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COST AND MANAGEMENT ACCOUNTING

BY-:MINIHA GUPTAMANAGEMENT FACULTYRSD ACADEMY (COLLEGE OF MANAGEMENT AND TECHNOLOGY)

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UNIT 2TOPICS TO BE COVERED

MARGINAL COSTING Introduction Marginal costing versus Absorption Costing P/V Ratio Analysis and implications Break Even Point and its concept and uses in various

ways. DIFFERENTIAL COSTING

Incremental costing Concept, uses and applications Methods of calculation of these costs Roles of cost in Management Decision making.

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CLASSIFICATION OF COST

Total cost

Production Cost Period Cost

Direct Material Cost

Direct Labour Cost

Manufacturing Overhead

Fixed Cost Variable cost

Selling Cost

Administration Cost

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It is the cost incurred in producing an additional unit of product.

1 Manufacture 100 radioVariable costs Rs150 p uFixed cost Rs 50002 If Manufacture 101 radios

Marginal Cost 100 x150= 15000Fixed Cost = 5000 total 20000

Marginal cost 150 x101=15150Fixed Cost = 5000

TOTAL 20150

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“Marginal Costing is a technique of ascertaining cost of production of goods or services manufactured.”

“Marginal Costing is ascertainment of marginal cost by differentiating between fixed and variable costs and of the effect of changes in volume or type of output”

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1. Impact of Variable Cost

2. Calculation of

Work In Process and

Finished Goods

3.Basis ofSelling Price

4. Break Even And

CVP Analysis

5. Profitability of Product

OrDepartment

6. VC are chargedTo

Production

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It is a principle wherebyFixed as well as Variable costs are

allotted to cost units and total overheadsare absorbed according to activity level.

Here all costs are taken into account.

Its also termed as “Full Costing”.

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Both agree that the variable manufacturing costs are product cost.

Both agree that marginal costing presents the data for internal use.

Both agree that fixed and variable administration and selling expenses are period cost.

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1. Sales = Variable Cost + Fixed Cost + Profit.2. Sales - Variable Cost = contribution.3. Sales – Variable Cost = Fixed Cost + Profit.4. Contribution = Fixed Cost + Profit.5. Contribution – Fixed Cost = Profit.

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1. All costs are charged in cost of production.

2. WIP and FG are valued at total cost.

3. The difference b/w sales and TC creates profit.

4. The apportionment of FC give rise to under/over absorption of Overheads.

5. Costs are classified according to Functionality.

1. Only VC is charged to cost of production.

2. WIP and FG are charged to facilitate cost comparison.

3. The excess of sales revenue over VC is contribution.

4. VC alone wont give rise to under/over absorption of Overheads.

5. Costs are classified according to variability.

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CVP Analysis studies the relationship between expenses and income.

It is the study of the interrelationship of cost behaviorpatterns, levels of activity and the profit that results from each alternative combination.

It considers SALES and COST OF PRODUCTION.

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To forecast the profit accurately. To facilitate in preparation of Flexible

Budget. To enable management in determining

the pricing policies. To evaluate the performance of the

business. To enable the charging of overheads to

cost of production at different levels. To determine the minimum sales volume

to avoid losses.

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• The analysis is valid for limited range of values.• Revenues change proportionately with volumes.• There exists a constant product mix.• Changes in volume alone are responsible for

changes in cost and revenue.• The analysis is deterministic in nature.• Produced units are assumed to be sold.• It ignores inflation, efficiency etc as well as

uncertainty and probability approach.

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o It reveals the rate o contribution per product as a percentage of turnover.

o It indicates the relationship of the contribution to the sales.

o It helps in knowing the profitability of business.

o It can be calculated as-:o P/V Ratio = (Contribution /Sales) X 100

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What Could be the Uses of PV Ratio?Break Even Point

Profit at Given Sales

Volume required to earn given Profit

Required Selling Price

Variable Cost for sales

How Improvement in PV Ratio Could be Achieved?

Increasing Selling Price

Reducing Variable Cost

Changing Sales Mix

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• It heavily leans on excess of revenues over variable costs.

• It fails to consider capital outlays required• It gives only an additional indication of relative

profitability of product and product line.• Only simplifications may lead to erroneous

conclusion.• It will be helpful only when other conditions are

constant.

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•A point of no profit no loss•A point where revenue equals cost

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All costs are fixed or variableAll costs remain constant at various levels.VC remains Variable and changes as per level of output.Total FC remains ConstantSelling Price don’t change With VolumeSynchronization of Prod & Sales No Change in Productivity per workers No Change in Operating Efficiency, product specification and methods of manufacturing.

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Fixed Cost BEP (Units) = --------------- = F Contribution PU S-V

Fixed Cost BEP (Rs ) = ----------------- x Sales Contribution

Fixed Cost BEP (Rs) = ------------------ P/V Ratio

F Cost=Rs 12000S Price=Rs12 puV Cost =Rs 9 pu

Find BEP

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Other UsesProfit at diff. Sales Vol.Sales at Desired Profit

F Cost=Rs 12000S Price=Rs12 puV Cost =Rs 9 puProfit when sales area) Rs 60,000b) Rs 1,00,000

Profit at diff. Sales Vol. CP/V Ratio= ----- = 3/12=25% SWHEN SALES=Rs 60,000

contribution=sales x p/vratio =60000x25% =Rs 15000

Profit =contribution-fixed cost =15000-12000 =Rs3000

Sales at Desired Profit

F Cost +Desired ProfitSales= ------------------------------- P/V Ratio

12,000+6000a)Sales= --------------- 25% =Rs 72,000

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Break-Even Analysis

Costs/Revenue

Output/Sales

Initially a firm will incur fixed costs, these do not depend on output or sales.

FC

Q1

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Break-Even Analysis

Costs/Revenue

Output/Sales

Initially a firm will incur fixed costs, these do not depend on output or sales.

FC

As output is generated, the firm will incur variable costs – these vary directly with the amount produced

VC

The total costs therefore (assuming accurate forecasts!) is the sum of FC+VC

TC

Total revenue is determined by the price charged and the quantity sold – again this will be determined by expected forecast sales initially.

TRThe lower the price, the less steep the total revenue curve.

TR

Q1

The Break-even point occurs where total revenue equals total costs – the firm, in this example would have to sell Q1 to generate sufficient revenue to cover its costs.

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Break-Even Analysis

Costs/Revenue

Output/Sales

FC

VCTCTR

Q1

If the firm chose to set price higher than Rs2 (say Rs3) the TR curve would be steeper – they would not have to sell as many units to break even

TR

Q2

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Break-Even Analysis

Costs/Revenue

Output/Sales

FC

VCTCTR

Q1

If the firm chose to set prices lower it would need to sell more units before covering its costs

TR)

Q3

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Break-Even Analysis

Costs/Revenue

Output/Sales

FC

VC

TCTR

Q1

Loss

Profit

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Break-Even Analysis

Costs/Revenue

Output/Sales

FC

VC

TCTR

Q1 Q2

Assume current sales at Q2

Margin of Safety

Margin of safety shows how far sales can fall before losses made. If Q1 = 1000 and Q2 = 1800, sales could fall by 800 units before a loss would be made

TR

Q3

A higher price would lower the break even point and the margin of safety would widen

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Costs/Revenue

Output/Sales

FC

VC

TR

High initial FC. Interest on debt rises each year – FC rise therefore

FC 1

Losses get bigger!

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Break-Even Analysis

Remember:• A higher price or lower price does not mean that

break even will never be reached!• The BE point depends on the sales needed to

generate revenue to cover costs• Importance of Price Elasticity of Demand:• Higher prices might mean fewer sales to break-

even • Lower prices might encourage more customers but

higher volume needed before sufficient revenue generated to break-even.

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Links of BE to pricing strategies and elasticity

•Penetration pricing – ‘high’ volume, ‘low’ price – more sales to break even•Market Skimming – ‘high’ price ‘low’ volumes – fewer sales to break even•Elasticity – what is likely to happen to sales when prices are increased or decreased?

Break-Even Analysis

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Limitations of BEP Analysis

It is difficult to segregate Fixed and Variable Costs.In long run FC also changes to VC.VC doesn’t be strictly Variable with Output.Inventory exists compulsorily.In actual Operating efficiency and productivity depends on manpower.In real world costs and revenue are curvilinear in nature.

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For a single product firm BEP can be calculated as-: BEP= Total FC S.P.-VCP (per unit)

Eg. Let ‘Q’ be quantity of sales, ‘s’ selling price, ‘v’ unit variable cost, ‘f’ total fixed cost and ‘p’ as profit. Q (s-v)= F+P Thus BEP= Total Fixed Cost

1- Variable cost per unit Selling price

It provides both the “Per unit data” as well as “Total data”.

Break-Even Analysis- Single Product Line.

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Break-Even Analysis- Multi Product Line.

Firm’s face difficulties in measuring volume in terms of any common unit of product.

For such BEP is calculated as-:

BEP = Total Fixed Cost 1- Variable Cost per unit

Selling Price It gives a detailed combination of total sales

and total variable cost information.

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Costs/Revenue

Production

FC

TC

TR

Q1

BEP Analysis

TFC

B/E Point

Angle of Incidence

Sales

Total Variable Cost

Margin of Safety

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•It is a broader and fundamental concept.

•Helps in making appropriate decision by examining revenue and cost differences.

•Technique used for analysing differential costs

•According to ICMA Technology,•“It’s a technique used in the preparation of ADHOC information in which only cost and income differences between alternative courses of action are taken into consideration.”

•Process of determining how costs in particular and profit in general will be affected if one alternative is chosen over another.

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1. Expressed in total but not cost per unit.2. Data considered is Cost, Revenue and

Investment.3. Its not a part of accounting used by

management.4. Considers only differential costs but ignores

constant cost at different levels.5. Differentials are measured from a common

position or level of activity.6. It considers the cost where the difference

between revenue and cost is highest.

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1. Make or buy decisions.2. Expanding the marketability of the product.3. Changing the product mix.4. Further processing of products.5. Changing the method of production.6. Introducing a new product line.7. Replacing manual labour with mechanical one.8. Fixation of selling price below competitive price.9. Accepting or rejecting a new order.10. Dealing about the most profitable level of

production.11. Shut down or continue operation.

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Incremental Cost is an additional cost caused by a particular decision.

A technique of estimating the increase in cost occurred due to increase in the level of production.

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