costing project

Page |1

Index
Chapter
No.

Contents

Page No.

1

Introduction of Marginal Costing

2-4

2

Meaning and Definition

4-5

3

Features of Marginal Costing

5

4

Advantages of Marginal Costing

6

5

Disadvantages of Marginal Costing

7

6

Basic principal of Marginal Cost pricing

8

7

Absorption Costing (meaning)

8

8

Advantages and disadvantages

9

9

Marginal costing V/S Absorption Costing

10-11

10

Contribution Analysis

12-13

11

Break-even-analysis

13-14

12

Assumption and Limitation

15-16

13

Cost-Volume profit (C.V.P) Analysis

17

14

Marginal costing and Decision making

18

15

Technique of Costing

19-21

16

Marginal Cost equations

22-25

17

Absorption Costing pro-forma

25-26

18

Marginal Costing pro-forma

19

Problems

20

Conclusion

21

Sources

27
28-32
33
34

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INTRODUCTION TO MARGINAL COSTING
The costs that vary with a decision should only be included in decision analysis. For many
decisions that involve relatively small variations from existing practice and/or are for
relatively limited periods of time, fixed costs are not relevant to the decision. This is
because either fixed costs tend to be impossible to alter in the short term or managers are
reluctant to alter them in the short term. Marginal costing distinguishes between fixed
costs and variable costs as convention ally classified. The marginal cost of a product –“is
its variable cost”. This is normally taken to be; direct labor, direct material, direct
expenses and the variable part of overheads.

Like Marginal costing or job costing, Marginal costing is not a distinct method of
ascertainment of cost but is a technique which applies existing methods in a particular
manner so that the relationship between profit & the volume of output can be clearly
brought out. Marginal costing ascertains marginal or variable costs & the effect on profit,
of the changes in volume or type of output, by differentiating between variable costs &
fixed costs. To any type of costing such as historical, standard, Marginal or job; the
Marginal costing technique may be applied.

Under the Marginal of Marginal costing, from the cost components, fixed costs are
excluded. The difference which arises between the variable costs incurred for activities &
the revenue earned from those activities is defined as the gross margin or contribution. It
may relate to total sales or may relate to one unit.

For the business as a whole, Contribution earned by specific products or group of
products, are added so as to calculate the „pool‟ of total contribution. The fixed costs of

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the business are paid from this „pool‟ & then the part of the total contribution which
remains becomes the profit of the business as a whole.

A typical format for Marginal costing statement is as below:

Product types or departments

A

B

C

Total

Sales Revenue

X

X

X

X

Less Variable cost of production

X

X

X

X

Contribution

X

X

X

X

Less: Fixed Costs

X

Total Profit

X

Under Marginal costing, for the calculation of profits for individual products or
departments, no attempt is made- only calculation of individual Contribution is done. The
fixed cost does not allocated to or gets absorbed by the individual products or departments.
Thus, accounting techniques relating to the treatment of fixed costs will not influence the
decisions which are based on Marginal costing system.

Examples of typical problems which require executive decisions are:

At a lower price should a particular order be accepted or declined?
Should purchase of a particular component be made from an outside supplier or
manufactured within the factory?
Concentration should be given on which products?
By which profit-mix, profit will be maximized?

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What should be the effect on the business when an existing department is being
closed or a new department is being opened?
To make up for wage rise, what should be the additional volume of business?

MEANING OF MARGINAL COSTING
It is the amount by which total cost increases when one extra unit is produced, or the
amount of cost which can be avoided by producing one unit less. Accordingly, marginal
cost may also be defined as the variable cost incurred due to a specific activity. It is
concerned with variable costs, because fixed costs by definition do not change with the
volume produced.

DEFINATION OF MARGINAL COSTING

The Official C.I.M.A Costs of the Terminology defines Marginal costing as, ³Theaccounting
system in which variable costs are changed to costs units and fixed period are written off in full against the
aggregate contribution. Its special value is in decision-making ´Accordingly, Marginal cost =
Variable cost = Direct material + Direct labor +Direct expenses + Variable overheads.

Marginal costing is formally defined as: „the accounting system in which variable costs are
charged to cost units and the fixed costs of the period are written-off in full against the
aggregate contribution. Its special value is in decision making‟. The term „contribution‟
mentioned in the formal definition is the term given to the difference between Sales and
Marginal cost. Thus M A R G I N A L
C O S T

D I R E C T

C O S T

L A B O U R

=

+DIRECT

V A R I A B L E
MATERIAL+DIRECT

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EXPENSE+VARIABLE OVERHEADS CONTRIBUTION SALES - MARGINAL
COST. The term marginal cost sometimes refers to the marginal cost per unit and
sometimes to the total marginal costs of a department or batch or operation.

FEATURES OF MARGINAL COSTING
Classification of costs into fixed costs & variable costs is done under Marginal
costing system. Also semi-fixed or semi-variable cots get further classified into
fixed & variable elements.
To the product, only variable elements of cost, which constitute marginal cost, are
attached.
After the marginal cost & marginal contribution are taken into consideration; price
is fixed.
From the total contribution for any period, fixed cost for the period are deducted.
The profitability of a department or product is decided by the marginal
contribution.
At variable production cost, the valuation of work-in-progress & finished product
is made.

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ADVANTAGES OF MARGINAL COSTING
As there is involvement of computation of variable costs only in Marginal costing,
it is easy to understand & operate the same.
Among different products or departments, arbitrary apportionment of fixed costs is
avoided & the under-recovery or over-recovery problems are eliminated.
Any attempt of measurement of relative profitability of different products or
different departments becomes complicated due to the arbitrary apportionment of
fixed costs.
Analysis of contribution, break even charts & analysis of cost-volume-profitanalysis are resulted out of a Marginal costing system; for making short term
decisions all of these are important.
More uniform & realistic figures are resulted out of Marginal costing system
because fixed overhead costs are excluded from valuation of stock & work-inprogress.
Apportionment of responsibility of control can be more easily done since to each
level of management only variable costs are presented over which they have
control.
The effects of their decisions can be more readily seen by all levels of
management- sometimes even before taking of an action.

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DISAVANTAGES OF MARGINAL COSTING
The Marginal of separating semi-variable or semi-fixed costs into their variable &
fixed elements is an arbitrary exercise which at different levels of output may be
subject to fluctuations & inaccuracy. Consequently, a substantial degree of error may
be contained in the basic cost information which is used in decision making
Marginal.

When selling prices are based on marginal costs, great care need to be exercised, as
in the long run, all fixed overheads should be covered by the prices & a reasonable
margin over & above the total costs should be left.
Under many circumstances, the deduction of contribution made by some
production units may be difficult. Thereby the effectiveness of the system is lost.
Since on the basis of variable costs only the valuation of stock of finished goods &
work-in-progress is done, they are always understated. As result profit is also
understated.
More effective utilization of present resources or by expansion of resources or by
mechanization, increased production & sales may be effected. The disclosure of
this fact cannot be done by Marginal costing.

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BASIC PRINCIPAL OF MARGINAL COST PRICING
For years economists have noted the benefits of marginal cost based prices and have
advocated their use. Not until fairly recently, however, has the concept of marginal cost
pricing received widespread attention in electric utility rate setting in the United States.
Economic theory states that maximum economic benefits to society can be achieved if
prices are set equal to marginal costs. Marginal cost is the cost of producing one additional
unit of an industry's output, other things remaining the same. If the price of all units sold is
set equal to the marginal cost, the customer will pay an amount that adequately reflects the
cost to society of producing the product. In this way, economic efficiency is achieved in
that society's scarce resources are used in productive Marginal‟s where the prices of
finished goods and services adequately reflect the actual costs of producing them.

ABSORPTION COSTING
MEANING
Absorption costing refers to the analysis of the cost data for the purpose of allotment of
costs to cost units. In absorption costing fixed as well as variable costs are charged to
products. We have already seen in the previous chapters on unit costing, Marginal costing
and contract costing, how the direct costs and overheads, whether fixed of variable, are
charged to the individual product, Marginal or contract. The Technique of absorption
costing thus refers to the principal of allocation, apportionment and absorption of costs
used for ascertaining the cost of a product, Marginal or contract.

Page |9

Advantages of Absorption Costing:
It recognizes the importance of fixed costs in production;

This method is accepted by Inland Revenue as stock is not undervalued;

This method is always used to prepare financial accounts;

When production remains constant but sales fluctuate absorption costing will show
less fluctuation in net profit and

Unlike Marginal costing where fixed costs are agreed to change into variable cost,
it is cost into the stock value hence distorting stock valuation.

Disadvantages of Absorption Costing:
As absorption costing emphasized on total cost namely both variable and fixed, it
is not so useful for management to use to make decision, planning and control;
As the manager‟s emphasis is on total cost, the cost volume profit relationship is
ignored. The manager needs to use his intuition to make the decision.

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MARGINAL COSTING V/S ABSORPTION COSTING
The difference between Marginal costing & absorption costing is as below:

1. Under Marginal costing: for product costing & inventory valuation, only variable
cost is considered whereas, under absorption costing; for product costing &
inventory valuation, both fixed cost & variable cost are considered.

2. Under Marginal costing, there is a different treatment of fixed overhead. Fixed cost
is considered as period cost & by Profit/Volume ratio (P/V ratio), profitability of
different products is judged. On the other hand, under absorption costing system,
the fixed cost is charged to cost of production. A reasonable share of fixed cost is
to be borne by each product & thereby subjective apportionment of fixed
overheads influences the profitability of product.

3. Under Marginal costing, the presentation of data is so oriented that total
contribution & contribution from each product gets highlighted. Under absorption
costing, the presentation of cost data is on conventional pattern. After deducting
fixed overhead, the net profit of each product is determined.

4. Under Marginal costing, the unit cost of production does not get affected by the
difference in the magnitude of opening stock & closing stock. Whereas, under
absorption costing, due to the impact of the related fixed overheads, the unit cost of
production get affected by the difference in the magnitude of opening stock &
closing stock.

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Effects of opening & closing stock on profit:
When income statements under absorption costing & Marginal costing are
compared, the under mentioned points should be considered:

1. The results under both the methods will be same in situations where sales &
production coincide i.e., there is neither opening stock nor closing stock.

2. Profit under absorption costing will be more than the profit under Marginal
costing, when closing stock is more than the opening stock. The reason behind this
is that, under absorption costing, a portion of fixed overhead, instead of being
charged to the current period, is charged to the closing stock & carried over to the
next period.

3. Profit shown under absorption costing will be lower than the profit shown under
Marginal costing, when closing stock is less than the opening stock. The reason
behind this is that, under absorption costing, to the current period, a portion of
fixed cost related to previous year is charged.

Reconciliation of results of absorption costing & Marginal costing:
When comparison of the results of absorption costing & Marginal costing is
undertaken, the adjustments for under- absorbed & / or over absorbed overheads becomes
necessary. Under absorption costing, on the basis of normal level of activity, the fixed
overhead rate is predetermined. A situation of under-absorption &/or over-absorption
arises when there is a difference between actual level of activity & normal level of
activity.

(i) Under-absorbed fixed overhead = Excess of normal level of activity over actual level of
activity * Fixed overhead rate per unit.

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If there is under-absorption, the profit under absorption costing, before comparison
with profit as per Marginal costing, should be reduced with under-absorbed fixed
overheads. Alternatively, by adding the under-absorbed fixed overhead to the cost of
production, the same objective can be achieved.

(ii) Over absorbed Fixed overhead = Excess of actual level of activity over normal level of
activity * Fixed overhead rate per unit.

If there is over absorption, then before the comparison of profit as per absorption
costing with the profit as per Marginal costing, with over-absorbed fixed overheads, the
profit under absorption costing should be increased. Alternatively, by reducing the overabsorbed fixed overhead from the cost of production, the same objective can be achieved

CONTRIBUTION ANALYSIS
Contribution is the most important concept in Marginal costing. It is, as seen above equal to Sales
Less
Variable Cost. Contribution is the profit before adjusting the fixed costs. Marginal costing is
concerned with the `product costs` rather than the `periods costs`. Contribution indicates the
Product profit = product Income – product cost i.e.
Contribution = sale Value – Variable cost.

Marginal costing assumes that ht excess of sales value over variable costs contributes to a fund
which will cover fixed costs as well as provide the concern`s profits. The amount of contribution is
credited to the marginal profit and loss account. The fixed costs are debited to the marginal profit
and loss account. If the contribution is equal to the fixed costs, the concern is said to break- even
profit. If the contribution is less than the fixed costs, there will be net loss. Thus, the fixed costs

P a g e | 13
which are period costs do not affect the product cost. Fixed costs are directly adjusted in the profit
and loss account prepared for the relevant period. The concept of contribution plays a key role in
assisting the management in taking many important decisions such as1. Deciding the break-even point,
2. Deciding which article to produce, or continue or discontinue to produce,
3. Deciding the quantity of each article to be produce or sold,
4. Fixing the selling price, especially in a trade depression, or for a special order.

The difference between contribution and accounting profit is explained below.
No.

Contribution

Profit

1.

It is a concept used in Marginal costing.

It is an accounting concept.

2.

It is before deducting Fixed Costs.

It is after deducting Fixed Costs.

3.

At break- over point, Contribution is equal to Profit arises only when Sales go beyond
fixed cost.

the break- even point.

BREAK – EVEN ANAYSIS
Break – even point means the point of no profit and no loss. BEP is the volume of output or sales
at which the total cost is exactly equal to the revenue. Below the BEP the concern makes losses, at
the BEP, the concern makes neither profit nor loss, above the BEP, the concern earns profits.

The focal point of this analysis is the determination of the sales volume (in pesos or in
units) that will equal its total revenues to its total costs, thus, where the profit equals zero.
As stated earlier, since direct connection of expenses to production cannot be conclusively
established under functional classification of costs, analysis under CVP, as well as BE
analysis, is directed towards cost behavior. Thus, if we reclassify our costs from functional

P a g e | 14

to behavioral, our income statement would look like this:

Sales

xx

Less: Variable Cost (VC)

(xx)

Contribution Margin (CM)

xx

Less: Fixed Cost

(xx)

Profit (loss)

xx

Contribution Margin (CM) is the excess of sales over variable cost or the excess from
sales when variable costs are deducted. It can be computed per unit or total. In computing
for the CM per unit, simply deduct the VC per unit from the selling price of each unit.
This is also synonymous with marginal income, marginal balance, profit contribution and
others.

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Assumptions and Limitations Underlying
BREAK-EVEN ANALYSIS
1.

All costs are classified as either fixed or variable. If not impossible or impractical,
dividing costs into the variable and fixed cost elements as an extremely difficult
job. This is attributable to the inherent nature or characteristics of the cost per se.

2.

Fixed costs remain constant within the relevant range. Fixed costs remain
unchanged at any level of activity within the relevant range, even at the zero level.

3.

The behavior of total revenues and total costs will be linear over the relevant
range, i.e. will appear as a straight line on the BE chart. This is based on the idea
that variable costs vary in direct proportion to volume; the fixed costs remain
unchanged, hence drawn as a straight horizontal line on the graph within the
relevant range; and that selling price is constant.

4.

In case of multiple product companies, the selling prices, costs and proportion of
units (sales mix) sold will not change. This cannot always be correct. Sales mix
ratio may be due to the change in the consuming habits of customers. Selling prices
of the individual products may likewise change due to competition, popularity and
salability of the products, etc.

5.

There is no significant change in the inventory levels during the period under
review. Stated in another way, production volume is assumed to be almost (if not
exactly) equal to the sales volume, which causes an immaterial (or none at all)
difference between the beginning and ending inventories.

6.

Other assumptions which have already been discussed in the preceding numbers,
are again credited and highlighted here as follows:

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o

Unit selling price will remain constant.

o

Unit

variable

cost

will

not

change.

prices of the factors of production like material

(This

may

include

costs, labor costs etc.)

o

There will be no change in efficiency and productivity.

o

The design of the product will not change.(A change in
the product may bring about a change
and production

the design of

in production costs, selling price

volume.

o

Cost-Volume-Profit (CVP) Analysis
Cost-Volume-Profit (CVP) Analysis analysis is defined as a systematic examination of
the relationships among costs, activity levels, or volume, and profit. CVP analysis
establishes the relationship of profit to level of sales. And one of these relationships is the
Break-even analysis.

Since direct connection of expenses to production cannot be conclusively established
under functional classification of costs, analysis under CVP is directed towards cost
behavior; the way costs behave or change with respect to a change in the activity level.
Costs can be classified according to its behavior as:

1. Fixed Costs
These are costs that do not change regardless of changes in the level of activity
within a relevant range. In other words, they remain constant regardless of the
change in the activity level per total; however, fixed cost per unit is inversely
proportional to the activity level.

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2. Variable Costs
In total, these costs change directly and proportionately with the level of
activity. As the activity level increases, variable cost per total will also increase
proportionately to the increase in activity level. However, variable cost per unit
remains constant, within the relevant range.
3. Semi-Variable Costs
Costs that varies with the change of activity level but not proportionately, they
are called semi-variable costs. They may either increase at an increasing rate or
increase at a decreasing rate. A typical example of this is the cost of electricity
(increasing at an increasing rate) because it is subject to graduated brackets, thus,
the greater the consumption, the higher the rate per kilowatt hour as they will be
categorized in a higher bracket.
4. Semi-Fixed Costs
This kind of costs has the characteristics of both variable and fixed cost and is
usually known as the step function cost or step cost. Like semi-variable cost, semifixed cost increases with activity level but not proportionately. And like fixed cost,
it is constant for some stretches of activity levels.
5. Mixed Costs
Costs that cannot be identified by a single cost behavior pattern are called
mixed costs. This kind of cost is composed of variable and fixed cost. We have
concluded earlier that costs are more meaningful when they are classified
according to behavior. When costs therefore are mixed, it is important that we
know how to segregate them. Some tools and techniques popularly used are the
High-Low Method, Scatter Graph Method, Regression Analysis, and Correlation

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MARGINAL COSTING AND DECESSION MAKING
The supreme goal of every management is to maximize profits. To achieve this goal, management
has to take several decisions regarding the marginal unit, the product mix, the pricing, making or
buying an Article and so on. It has also to ascertain the cost that are controllable and establish a
system to actually control them. Marginal costing is an effective policy decisions such as pricing,
product mix, special offers, discontinued a product, optimum level of production, cost control and
so on. It also help in „profit planning`. Marginal costing enables the management to study
different scenarios (cost and revenue situations) under various alternatives. The management can
plan its short- term profits.

WHEN MARGINAL COSTING IS USEFUL FOR FIXING PRICE

Marginal costing helps the management in taking price decisions. In Absorption costing, the prices
are fixed so as to cover the total costs which include Fixed Costs as well as Variable Costs. In
Marginal costing
the price can be fixed on the basis of only Variable Costs. This can be useful in the following
situations
when supply exceeds demand
pricing of new products
utility services
cut-throat competition in market
Export orders or special orders.

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Techniques of Costing
Besides the methods of costing, following are the types of costing techniques which are
used by management only for controlling costs and making some important managerial
decisions. As a matter of fact, they are not independent methods of cost finding such as
job or Marginal costing but are basically costing techniques which can be used as an
advantage with any of the methods discussed above.
1. Marginal costing
Marginal costing is a technique of costing in which allocation of expenditure to production
is restricted to those expenses which arise as a result of production, e.g., materials, labor,
direct expenses and variable overheads. Fixed overheads are excluded in cases where
production varies because it may give misleading results. The technique is useful in
manufacturing industries with varying levels of output.
2. Direct Costing
The practice of charging all direct costs to operations, Marginales or products and leaving
all indirect costs to be written off against profits in the period in which they arise is termed
as direct costing. The technique differs from Marginal costing because some fixed costs
can be considered as direct costs in appropriate circumstances.
3. Absorption or Full Costing
The practice of charging all costs both variable and fixed to operations, products or
Marginales is termed as absorption costing.
4. Uniform Costing
A technique where standardized principles and methods of cost accounting are employed
by a number of different companies and firms is termed as uniform costing.
Standardization may extend to the methods of costing, accounting classification including
codes, methods of defining costs and charging depreciation, methods of allocating or

P a g e | 20

apportioning overheads to cost centers or cost units. The system, thus, facilitates interfirm comparisons, establishment of realistic pricing policies, etc.
Systems of Costing
It has already been stated that there are two main methods used to determine costs. These
are:
Job cost method • Marginal cost method
It is possible to ascertain the costs under each of the above methods by two different ways:
Historical costing
Standard costing
Historical Costing
Historical costing can be of the following two types in nature:
Post costing
Continuous costing
Post Costing
Post costing means ascertainment of cost after the production is completed. This is done
by analyzing the financial accounts at the end of a period in such a way so as to disclose
the cost of the units which have been produced.
For instance, if the cost of product A is to be calculated on this basis, one will have to wait
till the materials are actually purchased and used, labor actually paid and overhead
expenditure actually incurred. This system is used only for ascertaining the costs but not
useful for exercising any control over costs, as one comes to know of things after they had
taken place. It can serve as
guidance for future production only when conditions in future continue to be the same.

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Continuous Costing
In case of this method, cost is ascertained as soon as a job is completed or even when a job
is in progress. This is done usually before a job is over or product is made. In the
Marginal, actual expenditure on materials and wages and share of overheads are also
estimated. Hence, the figure of cost ascertained in this case is not exact. But it has an
advantage of providing cost information to the management promptly, thereby enabling it
to take necessary corrective action on time. However, it neither provides any standard for
judging current efficiency nor does it disclose what the cost of a job ought to have been.
Standard Costing
Standard costing is a system under which the cost of a product is determined in advance
on certain pre-determined standards. With reference to the example given in post costing,
the cost of product A can be calculated in advance if one is in a position to estimate in
advance the material labor and overheads that should be incurred over the product. All this
requires an efficient system of cost accounting. However, this system will not be useful if
a vigorous system of controlling costs and standard costs are not in force. Standard costing
is becoming more and more popular nowadays

P a g e | 22

Marginal costing Equations

Sales – Variable Cost = Contribution
Contribution – Fixed Cost = Profit
Sales – Variable Cost = Fixed Cost + Profit
Profit Volume Ratio = Contribution / Sales
Contribution = Sales * PV Ratio
Sales = Contribution / PV Ratio
BEP (in units) = Fixed Cost / Contribution per unit
BEP (in rupees) = Fixed Cost / Contribution * Sales
BEP (in rupees) = Fixed Cost / PV ratio
Required Sales (in rupees) = Fixed Cost + Profit / PV ratio
Required Sales (in units) = Fixed Cost + Profit / Contribution per unit
Actual Sales = Fixed Cost + Profit / PV ratio
Margin of safety (in rupees) = Actual Sales – BEP Sales
Margin of safety (in units) = Actual Sales (units) – BEP Sales (units)
Profit = Margin of safety * PV ratio

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Ascertaining Missing figures

1. CONTRIBUTION
= Sales – Variable Cost
= Fixed Cost + Profit
= Sales * PV Ratio
= (BE Sales in units * Contribution per units) + Profit
= (BE Sales in value * PVR ) + Profit
= Fixed Cost + (MS in units * Contribution per unit)
= Fixed Cost + (MS in value * PVR)
= Profit / MS in %
= Fixed Cost / BE sales in%

2. PROFIT VOLUME RATIO (PVR)
= Sales - Variable Cost / Sales * 100
= Contribution / Sales *100
= Fixed Cost + Profit / Sales *100
= Fixed Cost / BE Sales in value * 100
= Fixed Cost / BE Sales in units *100 / Selling price per unit
= Profit / Margin of safety in value *100
= Profit / Margin of safety in units *100 / Selling price per unit
= Change in profit / Change in sales *100
= 100 – Variable cost to sales ratio
3. BE SALES IN UNITS
= Fixed Cost / Contribution per unit

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= BE Sales / Selling price
= Fixed Cost / S.P. per unit – Variable cost P.U
= Actual Sales per unit – Margin of safety in units

4. BE SALES IN VALUE
= Fixed Cost / PVR
= Actual Sales in value – Margin of safety in value
= Fixed Cost / Contribution per unit * Selling price per unit
= BE Sales in units * Selling price per unit
= Fixed Cost / 1- Variable Cost / Sales
= Fixed Cost / % of Contribution to sales

5. BE SALES IN % OF SALES
= Fixed Cost / Contribution *100
= BE Sales / Actual Sales *100
= 100 – margin of safety (in %)

6. MARGIN OF SAFETY IN UNITS
= Profit / Contribution per unit
= Actual Sales in units – BE Sales in units

7. MARGIN OF SAFETY IN VALUE
= Profit / PV Ratio
= Actual Sales in value – BE Sales in value
= Profit / Contribution per unit * Selling price per unit

P a g e | 25

= Margin of Safety in units * Selling price per unit

8. PROFIT
= Sales – Total Cost
= Sales – (Variable Cost + Fixed Cost)
= Contribution – Fixed Cost
= Margin of Safety in Value * PVR
= Margin of Safety (% of sales) * Total Contribution
= (Margin of Safety in % of Sales * Actual Sales) * PVR

9. SALES
= Total Cost + Profit
= Variable Cost + Fixed Cost + Profit
= Variable Cost + Contribution
= Contribution / PV ratio * 100
= BE Sales + Margin of Safety

ABSORPTION COSTING PRO-FORMA
£
Sales Revenue

xxxxx

Less Absorption Cost of Sales
Opening Stock (Valued @ absorption cost)

xxxx

Add Production Cost (Valued @ absorption cost) xxxx
Total Production Cost

£

xxxx

P a g e | 26

Less Closing Stock (Valued @ absorption cost) (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

Reconciliation Statement for Marginal costing and Absorption Costing Profit

$
Marginal costing Profit

Xx

ADD

Xx

(Closing stock – opening Stock) x OAR
= Absorption Costing Profit

Xx

Budgeted fixed production overhead
Where OAR( overhead absorption rate) =
Budgeted levels of activities

P a g e | 27

MARGINAL COSTING PRO-FORMA

£
Sales Revenue

£
xxxxx

Less Marginal Cost of Sales
Opening Stock (Valued @ marginal cost)

xxxx

Add Production Cost (Valued @ marginal cost) xxxx
Total Production Cost

xxxx

Less Closing Stock (Valued @ marginal cost)

(xxx)

Marginal Cost of Production

xxxx

Add Selling, Admin & Distribution Cost

xxxx

Marginal Cost of Sales

(xxxx)

Contribution

xxxxx

Less Fixed Cost

(xxxx)

Marginal costing Profit

xxxxx

P a g e | 28

Problems
Q.1 The Vijay Electronic Co. furnishes you the following income information of the year
1995.
Year

Sales in Rs

Profit in
Rs

First half

4,05,000

10,800

…………..

5,13,000

32,400

Second half
…………..

From the above table you are required to compute the following assuming that the fixed
cost remains the same in both the periods.
(a) P/V Ratio.
(b) Fixed cost.
(c) Break - even point.
(d) Variable cost for first and second half of the year.
(e) The amount of profit or loss where sales are Rs 3,24,00.
(f) The amount of sales required to earn a profit of Rs 54,000.

P a g e | 29

Solution:
Year

Sales in Rs

Profit in
Rs

First half

4,05,000

10,800

…………..

5,13,000

32,400

Second half

1,08,000

21,600

…………..
Difference
…………..

(a) P/V Ratio

=

Change in Profit/ Change in Sales*100

= 21,600/1,08,000*100 =20%
(b) Fixed Cost
S*(S/V)

=

F+P

4,05,000*20/100

=

F+10,800

Or 81,000

=

F+10,800

Or 81,000-10,800

=

Fixed Cost

Or Fixed Cost

=

Rs 70,200

Total Fixed Cost

=

70,200*2= Rs 1,40,400

(c) Break-even Point

(i) For the 1st half

Fixed Cost/P/V Ratio

=

(d) Variable Cost

=

1,04,400/20% = Rs 7,02,000

P a g e | 30

Sale – Variable Cost


Or 4,05,000-V.C.

= 70,200 + 10,800

Or 4,05,000 -V.C.

=

81,000

Or 4,05,000-81,000

=

VC

Or VC

= Rs 3,24,000

(ii) For the 2nd half
Sales-Variable Cost

= Fixed Cost+ Profit

5,13,000-VC

= 70,200+32,400

5,13,000-VC

= 1,02,600

5,13,000-1,02,600

= VC

VC

= Rs 4,10,400

(e) The amount of profit/Loss where sales are Rs 3,24,000
Sales*(P/V)


3,24,000*20%

= 1,40,400+Profit/Loss

64,800

= 1,40,400+Profit/Loss

Loss

= Rs 75,600

(f) The amount of Sales required to earn a profit of Rs 54,000
Sales*(P/V)


Sales*(20%)

= 1,40,400+54,000

Sales*20/100

=

1,94,400

20% of Sales

=

1,94,400*100/20 = Rs 9,72,00

P a g e | 31

Q.2 A manufacturer of packing cases makes three main types- Deluxe, Luxury, and
Economy. Overheads are incurred on the basis of labour hours. Wages are paid at Re 1.00
per hour.
Estimates for the cases show the following:
Particulars

Deluxe

Luxury

Economy

(Rs)

(Rs)

(Rs)

Material

10.00

8.00

3.00

Wages

6.00

3.00

2.00

Overheads

12.00

6.00

4.00

28.00

17.00

9.00

2.00

3.00

3.00

26.00

20.00

12.00

10,000

20,000

5,000

Net Profit/loss
Average Selling Price
Annual Sales ( Units)

The manufacture felt that he would be well advised to discontinue producing the Deluxe
and economy cases even though it would mean that some of production facilities would
remain unused. He cannot increase the sale of luxury cases. It has been ascertained that
60% of the overheads is fixed.
You are required to advise the manufacture.

P a g e | 32

Solution:
Statement of cost and contribution
Particulars

Deluxe
(Rs)

Luxury
(Rs)

Economy
(Rs)

Material

10.00

8.00

3.00

Wages

6.00

3.00

2.00

Variable Overheads (40%)

4.80

2.40

1.60

20.80

13.40

6.60

26.00

20.00

12.00

5.20

6.60

5.40

2.20

3.60

2.40

(-)2.80

3.00

3.00

5.20*100/26

6.60*100/20

5.4*100/12

=20%

=33%

=45%

Total Variable Cost
Selling Price
Contribution
Less: Fixed Cost (60%)
Net Profit / Loss
P/V Ratio (Contribution*100)/Sales

Note: The above statement clearly explains that product Deluxe is incurring loss and also
its P/V Ratio is less as compared to other two products. Hence it is advisable, that the
manufacturer should discontinue the product “Deluxe” and increase the production of
products Luxury and economy.

P a g e | 33

Conclusions
When I thought of studying „Marginal costing and Decision Making‟ first things in my
mind is that, this is only one topic in our syllabus of Mcom part-1 but really the concept
are deep and hard and after doing this project I come to know that how the combine topic
which have give me 30 marks (Max) to score in writing exam is giving me knowledge of
variances analysis and its benefits to industry at different levels. It is really helpful to deal
with future topic of cost accounting.
The theoretical constructs of economics texts are of little use; the platitude that increasing
returns to scale cause marginal to fall below average costs being one example, since it
relates only to brand new built from scratch systems.
Marginal costs depend not only upon the timing of a postulated change in output but also
upon the timing of the decision to adapt to it. Marginal costs are forecasts, and forecasts
are rarely accurate. However, all decisions are founded upon uncertain expectations about
the future effects of current choices.
Marginal costing and decision making are rarely important concept of cost accounting and
help full concept are future. I hope marginal costing and decision making is really good
topic of costing. The technically using marginal costing and decision making are helpful.
Here I conclude that this is very useful Project work given me by my project guide Mrs.
Babita kakkare madam. Once again I would like to thank her for this great opportunity .

P a g e | 34

SOURCES

BIBLOGRAPHY:

 Cost Accounting – Ainapure & Ainapure
 Cost Accounting – Chaudhari, Chopade

WEBLOGRAPHY:

http: //dictionary.refrences.com
http: //www.idadesal.org
http: //www.accountingcoach.com
http://www.accountingtools.com

costing project

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