CA.CS.NAVEEN.

ROHATGI Marginal costing

SYBMS- MARGINAL COSTING

The supreme goal of every manager is make profit . To achieve this management has to take several decisions regarding the marginal unit, the product mix, pricing, make or buy. It has to ascertain the cost which are controllable and establish a mechanism to control them. Marginal costing is an effective technique applied by the management in taking several decisions and controlling cost . The application of marginal is explained below.

(1)

Decision Regarding The Marginal Unit

. It means a single additional unit or an additional block of units such as a batch of articles, an order, a
process, a department and so on. Management .Management has to frequently take decisions regarding the additions or discontinuance of the Marginal Unit. Thus, Management has to decide whether to

increase or decrease the production of a single article continue or discontinue a batch of articles accept or reject a specific order continue or discontinue a specific process add or discontinue a department, and so on.

(2) Decision Regarding Optimum Product-mix

Marginal Costing helps the management in deciding the most profitable product-mix. The Breakeven Chart and the Profit- Volume Ratio for each product can be studied to decide upon the quantity of each product to be produced so as to earn the maximum Contribution and Profits. That ProductMix which yields the maximum possible profits is the optimum Product-Mix.

(3)Decision Regarding Utilisation of Scarce Resource

If any resources such as labour, machinery, raw material or finance are in short supply, the Contribution in relation to the Key Factor can be worked out. The product which yields the highest Contribution per unit of the scarce factor (Contribution per Labour Hour etc.) can be produced in large quantities to derive the maximum profits possible.

(4) Decision Regarding Pricing

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, however, the price can be fixed on the basis of only Variable Cost Thus prices can be fixed so as to (a)

Earn Maximum Contribution: Marginal Costing Techniques such as Profit Volume Ratio are L_ especially helpful in fixing the selling price for submitting quotations or tenders.

At Least Break-even . I.e. earn just enough to cover the costs. Thus if the product is perishable or seasonal, it is advisable to at least break even, i.e. sell on no profit no loss basis. The technique of Break-even Charts is useful in deciding the break-even point. It assists in deciding the minimum quantity to be sold or the minimum price to be charged in order to break-even. (a) Recover At Least the Marginal Costs, e.g. in the following circumstances (b)

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SYBMS- MARGINAL COSTING

(i)Depression: When there is trade depression, the concern must survive somehow. Even if the production is stopped, the Fixed Costs will continue. Hence it is better to continue the production so as to retain the trained labour, staff and the consumers. The plant will also remain in working condition. This will avoid the costs of closing down and re-starting again when the trade conditions improve (ii)Eliminate Competition: When the concern wants to eliminate competition, it may initially sell at the Marginal Cost. Thereafter once the competition is eliminated; it will enjoy monopoly, can charge higher prices and recover its losses. (iii)Establish New Product: When the concern wants to introduce or popularize a new product, initially, it may sell at the Marginal Cost. Once the product is established, it can increase its prices and recover its losses. The same strategy can be applied in case of a special order, or for an export order etc. (5) Decision Regarding Make or Buy Management has to decide whether it would be more profitable to manufacture a product or a. component in-house rather than buying it from outside. Thus The concern should make ail article itself if its Mar g inal Cost is lower than the market price of the article. Thus, Make Article A if Marginal Cost of A < Market Price of A
(1) the makingIfC7 machinery being used for producing another article (saythe Market be diverted forA is For making Article A the concern itself should make the article A, only if B) has to Price of article

more than the total of the Marginal Cost of A + Contribution of Article B which will be lost.

Make Article A if [Marginal Cost of A + Contribution of B] < Market Price of A

(6) Cost Control Marginal Costing deals withcontrollable in the short are easier once the rent of the factory premises is Margina and hence are not Variable Costs which run. Thus, to control. Fixed Costs arise in relation time
g Fixed by agreement,material, labour and expenses which are it. The Variable Costs, on the other hand, Y are the direct costs of the mana ement has no control over amenable to control. Flexible Budgets g C Help the mana ement in controlling the marginal costs. Break-even Charts and PV Ratios also help LZ~ -the management in controlling cost and maximising the profits

Illustration 1 : From the following data, calculate break-even point (BEP) in units as well as value.
Rs. Selling price per unit 20 Variable cost per unit 15 Fixed overheads 20,000 If sales are 20% above BEP, determine the net profit. Illustration 2: (i) Find out contribution and BEP sales if Budgeted Output is 80,000 units. Fixed Cost is Rs. 4,00,000, Selling Price per unit is Rs. 20. Variable Cost per unit is Rs. 10 (ii) Find out Margin of safety, if profit is Rs. 20,000 and PV Ratio is 40%.

Illustration 3: The difference between a successful person and others is not a lack of strength, not a lack of knowledge, but rather in a lack of will. 2

CA.CS.NAVEEN.ROHATGI SYBMS- MARGINAL COSTING From the following data, calculate: (i) Break-even point expressed in amount of sales in rupees. (ii) Number of units that must be sold to earn a profit of Rs. 1,60,000 per year. Selling price Rs. 20 per unit Variable manufacturing cost Rs. 11 per unit Variable selling cost Rs. 3 per unit Fixed factory overheads Rs. 5,40,000 per year Fixed selling cost Rs. 2,52,000 per year
Illustration 4 Sales Rs. 1,00,000, Profit Rs. 10,000, Variable Cost 70%. Find out (a) PV ratio (b) Fixed cost and (C) Sales to earn of profit Rs. 40,000. Illustration 5: Profit Volume Ratio of a company is 50%, while its margin of safety is 40%. It sales volume of the company is Rs. 50 lakhs, find out its break-even point and net profit. Illustration 6: (1) Ascertain Profit, when Sales Rs. 2,00,000 Fixed Cost Rs. 40,000 BEP Rs. 1,60,000 (2) Ascertain Sales, when Fixed Cost Rs. 20,000 Profit Rs. 10,000 BEP Rs. 40,000

Illustration 7: (PVR, BEP, MS & New Sales) S. Ltd. furnishes you the following information relating to the half year ending 30th Sept. 2003 Rs. Fixed expenses 50,000 Sales value 2,00,000 Profit 50,000 During the second half of the same year the company, has projected a loss of Rs. 10,000. Calculate (i) The P/V Ratio, break-even point and margin of safety for six months ending 30th Sept., 2003. (ii) Expected sales value for second half of the year assuming that selling price and fixed expenses remain unchanged in the second half year also. (iii) The break-even point and margin of safety for the whole year 2003-2004. Illustration 8: (Ascertaining PYR, FC, BEP, New Sales, New Profit) Particulars Sales Profit Rs. Rs. Period 1 10,000 2,000 Period 2 15,000 4,000 You are required to calculate: (a) PV ratio, (b) Fixed Cost, (c) Break-even sales volume, (d) Sales to earn a profit of Rs. 3,000 and (e) Profit when sales are Rs. 8,000. Illustration 9: (BEP - Amount & Units) A company sells its product at Rs. 15 per unit. In a period if it produces and sells 8,000 units, it incurs a loss of Rs. 5 per unit. If the volume is raised to 20,000 units it earns a profit of Rs. 4 per unit. Calculate break-even point both in terms of rupees as well as in units.

The difference between a successful person and others is not a lack of strength, not a lack of knowledge, but rather in a lack of will.

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SYBMS- MARGINAL COSTING

Illustration 10: (Sales from BEP) From the following data find out (i) sales and (ii) new break-even sales, if selling price is reduced by 10%. Particulars Rs. Fixed Cost 4,000 Break-even sales 20,000 Profit 1,000 Selling price per unit 20 Illustration 11: (PVR & FC) Calculate PV Ratio and Fixed expenses from the following: Margin of Safety Rs. 80,000 Profit Rs. 20,000 Sales Rs. 3,00,000 Illustration 12: (Sales From PVR, BEP) The ratio of variable cost to sales is 70%. The break-even point occurs at 60% of the capacity sales. Find this capacity sales when fixed costs are Rs. 90,000. Also compute profit at 75% of the capacity sales.

Illustration 1 : (Export Order) The cost sheet of a product is as follows: Particulars Direct Material Direct Wages Factory Overheads Fixed Variable Administrative Expenses (fixed)

Rs. per unit 10.00 05.00 01.00 02.00 1.50

Selling and Distribution Expenses: Fixed 00.50 Variable 01.00 Cost of Sales 21.00 The selling price per unit is Rs. 25.00. The above cost information is for an output of 50,000 units, whereas the capacity of the firm is 60,000 units. A foreign customer is desirous of buying 10,000 units at a price of Rs.19 per unit. The extra cost of exporting the product is Rs. 0.50 per unit. You are required to advise the manufacturer whether the order should be accepted? Illustration 2: (Discontinue A Product) A manufacturing company makes two product - Luxury and Delux. The results for 2009 were as under: Particulars Luxury Delux Rs. Rs. Sales 2,00,000 1,60,000 Variable Cost 1,20,000 1,32,000 Fixed Cost 40,000 32,000 Profit/Loss 40,000 (-) 4,000 The managing director has suggested that Delux should be dropped. Should Delux be dropped, if: (1) His decision has no effect on sales of luxury; or (2) By using the vacant factory space, sales of luxury could be increased by Rs. 1,00,000 the extra production would lead to increase in the total fixed cost to Rs. 76,000. (3) If deluxe is discontinued fixed cost would be nil for the product.

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SYBMS- MARGINAL COSTING Illustration 3 (Discontinue Division C)- XYZ Ltd. has three divisions each of which makes a different product. The budgeted data for the next year are as follows:
A B C Sales 1,12,000 56,000 84,000 Costs: Direct material 14,000 7,000 14,000 Direct labour 5,600 7,000 22,400 Variable Overhead 14,000 7,000 28,000 Fixed costs 28,000 14,000 28,000 Total Costs 61,600 35,000 92,400 Profit/(Loss) 50,400 21,000 (8,400) The management is considering to close down Division C. There is no possibility of reducing fixed costs. Advise whether or/not Division C should be closed down?

Illustration 4 ( temporary cessations of operations/ shut down point) - ABC Ltd. operates at normal capacity. It produces 20,000 units of a product from plant 111. The unit cost of manufacturing at normal capacity is as follows: (Rs.) Direct materials 6.50 Direct labour 2.60 Variable overhead 3.30 Fixed overhead 4.00 Each unit of the product is sold for Rs. 20 with variable selling and administrative expenses of 60 paise per unit c product. The company excepts that during the next year only 2,000 units can be sold. Management plants to shut-down the plant, estimating that the fixed manufacturing overhead can be reduced to Rs. 45,000 for the next year. When the plant is operating the fixed overhead costs are incurred at a uniform rate throughout the year. Additional costs of plant shut are estimated at Rs. 15,000. Should the plant be shut-down? Show computations. What is the shut-down point? Illustration 5 : ( selection of product mix ) From the following date you are required to present the best alternative Particulars Product Per unit Rs. Direct Materials X 10.50 Direct Materials Y 8.50 Direct Wages X 3.00 Direct Wages Y 2.00 Variable expenses 100% of direct wages per product. Fixed expenses (total) Rs. 800 Sales Price X Rs. 20.50 and Y Rs. 14.50 Suggested sales mixes: Alternatives No of Units x y A 100 200 B 150 150 C 200 100

The difference between a successful person and others is not a lack of strength, not a lack of knowledge, but rather in a lack of will.

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SYBMS- MARGINAL COSTING

Illustration 6: (Key Factors) The following particulars are taken from the records of a company engaged in manufacturing two products, A and B, from a certain material: Particulars Product Product B A (per unit) (per unit) Rs. Rs. Sales 2,500 5,000 Material cost (Rs. 50 per kg.) 500 1,250 Direct Labour (Rs. 30 per hour) 750 1,500 Variable overhead 250 500 Total Fixed Overhead: Rs. 10,00,000 Comment on the profitability of each product when: (1) Total sale in value is limited and only one product to be sold. (2) Raw materials is in short supply .Total availability of raw materials is 20,000 kg. and maximum sales potential of each product is 1,000 units, find the product mix to yield maximum profits. (3) Labour is the limiting factor. Total availability of labour hours is 40,000 hours. and maximum sales potential of each product is 1,000 units, find the product mix to yield maximum profits. Illustration 7: (Key Factor : Raw Materials) Vinak Ltd. which produces three products furnishes you the following data for 2003-04: Particulars Products A B C Selling Price per unit (Rs.) 100 75 50 Profit volume, ratio (%) 10 20 40 Maximum sales potential (Units) 40,000 25,000 10,000 Raw Material content as percentage of variable costs (%) 50 50 50 The fixed expenses are estimated at 6,80,000. The Company uses a single raw material in all the three products. Raw material is in short supply and the company has a quota foe the supply of raw materials of the value of Rs. 18,00,000 for the year 2003-04 for the manufacture of its products to meet its sales demand. You are required to: (1) Set a product mix which will give a maximum overall profit keeping the short supply of raw materials in view. (2) Compute that maximum profit. Illustration 8: ( Key factor sums) ABC Ltd. manufactures and sells three products X, Y and Z. Budgeted sales x Y Z demand 300 500 200 units units units Unit sales price 16 18 14 Variable costs: Materials 8 6 2 Labour 4 12 6 12 9 11 Contribution 4 6 3 All three products use the same dire materials and the same type of direct labour, in the next year, the available supply of materials will be restricted to Rs.4,800, and the a supply of labour to Rs. 6,600. What would be the profit maximising budget?

Illustration 9- (key factor sum)-

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CA.CS.NAVEEN.ROHATGI
A 90 30 24 12 B 71 20 18 9 C 100 40 30 15 D 86 40 12 6

SYBMS- MARGINAL COSTING

A company manufactures four products. The cost data per unit areas under:
Selling price Direct materials Direct labour Variable overheads

Fixed costs are estimated at Rs. 2,00,000 per month. The company employs 250 direct workers, who work eight hours a day for 25 days a month. The direct wage rate is Rs. 6 per hour. It is not possible for the company to increase its operatives in the short run nor is it practicable to work overtime. The companys policy does not allow subcontracting of work. The Marketing Director has forecast the following demands for a month: Produc t A B C D Units 5,500 5,000 6,250 8,250

The management desires you to find out the most profitable product mix Illustration 10: Novelties Ltd. seeks your advice on production mix in respect of the three products Super, Bright Fine. You have the following information: for standard costs per unit: Particulars Direct materials Variable overhead Direct labour: Departme nt A B Supe r 320 16 Rate per (Rs./Hour) 8.00 16.00 Brigh t 240 40 Fine 160 24 Fine Hour s 5 11

Supe Brigh r t Hour Hours s 6 10 6 15

From current budget, you have further details as below: Super Bright Fine Selling price per unit (Rs.) Fixed overhead: Rs. 16,00,000 Sales departments estimate of maximumpossible sales in the coming year (Nos.) 624 6,000 800 8,000 430 12,000

You are also to note that there is a constraint on supply of labour in Department A and its manpower cannot be increase beyond its present level.

The difference between a successful person and others is not a lack of strength, not a lack of knowledge, but rather in a lack of will.

CA.CS.NAVEEN.ROHATGI

Suggest the best production and sales mix from the stand point of maximum profitability. Prepare statement setting out the profit resulting from the budgeted production and the best alternative suggested by you.

SYBMS- MARGINAL COSTING

Illustration 11: (Evaluate Alternative Responses to Price Changes) The accounts of a company are expected to reveal a profit of Rs. 14,00,000 after charging fixed costs of Rs. 10,00,000 for the year ended 31sf March, 2009. The Selling price of the product is 95. 50 per unit and variable cost per unit is Rs. 20. Market investigations suggest the following responses to the price changes: Alternative I II III Selling Price Reduced by 5% 7% 10% Quantity Sold Increases by 10% 20% 25%

Evaluate these alternatives and state which of the alternatives, on profitability, consideration, should be adopted for the forthcoming year. Illustration 12 : Cook well Ltd. manufactures pressure cookers the selling price of which is Rs. 300 per unit. Currently the capacity utilisation is 60% with sales turnover of Rs. 18 lakhs. The company proposes to reduce the selling price by 20% but desires to maintain the same profit position by increasing the output. Assuming that the increased output could be made and sold, determine the level at which the company should operate to achieve the desired objective. The following further date are available: (1) Variable cost per unit Rs. 60. (2) Semi-variable cost (including a variable element of Rs. 10 per unit) Rs. 1,80,000. (3) Fixed cost Rs. 3,00,000 will remain constant up to 80% level. Beyond this an additional amount of Rs. 60,000 will be incurred. Illustration 13: Pioneer engineering company Ltd has just completed first of year of its operation as 31st March 2009and summarized result of the information is given below: Installed capacity- 20,000 kg : production 14,000 kg. Income and expenditure details: Particulars Rs Rs Income 28,00,000 Expenditure Variable Material 3,50,000 Labour 4,20,000 Overheads Factory 2,80,000 Marketing 2,10,000 12,60,000 Contribution 15,40,000 Fixed cost 10,00,000 Profit 5,40,000 The Managing Director wishes to expand the operation for the year next year and has asked you to prepare flexible budgets on capacity utilisation levels of 80%, 90% and 100% based on the following

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CA.CS.NAVEEN.ROHATGI
estimate (Rs. per kg.)
(a)

SYBMS- MARGINAL COSTING

Price

at 80% level-

220

at 90% level210 at 100% level200 Whatever produced during the year is expected to be sold within the year.
(b)

Increase in variable cost components. Materials Labour Overheads: Factory @ 12% @ 10% @ 15%

(a)

Marketing @ 20% Inflation rate applicable to fixed cost is 15%. Additionally, if the capacity utilisation exceeds 80% fixed cost is expected to increase by 10% up to 100% capacity utilisation level.

Part 2: To avoid the incidence of increase in fixed cost for production levels beyond 80% capacity utilization the production manager has submitted the plan to sub-contract the additional production of 4,000 kg to the party at cost of Rs 105 Kg including marketing cost. You are requested to comment on this plan of sub contracting with a view to maximize the profit of the company,

Illustration 14 The following is the summarised trading account of a manufacturing concern which makes two : X and Y. Summarised trading account for the four months to 30th April, 2003. Particulars Sales Less: Cost of sales Direct costs* Labour Materials Indirect costs Variable expenses Fixed expense Common to both X and Y Net profit X Rs. 10,000 3,000 1,500 1,000 1,000 Y Rs. 4,000 Total Rs. 14,000

4,500 5,500 2,000 3,500 1,250 2,250

2,000 2,000 1,000 1,000 1,250 (-)250

6,500 7,500 3,000 4,500 2,500 2,000

Fixed costs tend to remain constant irrespective of the physical outputs of X and Y. It has been the practice of the concern to allocate these costs equally between X and Y. The following proposals have been made by the Board of Directors for your consideration as financial adviser: 1. Discontinue Product Y. 2. As an alternative to (1) reduce the price of Y, by 20 per cent. (It is estimated that the demand will then increase by 40 per cent

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3. Double the price of X. (It is estimated that this will reduce the demand by the three-fifths). You are required to recommend the proposals to be taken after evaluating each of these three proposals. Illustration 15 (pricing of the product) - ABC Ltd. manufactures a product involving the assembly of some parts purchased and other worked from raw-materials. The plant has been operating at an even rate throughout the year on one eight hour shift producing 500 units per month. The average annual cost for the past year was as follows: (Rs.) Raw materials 1,60,000 Purchase parts 1,00,000 Direct wages 3,00,000 Variable overhead 70,000 Fixed overhead Total 1,20,000 7,50,000 At this point, sales department wanted to know the minimum price to be quoted for an order of 3,000 additional units to be produced and delivered at the rate of 250 units each month for the next twelve months. No additional selling and administration expenses will be incurred, if the order is accepted and the management wants a minimum profit of 5% on the selling price. Any additional raw-material purchase can be made at a saving of 5% of cost of such materials, labour requirements above the present one shift can be secured only at an increase of 10% over present rate. Total variable overheads are expected to increase by 60% due to the increase in volume and fixed production overheads will go up by Rs. 9,000 only. Prepare a statement showing details of price calculation for new order.

SYBMS- MARGINAL COSTING

Illustration 16 (accept / reject order and sub contracting) - A company currently operating at 80% capacity has the following particulars: Sales 32,00,000 Direct Materials 10,00,000 Direct Labour Variable 4,00,000 Overheads 2,00,000 Fixed Overheads 13,00,000 An export order has been received that would utilise half the capacity of the Factory. The order cannot be split. i.e., if has either to be taken in full and executed at 10% below the normal domestic prices, or rejected totally. The alternatives available to the Management are: 1. Reject the order and continue with the domestic sales only (as at present), or 2. Accept the export order, split capacity between overseas and domestic sales and turn away excess domestic demand (operate at 100%) or 3. Increase capacity so as to accept the export order and maintain the present domestic sales by: a) Buying equipment that will increase capacity by 10%. This will result in an increase of Rs. 1,00000 in fixed costs, and b) Work overtime to meet balance of required capacity. In that case labour will be paid at one and a half- times the normal wage rate. Prepare a comparative statement of profitability and suggest the best alternative.

The difference between a successful person and others is not a lack of strength, not a lack of knowledge, but rather in a lack of will.

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