presentation on marginal costing & absorption costing
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PRESENTATIONON
MARGINAL COSTING&
ABSORPTION COSTING
GROUP MEMBERS
1) ANKIT KUMAR RANKA(06A)
2) HARISH KUMAR(21B)
3) 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 ClassificationThe 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 ContributionMarginal 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
AdvantagesThe 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
= 30000Total fixed cost = 20000Profit = 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
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?
€
BEP(INUNITS) =TFC
CONTRIBUTION /UNIT
€
BEP(InSales) =TFC
PVRatio
Solution… Break Even Point(In units) =
=7000/14 =500 units
BEP(in Sales)= TFC/PV ratio =7000/40%
=17500P/v ratio=contribution/sales*100
=14/35*100=40%
=500 units
€
TotalFixedCost
contribution /unit
Margin of Safety (MOS)
Margin of Safety is the difference betweenthe 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 – BEPProfit= 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 20000Profit 20000Margin of safety = sales-Break even pointBreak Even Point(in rs.) = TFC/PV ratio
= 20000/P/V ratio = contribution/sales*100
= 40/50*100=80%BEP = 20000/80%=25000MOS = 50000-25000=25000
Solution… Sales 50000(50/unit)(-) variable cost 10000(10/unit)Contribution 40000(40/unit)Fixed Cost 20000Profit 20000Margin of safety = sales-Break even pointBreak Even Point(in rs.) = TFC/PV ratio
=20000/P/V ratio = contribution/sales*100
= 40/50*100=80%BEP = 20000/80%=25000MOS = 50000-25000
= 25000
Profit/Volume 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 =
€
CONTRIBUTION
SALES*100
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 35 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 CSales 100000 80000 110000Less: Variable cost of good
sold (@35) 35000 28000 38500Product contribution margin 65000 52000 71500Less: Variable selling O/H 4000 3200 4400Total contribution margin 61000 48800 67100Less: Fixed Expenses Fixed factory overhead 31000 31000 31000
Net profit 30000 32800 30100
Absorption costing
• Absorption cost is a total cost technique Absorption cost is a total cost technique Under which total cost i.e. fixed & variableUnder which total cost i.e. fixed & variable is charged to productionis charged to production.. • Includes direct materials, direct labor, variable factory overhead, and fixed factory overhead as part of total product cost.
MEANING……….
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 CentresAgain 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
AllocateAllocate 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 productIn both cases there is no need to divide up the costs between products since the facility is directly linked to the productBut if an overhead cannot be allocated it must be apportioned
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 AllocationVikas 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
20
100
12
500
160000
15
70
8
-
100000
10
30
5
-
50000
5
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
SolutionItems 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)
Total
5000
7500
4500
6000
800
23800
1800
2400
1800
2000
300
8300
1200
2000
1200
1500
200
6100
1000
1600
1500
1200
150
5450
700
1000
-
800
100
2600
300
500
-
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
500
200
-
-
-
200
30%
30
600
50%
300
-
-
-
400
30%
40
800
30%
360
-
-
-
400
20%
20
600
20%
SolutionItems 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)
Total
5000
7500
4500
6000
800
23800
1800
2400
1800
2000
300
8300
1200
2000
1200
1500
200
6100
1000
1600
1500
1200
150
5450
700
1000
-
800
100
2600
300
500
-
500
50
1350
SolutionExpenses Basis of
ApportionmentTotal
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)
Actual
Ratio Given (5:3:2)
Total
1100
2000
500
600
1200
5400
-
5400
240
400
100
60
200
1000
(1000)
Nil
200
600
120
180
200
1300
500
1800
300
600
160
240
400
1700
300
2000
360
400
120
120
400
1400
200
1600
ABSORPTION COSTING PRO-FORMA
Sales Revenue xxxxxLess 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 xxxxxFixed Production O/H absorbed xxxx Fixed Production O/H incurred (xxxx) (Under)/Over Absorption xxxxxAdjusted Profit xxxxx
EXAMPLERanka 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
particulars 5000 6000 7000Sales
Production Cost
(-)closing Stock
(-)over absorbed FC
Cost of sales
GrossProfit
(-) admin cost
Net Profit
205K
Nil
Nil
300000
205000
95000
19000
76000
246K
41K
6K
300000
199000
101000
19000
82000
287K
82K
12K
300000
193000
107000
19000
88000
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
COST SHEET
Direct Material Cost xxxDirect Labour Cost xxxDirect Expenses xxxPRIME COST XXXAdd: Factory Overhead xxxFACTORY COST XXXAdd: Administrative overhead xxxCOST OF PRODUCTION XXXAdd: Selling & Distribution cost xxxCOST OF SALES XXXAdd: Profit xxxSELES 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
PRODUCTIONADMINISTRATION
SELLING &
DISTRIBUTION
RESEARCH &
DEVELOPMENT
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.
CostManufacturing cost Non-manufacturing cost
Direct Materials
Direct Labour
Overheads
Finished goods Cost of goods sold
Period cost
Profit and loss account
Absorption Costing
CostManufacturing cost Non-manufacturing cost
Direct Materials
Direct Labour
Variable Overheads
Finished goods Cost of goods sold
Period cost
Profit and loss account
Marginal Costing
Fixedoverhead
THANK YOU
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