Marginal Costing and Management Decision

 Students today we are to discuss C-V-P analysis, Marginal cost, Marginal costing and management decision. You are familiar with traditional costing i.e. absorption costing or full costing method where we consider the total cost i.e. variable cost as well as fixed cost for product pricing or cost determination. Absorption costing is used for external reporting purpose. It should be understood that marginal costing is not a method of costing like process costing or job costing. It is simply a technique of the analysis of cost information for the guidance of the management who tries to find out an effect on profit or cost due to changes in the volume of output and valuation of inventory. Unlike Absorption costing, the principle and practice of marginal costing is not for external reporting. It is applicable only for internal purposes for taking managerial decisions.

 CVP analysis studies the relationship among expenses (cost), revenues (sales) and the net income (net profit). CVP analysis may be applied for profit planning, cost control and decision making.  The basic assumptions in making CVP analysis is that fixed cost in total remains constant, variable cost per unit remains constant, selling price per unit does not change with volume. In real world situation, all of them keep on changing, but still CVP analysis considered the more useful technique in management decision making.

 Now let us understood the concept of Marginal cost and Marginal costing. Marginal cost is the cost of one unit of product or service which would be avoided if that unit were not produced or provided i.e. additional cost for additional unit.  Marginal costing is the technique in which variable cost are charged to the cost units and fixed costs of the period are written-off in full against the aggregate contribution.

 Marginal costing has special value in decision making. It is also a technique which provides presentation of cost data in such a way that true cost-volume-profit relationship is revealed.  In fact there are certain areas e.g. Make or Buy, Problems of limiting factors etc. where management can take right decision using Marginal costing technique. If they use other costing method then decision may prove to be wrong one.

 Contribution. It is the amount a unit contributes to cover fixed cost and to earn profit if possible. Contribution =Sales- Variable cost.  P/V Ratio. It is the relative position of contribution and sales.  Break-even-point. It is the level of activity at which the total cost is equal to total sales value i.e. the concern is neither earning any profit nor suffering any loss.

 Margin of Safety. It is the excess of actual sales over the break-even sales. The greater the actual sales the greater the amount of margin of safety.  Angle of Incidence. The angle formed by the intersection of sales line and total cost line at he Break-even point is called angle of incidence.

 DB Ltd. Furnished the following information: Rs. Rs. Sales 2,00,000 2,50,000 Total Cost 1,70,000 2,00,000 You are required to compute: i) P/V ratio ii) Break-even point iii) Sales required to earn a profit of Rs. 60,000 iv) Profit or Loss when sales is Rs. 80,000

i) P/V ratio= Change in profit/Change in sales = Rs. 20,000/Rs. 50,000=.4 ii) Break-even-sales(in Rs)=Fixed cost/P/V ratio Now, contribution= Fixed cost + profit Or, Rs. 2,50,000X.4=Fixed cost+ Rs. 50,000 Or, Rs. 1,00,000-Rs. 50,000= Fixed cost Or, Fixed cost = Rs. 50,000 B-E-P= Rs. 50,000/.4=Rs. 1,25,000