Marginal costing

The supreme goal of every manager is make profit . To achieve this management has to take
several decisions regarding the marginal unit, the product mix, pricing, make or buy. It has to
ascertain the cost which are controllable and establish a mechanism to control them. Marginal
costing is an effective technique applied by the management in taking several decisions and
controlling cost. The application of marginal is explained below.

(1) Decision Regarding The Marginal Unit

It means a single additional unit or an additional block of units such as a batch of articles, an
order, a process, a department and so on. Management .Management has to frequently take
decisions regarding the additions or discontinuance of the Marginal Unit. Thus,
Management has to decide whether to
· increase or decrease the production of a single article
· continue or discontinue a batch of articles
· accept or reject a specific order
· continue or discontinue a specific process
· add or discontinue a department, and so on.
(2) Decision Regarding Optimum Product-mix
Marginal Costing helps the management in deciding the most profitable product-mix. The
Break- even Chart and the Profit- Volume Ratio for each product can be studied to decide
upon the quantity of each product to be produced so as to earn the maximum Contribution
and Profits. That Product-Mix which yields the maximum possible profits is the optimum
Product-Mix.
(3)Decision Regarding Utilisation of Scarce Resource
If any resources such as labour, machinery, raw material or finance are in short supply, the
Contribution in relation to the Key Factor can be worked out. The product which yields the
highest Contribution per unit of the scarce factor (Contribution per Labour Hour etc.) can be
produced in large quantities to derive the maximum profits possible.
(4) Decision Regarding Pricing
Marginal Costing helps the management in taking price decisions. In Absorption Costing, the
prices are fixed so as to cover the total costs which include Fixed Costs as well as
Variable Costs. In Marginal Costing, however, the price can be fixed on the basis of only
Variable Cost
Thus prices can be fixed so as to -
(a) Earn Maximum Contribution: Marginal Costing Techniques such as Profit Volume Ratio are
L_
especially helpful in fixing the selling price for submitting quotations or tenders.
(b) At Least Break-even. i.e. earn just enough to cover the costs. Thus if the product is
perishable or seasonal, it is advisable to at least break even, i.e. sell on no profit no loss basis.
The technique of Break-even Charts is useful in deciding the break-even point. It assists in
deciding the minimum quantity to be sold or the minimum price to be charged in order to break-
even.
(a) Recover At Least the Marginal Costs, e.g. in the following circumstances -
 (i) Depression: When there is trade depression, the concern must survive
somehow. Even if the production is stopped, the Fixed Costs will continue.
Hence it is better to continue the production so as to retain the trained
labour, staff and the consumers. The plant will also remain in working
condition. This will avoid the costs of closing down and re-starting again when
the trade conditions improve.
(11) Eliminate Competition: When the concern wants to eliminate competition, it may
initially sell at the Marginal Cost. Thereafter once the competition is eliminated, it will
enjoy monopoly, can charge higher prices and recover its losses.

(111) Establish New Product: When the concern wants to introduce or popularise a new
product, initially, it may sell at the Magrinal Cost. Once the product is established, it
can increase its prices and recover its losses. The same strategy can be applied in
case of a special order, or for an export order etc.
(5) Decision Regarding Make or Buy
Management has to decide whether it would be more profitable to manufacture a product
or a. component in-house rather than buying it from outside. Thus-
(1) The concern should make ail article itself if its Mar g inal Cost is lower than the
market price of the article. Thus,
Make Article A if Marginal Cost of A < Market Price of A

(1) If theB)
(say machinery
has to be being used
diverted forfor producing
making C7 another article
For making Article A the concern itself should make the article A, only if the Market Price of
article A is more than the total of the Marginal Cost of A + Contribution of Article B which will be
lost.
Make Article A if [Marginal Cost of A + Contribution of B] < Market Price of A

(6) Cost Control

Marginal Costing deals with Variable Costs which are easier to control. Fixed Costs arise in
relation Margina
time and hence are not controllable in the short run. Thus, once the rent of the factory premises is
fixed by agreement , the management has no control over it. The Variable Costs, on the
are the direct costs of material, labour and expenses which are amenable to control. Flexible
Budgets help the management in controlling the marginal costs. Break-even Charts and PV Ratios
also help the management in controlling cost and maximising the profits

Illustration 1 :
From the following data, calculate break-even point (BEP) in units as well as value.
Rs.
Selling price per unit 20
Variable cost per unit 15
Fixed overheads 20,000
If sales are 20% above BEP, determine the net profit.

Illustration 2:
(i) Find out contribution and BEP sales if Budgeted Output is 80,000 units. Fixed Cost is Rs.
4,00,000, Selling Price per unit is Rs. 20. Variable Cost per unit is Rs. 10
(ii) Find out Margin of safety, if profit is Rs. 20,000 and PV Ratio is 40%.
Illustration 3:
From the following data, calculate:
(i) Break-even point expressed in amount of sales in rupees.
(ii) Number of units that must be sold to earn a profit of Rs. 1,60,000 per year.
Selling price Rs. 20 per unit
Variable manufacturing cost Rs. 11 per unit
Variable selling cost Rs. 3 per unit
Fixed factory overheads Rs. 5,40,000 per year
Fixed selling cost Rs. 2,52,000 per year

Illustration 4
Sales Rs. 1,00,000, Profit Rs. 10,000, Variable Cost 70%. Find out (a) PV ratio (b) Fixed cost and
(C) Sales to earn of profit Rs. 40,000.

Illustration 5:
Profit Volume Ratio of a company is 50%, while its margin of safety is 40%. It sales volume of the
company is Rs. 50 lakhs, find out its break-even point and net profit.

Illustration 6:
(1) Ascertain Profit, when Sales Rs. 2,00,000
Fixed Cost Rs. 40,000
BEP Rs. 1,60,000
(2) Ascertain Sales, when Fixed Cost Rs. 20,000
Profit Rs. 10,000
BEP Rs. 40,000

Illustration 7: (PVR, BEP, MS & New Sales)

S. Ltd. furnishes you the following information relating to the half year ending 30th Sept. 2003
Rs.
Fixed expenses 50,000
Sales value 2,00,000
Profit 50,000
During the second half of the same year the company, has projected a loss of Rs. 10,000.
Calculate -
(i) The P/V Ratio, break-even point and margin of safety for six months ending 30th Sept., 2003.
(ii) Expected sales value for second half of the year assuming that selling price and fixed
expenses remain unchanged in the second half year also.
(iii) The break-even point and margin of safety for the whole year 2003-2004.

Illustration 8: (Ascertaining PYR, FC, BEP, New Sales, New Profit)

Particulars Sales Profit
Rs. Rs.
Period 1 10,000 2,000
Period 2 15,000 4,000
You are required to calculate: -
(a) PV ratio, (b) Fixed Cost, (c) Break-even sales volume, (d) Sales to earn a profit of Rs. 3,000
and (e) Profit when sales are Rs. 8,000.

Illustration 9: (BEP - Amount & Units)

A company sells its product at Rs. 15 per unit. In a period if it produces and sells 8,000 units, it
incurs a loss of Rs. 5 per unit. If the volume is raised to 20,000 units it earns a profit of Rs. 4 per
unit. Calculate break-even point both in terms of rupees as well as in units.

Illustration 10: (Sales From BEP)

From the following data find out (i) sales and (ii) new break-even sales, if selling price is reduced by 10%.
Particulars Rs.
Fixed Cost 4,000
Break-even sales 20,000
Profit 1,000
Selling price per unit 20

Illustration 11: (PVR & FC)

Calculate PV Ratio and Fixed expenses from the following:
Margin of Safety Rs. 80,000
Profit Rs. 20,000
Sales Rs. 3,00,000

Illustration 12: (Sales From PVR, BEP)

The ratio of variable cost to sales is 70%. The break-even point occurs at 60% of the capacity
sales. Find this capacity sales when fixed costs are Rs. 90,000. Also compute profit at 75% of the
capacity sales.

Illustration 1 : (Export Order)

The cost sheet of a product is as follows:
Particulars Rs. per
unit
Direct Material 10.00
Direct Wages 05.00
Factory Overheads
Fixed 01.00
Variable 02.00
Administrative Expenses (fixed) 1.50
Selling and Distribution Expenses:
Fixed
Variable 00.50
Cost of Sales 01.00
21.00
The selling price per unit is Rs. 25.00. The above cost information is for an output of 50,000 units,
whereas the capacity of the firm is 60,000 units. A foreign customer is desirous of buying 10,000
units at a price of Rs.19 per unit. The extra cost of exporting the product is Rs. 0.50 per unit. You
are required to advise the manufacturer whether the order should be accepted?

Illustration 2: (Discontinue A Product)

A manufacturing company makes two product - Luxury and Delux. The results for 2009 were as under:
Particulars Luxury Delux
Rs. Rs.
Sales 2,00,000 1,60,000
Variable Cost 1,20,000 1,32,000
Fixed Cost 40,000 32,000
Profit/Loss 40,000 (-) 4,000
The managing director has suggested that Delux should be dropped. Should Delux be dropped, if:
(1) His decision has no effect on sales of luxury; or
(2) By using the vacant factory space, sales of luxury could be increased by Rs. 1,00,000 the extra
production would lead to increase in the total fixed cost to Rs. 76,000.
(3) If deluxe is discontinued fixed cost would be nil for the product.

Illustration 3 (Discontinue Division C)- XYZ Ltd. has three divisions each of which makes a
different product. The budgeted data for the next year are as follows:
A B C
Sales 1,12,000 56,000 84,000
Costs:
Direct material 14,000 7,000 14,000
Direct labour 5,600 7,000 22,400
Variable Overhead 14,000 7,000 28,000
Fixed costs 28,000 14,000 28,000
Total Costs 61,600 35,000 92,400
Profit/(Loss) 50,400 21,000 (8,400)
The management is considering to close down Division C. There is no possibility of reducing fixed
costs. Advise ‘whether or/not Division C should be closed down?

Illustration 4 ( temporary cessations of operations/ shut down point) - ABC Ltd. operates at
normal capacity. It produces 20,000 units of a product from plant 111. The unit cost of
manufacturing at normal capacity is as follows: (Rs.)
Direct materials 6.50
Direct labour 2.60
Variable overhead 3.30
Fixed overhead
4.00

Each unit of the product is sold for Rs. 20 with variable selling and administrative expenses of 60
paise per unit c product. The company excepts that during the next year only 2,000 units can be
sold. Management plants to shut-down the plant, estimating that the fixed manufacturing overhead
can be reduced to Rs. 45,000 for the next year. When the plant is operating the fixed overhead
costs are incurred at a uniform rate throughout the year. Additional costs of plant shut are
estimated at Rs. 15,000. Should the plant be shut-down? Show computations. What is the shut-
down point?

Illustration 5: ( selection of product mix )

From the following date you are required to present the best alternative

Particulars Product Per unit

Rs.
Direct Materials X 10.50
Direct Materials Y 8.50
Direct Wages X 3.00
Direct Wages Y 2.00
Variable expenses 100% of direct wages per product.
Fixed expenses (total) Rs. 800
Sales Price X Rs. 20.50 and
Y Rs. 14.50
Suggested sales mixes:
Alternatives No of Units
x y
A 100 200
B 150 150
C 200 100
Illustration 6: ( Key Factors)
The following particulars are taken from the records of a company engaged in manufacturing two products,
A and B, from a certain material:
Particulars Product Product B
A (per unit)
(per Rs.
unit)
Rs.
Sales 2,500 5,000
Material cost (Rs. 50 per kg.) 500 1,250
Direct Labour (Rs. 30 per hour) 750 1,500
Variable overhead 250 500
Total Fixed Overhead: Rs. 10,00,000
Comment on the profitability of each product when:
(1) Total sale in value is limited and only one product to be sold.
(2) Raw materials is in short supply .Total availability of raw materials is 20,000 kg. and maximum
sales potential of each product is 1,000 units, find the product mix to yield maximum profits.
(3) Labour is the limiting factor. Total availability of labour hours is 40,000 hours. and maximum
sales potential of each product is 1,000 units, find the product mix to yield maximum profits.

Illustration 7: (Key Factor: Raw Materials)

Vinak Ltd. which produces three products furnishes you the following data for 2003-04:
Particulars Products
A B C
Selling Price per unit (Rs.) 100 75 50
Profit volume, ratio (%) 10 20 40
Maximum sales potential (Units) 40,000 25,000 10,000
Raw Material content as percentage of variable costs
(%) 50 50 50
The fixed expenses are estimated at 6,80,000. The Company uses a single raw material in all the
three products. Raw material is in short supply and the company has a quota foe the supply of raw
materials of the value of Rs. 18,00,000 for the year 2003-04 for the manufacture of its products to
meet its sales demand.
You are required to:
(1) Set a product mix which will give a maximum overall profit keeping the short supply of raw
materials in view.
(2) Compute that maximum profit.

Illustration 8: (Key factor sums)

ABC Ltd. manufactures and sells three products X, Y and Z.

Budgeted sales demand x Y Z
300 units 500 200 units
units
Unit sales price 16 18 14
Variable costs: Materials
Labour 8 6 2
Contribution 4 12 6 12 9 11
4 6 3
All three products use the same dire materials and the same type of direct labour, in the next year,
the available supply of materials will be restricted to Rs.4,800, and the a supply of labour to Rs.
6,600. What would be the profit maximizing budget?

Illustration 9- (key factor sum) - A company manufactures four products. The cost data per unit
areas under:
 A B C D
Selling price 90 71 100 86
Direct materials 30 20 40 40
Direct labour 24 18 30 12
Variable overheads 12 9 15 6
Fixed costs are estimated at Rs. 2,00,000 per month. The company employs 250 direct workers, who work
eight hours a day for 25 days a month. The direct wage rate is Rs. 6 per hour. It is not possible for the
company to increase its operatives in the short run nor is it practicable to work overtime. The company’s
policy does not allow subcontracting of work. The Marketing Director has forecast the following demands
for a month:
Product Units
A 5,500
B 5,000
C 6,250
D 8,250
The management desires you to find out the most profitable product mix

Illustration 10: -‘Novelties Ltd. seeks your advice on production mix in respect of the three
products Super, Bright Fine. You have the following information:
for standard costs per unit:
Particulars Super Bright Fine
Direct materials 320 240 160
Variable overhead
16 40 24
Direct labour:
Department Rate per Super Bright Fine
(Rs./Hour) Hours Hours Hours
A 8.00 6 10 5
B 16.00 6 15 11
From current budget, you have further details as below:
Super Bright Fine

Selling price per unit 624 800 430

(Rs.)
Fixed overhead: Rs. 16,00,000
Sales department’s estimate of maximum 6,000 8,000 12,000
possible sales in the coming year
(Nos.)
You are also to note that there is a constraint on supply of labour in Department A and its
manpower cannot be increase beyond its present level.
Suggest the best production and sales mix from the stand point of maximum profitability. Prepare
statement setting out the profit resulting from the budgeted production and the best alternative
suggested by you.

Illustration 11: (Evaluate Alternative Responses to Price Changes)

The accounts of a company are expected to reveal a profit of Rs. 14,00,000 after charging fixed
costs of Rs. 10,00,000 for the year ended 31sf March, 2009. The Selling price of the product is 95.
50 per unit and variable cost per unit is Rs. 20.
Market investigations suggest the following responses to the price changes:
Alternative Selling Price Reduced Quantity Sold Increases
by by
I 5% 10%
II 7% 20%
III 10% 25%
Evaluate these alternatives and state which of the alternatives, on profitability, consideration,
should be adopted for the forthcoming year.

Illustration 12:
Cookwell Ltd. manufactures pressure cookers the selling price of which is Rs. 300 per unit.
Currently the capacity utilisation is 60% with sales turnover of Rs. 18 lakhs. The company
proposes to reduce the selling price by 20% but desires to maintain the same profit position by
increasing the output. Assuming that the increased output could be made and sold, determine the
level at which the company should operate to achieve the desired objective.
The following further date is available:
(1) Variable cost per unit Rs. 60.
(2) Semi-variable cost (including a variable element of Rs. 10 per unit) Rs. 1,80,000.
(3) Fixed cost Rs. 3, 00,000 will remain constant upto 80% level. Beyond this an additional amount
of Rs. 60,000 will be incurred.

Illustration 13:

Pioneer engineering company Ltd has just completed first of year of its operation as 31 st March
2009and summarized result of the information is given below: Installed capacity- 20,000 kg :
production 14,000 kg.
Income and expenditure details :
Particulars Rs Rs
Income 28,00,000
Expenditure
Variable
Material 3,50,000
Labour 4,20,000
Overheads
Factory 2,80,000
Marketing 2,10,000 12,60,000
Contribution 15,40,000
Fixed cost 10,00,000
Profit 5,40,000

The Managing Director wishes to expand the operation for the year next year and has
asked you to prepare flexible budgets on capacity utilisation levels of 80%, 90% and
100% based on the following estimate
(Rs. per kg.)
(a) Price at 80% level- 220
at 90% level- 210
at 100% level- 200
Whatever produced during the year is expected to be sold within the year.
(b) Increase in variable cost components.
Materials @ 12%
Labour @ 10%
Overheads:
Factory @ 15%
Marketing @ 20%
 (a) Inflation rate applicable to fixed cost is 15%. Additionally, if the capacity utilisation
exceeds 80% fixed cost is expected to increase by 10% up to 100% capacity utilisation
level.

Part 2: To avoid the incidence of increase in fixed cost for production levels beyond 80% capacity
utilization the production manager has submitted the plan to sub-contract the additional production
of 4,000 kg to the party at cost of Rs 105 Kg including marketing cost . You are requested to
comment on this plan of sub contracting with a view to maximize the profit of the company,

Illustration 14 - The following is the summarised trading account of a manufacturing concern

which makes two : X and Y.
Summarised trading account for the four months to 30th April, 2003.
Particulars X Y Total
Rs. Rs. Rs.
Sales 10,000 4,000 14,000
Less: Cost of sales
Direct costs*
Labour 3,000 1,000
Materials 1,500 4,500 1,000 2,000 6,500
5,500 2,000 7,500
Indirect costs
Variable expenses 2,000 1,000 3,000
3,500 1,000 4,500
Fixed expense
Common to both X and Y 1,250 1,250 2,500
Net profit
2,250 (-)250 2,000

Fixed costs tend to remain constant irrespective of the physical outputs of X and Y.
It has been the practice of the concern to allocate these costs equally between X and Y. The
following proposals have been made by the Board of Directors for your consideration as financial
adviser:
1. Discontinue Product Y.
2. As an alternative to (1) reduce the price of Y, by 20 per cent. (It is estimated that the demand
will then increase by 40 per cent
3. Double the price of X. (It is estimated that this will reduce the demand by the three-fifths).
You are required to recommend the proposals to be taken after evaluating each of these three
proposals.

Illustration 15 (pricing of the product) - ABC Ltd. manufactures a product involving the
assembly of some parts purchased and other worked from raw-materials. The plant has been
operating at an even rate throughout the year on one eight hour shift producing 500 units per
month. The average annual cost for the past year was as follows:
(Rs.)
Raw materials 1,60,000
Purchase parts 1,00,000
Direct wages 3,00,000
Variable overhead 70,000
Fixed overhead
Total 1,20,000
7,50,000
At this point, sales department wanted to know the minimum price to be quoted for an order of
3,000 additional units to be produced and delivered at the rate of 250 units each month for the
next twelve ‘months. No additional selling and’ administration expenses will be incurred, if the
order is accepted and the management wants a minimum profit of 5% on the selling price.
Any additional raw-material purchase can be made at a saving of 5% of cost of such materials,
labour requirements above the present one shift can be secured only at an increase of 10% over
present rate. Total variable overheads are expected to increase by 60% due to the increase in
volume and fixed production overheads will go up by Rs. 9,000 only.
Prepare a statement showing details of price calculation for new order.

Illustration 16 (accepts / rejects order and sub contracting) - A company currently operating at
80% capacity has the following particulars:
Sales 32,00,000
Direct Materials 10,00,000
Direct Labour
Variable 4,00,000
Overheads 2,00,000
Fixed Overheads
13,00,000
An export order has been received that would utilise half the capacity of the Factory. The order
cannot be split. i.e., if has either to be taken in full and executed at 10% below the normal
domestic prices, or rejected totally.
The alternatives available to the Management are:
1. Reject the order and continue with the domestic sales only (as at present), or
2. Accept the export order, split capacity between overseas and domesectic sales and turn
away excess domestic demand (operate at 100%) or
3. Increase capacity so as to accept the export order and maintain the present domestic sales
by:
a) buying an equipment that will increase capacity by 10%. This will result in an
increase of Rs. 1,00000 in fixed costs, and
b) work overtime to meet balance of required capacity. In that case labour will be paid
at one and a half- times the normal wage rate.
Prepare a comparative statement of profitability and suggest the best alterative.