Marginal Costing for Decision Making Techniques

Dr.R.VASANTHAGOPAL

1. Relevant Techniques for
Decision Making
Dr.R.VASANTHAGOPAL

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Marginal Costing
Marginal costing is a technique of costing largely employed for
cost control
Marginal costing is defined as the ascertainment of marginal cost
and effect of changes in volume or type of out put on the
company’s profit, by segregating total costs into variable and
fixed costs (CIMA)
Marginal cost is the additional cost of producing an additional
unit of a product.
Marginal cost is the amount to any given volume of output by
which aggregate costs are changed if the volume of output is
increased or decreased by one unit (ICMA).

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Features of Marginal Costing
Marginal costing is a technique of control or decision
making.
Under marginal costing the total cost is classified as
fixed and variable cost.
Fixed costs are treated as period cost and charged
to profit and loss a/c for the period for which they are
incurred.
The variable costs are regarded as the costs of the
products.
The stock of finished goods and work-in-progress
are valued at marginal costs only.
Prices are determined on the basis of marginal cost.

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Assumptions of Marginal Costing
All costs can be classified into two categories – Fixed and
Variable
Fixed costs remain constant at all levels of activity
Variable costs vary in total, but remain constant per unit
Level of efficiency of operations is uniform
Product risk remains unaltered, unless specified otherwise.
Selling price remains constant at different levels of activity.

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Advantages of Marginal Costing
Simplicity
Stock valuation
Meaningful reporting
Fixation of selling price
Profit planning
Cost control and cost reduction
Pricing policy
Helpful to management
Production Planning
Make or Buy Decisions

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Limitations of Marginal Costing
Classification of cost
Not suitable for external reporting
Lack of log-term perspective
Under valuation of stock
Automation – Lack of Advancement
Production aspect is ignored
Not applicable in all types of business
Misleading picture -Assumptions

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Marginal Costing-Terminologies
Contribution
The difference between selling price and variable costs. Thus,
Contribution= Selling price/unit-Variable cost/unit OR
Contribution= Fixed cost+ Profit OR
Contribution= Sales x PV Ratio
Break Even Point (BEP)
The point or level of out put at which cost is equal to revenue
Break Even Point (Units) = Fixed Cost/ Contribution
Break Even Point (Value)= Fixed Cost/ P/V Ratio OR
Fixed Cost x Sales
Contribution

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Marginal Costing-Terminologies
Profit-Volume Ratio (P/V Ratio)
The ratio which establishes the relationship between contribution
and sales. Thus,
P/V Ratio= Contribution x 100
Sales
OR
P/V Ratio= Change in Profit x 100
Change is Sales
OR
P/V Ratio= Change in Contribution x 100
Change is Sales

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Marginal Costing-Terminologies
Margin of Safety
Difference between actual sales and break even sales.
Margin of Safety= Actual sales-Break even sales OR
Margin of Safety= Profit
P/V Ratio
Sales for required profit= Fixed Cost + Required Profit P/V
Ratio
Profit for given sales= Contribution-Fixed Cost
Fixed Cost = Contribution – Profit
Angle of Incidence- An angle formed between sales line and
total cost line in break even chart.

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Marginal Costing-Terminologies
Cost-Volume-Profit (C-V-P) Analysis
CVP is a management accounting tool that expresses
relationship among sale volume, cost and profit.
CVP can be used in the form of a graph (break even chart) or an
equation.
CVP Analysis is also called Break-even analysis
Break-even analysis is used in two ways- Narrow sense and
broader sense
In narrow sense break-even analysis is the determination of
break-even point
In broader sense break-even analysis refers to the analysis of
impact of costs, price and volume on profit
cont’d

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Marginal Costing-Terminologies
CVP analysis can answer a number of analytical
questions.
Some of the questions are as follows:
What is the breakeven revenue of an organization?
How much revenue does an organization need to achieve a
budgeted profit?
What level of price change affects the achievement of budgeted
profit?
What is the effect of cost changes on the profitability of an
operation?
Cost-volume-profit analysis can also answer many other “what if”
type of questions.