PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

GROUP MEMBERS ANKIT KUMAR RANKA(06A) HARISH KUMAR(21B) VIKAS AGRAWAL(59B)

MARGINAL COSTING

Meaning…. Marginal cost is amount at any given volume of output by which aggregate costs are changed, if volume of output is increased or decreased by one unit. It is a costing system which treats only the variable manufacturing costs as product costs. The fixed manufacturing overheads are regarded as period cost.

Features of Marginal costing 1.Cost Classification The marginal costing technique makes a sharp distinction between variable costs and fixed costs. It is the variable cost on the basis of which production and sales policies are designed by a firm following the marginal costing technique 2. Stock/Inventory Valuation Under marginal costing, inventory/stock for profit measurement is valued at marginal cost. It is in sharp contrast to the total unit cost under absorption costing method 3. Marginal Contribution Marginal costing technique makes use of marginal contribution for marking various decisions. Marginal contribution is the difference between sales and marginal cost. It forms the basis for judging the profitability of different products or departments

Advantages The technique is less complicated and free from confusion. Under this technique net profit is not effected by the changes in production level or changes in stock volume; in fact profit is directly related to sales. Reports based on this technique provide information based on sales rather than production conveying real estate of efficiency. It helps in profit planning, particularly of short term nature. Most significant use of this technique is in the area of price-policy and its determination.

Disadvantages It lays too much emphasis on selling function,and as such production function has been considered to be less significant. Valuation of stock only at Marginal cost may amount to under-valuation from the financial manager’s view point and this may have working capital problem. Not suitable for external reporting,viz., for tax authorities where marginal income is not considered to be taxable profit. This technique does not attach due importance to time factor.

Contribution Contribution is the difference between sales and variable cost. Contribution = Sales - Variable Cost Contribution = Profit + Fixed Cost

Contribution Contribution is the difference between sales and variable cost. Contribution = Sales - Variable Cost Contribution = Profit + Fixed Cost

Example… Sales 50000 Variable cost 20000 Fixed cost 20000 Contribution ???

Solution… Sales = 50000 Variable cost = 20000 Contribution = sales-variable cost = 50000-20000 = 30000 Total fixed cost = 20000 Profit = contribution-total fixed cost = 30000-20000 = 10000 Contribution = total fixed cost + profit = 20000 + 10000 = 30000

Break-even analysis

Definition……… Breakeven analysis is the study of the relationship between selling prices, sales volumes, fixed costs, variable costs and profits at various levels of activity. Breakeven analysis is also known as cost-volume profit analysis.

Application……… Breakeven analysis can be used to determine a company’s breakeven point (BEP). Breakeven point is a level of activity at which the total revenue is equal to the total costs. At this level, the company makes no profit.

Assumption of breakeven point analysis Relevant range The relevant range is the range of an activity over which the fixed cost will remain fixed in total and the variable cost per unit will remain constant. Fixed cost :Total fixed cost are assumed to be constant in total. Variable cost : Total variable cost will increase with increasing number of units produced Relevant range The relevant range is the range of an activity over which the fixed cost will remain fixed in total and the variable cost per unit will remain constant Fixed cost Total fixed cost are assumed to be constant in total Variable cost Total variable cost will increase with increasing number of units produced

BEP Calculation – an Example Assume selling price is Rs.35 per unit. Variable expense is Rs.21 per unit. Fixed cost is Rs.7,000. What is the breakeven point?

Solution… Break Even Point(In units) = =7000/14 =500 units BEP(in Sales)= TFC/PV ratio =7000/40% =17500 P/v ratio=contribution/sales*100 =14/35*100 =40%

Margin of Safety (MOS) Margin of Safety is the difference between the expected level of sales and the BEP. The larger the margin of safety , the more likely it is that a profit will be made. MOS= Projected sales – BEP Profit= MOS X Contribution per unit

Example… Selling price = 50000 Variable cost 10000 Fixed cost 20000 Margin of safety ???

Solution… Contribution/unit = sales-variable cost BEP(in units) =TFC/contribution/unit BEP(in sales) =TFC/pv ratio P/V ratio =contribution/sales*100 Mos =sales-BEP(sales)

Solution… Sales 50000(50/unit) (-) variable cost 10000(10/unit) Contribution 40000(40/unit) Fixed Cost 20000 Profit 20000 Margin of safety = sales-Break even point Break Even Point(in rs.) = TFC/PV ratio = 20000/ P/V ratio = contribution/sales*100 = 40/50*100=80% BEP = 20000/80%=25000 MOS = 50000-25000=25000

Solution… Sales 50000(50/unit) (-) variable cost 10000(10/unit) Contribution 40000(40/unit) Fixed Cost 20000 Profit 20000 Margin of safety = sales-Break even point Break Even Point(in rs.) = TFC/PV ratio =20000/ P/V ratio = contribution/sales*100 = 40/50*100=80% BEP = 20000/80%=25000 MOS = 50000-25000 = 25000

Profit/Volume Ratio : P/V Ratio = 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 sales. P/V Ratio =

EXAMPLE… Sales = 50000 Variable cost = 20000 Fixed cost = 20000 Profit volume Ratio ???

Solution… Profit Volume Ratio = = contribution/sales*100 =20000/50000*100 =40%

PROFORMA Amt. Amt. Sales X Less: Variable cost of Goods sold X Variable non- manufacturing exp. Variable selling expenses X Variable admin. expenses X Other variable expenses X X Total contribution expenses X Less: Expenses Fixed selling expenses X Fixed admin. expenses X Other fixed expenses X X Net Profit X

Example…. A B C SALES (P.U @100) 1000 800 1100 Variable COGS (RS/UNIT) 35 Variable selling OH (in rs) 4000 3200 4400 Find out profit of RANKA LTD if the fixed cost is Rs. 31000 for all the plants

A B C Sales 100000 80000 110000 Less: Variable cost of good sold (@35) 35000 28000 38500 Product contribution margin 65000 52000 71500 Less: Variable selling O/H 4000 3200 4400 Total contribution margin 61000 48800 67100 Less: Fixed Expenses Fixed factory overhead 31000 31000 31000 Net profit 30000 32800 30100

Absorption costing

MEANING………. Absorption cost is a total cost technique Under which total cost i.e. fixed & variable is charged to production. Includes direct materials, direct labor, variable factory overhead, and fixed factory overhead as part of total product cost.

Importance of Absorption costing All the overheads are included when calculating the cost of producing particular items Fixed costs are brought into the calculations on the assumption that they must be recovered All the overheads are absorbed into cost units but each aspects of overheads is absorbed separately by cost centres of an appropriate basis -i.e. not a blanket approach Absorption costing is used to calculate profit and to calculate stock valuation for financial statement.

What is a Cost Centre? “Any unit of Cost Accounting selected with a view to accumulating all cost under that unit. The unit may be a product, a service, division, department, section, a group of plant and machinery , a group of employees or a combination of several units.”

Types of Cost Centres Again Cost centers may be divided into broad types : Production Cost Centres are those which are engaged in production like Machine shop, Welding shop, Assembly shop etc. Service Cost centers are for rendering service to production cost centre like Power house, Maintenance, Stores, Purchase office etc.

Allocation & Apportionment Cost Allocation is possible when we can identify a cost as specifically attributable to a particular cost centre. Cost Apportionment is necessary when it is not possible to allocate a cost to a specific cost centre. In this case the cost is shared out over two or more cost centres according to the estimated benefit received by each cost centre. As far as possible the basis of apportionment is selected to reflect this benefit received

Allocate overhead costs that are directly incurred by particular cost centre. Allocation is the process of charging costs that is fully associated with a particular cost centre. Examples: machines dedicated to the production of a particular product, building whose sole use is the production of a particular product In both cases there is no need to divide up the costs between products since the facility is directly linked to the product But if an overhead cannot be allocated it must be apportioned Allocate

Bases for Allocation Area Occupied- Rent, Rates & Taxes etc. Capital value of Assets- Repairs, Insurance, Depriciation. Kwh / HP of Machines- Power. Number of Employees- Supervision,Canteen, Time-Keeping etc. Light Points- Electricity. Insurance- the book value of an assets Material handling- Weight or size

Example Of Allocation Particulars A B C D E Vikas Ltd has 5 Departments of which A,B,C are Production Departments, while X & Y are Service Departments. Particulars A B C D E Floor area No. of Employees HP of Machines Value of Plant No. of Light Points 180 20 600 240000 30 120 15 400 200000 100 12 500 160000 70 8 - 100000 10 5 50000 Distribute the following Costs to various Departments : Rent,Rates & Taxes = Rs.5000, Repairs to Plant = Rs.7500,Power = Rs.4500, Supervision = Rs.6000, Lighting = Rs.800

Solution Items of cost Basis Total A B C D E Rent Repairs Power Supervision Lighting Floor Area (18:12:10:7:3) Value (10:6:4:2:1) HP (6:4:5) Employees (20:15:12:8:5) No.of Light points (6:4:3:2:1) 5000 7500 4500 6000 800 23800 1800 2400 2000 300 8300 1200 1500 200 6100 1000 1600 150 5450 700 - 100 2600 500 50 1350

Example Of Apportionment Harish Ltd has three Manufacturing Departments (A, B, & C) & one Service Department (S). Calculate the Statement showing Apportionment of expenses : Expenses Total S A B C Power Supervisors’ Salary Rent Welfare Others Sup. Salary No. of workers Floor Area Services by S to A, B & C 1100 2000 500 600 1200 5400 240 - 200 20% 10 30% 30 50% 300 400 40 800 360 20

Solution Items of cost Basis Total A B C D E Rent Repairs Power Supervision Lighting Floor Area (18:12:10:7:3) Value (10:6:4:2:1) HP (6:4:5) Employees (20:15:12:8:5) No.of Light points (6:4:3:2:1) 5000 7500 4500 6000 800 23800 1800 2400 2000 300 8300 1200 1500 200 6100 1000 1600 150 5450 700 - 100 2600 500 50 1350

Solution Expenses Basis of Apportionment Total S A B C Power Supervisors’ Salary Rent Welfare Others Expenses of S Actual Service rendered (2:3:3:2) Floor Area (5:6:8:6) No. of Workers(1:3:4:2) Ratio Given (5:3:2) 1100 2000 500 600 1200 5400 - 240 400 100 60 200 1000 (1000) Nil 120 180 1300 1800 300 160 1700 360 1400 1600

ABSORPTION COSTING PRO-FORMA Sales Revenue xxxxx Less Absorption Cost of Sales (xxx) Opening Stock xxxx Add Production Cost xxxx Total Production Cost xxxx Less Closing Stock (xxx) Absorption Cost of Production xxxx Add Selling, Admin & Distribution Cost ` xxxx Absorption Cost of Sales (xxxx) Un-Adjusted Profit xxxxx Fixed Production O/H absorbed xxxx Fixed Production O/H incurred (xxxx) (Under)/Over Absorption xxxxx Adjusted Profit xxxxx

EXAMPLE Ranka Ltd, an organization that produces a product that sells for Rs.60 per unit.Variable production costs are Rs.35 per unit and the fixed production costs of Rs.30,000 per period are absorbed on the basis of the normal capacity of 5,000 units per period.Fixed administration, selling and distribution overheads are Rs.19,000 per period. There was no opening inventory for the latest period.Required Calculate the profit on 5,000 units, 6,000 units and 7,000 units,

solution Fixed production cost per unit = Rs.30,000/5,000 = Rs.6 P.U Full production cost per unit = Rs.35 + Rs.6 = Rs.41 per unit particulars 5000 6000 7000 Sales Production Cost (-)closing Stock (-)over absorbed FC Cost of sales GrossProfit (-) admin cost Net Profit 205K Nil 300000 205000 95000 19000 76000 246K 41K 6K 199000 101000 82000 287K 82K 12K 193000 107000 88000

COST SHEET Direct Material Cost xxx Direct Labour Cost xxx Direct Expenses xxx PRIME COST XXX Add: Factory Overhead xxx FACTORY COST XXX Add: Administrative overhead xxx COST OF PRODUCTION XXX Add: Selling & Distribution cost xxx COST OF SALES XXX Add: Profit xxx SELES XXX

Prepare cost sheet of RANKA ltd Direct mat 120K Direct labor 160K Factory rent 30K Office rent 20K Show room rent 40K Power 10K Light 5K Sundry factory exp 15K Indirect wages 50K Advertisements 50K Sales commission 25K Office salaries 60K Sales salaries 80K Carriage outward 10K Delivery van exp 15K Dep of plant 25k Direct factory exp 40k Crane exp 25K Factroy supervision 40k Dep on office equipment 5K sales 1000K

Classification of costs by functions Costs should be classified according to the major functions for which the elements are used into the following four major functions COST ADMINISTRATION RESEARCH & DEVELOPMENT PRODUCTION SELLING & DISTRIBUTION

Direct material consumed = Opening Stock of DM+ Purchase of DM-Closing Stock of DM Factory cost = Prime cost +Factory O/H + Opening WIP - Closing WIP Cost of production of goods sold = cost of production +opening stock of FG – Closing stock of FG

Comparison between “Marginal & Absorption Costing”

Diff b/w Absorption & Marginal costing 1) It is a total cost technique I.e. both variable and fixed costs are charged to products, processes or operations. 2) In spite of best possible forecast and equitable basis of apportionment /allocation of fixed costs, under or over recovery of fixed overheads generally arises. 3) Managerial decisions under this costing technique are based on profit I.e. excess of sales value over total costs, which may at times lead to erroneous decisions. Here only variable costs are charged to product, processes or operations. Fixed costs are charged to the profit statement. Since fixed overheads are not included in the cost of production, therefore the question of their under/ over recovery does not arise. Here decisions are made on the basis of contribution I.e. excess of sales price over variable costs. This basis of decision making results in optimum profitability.

Absorption Costing Cost Manufacturing cost Non-manufacturing cost Direct Materials Direct Labour Overheads Period cost Finished goods Cost of goods sold Profit and loss account Marginal Costing Cost Manufacturing cost Non-manufacturing cost Direct Materials Direct Labour Variable Overheads Fixed overhead Period cost Finished goods Cost of goods sold Profit and loss account

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