INDEX

SR.NO

TOPIC
SIGN

1.
Marginal Costing.
2.
3.
4.

Meaning.
Features of Marginal Costing.
Advantages of Marginal Costing.

5.

Disadvantages of Marginal Costing.

6.

Formulas of Marginal Costing.

7.

Absorption Costing.
Meaning.

8.
9.

Advantages of Absorption Costing.

10.

Disadvantages of Absorption Costing.

11.

Marginal Costing V/S Absorption Costing.

12.

Break Even Analysis.

13.

Assumption and Limitations Break-Even Analysis.

14.

Cost-Volume-Profit analysis.

15.

Contribution Analysis.

16.

Conclusion.
Bibliography.

17.

CHAPTER 1
Marginal Costing
The increase or decrease in the total cost of a production run for making one
additional unit of an item. It is computed in situations where the breakeven point has been
reached: the fixed costs have already been absorbed by the already produced items and only the
direct (variable) costs have to be accounted for.
Marginal costs are variable costs consisting of labor and material costs, plus an estimated
portion of fixed costs (such as administration overheads and selling expenses) In companies
where average costs are fairly constant, marginal cost is usually equal to average cost. However,
in industries that require heavy capital investment (automobile plants, airlines, mines) and
have high average costs, it is comparatively very low. The concept of marginal cost is critically

important in resource allocation because, for optimum results, management must concentrate
its resources where the excess of marginal revenue over the marginal cost is maximum.
Also called choice cost, differential cost, or incremental cost.
Like process costing or job costing, marginal costing is not a distinct method of
ascertainment of cost but is a technique which applies existing methods in a particular manner so
that the relationship between profit & the volume of output can be clearly brought out. Marginal
costing ascertains marginal or variable costs & the effect on profit, of the changes in volume or
type of output, by differentiating between variable costs & fixed costs. To any type of costing
such as historical, standard, process or job; the marginal costing technique may be applied.
Under the process of marginal costing, from the cost components, fixed costs are
excluded. The difference which arises between the variable costs incurred for activities & the
revenue earned from those activities is defined as the gross margin or contribution. It may relate
to total sales or may relate to one unit.

The calculation of contribution for a specific product or group of products is done as follows:
Sales Revenue
Less Variable cost of production
Contribution

XXX
XXX
XXF

or the business as a whole, contributions earned by specific products or group of products, are
added so as to calculate the pool of total contribution. The fixed costs of the business are paid
from this pool & then the part of the total contribution which remains becomes the profit of the
business as a whole.
A typical format for marginal costing statement is as below:

Product types or departments A B C Total

Sales Revenue
Less Variable cost of production
Contribution

XXXX
XXXX
XXXX

Less: Fixed Costs

XX

Total Profit

XX

Under marginal costing, for the calculation of profits for individual products or
departments, no attempt is made- only calculation of individual contributions is done. The fixed
cost does not allocated to or gets absorbed by the individual products or departments. Thus,
accounting techniques relating to the treatment of fixed costs will not influence the decisions
which are based on marginal costing system.

Examples of typical problems which require executive decisions are:

a. At a lower price should a particular order be accepted or declined?
b. Should purchase of a particular component be made from an outside supplier or manufactured
within the factory?
c. Concentration should be given on which products?
d. By which profit-mix, profit will be maximized?
e. What should be the effect on the business when an existing department is being closed or a
new department is being opened?
f. To make up for wage rise, what should be the additional volume of business?

g. How by change in sales volumes or sales prices, the level of profit of business be influenced?

CHAPTER 2
Meaning
The increase or decrease in the total cost of a production run for making one additional
unit of an item. It is computed in situations where the breakeven point has been reached: the
fixed costs have already been absorbed by the already produced items and only the direct
(variable) costs have to be accounted for.
Marginal costs are variable costs consisting of labor and material costs, plus an estimated
portion of fixed costs (such as administration overheads and selling expenses). In companies
where average costs are fairly constant, marginal cost is usually equal to average cost. However,
in industries that require heavy capital investment (automobile plants, airlines, mines) and have
high average costs, it is comparatively very low. The concept of marginal cost is critically

important in resource allocation because, for optimum results, management must concentrate its
resources where the excess of marginal revenue over the marginal cost is maximum. Also called
choice cost, differential cost, or incremental cost.
Marginal costing distinguishes between fixed costs and variable costs as conventionally
classified.
The marginal cost of a product is its variable cost. This is normally taken to be; direct
labour, direct material, direct expenses and the variable part of overheads. Marginal costing is
formally defined as: the accounting system in which variable costs are charged to cost units and
the fixed costs of the period are written-off in full against the aggregate contribution. Its special
value is in decision making.
The term contribution mentioned in the formal definition is the term given to the
difference between Sales and Marginal cost. Thus:

MARGINAL COST = VARIABLE COST DIRECT LABOUR

+
DIRECT MATERIAL
+
DIRECT EXPENSE
+
VARIABLE OVERHEADS

CONTRIBUTION = SALES - MARGINAL COST

The term marginal cost sometimes refers to the marginal cost per unit and sometimes to
the total marginal costs of a department or batch or operation. The meaning is usually clear from
the context.

Note:
Alternative names for marginal costing are the contribution approach and direct costing
In this lesson, we will study marginal costing as a technique quite distinct from absorption
costing. Marginal cost is the cost to create one more unit of a product. In a highly automated
environment, this incremental change is likely to be solely the material cost of a product; in a
less automated environment, it may also include the cost of the labor needed to create the
product.
For example, it costs $20,000 to produce 50 units of a green widget, with most of the cost
associated incurred during the setup of the production equipment at the beginning of the
production run. It costs $20,100 to produce 51 units of the green widget, which means that the
marginal cost of the next unit of production is $100. The average cost of producing 51 units of
the green widget is $394 ($20,100 divided by 51 units).

CHAPTER 3
Features of Marginal Costing

Classification of costs into fixed costs & variable costs is done under marginal costing
system. Also semi-fixed or semi-variable cots get further classified into fixed & variable

elements.
To the product, only variable elements of cost, which constitute marginal cost, are

attached.
After the marginal cost & marginal contribution are taken into consideration; price is

fixed.
From the total contribution for any period, fixed cost for the period are deducted.
The profitability of a department or product is decided by the marginal contribution.

At variable production cost, the valuation of work-in-progress & finished product is

made.

But the main features of marginal costing are as follows:

1. Cost Classification:-The marginal costing technique makes a sharp distinction between
variable costs and fixed costs. It is the variable cost on the basis of which production and sales
policies are designed by a firm following the marginal costing technique.
2. Stock/Inventory Valuation:-Under marginal costing, inventory/stock for profit measurement
is valued at marginal cost. It is in sharp contrast to the total unit cost under absorption costing
method.
3. Marginal Contribution: - Marginal costing technique makes use of marginal contribution for
marking various decisions. Marginal contribution is the difference between sales and marginal
cost. It forms the basis for judging the profitability of different products or departments.

CHAPTER 4
Advantages of Marginal Costing
Components and spare parts may be made in the factory instead of buying from the
market. In such cases, the marginal cost of manufacturing the components or spare parts should
be compared with market price while taking decision to make or buy. If marginal cost is lower
than the market price, it is more profitable to make than purchasing from market. Additional or
specific fixed cost may be a relevant cost. Following are the advantages of Marginal Costing

Variable cost remains constant per unit of output and fixed costs remain constant in total
during short period. Thus control over costs becomes more effective and easier. Standards
can be set for variable costs, while Budgets can be established for fixed cost in order to
exercise full control over the total activities.

Marginal costing brings out contribution or profit margin per unit of output, and clearly
brings out the effect of change in activity. It facilitates making policy decisions in a
number of management problems, such as determining profitability of products,
introducing a new product, discontinuing a product, fixing selling price, deciding whether

to make or buy, utilizing spare capacity, profit-planning, etc.

The distinction between product cost and period cost helps easy understanding of
marginal cost statements. Closing inventory of work-in-progress and finished goods are
valued at marginal or variable cost only. This method leads to greater accuracy in arriving
at profit as it eliminates any carryover of fixed costs of the previous period through

inventory valuation.
As a corollary to above, since fixed costs do not enter into product-cost, it eliminates the
process of allocating, apportioning and absorbing overheads and adjusting under and

over-absorbed overheads. Therefore, the method is simpler to operate.

As there is involvement of computation of variable costs only in marginal costing, it is

easy to understand & operate the same.

Among different products or departments, arbitrary apportionment of fixed costs is

avoided & the under-recovery or over-recovery problems are eliminated.

Any attempt of measurement of relative profitability of different products or different

departments becomes complicated due to the arbitrary apportionment of fixed costs.

Analysis of contribution, break even charts & analysis of cost-volume-profit-analysis are
resulted out of a marginal costing system; for making short term decisions all of these are

important.
More uniform & realistic figures are resulted out of marginal costing system because

fixed overhead costs are excluded from valuation of stock & work-in-progress.
Apportionment of responsibility of control can be more easily done since to each level of

management only variable costs are presented over which they have control.
The effects of their decisions can be more readily seen by all levels of management-

sometimes even before taking of an action.

Marginal costing is simple to understand.
By not charging fixed overhead to cost of production, the effect of varying charges per

unit is avoided.
It prevents the illogical carry forward in stock valuation of some proportion of current
years fixed overhead.

The effects of alternative sales or production policies can be more readily available and

assessed, and decisions taken would yield the maximum return to business.
It eliminates large balances left in overhead control accounts which indicate the difficulty

of ascertaining an accurate overhead recovery rate.

Practical cost control is greatly facilitated. By avoiding arbitrary allocation of fixed
overhead, efforts can be concentrated on maintaining a uniform and consistent marginal

cost. It is useful to various levels of management.

It helps in short-term profit planning by breakeven and profitability analysis, both in
terms of quantity and graphs. Comparative profitability and performance between two or
more products and divisions can easily be assessed and brought to the notice of
management for decision making.

Main advantages of Marginal Costing are as follows:

Cost Control: Practical cost control is greatly facilitated. By avoiding arbitrary allocation of
fixed overhead, efforts can be concentrated on maintaining a uniform and consistent marginal
cost useful to the various levels of management.
Simplicity: Marginal Costing is simple to understand and operate; it can be combined with
other forms of costing, such as, budgetary costing, standard costing without much difficulty.
Elimination of varying charge per unit: In marginal Costing fixed overheads are not charged
to the cost of production due to this the effect of varying charges per unit is avoided.
Short-Term Profit Planning: It helps in short-term profit planning by break-even charts and
profit graphs. Comparative profitability can be easily accessed and brought to the notice of the
management for decision-making.
Prevents Illogical Carry forwards: It prevents the illogical carry-forwards in stock-valuation
of some proportion of current years fixed overhead.

 Accurate Overhead Recovery Rate: It eliminates large balances left in overhead control
accounts, which indicate the difficulty of ascertaining an accurate overhead recovery rate.
Maximum return to the business: The effects of alternative sales or production policies can
be more readily appreciated and assessed, and decisions taken will yield the maximum return to
the business.

CHAPTER 5
Disadvantages of Marginal Costing

The technique is based on the segregation of costs into fixed and variable ones, while
many expenses are neither totally fixed nor totally variable at various levels of activity.
Thus, classifying all expenses into two categories of either fixed or variable is a difficult

task.
The assumptions regarding behavior of costs, such as, fixed cost remains static, are often

not realistic.
Contribution is not the only index to take decisions. For example, where fixed cost is
very high, selling price should not be fixed on the basis of contribution alone without

considering other key factors such as capital employed.

Marginal cost, if confused with total cost while fixing selling price may lead to a disaster.
Inventory valuation at marginal cost will understate profits and may not be acceptable by
tax-authorities. Any claim based on cost will be very low, as it will not have a share of
fixed cost.

The process of separating semi-variable or semi-fixed costs into their variable & fixed
elements is an arbitrary exercise which at different levels of output may be subject to
fluctuations & inaccuracy. Consequently, a substantial degree of error may be contained

in the basic cost information which is used in decision making process.

When selling prices are based on marginal costs, great care need to be exercised, as in the
long run, all fixed overheads should be covered by the prices & a reasonable margin

over& above the total costs should be left.

Under many circumstances, the deduction of contribution made by some production units

may be difficult. Thereby the effectiveness of the system is lost.

Since on the basis of variable costs only the valuation of stock of finished goods & work-

in-progress is done, they are always understated. As result profit is also understated.
More effective utilization of present resources or by expansion of resources or by
mechanization, increased production & sales may be effected. The disclosure of this fact

cannot be done by marginal costing.

The separation of costs into fixed and variable is difficult and sometimes gives

misleading results.
Normal costing systems also apply overhead under normal operating volume and this

shows that no advantage is gained by marginal costing.

Under marginal costing, stocks and work in progress are understated. The exclusion of
fixed costs from inventories affect profit, and true and fair view of financial affairs of an

organization may not be clearly transparent.

Volume variance in standard costing also discloses the effect of fluctuating output on
fixed overhead. Marginal cost data becomes unrealistic in case of highly fluctuating

levels of production, e.g., in case of seasonal factories.

Application of fixed overhead depends on estimates and not on the actual and as such

there may be under or over absorption of the same.

Control affected by means of budgetary control is also accepted by many. In order to
know the net profit, we should not be satisfied with contribution and hence, fixed
overhead is also a valuable item. A system which ignores fixed costs is less effective

since a major portion of fixed cost is not taken care of under marginal costing.
In practice, sales price, fixed cost and variable cost per unit may vary. Thus, the
assumptions underlying the theory of marginal costing sometimes becomes unrealistic.
For long term profit planning, absorption costing is the only answer.

Main Disadvantages of Marginal Costing are as follows:

Misleading Results: It is very difficult to segregate all costs into fixed and variable costs very
clearly, since all costs are variable in the long run. Hence such segregation sometimes may give
misleading results.
Distorted Picture of Profits: The closing stock consists of variable cost only and ignores
fixed costs. This gives Distorted Picture of Profits.
Avoids Semi-Variable Costs: Semi-Variable costs are not considered in the analysis.
Problem of Recovery of Overheads: There is problem of under or over-recovery of
overheads, since variable costs are apportioned on estimated basis and not on the actual.

CHAPTER 6
Formulas of Marginal Costing
Marginal cost = prime cost + total variable overheads
Or
Marginal cost = total variable cost.
Contribution = selling price variable (marginal) cost
Or
Contribution = fixed cost + profit (or-loss)
Or
Contribution fixed cost = profit (or loss)
Thus,
Sales = Variable cost + fixed cost + profit (or loss)
Sales = Variable cost = fixed cost + profit (or loss)

P/V = contribution/sales = S/C

Or = [Fixed Costs + Profit/sales] = [F+P/S]
Or = [Sales-Variable Cost/Sales] = [S-V/S]
Break-even Point (units) = Total fixed costs/Contribution per unit [F/C per unit]
Break-even Sales = Total Fixed Costs x selling price per unit / contribution per unit[F/C*S]Fixed
Cost/P/V Ratio [F/P/V]

CHAPTER 7
Absorption Costing
The objective of absorption costing is to include in the total cost of a product an
appropriate share of the organizations total overheads. Overhead is the cost incurred in the course
of making a product, providing a service or running a department, but which cannot be traced
directly and fully to the product, service or department.
Overheads are actually the total of the following: Indirect materials
Indirect labour
Indirect expenses
In cost accounting there are two schools of thoughts as to the correct method of dealing with
overheads: Absorption costing
Marginal costing.
An appropriate share is generally taken to mean an amount which reflects the amount of
time and effort which has gone into producing a unit or completing a job. The theoretical

justification for using absorption costing is that all production overhead are incurred in
production of output so each unit of the product receives some benefits from these cost.
Therefore each unit of output should be charged with some of the overhead costs.
Practical reasons for using absorption costing- Inventory valuations

Inventory in hand must be valued for two reasons

For the closing inventory figure in the statement of financial position
For the cost of sales figure in the statement of comprehensive income
In absorption costing, closing inventory is valued at fully absorbed factory costs.

Practical reasons for using absorption costing- Pricing decisions

Many companies attempt to fix selling prices by calculating the full cost of production or
sales of each product, and then adding a margin for profit.
Without using absorption costing, a full cost is difficult to ascertain.
Practical reasons for using absorption costing- Establishing profitability of different
products
If a company sells more than one product, it will be difficult to judge how profitable each
individual product is, unless overhead costs are shared on a fair basis and charged to the
cost of sales of each product

Absorption of overheads

Absorption of overheads is charging of overheads from cost centres to products or

services by means of absorption rates for each cost center which is calculated as follows:
Overhead absorption Rate = total overheads of cost centre / total quantum of base
The base (denominator) is selected on the basis of type of the cost centre and its
contribution to the products or services, for example, machine hours, labour
quantity produced etc.

Overhead absorption

hours,

 Overhead absorption is the process whereby overhead costs allocated and apportioned to
production cost centres are added to unit, job or batch costs.
Overhead absorption is sometimes known as overhead recovery.
Therefore having allocated and/or apportioned all overheads, the next stage is to add
them to, or absorb them into, cost units.
Overheads are usually added to costs units using a predetermined overhead absorption
rate, which is calculated using figures from the budget.

Calculation of overhead absorption rate.

Estimate the overhead likely to be incurred during the period.

Estimate the activity level for the period.
Divide the estimated overhead by the budgeted activity level.
Absorb the overhead into the cost unit by applying the calculated absorption rate.

Choosing the appropriate absorption base

A percentage of direct materials cost.

A percentage of direct labour cost.
A percentage of prime cost.
A rate per machine hour.
A rate per direct labour hour.
A rate per unit.
A percentage of factory cost (for admin overhead).
A percentage of sales or factory cost (for selling and distribution overhead)

Blanket absorption rate and departmental absorption rate

A blanket overhead absorption rate is an absorption rate used throughout a factory and
for all jobs and units of output irrespective of the department in which they are produced
If a separate absorption rate is used for each department, charging of overheads will be
fair and the full cost of production of items will represent the amount of effort and
resources put in making them
Blanket overhead rates are not appropriate in the following circumstances:--There is more than one department.
--Jobs do not spend an equal amount of time in each department

Over and under absorption of overheads

The rate of overhead absorption is based on estimates (of both numerator and
denominator) and it is quite likely that either one or both of the estimates will nit agree
with what actually occurs
--Over absorption means that the overheads charged to the cost of sales is more than the
overheads actually incurred.
--Under absorption means that insufficient overheads have been included in the cost of
sales
The reasons for over/under absorbed overheads.
The overhead absorption rate is predetermined from budget estimates of overhead cost
and the expected volume of activity.
Over or under recovery of overhead will occur in the following circumstances:
--Actual overhead costs are different from budgeted overhead.
--The actual activity level is different from the budgeted activity level.
--Actual overhead costs and actual activity level differ from the budgeted costs and
levels.

CHAPTER 8
Meaning
A managerial accounting cost method of expensing all costs associated with
manufacturing a particular product. Absorption costing uses the total direct costs and overhead
costs associated with manufacturing a product as the cost base. Generally accepted accounting
principles (GAAP) require absorption costing for external reporting.
Absorption costing is also known as full absorption costing.
Some of the direct costs associated with manufacturing a product include wages for
workers physically manufacturing a product, the raw materials used in producing a product, and
all of the overhead costs, such as all utility costs, used in producing a good.
Absorption costing includes anything that is a direct cost in producing a good as the cost
base. This is contrasted with variable costing, in which fixed manufacturing costs are not
absorbed by the product. Advocates promote absorption costing because fixed manufacturing
costs provide future benefits.
It is a costing technique where all normal costs whether it is variable or fixed costs are
charged to cost units produced.
Unlike marginal costing which take the fixed cost as period cost.
Absorption costing means that all of the manufacturing costs are absorbed by the units
produced. In other words, the cost of a finished unit in inventory will include direct materials,
direct labor, and both variable and fixed manufacturing overhead. As a result, absorption costing
is also referred to as full costing or the full absorption method.
Absorption costing is often contrasted with variable costing or direct costing. Variable costing is
often useful for managements decision-making. A method of costing a product in which all fixed
and variable costs are apportioned to cost centers where they are accounted for using absorption

rates. This method ensures that all incurred costs are recovered from the selling price of a good
or service. Also called full absorption costing.

CHAPTER 9
Advantages of Absorption Costing

It recognizes the importance of fixed costs in production.

This method is accepted by Inland Revenue as stock is not undervalued.
This method is always used to prepare financial accounts.
When production remains constant but sales fluctuate absorption costing will

show less fluctuation in net profit and.

Unlike marginal costing where fixed costs are agreed to change into variable cost,

it is cost into the stock value hence distorting stock valuation.

Absorption costing recognizes fixed costs in product cost. As it is suitable for
determining price of the product. The pricing based on absorption costing ensures

that all costs are covered.

Absorption costing will show correct profit calculation than variable costing in a
situation where production is done to have sales in future ( e.g. seasonal

production and seasonal sales).

Absorption costing conforms with accrual and matching accounting concepts

which requires matching costs with revenue for a particular accounting period.
Absorption costing has been recognized for the purpose of preparing external

reports and for stock valuation purposes.

Absorption costing avoids the separating of costs into fixed and variable elements.
The allocation and apportionment of fixed factory overheads to cost centers
makes manager more aware and responsible for the cost and services provided to

others.
It identifies the importance of fixed costs involved in production.
The absorption costing method is accepted by Inland Revenue as stock is not

undervalued.
The absorption costing method is always used for preparing financial accounts.
The absorption costing method shows less fluctuation in net profits in case of
constant production but fluctuating sales.

CHAPTER 10

Disadvantages of Absorption Costing

Absorption costing, also known as full costing is an accounting method that includes
fixed overhead costs in the cost of goods sold by allocating an equal portion of the overhead cost
to each finished unit of inventory. Absorption costing is the Generally Accepted Accounting
Practices, or GAAP, method and publicly held companies must use this method on their income
statements. While this system has some advantages, particularly for outside analysts, it also has a
number of disadvantages, such as:

As absorption costing emphasized on total cost namely both variable and fixed, it is not

so useful for management to use to make decision, planning and control;

As the managers emphasis is on total cost, the cost volume profit relationship is ignored.

The manager needs to use his intuition to make the decision.

Absorption costing is not useful for decision making. It considers fixed manufacturing
overhead as product cost which increase the cost of output. As a result, it does not help in
accepting specially offered price for the product. Various types of managerial problems

relating to decision making can be solved only with the help of variable costing system.
Absorption costing is not helpful in control of cost and planning and control functions. It
is not useful in fixing the responsibility for incurrence of costs. It is not practical to hold a

manager accountable for costs over which he/she has not control.
Some current product costs can be removed from the income statement by producing for
inventory. As such, managers who are evaluated on the basis of operating income can

temporarily improve profitability by increasing production.

Since absorption costing emphasized on total cost that is to say both variables as well as

fixed, it is not useful for management to use to make decision, control, and planning.
Besides, since the manager emphasizes on the total cost, the cost volume profit
relationship is ignored. The manager, therefore, needs to use his intuition for decision

making.
Absorption costing can artificially inflate your profit figures in any given accounting
period. Because you will not deduct your entire fixed overhead if you havent sold all of
your manufactured products, your profit-and-loss statement does not show the full
expenses you had for the period. This can mislead you when you are analyzing your
profitability.

Some of the important disadvantages of absorption costing are as follows:

1) Inadequate for Managerial Decision Making

Because absorption costing allocates fixed overhead costs to the unit level, it
makes it appear as though additional units produced add overhead cost, when in fact they are
revenue opportunities. If a company makes 100 baseballs per month for a variable cost of $4
and fixed overhead costs are $100 per month, absorption costing allocates $1 to each baseball
for a total cost of $5 per baseball. If the company has an opportunity to sell another 10
baseballs at $4.50 each, absorption costing makes it look as if the company is taking a loss of
$.50 each, when in fact it is making$.50 each because it is not adding fixed cost by producing
10 more units, only variable cost.

2) Costs Hides in Inventory

Inventory shows as an asset on a companys balance sheet. Since the company
allocates fixed overhead to the finished unit level in absorption costing, until the company
sells a unit, the cost does not show up as an expense, or Cost of Goods Sold. This means that
if a company builds10,000 units of a finished good in a period, with $1 fixed overhead
allocated to each unit, and sells only 1,000 of those units, $9,000 of the fixed overhead
incurred in that period will show on the balance sheet as an asset, rolled into the cost of
inventory, instead of as a cost.

3) Unsuitable for Irregular Volume

In theory, if a company using absorption costing produces and sells an equal,
steady amount of units each period, absorption costing will accurately reflect the true cost of
goods sold. However, if production or sales are irregular, this method of costing will make it
appear that fixed overhead and variable costs fluctuate with sales. In fact, the level of
production or sales does not affect fixed overhead costs, and only the level of production
affects variable costs. For irregular production and sales patterns, variable costing gives a
much clearer picture of the costs of running the business.

4) Considerations

Absorption costing has its benefits, particularly for external reporting. The fact
that absorption costing combines variable and fixed costs allows a company to report its
profits to shareholders without disclosing too much detail to competitors. In addition, since
the business includes costs as an inventory asset on the balance sheet until it sells the
inventory, this method sometimes benefits a slow quarters metrics. The alternative to
absorption costing, known as variable costing, presents costs in a way that internal decision
makers find useful. A well-informedmanager will look at costs using both methods.

CHAPTER 11
Marginal Costing V/S Absorption Costing

The difference between Marginal costing & absorption costing is as below:

1. Under Marginal costing: for product costing & inventory valuation, only variable cost is
considered whereas, under absorption costing; for product costing & inventory valuation, both
fixed cost & variable cost are considered.
2. Under Marginal costing, there is a different treatment of fixed overhead. Fixed cost is
considered as period cost & by Profit/Volume ratio (P/V ratio), profitability of different products
is judged. On the other hand, under absorption costing system, the fixed cost is charged to cost of
production. A reasonable share of fixed cost is to be borne by each product & thereby subjective
apportionment of fixed overheads influences the profitability of product.
3. Under Marginal costing, the presentation of data is so oriented that total contribution &
contribution from each product gets highlighted. Under absorption costing, the presentation of
cost data is on conventional pattern. After deducting fixed overhead, the net profit of each
product is determined.
4. Under Marginal costing, the unit cost of production does not get affected by the difference in
the magnitude of opening stock & closing stock. Whereas, under absorption costing, due to the
impact of the related fixed overheads, the unit cost of production get affected by the difference in
the magnitude of opening stock & closing stock.

CHAPTER 12
Break Even Analysis

Break even point means the point of no profit and no loss. BEP is the volume of output
or sales at which the total cost is exactly equal to the revenue. Below the BEP the concern makes
losses, at the BEP, the concern makes neither profit nor loss, above the BEP, the concern earns
profits. The focal point of this analysis is the determination of the sales volume (in pesos or in
units) that will equal its total revenues to its total costs, thus, where the profit equals zero. As
stated earlier, since direct connection of expenses to production cannot be conclusively
established under functional classification of costs, analysis under CVP, as well as BE analysis,
is directed towards cost behavior. Thus, if we reclassify our costs from functional to behavioral,
our income statement would look like this:

Sales

xx

Less: Variable Cost (VC)

(xx)

Contribution Margin (CM)

xx

Less: Fixed Cost

(xx)

Profit (loss)

xx

Contribution Margin (CM) is the excess of sales over variable cost or the excess from
sales when variable costs are deducted. It can be computed per unit or total. In computing for the
CM per unit, simply deduct the VC per unit from the selling price of each unit. This is also
synonymous with marginal income, marginal balance, profit contribution and others.
Break-even analysis is an analytical technique that is used to determine the probable
profit at any level of production. It is basically an extension of marginal costing.
Break-even point is that point at which there is neither profit nor loss. It is at point costs
are equal to sales. It is otherwise called as balancing point, neutral point, equilibrium point, loss
ending point, profit beginning point etc. After BEP is achieved, all the further sales will
contribute to profit.

At BEP, Sales Variable cost = Fixed costs. OR Contribution = Fixed costs.

Break-even Point is the representation position of that volume of sales or production
which has no profit no loss. It means total sales are just equal to total cost.

Advantages of Break-even analysis:

1. Profit planning
2. Product planning
3. Activity Planning
4. Lease Decisions
5. Make or buy decisions
6. Capital profit decisions
7. Distribution channel decisions
8. Price decisions
9. Choosing Promotion Mix
10. Decision regarding profitability of products or department.

CHAPTER 13
Assumption and Limitations Break-Even Analysis

1. All costs are classified as either fixed or variable. If not impossible or impractical, dividing
costs into the variable and fixed cost elements as an extremely difficult job. This is attributable to
the inherent nature or characteristics of the cost per se.
2. Fixed costs remain constant within the relevant range. Fixed costs remain unchanged at any
level of activity within the relevant range, even at the zero level.
3. The behavior of total revenues and total costs will be linear over the relevant range, i.e. will
appear as a straight line on the BE chart. This is based on the idea that variable costs vary in
direct proportion to volume; the fixed costs remain unchanged, hence drawn as a straight
horizontal line on the graph within the relevant range; and that selling price is constant.
4. In case of multiple product companies, the selling prices, costs and proportion of units (sales
mix) sold will not change. This cannot always be correct. Sales mix ratio may be due to the
change in the consuming habits of customers. Selling prices of the individual products may
likewise change due to competition, popularity and salability of the products, etc.
5. There is no significant change in the inventory levels during the period under review. Stated in
another way, production volume is assumed to be almost (if not exactly) equal to the sales
volume, which causes an immaterial (or none at all) difference between the beginning and ending
inventories.
6. Other assumptions which have already been discussed in the preceding numbers, are again
credited and highlighted here as follows:
Unit selling price will remain constant.
Unit variable cost will not change prices of the factors of production like material (This
may include costs, labor costs etc.)
There will be no change in efficiency and productivity.
The design of the product will not change.(A change in the product may bring about a
change and production the design of in production costs, selling price volume.

CHAPTER 14
Cost-Volume-Profit analysis

Cost-Volume-Profit (CVP) Analysis is defined as a systematic examination of the

relationships among costs, activity levels, or volume, and profit. CVP analysis establishes the
relationship of profit to level of sales. And one of these relationships is the Break-even analysis.
Direct connection of expenses to production cannot be conclusively established under
functional classification of costs, analysis under CVP is directed towards cost behavior; the way
costs behave or change with respect to a change in the activity level. Costs can be classified
according to its behavior as:

Fixed Costs
These are costs that do not change regardless of changes in the level of activity within a
relevant range. In other words, they remain constant regardless of the change in the activity level
per total; however, fixed cost per unit is inversely proportional to the activity level.

Variable Costs
In total, these costs change directly and proportionately with the level of activity. As the
activity level increases, variable cost per total will also increase proportionately to the increase in
activity level. However, variable cost per unit remains constant, within the relevant range.

Semi-Variable Costs
Costs that varies with the change of activity level but not proportionately, they are called
semi-variable costs. They may either increase at an increasing rate or increase at a decreasing
rate. A typical example of this is the cost of electricity (increasing at an increasing rate) because
it is subject to graduated brackets, thus, the greater the consumption, the higher the rate per
kilowatt hour as they will be categorized in a higher bracket.

Semi-Fixed Costs

This kind of costs has the characteristics of both variable and fixed cost and is usually
known as the step function cost or step cost. Like semi-variable cost, semi fixed cost increases
with activity level but not proportionately. And like fixed cost, it is constant for some stretches of
activity levels.

Mixed Costs
Costs that cannot be identified by a single cost behavior pattern are called mixed costs.
This kind of cost is composed of variable and fixed cost. We have concluded earlier that costs are
more meaningful when they are classified according to behavior. When costs therefore are
mixed, it is important that we know how to segregate them. Some tools and techniques popularly
used are the High-Low Method, Scatter Graph Method, Regression Analysis, and Correlation
Cost-Volume-Profit analysis is the analysis of three variables, i.e. cost, volume and profit.
Cost-Volume-Profit analysis helps the management in profit planning.
Profit of a concern can be increased by increasing the output and sales or reducing cost.

The most significant single factor in planning of the average business is the relationship
between the volume of business, its costs and profit.

-HEISER

CHAPTER 15
Contribution Analysis

Contribution is the most important concept in Marginal costing. It is, as seen above equal
to Sales Less Variable Cost. Contribution is the profit before adjusting the fixed costs. Marginal
costing is concerned with the `product costs` rather than the `periods costs`.
Contribution indicates the:
Product profit = product Income product cost
i.e. Contribution = sale Value Variable cost.
Marginal costing assumes that ht excess of sales value over variable costs contributes to a
fund which will cover fixed costs as well as provide the concern`s profits. The amount of
contribution is credited to the marginal profit and loss account. The fixed costs are debited to the
marginal profit and loss account. If the contribution is equal to the fixed costs, the concern is said
to break- even profit. If the contribution is less than the fixed costs, there will be net loss. Thus,
the fixed costs which are period costs do not affect the product cost. Fixed costs are directly
adjusted in the profit and loss account prepared for the relevant period. The concept of
contribution plays a key role in assisting the management in taking many important decisions
such as
1. Deciding the break-even point,
2. Deciding which article to produce, or continue or discontinue to produce,
3. Deciding the quantity of each article to be produce or sold,
4. Fixing the selling price, especially in a trade depression, or for a special order.

The difference between contribution and accounting profit is explained below.

Contribution
1. It is a concept used in Marginal costing.
2. It is before deducting Fixed Costs.
3. At break- over point, Contribution is equal to fixed cost
Profit
1. It is an accounting concept.
2. It is after deducting Fixed Costs.
3. Profit arises only when Sales go beyond the break- even point.

CHAPTER 16
Conclusion

Marginal cost is the cost management technique for the analysis of cost and revenue
information and for the guidance of management. The presentation of information through
marginal costing statement is easily understood by all managers, even those who do not have
preliminary knowledge and implications of the subjects of cost and management accounting.
Absorption costing and marginal costing are two different techniques of cost accounting.
Absorption costing is widely used for cost control purpose whereas marginal costing is used for
managerial decision-making and control.
The following are the criticisms towards absorption costing:
1. A portion of fixed cost is carried over to the subsequent accounting period as part of closing
stock. This is an unsound practice because costs pertaining to a period should not be allowed to
be vitiated by the inclusion of costs pertaining to the previous period and vice versa.
2. Absorption costing is dependent on the levels of output which may vary from period to period,
and consequently cost per unit changes due to the existence of fixed overhead. Unless fixed
overhead rate is based on normal capacity, such changed costs are not helpful for the purposes of
comparison and control. The cost to produce an extra unit is variable production cost. It is
realistic to the value of closing stock items as this is a directly attributable cost. The size of total
contribution varies directly with sales volume at a constant rate per unit. For the decision-making
purpose of management, better information about expected profit is obtained from the use of
variable costs and contribution approach in the accounting system.

CHAPTER 17
Bibliography

costaccounting.blogspot.com
www.accountingtools.com
www.investopedia.com
basiccollegeaccounting.com