Marginal Costing.ppt

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L5

Marginal/VariableCosting


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Definition

A marginal cost is The part of the cost ofone unit of product or service which wouldbe avoided if that unit were not produced,

or which would increase if one extra unitwere produced.

Marginal costing is The accounting

system in which variable costs are chargedto cost units and fixed costs of the periodare written off in full against theaggregate contribution. Its special value isin recognizing

cost behavior, and hence

assisting in decision-making.CIMA


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Components of Marginal Cost

The marginal production cost per unit ofan item usually consists of the following:

Direct material Direct labor

Direct expense

Variable production overheads


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Cost of Sales include only variable costs

Closing stock of WIP and Finished Goods

-valued at variable production costs.

Fixed costs treated as a period cost


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Contribution

The difference between the sales revenueand the variable cost of sales.

It is contribution towards covering fixedoverheads and making a profit.


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Principles of Marginal Costing

As fixed costs remain the same:-

(i) revenue will inc. by the sales value

(ii) costs will inc. only by the variablecost per unit

(iii) inc. in profit will equal to the

amount of contribution If sales fall by one unit, profit will fall by

the amount of contribution per unit.


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Continue..

Profit measurement should be based onan analysis of total contribution.

When a unit is made, the extra costsincurred is the variable production cost.

Fixed costs are unaffected when output isincreased.


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Marginal Cost Statement(Next chapter)

Cost per unitDirect material 12Direct labor 8Direct expenses 3Prime cost 23

Add: variable overheads:

Factory 5Selling 7 12Marginal cost 35


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Contribution / Sales ratio (CS ratio)

Also known as profit / volume ratio (PVratio)

If no change in SP, contribution per unitwill be the same at all sales volume.

Constant relationship between

contribution and sales ie. Contribution earned per $1 of sales will

be constant.


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Comparisonof Marginal Costingand Absorption Costing

Marginal Costing

(a) Closing stocks valued at variable

production cost.

(b)Fixed costs charged in full in period

incurred.


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Continue

Absorption Costing

(a) Closing stocks valued at full productioncost and include fixed production cost.

(b) Cost of sales in a period include somefixed OH incurred in a previous period(opening stock ) and exclude somefixed OH in the current period whichis carried forward in closing stockvalues in the next period.


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Example 1

The variable costs of Product A are $10 perunit. The company has undertaken somemarket research which indicates what the

likely sales at each of a number of possibleselling prices would be:

Selling Price $12 $15 $20

Sales (units) 20 10 4.5

The company wants to decide whichselling price it should adopt.


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Answer 1

To determine the optimum price, we need toascertain the price at which the contribution ismaximized:

Selling Price $12 $15 $20 Contribution per unit 2 5 10

Sales 20 10 4.5

Total contribution 40 50 45

Therefore, the company should sell the product at$15 since this will maximize the contribution itmakes.


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Example 2

A company manufactures articles for $6each and normally sells them at $10 each.Fixed costs are $10,000 per month. Thefirm is currently short of work it isselling only 2,000 units a month. It has thechance of an additional contract for 500

units a month for four months if it willaccept a reduced selling price of $8 perunit. Fixed costs will not be increased ifthe contract is accepted. Should the

companyaccept the contract?


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Answer 2

Sale of 2,000 units will give a contributionof $4 per unit

Total mthy contribu = 2,000 x $4 = 8,000 Fixed costs, = 10,000

Loss = 2,000

If the new contract is accepted, the additionalcontribution is 500 x $2 = $1,000

Therefore, the loss is reduced by $1,000


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Example 3

A company manufactures articles at avariable cost of$5 each, and usually sells

them for $10 each. It has the chance ofan additional contract for 600 articles at$9 each but is unsure whether to accept

as fixed costs would be increased by$1,500.


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Answer 3

Contribution per unit on the extra sales

= $4

Total additional contribution = 600 x $4= $2,400

Additional fixed costs

incurred = 1,500 Additional profit 900


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The Contribution Format

Total Unit

Sales Revenue 100,000$ 50$

Less: Variable costs 60,000 30

Contribution margin 40,000$ 20$

Less: Fixed costs 30,000

Net income 10,000$

Thecontribution marginformat emphasizes costbehavior. Contribution margincovers fixed costs

and provides for income.


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The Contribution Format

Used primarily for

external reporting.

Used primarily by

management.


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WiseCo recorded the following production activityand maintenance costs for two months:

Using these two levels of activity, compute:

the variable cost per unit;the fixed cost; and then

express the costs in equation form Y = a + bX.

The High-Low Method

Units Cost

High activity level 9,000 9,700$

Low activity level 5,000 6,100

Change 4,000 3,600$


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Unit variable cost =Changein costChange in units

The High-Low Method

Units Cost



Change 4,000 3,600$


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The High-Low Method

Unit variable cost = $3,600 4,000 units = $0.90 per unit

Units Cost



Change 4,000 3,600$


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The High-Low Method


Fixed cost = Total cost Total variable cost

Fixed cost = $9,700

($0.90 per unit 9,000 units)

Fixed cost = $9,700 $8,100 = $1,600

Units Cost



Change 4,000 3,600$


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Fixed cost = Total cost Total variable cost

Fixed cost = $9,700

($0.90 per unit 9,000 units)

Fixed cost = $9,700 $8,100 = $1,600

Total cost = Fixed cost + Variable cost (Y = a + bX)Y = $1,600 + $0.90X

Units Cost



Change 4,000 3,600$

The High-Low Method


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If sales salaries and commissions are $10,000when 80,000 units are sold and $14,000 when120,000 units are sold, what is the variableportion of sales salaries and commission?

a. $0.08 per unit

b. $0.10 per unit

c. $0.12 per unit

d. $0.125 per unit

Quick Check


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If sales salaries and commissions are $10,000when 80,000 units are sold and $14,000 when

120,000 units are sold, what is the fixedportion of sales salaries and commissions?

a. $ 2,000

b. $ 4,000

c. $10,000

d. $12,000

Quick Check


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How does the high-low method workwhen you have data for more than two

periods? Select the two periods with the lowest

and highest level ofactivity.March 2,510 15,204$April 2,550 14,976$

May 2,480 14,680$

June 2,590 15,108$

July 2,670 15,060$

Low month

High month

Note


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Quick Check

Using the high-low method, estimate the costformula Y = a + bX for the patient admittingcosts.

a. Y = $9,720 + $2.00X

b. Y = $7,050 + $3.00X

c. Y = $8,385 + $2.50X

d. Y = $8,480 + $2.50X

March 2,510 15,204$

April 2,550 14,976$

May 2,480 14,680$June 2,590 15,108$

July 2,670 15,060$

Low month

High month


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Using the high-low method, estimate the costformula Y = a + bX for the patient admittingcosts.

a. Y = $9,720 + $2.00X

b. Y = $7,050 + $3.00X

c. Y = $8,385 + $2.50X

d. Y = $8,480 + $2.50X

March 2,510 15,204$

April 2,550 14,976$

May 2,480 14,680$June 2,590 15,108$

July 2,670 15,060$

Low month

High month

Quick Check

b = = = $2

a = $15,060 $2 2,670 = $15,060 $5,340 = $9,720

$15,060 $14,6802,670 2,480

$380190


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Problems with the high-low method:

Disregards information contained in all of the data

other than the low and the high points. The low and high levels of activity tend to be

unusual.

Always plot the data if you have more than two

points to make sure it even makes sense touse the high-low method.

Note

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Marginal Costing.ppt

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