Tuesday, November 25, 2008

Marginal Costing &Break Even Analysis
Marginal Cost & Marginal Costing
Acc to ICMA
Marginal cost represents "the amount of any given volume of output by which aggregates costs are changed if the volume of output is increased by one unit"
In practice it is measured by total variable cost attribute to one unit
Marginal Cost & Marginal Costing
Acc to Blocker & weltmore
"marginal cost is the increase or decrease in total cost which results from producing or selling additional or fewer unit of product or from a change in the method of production or distribution such as the use of improved machinery ,addition or exclusion of a product or territory"
Marginal Cost & Marginal Costing
ICMA
Marginal costing as " the ascertainment of marginal costs and of the effect on profit of changes in volume or type of output by differentiating between fixed & variable cost"
Marginal costing is also know as "variable costing"
Characteristics of marginal costing
Analysis & presentation
Classification of cost (fixed, variable, semi variable)
Variable cost are regarded as cost of product
Fixed cost is treated as period cost
Finished goods & work in progress are valued as marginal cost
Contribution = sales or SP – marginal cost of sales
Assumption of marginal costing
Variable cost remain constant per unit of output
SP per unit remain unchanged
Fixed cost remain unchanged

Contribution
It is difference between sales & variable cost or marginal cost
Excess of SP over variable cost per unit
Also know as contribution margin or gross margin

If SP = 20/-
Variable cost = 15/-
Fixed exp = 50000/-
Total no of unit sold 8000
C = 20-15 = 5
Total contribution = 8000*5 = 40000
Advantages
Fixing selling prices
Assist break even point
Suitable product mix
Alternative method of production
Purchase or manufacture
Adding new product
Marginal costing equation
Sales – variable cost = contribution
Sales = variable cost + contribution
Sales = variable cost + fixed cost + profit/loss
Sales – variable cost = fixed cost + profit/loss
S-V = F + P
Cost – Volume profit analysis
Studying the relationship between cost , volume & profits.
Cost of manufacture , volume of sales ,SP of product
In words of Herman C. Heiser
"the most significance single factor in profit planning of the average business is the relationship between the volume of business , cost & profits"
Break-Even Analysis
In two senses
Narrow senses
Broad senses

In broad sense break even analysis refers to the study of relationship between cost , volume , and profit at different levels of sales or production
In narrow sense it refers to a technique of determining that level of operation where total revenue equal total expenses no profit no loss point.
Assumptions
All element of cost
Variable cost remain constant per unit
Fixed cost remain constant
SP remain unchanged
Volume of factor is only influence cost
No change in general price level
Break even point
Point of sales volume at which total revenue is equal to total cost.
No profit no loss point
Total sales is equal to total cost
Also called as Critical point or Equilibrium point or balancing point
Managerial application of marginal costing
Pricing decision
Profit planning
Make or but decision
Selection of suitable sales mix
Effect of change in sales price
Alternative method of production
Optimum level of activity
Capital investment decision
Advantages of marginal costing
Simple to operate
Removes complexities
Help management in production planning
No possibility of fictitious profits
BEP calculation
Decision making
Helpful in cost control
Profit planning
Management reporting
Limitation
SP don’t remain constant
Ignores time factor