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MODULE V
Cost Volume Profit analysis-Standard costing- Analysis of Material and Labour Variances
MARGINAL COSTING
The basic objectives of Cost Accounting are cost ascertainment and cost control
...
Marginal costing
and Break even analysis are important techniques used for cost control and decision nmaking
...
It is the
addition made to total cost when the output is increased by one unit
...
Marginal cost of nth unit = Total cost of nth unit- total cost
Eg
...
5000
...
e, 101
of n-1
units, total cost is Rs
...
Then marginal cost of 101th unit is Rs
...
The chartered Institute of Management Accountants [CIMA] England defines Marginal as "the amount
atany
given volume of output by which aggregate costs are changed if the volume of output is increased or
decreased by one unit
MARGINAL COSTING
It is the technique of costing in which only marginal costs or variable are charged to output or production
...
Fixed costs are not charged to output
...
Therefore, these fixed costs are directly transferred to Costing Profit and Loss
Account
...
of
assumed that all costs can be classified into fixed and variable costs
...
Variable costs
in direct
proportion with
the volume of
output
...
Fixed costs
marginal
are
first
an
index of
profitability
...
It is
not
met out of contribution and
profit
...
only
fixed relationship with sales
...
Contribution = Sales --Variable cost
Marginal cost equation
Sales-Variable Cost = Contribution
Contribution = Fixed costs + Proit
Therefore, Fixed cost = Contribution-Profit
PROFIT VOLUME RATIO [PV RATIOJ
...
an
absolute
measure
of profitability but it
Therefore, the contribution is related
cannot
to volume
be used for
comparison
of two
products
or
of sales
...
profitability
of the
product
will also be
higher
...
It is
Marginal cost statement
The
Marginal
cost statement
is a profitability statement prepared
prepared in the following format
...
It is simple to understand and easy to apply to any firm
2
...
Fixed costs are transferred to costing profit and
Loss account
...
It also prevents the illegal carry forward in stock valuation of some proportion of current years fixed cost
...
The effect of different sales mix on profit can be ascertained and management can adopt the optimum sales mix
5
...
Disadvantages
Important disadvantages of marginal costing are
1,All Assumptions of marginal costing are not appropriate
...
2
...
3
...
4
...
5
...
BREAK EVEN ANALYSIS
Every business is interested in ascertaining the breakeven point
...
It is the point of no profit or no loss
...
The firm ceases to incur losses at this point or it
starts to earn a profit from this point
...
43|P a Be
1
...
Break even point in value = Total Fixed costs or Total Fixed cost x sales/ P/V Ratio Contribution
3
...
P/V Ratio
2
...
Breakeven point in Value
Given:
Selling price per unit Rs
...
12
Fixed costs Rs
...
PV Ratio = Contribution/Sales x 100=20-12/20x100 = 40 %
2
...
Breakeven point in value = Fixed costs = 32000/40 x100 = Rs
...
The fim can decide upon the target return or profit in advance
...
The volume of sales required to achieve the desired level of profit may be
computed as follows -
Number of units to be sold = Fixed costs + desired Profiv Contribution per unit
Sales volume required = Fixed costs+ Desired Profits/ P/V Ratio
Illustration 3
Product A is sold at a unit selling price of Rs
...
32
...
40000
...
The number of units to be produced to break even
2
...
10000
Solution
Contribution = SP-VC = 40-32 = 8 per unit
1
...
Number of units to be sold to
Fixed Cost
+
Desired Profit
earn a
=
4000/8
5000 units
...
10000
40000+10000/8
=
=
=
6250 units
Contribution per unit
Break Even Chart
It is the
graphical presentation
fixed costs
...
point
...
It is constructed using a database of variable costs, fixed costs, total costs and sales
Output,
The units of output
and sales
are
or
sales
plotted along
revenue are
plotted along
the X
axis, using
the Y axis
...
It forms
a
measurement
...
The variable cost line is plotted next, starting
from zero it progresses continuously indicating that the variable cost increase with the volume fixed cost line of
sales
...
It starts from the fixed cost line on the Y axis and
follows the same patterm of variable cost line
...
It starts from the zero and progresses
continuously, indicating that the sales increase with larger units of output
...
A vertical line drawn to the X axis from this point shows the
volume of output required to Break even
...
The width
of the angle represents the rate of profitability i
...
It is the excess of
actual sales over break even sales
...
Margin of safety
Margin
of safety
=
Actual sales- Break even sales
=
Profit/P/V Ratio
Or Profit margin ofsafety x P/V Ratio
Illustration 5
Calculate BEP and Margin of safety from the following?
Sales 50000 units @ Rs
...
3 per unit
Variable overhead Rs
...
75000 per annum
Solution- BEP
75000
Fixed Cost
=
=
37500 units
SP- VC per unit 6-4
BEP in value = 37500 x 6= 225000
Margin of safety
=
Actual sales
-
BE sales
=
[50000x6]-225000= Rs
...
Period I Period II
Sales 300000 320000
Total cost 260000 272000
Calculate
1
...
Profit when sales are Rs
...
3
...
50000
Solution:
P/V Ratio Change in Profit
Change in Sales
=
profit
Change
in
Change
in Sales
=
=
x
100
48000-40000= 8000
320000-300000
=
Rs
...
BEP
=
=
Contribution
Fixed
Profit
=
are
Profit
-
8000/40
=
100
x
=
Rs
...
360000
360000x40/100
Contribution
=
Rs
...
Profit when sales
Contribution
40/100
x
144000-80000=Rs
...
50000
required to earn a profit
Fixed cost + Profit required
Contribution required
P/V ratio
Sales Contribution requires/
3
...
325000
Analysis [ CVP Analysis)] (5 marks)
is a n a r r o w
volume on profit
...
volume profit analysis
...
It helps management
Cost-Volume Profit
analysis the relationship
planning,
decision
between cost, volume and
profit
cost control
...
variable components
...
e,
at
The
ever output is produced,
the same is sold
during that
period
...
When the output is zero, total
When the output
recovered gradually when the volume of output is increased
...
The fixed costs are
reaches the Break even point, the whole fixed costs are recovered
...
and the amount of profit increases with the increase in sales volume
...
The
important
uses
of
marginal costing
and Break Even analysis are the following
1
...
Once BEP is found
out
the
management
can
even
point
...
2
...
In marginal costing all costs are classified into fixed and
variable elements
...
But variable costs can be controlled by
managerial actions
...
3
...
II
...
IV
...
VI
...
VII
...
X
...
Fixation of selling price
actually the profit plus
Selling price
is
Sometimes a
firm may receive
cost
...
In marginal
depressed market,
sales
...
which gives the positive contribution is profitable
product
costing any
Offer
Accepting Special Offer / Export
the current selling price
...
This
quoted
price
any
technique,
costing
Marginal
According
If the new offer is accepted,
in the domestic market and making a profit
...
However,
and therefore the total profit of the
the contribution from such offer is purely profit
and there is no increase in fixed
confirmed that it is within the capacity
before accepting the offer, it should be
to
COsts as a result of increasing the output
Selection of a Product/ sales mix
The
shows
mix
...
Therefore, the company
marginal costing technique
is useful for
which
higher PV ratio is
shows the highest P/V ratio so as to maximize profits
...
Here, the
the supplier's price, it is profitable to
the supplier
...
the
component
produce
to buy the component from outside
...
Should this product
product
be discontinued
...
factor or
of operation of the firm
...
when
or
scarce supply
materials, labour hours production
Sometimes a firm may be confronted with
of the limiting factor is
that gives a higher contribution per unit
the
in
factor
product
operation,
a
there is limiting
the
of the limiting factor and choose
therefore contribution is related to unit
than
more profitable
other products
...
The CIMAIerminologydefinesthis term as,"abenchmark measurement ofresources usage, setin
defined conditions
Standardcostis apredeterminedoperatingcostcalculated from management'sstandards ofefficientoperation
and
the relevant necessary expenditure
...
Cost control
2
...
Fixation of selling price
4
...
Estimated cost is a pre determined
cost for a future period under normal conditions of operations
...
Cost estimation is made
for submitting tenders or quoting
Definition of standard costing:
price of a product or a
unit of
services
Standard costing is a technigque of cost control
...
" In standard costing the actual costs incurred are compared with the standard costs
...
Features: The following are the important characteristics of the standard costing system
1
...
It makes a comparison of actual cost with standard cost
3
...
Variances
are
reported to management for the purpose of decision making
Standard costing and Budgetary control
Both standard
costing
and
budgetary
control
similar in
principle
since both are concerned with setting
performance and cost levels for control purposes
...
are
Budgetary
control and standard costing are
Distinction between standard costing and budgetary control:
inseparably
linked
together
...
Budget is based on past performance, while standard is established on the basis of technical estimates
...
Budgets consider both income and
expenditure whereas standards are for
expenditure only
...
Budgets projects financial accounts, while standard cost project cost accounts
4
...
5
...
7
...
Budgets are used for the forecasting men, money and materials,
Budgetary
control
technique
is
applicable to all types
manufacturing organizations
8
...
of businesses
...
But standard
in total
...
analysis
Budgetary control does
product
...
Performance measurement
2
...
Stock valuation
4
...
Profit planning and decision making
6
...
Assisting establishment of budgets
Basic requirements of standard costing:
a
...
b
...
c
...
The manual
should describe the system to be introduced and the benefits thereof
...
Type of standards: It is very necessary to determine the type of standard to be used, whether current, basic or
normal standard
...
Co-operation of Executives and staff:- Without the co-operation of the executives and staff, it is very difficult to
run the standard costing system
...
Fixation of standards: Standard should be set for each element of cost and it should be scientific
...
Establishment ofcost centres: A cost centre is a location, person or item of equipmentfor which costs may be
ascertained and used for the purpose of cost control
...
2
...
3
...
Standards are always established scientifically
...
Ascertainment of actual cost: Measuring the actual cost which is incurred in the next stepin the standard costing
...
Comparison of Standard cost and Actual cost
...
Analysis of Variances
7
...
Basic standards: A standard established for use over a long period is known as the basic standard
...
Its use is to show long term trends, and it operates in a similar way to index numbers
...
This standard is used for items or costs which are likely to remain
constant over a long period
...
Current standard: A standard established for use over a short period of time and related to current conditions, is
known as the 'current standard"
...
Conditions during which period the standard is used are known as current conditions
...
Ideal standards & Expected standards:- Ideal standard is that which can be attained under the most favourable
conditions, while expected standard is that which is expected to be attained during a specified budget period
...
49 | P a ge
4
...
"It is difficult to follow normal standards in
practice as it is not possible to forecast performance with a reasonable degree of accuracy for a long period of time
...
It is the
deviation of actual cost from the standard cost
...
If the actual cost is less than the standard, the
difference is known as favourable or positive variance and it is symbol of efficiency
...
Analysis of variance means carrying out the
appropriate investigation to identify the reasons for the variance
...
Such variance can be corrected by taking a suitable action
...
reasons like increase in prices of material, labour etc it is a case of uncontrollable variances
...
It includes
I
...
Direct labour variance
3
...
Sales variance
MATERIAL VARIANCES
It includes:
a
...
It may be expressed as:
MCV=Standard cost of materials for actual output - Actual cost of materials used
Std
...
Material Price Variance (MPV): It is that
portion of the material cost variance which is due to the difference
between the standard cost of materials used for the output achieved and the actual cost of materials used
...
actual
d
...
MUV
variance
output and the
=Std price per unit (Std qty
Actual
cost
qty)
Material Mix Variance (MMV): It is that portion of the material usage variance which is due
to
the difference
between standard and actual composition of a mixture
...
In case of material mix
variance, two situations may arise:
Actual weight of mix and the A