presentation on marginal costing & absorption costing

55
PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

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Page 1: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

PRESENTATIONON

MARGINAL COSTING&

ABSORPTION COSTING

Page 2: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

GROUP MEMBERS

1) ANKIT KUMAR RANKA(06A)

2) HARISH KUMAR(21B)

3) VIKAS AGRAWAL(59B)

Page 3: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

MARGINAL COSTING

Page 4: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Meaning….

Marginal cost is amount at any given volume of output by which aggregate costs are changed, if volume of output is increased or decreased by one unit.

It is a costing system which treats only the variable manufacturing costs as product costs. The fixed manufacturing overheads are regarded as period cost.

Page 5: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Features of Marginal costing

1.Cost ClassificationThe 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 ContributionMarginal 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

Page 6: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

AdvantagesThe technique is less complicated and free from confusion.

Under this technique net profit is not effected by the changes in production level or changes in stock volume; in fact profit is directly related to sales.

Reports based on this technique provide information based on sales rather than production conveying real estate of efficiency.

It helps in profit planning, particularly of short term nature.

Most significant use of this technique is in the area of price-policy and its determination.

Page 7: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Disadvantages

It lays too much emphasis on selling function,and as such production function has been considered to be less significant.

Valuation of stock only at Marginal cost may amount to under-valuation from the financial manager’s view point and this may have working capital problem.

Not suitable for external reporting,viz., for tax authorities where marginal income is not considered to be taxable profit.

This technique does not attach due importance to time factor.

Page 8: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Contribution

Contribution is the difference between sales and variable cost.

Contribution = Sales - Variable Cost

Contribution = Profit + Fixed Cost

Page 9: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Contribution

Contribution is the difference between sales and variable cost.

Contribution = Sales - Variable Cost

Contribution = Profit + Fixed Cost

Page 10: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Example…

Sales 50000 Variable cost 20000 Fixed cost 20000 Contribution ???

Page 11: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Solution…

Sales = 50000 Variable cost = 20000 Contribution = sales-variable cost

= 50000-20000

= 30000Total fixed cost = 20000Profit = contribution-total fixed cost

= 30000-20000 = 10000

Contribution = total fixed cost + profit= 20000 + 10000= 30000

Page 12: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Break-even analysis

Page 13: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Definition……… Breakeven analysis is the study of the

relationship between selling prices, sales volumes, fixed costs, variable costs and profits at various levels of activity.

Breakeven analysis is also known as cost-volume profit analysis.

Page 14: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Application………

Breakeven analysis can be used to determine a company’s breakeven point (BEP).

Breakeven point is a level of activity at which the total revenue is equal to the total costs.

At this level, the company makes no profit.

Page 15: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Assumption of breakeven point analysis

Relevant range The relevant range is the range of an activity over which the fixed cost will remain fixed in total and the variable cost per unit will remain

constant.

Fixed cost :Total fixed cost are assumed to be constant in total.

Variable cost : Total variable cost will increase with increasing number of units produced

Page 16: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

BEP Calculation –an Example

Assume selling price is Rs.35 per unit. Variable expense is Rs.21 per unit. Fixed cost is Rs.7,000. What is the breakeven point?

BEP(INUNITS) =TFC

CONTRIBUTION /UNIT

BEP(InSales) =TFC

PVRatio

Page 17: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Solution… Break Even Point(In units) =

=7000/14 =500 units

BEP(in Sales)= TFC/PV ratio =7000/40%

=17500P/v ratio=contribution/sales*100

=14/35*100=40%

=500 units

TotalFixedCost

contribution /unit

Page 18: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Margin of Safety (MOS)

Margin of Safety is the difference betweenthe expected level of sales and the BEP. The larger the margin of safety , the more likely it is that a profit will be made.

MOS= Projected sales – BEPProfit= MOS X Contribution per unit

Page 19: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Example… Selling price = 50000 Variable cost 10000 Fixed cost 20000 Margin of safety ???

Page 20: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Solution… Contribution/unit = sales-variable cost BEP(in units) =TFC/contribution/unit BEP(in sales) =TFC/pv ratio P/V ratio =contribution/sales*100 Mos =sales-BEP(sales)

Page 21: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Solution…Sales 50000(50/unit)(-) variable cost 10000(10/unit)Contribution 40000(40/unit)Fixed Cost 20000Profit 20000Margin of safety = sales-Break even pointBreak Even Point(in rs.) = TFC/PV ratio

= 20000/P/V ratio = contribution/sales*100

= 40/50*100=80%BEP = 20000/80%=25000MOS = 50000-25000=25000

Page 22: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Solution… Sales 50000(50/unit)(-) variable cost 10000(10/unit)Contribution 40000(40/unit)Fixed Cost 20000Profit 20000Margin of safety = sales-Break even pointBreak Even Point(in rs.) = TFC/PV ratio

=20000/P/V ratio = contribution/sales*100

= 40/50*100=80%BEP = 20000/80%=25000MOS = 50000-25000

= 25000

Page 23: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Profit/Volume Ratio : Profit volume ratio is the ratio of contribution denoting

the difference between sales and variable cost. Since in the short term fixed cost does not change, Profit/volume ratio also measures the rate of change of profit due to change in the sales.

P/V Ratio =

CONTRIBUTION

SALES*100

Page 24: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

EXAMPLE…

Sales = 50000 Variable cost = 20000 Fixed cost = 20000 Profit volume Ratio ???

Page 25: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Solution…

Profit Volume Ratio =

= contribution/sales*100

=20000/50000*100

=40%

Page 26: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

PROFORMA Amt. Amt.

Sales X

Less: Variable cost of Goods sold X Variable non- manufacturing exp.

Variable selling expenses X Variable admin. expenses X

Other variable expenses X X

Total contribution expenses X

Less: Expenses Fixed selling expenses X Fixed admin. expenses X

Other fixed expenses X X Net Profit X

Page 27: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Example….A B C

SALES(P.U @100)

1000 800 1100

Variable COGS(RS/UNIT)

35 35 35

Variable selling OH (in rs)

4000 3200 4400

Find out profit of RANKA LTD if the fixed cost is Rs. 31000 for all the plants

Page 28: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

A B CSales 100000 80000 110000Less: Variable cost of good

sold (@35) 35000 28000 38500Product contribution margin 65000 52000 71500Less: Variable selling O/H 4000 3200 4400Total contribution margin 61000 48800 67100Less: Fixed Expenses Fixed factory overhead 31000 31000 31000

Net profit 30000 32800 30100

Page 29: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Absorption costing

Page 30: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

• Absorption cost is a total cost technique Absorption cost is a total cost technique Under which total cost i.e. fixed & variableUnder which total cost i.e. fixed & variable is charged to productionis charged to production.. • Includes direct materials, direct labor, variable factory overhead, and fixed factory overhead as part of total product cost.

MEANING……….

Page 31: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Importance of Absorption costing

All the overheads are included when calculating the cost of producing particular items

Fixed costs are brought into the calculations on the assumption that they must be recovered

All the overheads are absorbed into cost units but each aspects of overheads is absorbed separately by cost centres of an appropriate basis -i.e. not a blanket approach

Absorption costing is used to calculate profit and to calculate stock valuation for financial statement.

Page 32: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

What is a Cost Centre?

“Any unit of Cost Accounting selected with a view to accumulating all cost under that unit. The unit may be a product, a service, division, department, section, a group of plant and machinery , a group of employees or a combination of several units.”

Page 33: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Types of Cost CentresAgain Cost centers may be divided into broad

types :

Production Cost Centres are those which are engaged in production like Machine shop, Welding shop, Assembly shop etc.

Service Cost centers are for rendering service to

production cost centre like Power house, Maintenance, Stores, Purchase office etc.

Page 34: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Allocation & Apportionment

Cost Allocation is possible when we can identify a cost as specifically attributable to a particular cost centre.

Cost Apportionment is necessary when it is not possible to allocate a cost to a specific cost centre. In this case the cost is shared out over two or more cost centres according to the estimated benefit received by each cost centre. As far as possible the basis of apportionment is selected to reflect this benefit received

Page 35: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

AllocateAllocate overhead costs that are directly incurred by particular cost centre.Allocation is the process of charging costs that is fully associated with a particular cost centre.Examples: machines dedicated to the production of a particular product, building whose sole use is the production of a particular productIn both cases there is no need to divide up the costs between products since the facility is directly linked to the productBut if an overhead cannot be allocated it must be apportioned

Page 36: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Bases for Allocation

Area Occupied- Rent, Rates & Taxes etc.

Capital value of Assets- Repairs, Insurance, Depriciation.

Kwh / HP of Machines- Power.

Number of Employees- Supervision,Canteen, Time-Keeping etc.

Light Points- Electricity.

Insurance- the book value of an assets

Material handling- Weight or size

Page 37: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Example Of AllocationVikas Ltd has 5 Departments of which A,B,C are Production

Departments, while X & Y are Service Departments.

Particulars A B C

D E

Floor area

No. of Employees

HP of Machines

Value of Plant

No. of Light Points

180

20

600

240000

30

120

15

400

200000

20

100

12

500

160000

15

70

8

-

100000

10

30

5

-

50000

5

Distribute the following Costs to various Departments :Rent,Rates & Taxes = Rs.5000, Repairs to Plant = Rs.7500,Power = Rs.4500, Supervision = Rs.6000, Lighting = Rs.800

Page 38: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

SolutionItems of cost

Basis Total A B C D E

Rent

Repairs

Power

Supervision

Lighting

Floor Area

(18:12:10:7:3)

Value (10:6:4:2:1)

HP (6:4:5)

Employees

(20:15:12:8:5)

No.of Light points

(6:4:3:2:1)

Total

5000

7500

4500

6000

800

23800

1800

2400

1800

2000

300

8300

1200

2000

1200

1500

200

6100

1000

1600

1500

1200

150

5450

700

1000

-

800

100

2600

300

500

-

500

50

1350

Page 39: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Example Of Apportionment Harish Ltd has three Manufacturing Departments (A, B, &

C) & one Service Department (S). Calculate the Statement showing Apportionment of expenses :

Expenses Total S A B C

Power

Supervisors’ Salary

Rent

Welfare

Others

Sup. Salary

No. of workers

Floor Area

Services by S to A, B & C

1100

2000

500

600

1200

5400

240

-

-

-

200

20%

10

500

200

-

-

-

200

30%

30

600

50%

300

-

-

-

400

30%

40

800

30%

360

-

-

-

400

20%

20

600

20%

Page 40: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

SolutionItems of cost

Basis Total A B C D E

Rent

Repairs

Power

Supervision

Lighting

Floor Area

(18:12:10:7:3)

Value (10:6:4:2:1)

HP (6:4:5)

Employees

(20:15:12:8:5)

No.of Light points

(6:4:3:2:1)

Total

5000

7500

4500

6000

800

23800

1800

2400

1800

2000

300

8300

1200

2000

1200

1500

200

6100

1000

1600

1500

1200

150

5450

700

1000

-

800

100

2600

300

500

-

500

50

1350

Page 41: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

SolutionExpenses Basis of

ApportionmentTotal

S A B C

Power

Supervisors’

Salary

Rent

Welfare

Others

Expenses of S

Actual

Service rendered

(2:3:3:2)

Floor Area (5:6:8:6)

No. of Workers(1:3:4:2)

Actual

Ratio Given (5:3:2)

Total

1100

2000

500

600

1200

5400

-

5400

240

400

100

60

200

1000

(1000)

Nil

200

600

120

180

200

1300

500

1800

300

600

160

240

400

1700

300

2000

360

400

120

120

400

1400

200

1600

Page 42: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

ABSORPTION COSTING PRO-FORMA

Sales Revenue xxxxxLess Absorption Cost of Sales (xxx)Opening Stock xxxx Add Production Cost xxxx Total Production Cost xxxx Less Closing Stock (xxx) Absorption Cost of Production xxxx Add Selling, Admin & Distribution Cost ` xxxx Absorption Cost of Sales (xxxx)Un-Adjusted Profit xxxxxFixed Production O/H absorbed xxxx Fixed Production O/H incurred (xxxx) (Under)/Over Absorption xxxxxAdjusted Profit xxxxx

Page 43: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

EXAMPLERanka Ltd, an organization that produces a product that

sells for Rs.60 per unit.Variable production costs are

Rs.35 per unit and the fixed production costs of

Rs.30,000 per period are absorbed on the basis of the

normal capacity of 5,000 units per period.Fixed

administration, selling and distribution overheads are

Rs.19,000 per period. There was no opening inventory

for the latest period.Required Calculate the profit

on 5,000 units, 6,000 units and 7,000 units,

Page 44: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

solution

particulars 5000 6000 7000Sales

Production Cost

(-)closing Stock

(-)over absorbed FC

Cost of sales

GrossProfit

(-) admin cost

Net Profit

205K

Nil

Nil

300000

205000

95000

19000

76000

246K

41K

6K

300000

199000

101000

19000

82000

287K

82K

12K

300000

193000

107000

19000

88000

Fixed production cost per unit = Rs.30,000/5,000 = Rs.6 P.U

Full production cost per unit = Rs.35 + Rs.6 = Rs.41 per unit

Page 45: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

COST SHEET

Direct Material Cost xxxDirect Labour Cost xxxDirect Expenses xxxPRIME COST XXXAdd: Factory Overhead xxxFACTORY COST XXXAdd: Administrative overhead xxxCOST OF PRODUCTION XXXAdd: Selling & Distribution cost xxxCOST OF SALES XXXAdd: Profit xxxSELES XXX

Page 46: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Prepare cost sheet of RANKA ltd Direct mat 120K

Direct labor 160K

Factory rent 30K

Office rent 20K

Show room rent 40K

Power 10K

Light 5K

Sundry factory exp 15K

Indirect wages 50K

Advertisements 50K

Sales commission 25K

Office salaries 60K

Sales salaries 80K

Carriage outward 10K

Delivery van exp 15K

Dep of plant 25k

Direct factory exp 40k

Crane exp 25K

Factroy supervision 40k

Dep on office

equipment 5K

sales 1000K

Page 47: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Classification of costs by functions

Costs should be classified according to the major

functions for which the elements are used into the

following four major functions COST

PRODUCTIONADMINISTRATION

SELLING &

DISTRIBUTION

RESEARCH &

DEVELOPMENT

Page 48: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Direct material consumed = Opening Stock of DM+ Purchase of DM-Closing Stock of DM

Factory cost = Prime cost +Factory O/H + Opening WIP - Closing WIP

Cost of production of goods sold = cost of production +opening stock of FG – Closing stock of FG

Page 49: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Comparison between “Marginal & Absorption

Costing”

Page 50: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

Diff b/w Absorption & Marginal costing

1) It is a total cost technique I.e. both variable and fixed costs are charged to products, processes or operations.

2) In spite of best possible forecast and equitable basis of apportionment /allocation of fixed costs, under or over recovery of fixed overheads generally arises.

3) Managerial decisions under this costing technique are based on profit I.e. excess of sales value over total costs, which may at times lead to erroneous decisions.

Here only variable costs are charged to product, processes or operations. Fixed costs are charged to the profit statement.

Since fixed overheads are not included in the cost of production, therefore the question of their under/ over recovery does not arise.

Here decisions are made on the basis of contribution I.e. excess of sales price over variable costs. This basis of decision making results in optimum profitability.

Page 51: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING
Page 52: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING
Page 53: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING
Page 54: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

CostManufacturing cost Non-manufacturing cost

Direct Materials

Direct Labour

Overheads

Finished goods Cost of goods sold

Period cost

Profit and loss account

Absorption Costing

CostManufacturing cost Non-manufacturing cost

Direct Materials

Direct Labour

Variable Overheads

Finished goods Cost of goods sold

Period cost

Profit and loss account

Marginal Costing

Fixedoverhead

Page 55: PRESENTATION ON MARGINAL COSTING & ABSORPTION COSTING

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