fixed Selling Overhead = 60000 + 12000 = 72000 P/V Ratio = (S V)/S = [24 (12+3)]/24 = 9/24 = 37.5% BEP = 72000/0.375 = Rs 192000 Desired Sales volume for profit of Rs 90000 = (F + P)/(S - V) = (F + P)/C =72000+90000/9 = 18000 units

i. ii.

MAKE OR BUY DECISION

Variable cost of manufacturing (internal) should be compared with purchase price (outside) If variable cost of manufacturing is lower than purchase price-MAKE If purchase price is lower than variable cost of manufacturing -BUY

 A manufacturing company finds that while the cost of making a component No. 0.51 in its own workshop is Rs. 8.00 each, the same is available in market at Rs. 6.50 with an assurance of continuous supply. Give your suggestion whether to make or buy this component. Give also your views in case the supplier reduces the price from Rs. 6.50 to Rs. 5.50. The cost of data follows:-

Materials Direct Labor Other Variable Expenses. Depreciation And Other Fixed Expenses. Total .

3. 00 2. 00 1. 00 2. 00 8. 00

KEY FACTORS OR LIMITING FACTORS

Contribution per unit of limiting factor should be the criteria to assess the profitability of a product Product giving highest contribution should be preferred .

SELECTION OF A SUITABLE SALES MIX

Product with higher contribution should be retained and their production to be increased Product with lower contribution should be dropped or their production to be reduced

EFFECT OF CHANGES IN SALES PRICE

Effect of changes in any of the component particularly sales price can be easily analysed under marginal costing

DETERMINATION OF OPTIMUM LEVEL OF ACTIVITY

Contribution at the different level of activity can be found Level of activity which gives the highest contribution will be the optimum level

EVALUATION OF PERFORMANCE

Contribution of different products, department or sales divisions can be compared. Addition/ Elimination of product lines/ divisions/shifts/departments

Fun Garments Ltd. manufactures readymade garments and uses its cut pieces of cloth to manufacture toys. The following statement of cost has been prepared: (Amount in Rs.) Particulars Readymade Garments Toys Total Direct Material 80000 6000 86000 Direct Labour 13000 1200 14200 Variable Overheads 17000 2800 19800 Fixed Overheads 24000 3000 27000 Total Cost 134000 13000 147000 Sales 170000 12000 182000 Profit (loss) 36000 (1000) 35000 The cut pieces used in toys have a scrap value of Rs 1000 if sold in the market. On account of loss in manufacturing of toys, it is suggested to discontinue their manufacturing. Advise the management.

Particulars

Sales Revenue Scrap Value Less: Avoidable costs Direct Material Direct Labour Variable Overheads Differential Revenue

Production Nonof Toys Production of Toys 12000 6000 1200 2800 2000 1000 1000

Management is advised that differential revenue favours continuation of production of Toys.