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References:
M.N.Arrora -Cost and Management Accounting Khan and Jain-Management Accounting Accounting for Management-Dr. Jawahar Lal Management Accounting-I.M.Pandey Cost Accounting for Business ManagersAshish K Bhattacharyya
Marginal Costing
Cost-Amount incurred to get something/ resources used for the production of goods and services Marginal Cost-is the cost of producing an additional unit of product. A It is the total of all variable cost incurred to produce the extra one unit.
Types of Costs
Variable Fixed
Mixed
Variable Cost
variable costs change when activity/unit changes.
Total Long Distance Telephone Bill
Your total long distance telephone bill is based on how many minutes you talk.
Minutes Talked
The cost per long distance minute talked is constant. For example, Rs.7 per minute.
24
18
12
6 0 1 2 3 4 5
Mixed Costs
Contain fixed portion that is incurred even when facility is unused & variable portion that increases with usage. Example: monthly electric utility charge
Mixed Costs
Total Utility Cost
Variable
Utility Charge Fixed Monthly Utility Charge Activity (Kilowatt Hours)
Marginal Costing
Marginal Costing Technique is used for short term decision-making. It assumes that fixed costs are not affected by the decision to allocate resources to different activities. Therefore, variable costs are the only relevant cost for decision making. Marginal costing is also known as Variable costing and Direct Costing
Segregation of cost into fixed and variable cost Marginal cost as product cost Fixed cost as period cost Valuation of Inventory-valued at Marginal cost only Contribution Pricing-Prices are based on Marginal cost + contribution
Cost-Volume-Profit Analysis
CVP analysis is an extension of principles of marginal Costing Cost-Volume-Profit Analysis (CVP) is the study of the relationship between selling prices, sales volumes, fixed costs, variable costs and profits at various levels of activity. CVP analysis is used by the management in budgeting and profit planning. CVP analysis is also known as Break even point Analysis
Expenses can be classified as either variable or fixed. Mixed cost have to be divided into fixed and variable elements. Sales prices, unit variable cost, and total fixed expenses will not vary. Synchronisation between production and sales
Objective
Use CVP analysis to compute Contribution Margin Profit Volume Ratio (P/V) Break Even Point Margin of Safety
Contribution Margin
The contribution is calculated by following formula: Contribution=Sales-Variable cost (C=S-V) Also, Contribution=Fixed cost + Profit (C=F+P) Or Contribution=Fixed cost Loss (C=F-L) From this the following marginal cost equation is developed S-V = F+P
Example:
If Given Sales =Rs 12000 Variable Cost = Rs 7000 Fixed Cost =Rs. 4000 Find out Contribution and Profit.
Example:
If Given Profit = Rs 1000 Contribution=Rs 5000 Variable Cost = Rs 7000 Find out :Sales and Fixed Profit
Example
Mr.Thomas manufacture a device that allows users to take a closer look at icebergs from a ship. He receive a proposal from a company Tiggertol to sell 20,000 units at a price of Rs.850. Variable costs are Rs700 per unit.
There is sufficient capacity to produce the order. How do we analyze this situation? Rs.850 Rs.700 = Rs.150 contribution margin. Rs.150 20,000 units = Rs.30,00,000 (total increase in contribution margin)
Contribution Margin ratio also known as Contribution to Sales ratio or Profitvolume ratio This ratio denotes the percentage of each sales rupee available to cover the fixed cost and to provide income to firm.
Example
Sales= Rs 10000 Variable Cost = Rs. 8000 Then P/V Ratio = C/S = (S-V)/S =10000-8000 10000 = 20%
Alternative
P/V ratio= Change in contribution Change in Sales =Change in Profit Change in sales
Example-P/V ratio
Year 2009 2010 Sales Net Profit 20000 1000 22000 1600
P/V Ratio = Change in Profit Change in Sales = 1600 1000 X 100 = 30% 22000-20000
Break-Even Analysis
Break Even Analysis may be performed by the following two methods
a) b)
Algebraic Method
Breakeven point in Sales Rupees = Fixed costs P/V Ratio Breakeven point in units = Fixed costs Contribution per unit
Breakeven point is =
= 5000 units
Sales revenue at breakeven point = Rs.12 * 5000 = Rs.60000
Suppose that our business would be content with Profit of _________________.(Target Profit) How many units must be sold?
Formula
No. of units to be sold at target profit
= Fixed cost + Target profit Contribution per unit Required sales revenue Fixed cost + Target profit = Contribution to sales ratio
Example
Selling price per unit Variable cost per unit Fixed costs Target profit Required:
No. of units at target profit Fixed cost + Target profit = Contribution per unit Rs.45000 + Rs.18000 = Rs.12 - Rs.3
= 7000 units Required to sales revenue = Rs.12 *7000 = Rs.84000
Alternative method
Required sales revenue Fixed cost + Target profit = Contribution to sales ratio Rs.45000 + Rs.18000 = 75% = Rs.84000 Units sold at target profit = Rs.84000 /Rs.12 = 7000 units
Problem:The following data is given: Fixed Cost Rs. 12000 Selling Price Rs. 12 per unit Variable Cost Rs. 9 per unit What will be the Amount of Sales if it is desired to earn a profit of a) Rs. 6000 b) Rs 15000
Answer
a) b)
Solution
Contribution=Fixed cost + Profit =6000 + 1500=7500 Break-Even Point= Fixed Cost P/V Ratio
P/V Ratio=Contribution/Sales Sales =7500 x 100/20 Sales = 37500 Variable cost=Sales-Contribution =37500-7500 =30000
Home work
Sales=4000 units @ Rs 10 per unit Break Even Point=Rs. 1500 units Fixed Cost= Rs. 3,000 What is the amount of a) Variable Cost b) Profit
Problem:The following data is given: Fixed Cost Rs. 12000 Selling Price Rs. 12 per unit Variable Cost Rs. 9 per unit What will be the profit when sales are a) Rs. 60000 b) Rs 100000
Solution
a)
P/V Ratio=C/S=3/12=25% When Sales=Rs 60000 Contribution =Sales x P/V ratio =60000 x 25 % =Rs.15000 Profit = Contribution-Fixed Cost = 15000 12000 = 3000
B) Answer=Rs.13000
Problem
The following information is given: Sales=Rs. 200000 Variable Cost=Rs. 120000 Fixed Cost=Rs. 30000 Calculate a) Break Even Point b) New BEP
a)
b)
c)
If Selling price is reduced by 10% If Variable cost increases by 10% If fixed Cost increases by 10%
Answer
a)
75000
a) b) c)
Use CVP analysis for profit planning and graph the cost-volume-profit relations
Total costs
Volume in Units
Volume in Units
Margin of safety
Margin of safety
breakeven sales. Margin of safety is a measure of amount by which the sales may decrease before a company suffers a loss. This can be expressed as a number of units or a percentage of sales
Formula
Margin of safety = Budget sales level breakeven sales level
Margin of safety = Margin of safety *100% Budget sales level
Sales revenue
Total Cost/Revenue Rs.
Profit
Total cost
Sales (units)
Example
The breakeven sales level is at 5000 units. The company sets the target profit at Rs.18000 and the budget sales level at 7000 units Required: Calculate the margin of safety in units and express it as a percentage of the budgeted sales revenue
Margin of safety = Budget sales level breakeven sales level = 7000 units 5000 units = 2000 units Margin of safety = Margin of safety *100 % Budget sales level = 2000 *100 % 7000 = 28.6% The margin of safety indicates that the actual sales can fall by 2000 units or 28.6% from the budgeted level before losses are incurred.
Example
Selling price per unit Variable price per unit Fixed costs Current profit Rs.18000
If the selling prices is raised from Rs.12 to Rs.13, the minimum volume of sales required to maintain the current profit will be:
Fixed cost + Target profit Contribution to sales ratio Rs.45000 + Rs.18000 Rs.13 - Rs.3 = 6300 units
If the fixed cost fall by Rs.5000 but the variable costs rise to Rs.4 per unit, the minimum volume of sales required to maintain the current profit will be:
Fixed cost + Target profit
Unit contribution margin is replaced with contribution margin for a composite unit. A composite unit is composed of specific numbers of each product in proportion to the product sales mix. Sales mix is the ratio of the volumes of the various products.
Windows Selling Price $200 Variable Cost 125.00 Unit Contribution $ 75.00 Sales Volume 8,000 Total Contribution $ 600,000 Fixed Costs Income
Combined
$ 900,000 900,000 $ 0