CHAPTER SIX :
MARGINAL COSTING, ABSORPTION COSTING AND BREAK-EVEN ANALYSIS
Marginal
Costing
Marginal costing recognizes the different behaviour of fixed costs
and variable costs and the effect these costs have on the profit of the
business. 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. Under absorption
costing, variable production costs as well as fixed production costs are
charged to stocks.
Marginal costing may be used for internal management reporting as
an alternative to absorption costing.
Comparison
of Marginal and Absorption Costing Statements
Marginal
Costing Statement
|
|
D
|
D
|
|
Sales
|
|
X
|
|
Less: Cost of
Sales
|
|
|
|
Manufacturing
cost (Variable cost)
|
X
|
|
|
Add : Opening
stock (Variable cost)
|
X
|
|
|
|
X
|
|
|
Less: Closing
stock (Variable cost)
|
(X)
|
|
|
|
|
X
|
|
Gross Margin
|
|
X
|
|
Less : Variable
Expenses
|
|
|
|
Selling
|
(X)
|
|
|
Administration
|
(X)
|
|
|
Financial
|
(X)
|
|
|
|
|
(X)
|
|
Contribution Margin
|
|
X
|
|
Less: Fixed
Expenses
|
|
|
|
Selling
|
(X)
|
|
|
Administration
|
(X)
|
|
|
Financial
|
(X)
|
|
|
|
|
(X)
|
|
Net Profit
|
|
X
|
Arguments
for the use of Marginal Costing
v It is simple
to operate
v No
apportionments
v Under or
over absorption of overhead is almost entirely avoided.
v Where sales
are constant, but production fluctuates marginal costing shows a constant net
profit whereas absorption costing shows variable amounts of profits.
Absorption
Costing Statement
|
|
D
|
D
|
|
Sales
|
|
X
|
|
Less: Cost of
Sales
|
|
|
|
Manufacturing
cost (Full cost)
|
X
|
|
|
Add : Opening
stock (Full cost)
|
X
|
|
|
|
X
|
|
|
Less: Closing stock (Full cost)
|
(X)
|
|
|
|
|
X
|
|
Gross Profit
|
|
X
|
|
Less : Expenses
|
|
|
|
Selling (Fixed
+ Variable)
|
(X)
|
|
|
Administration (Fixed
+ Variable)
|
(X)
|
|
|
Financial
(Fixed + Variable)
|
(X)
|
|
|
|
|
(X)
|
|
Net Profit
|
|
X
|
Traditional absorption costing statement fails to distinguish
between fixed and variable costs and therefore cannot be used for
cost-volume-profit analysis. It is also normally procedure to calculate the
cost and profit per unit based on absorption costing.
Argument for
the use of absorption costing
v Production
cannot be achieved without incurring fixed costs which thus form an inescapable
part of the cost of production. Marginal costing may give the impression that
fixed costs are somehow divorced from production.
v Where
production is constant but sales fluctuates, net profit fluctuations are less
with absorption costing than with marginal costing.
v The
calculation of marginal cost and the concentration upon contribution may lead
to the firm setting prices which are below total cost although producing some
contribution. Absorption cost makes this less likely because of the automatic
inclusion of fixed charges.
Worked
Examples
1. Show the absorption and marginal costing statements using the
following information:
|
|
Period 1
|
Period 2
|
|
Production (units)
|
20,000
|
5,000
|
|
Sales@D1.50 per unit
|
D15,000
|
D22,500
|
|
Variable production cost per unit
|
D0.50
|
D0.50
|
|
Fixed production cost (total)
|
D6,000
|
D6,000
|
|
Fixed Production cost per unit assuming a normal capacity
of 20,000 units
|
D0.30
|
D0.30
|
|
Opening stocks (units)
|
0
|
10,000
|
|
Closing stocks (units)
|
10,000
|
0
|
|
Variable selling & Admin. Expenses per unit
|
D0.10
|
D0.10
|
|
Fixed selling & Admin. Expenses (total)
|
D1,000
|
D1,000
|
Solution
Absorption
Costing Statement
|
Period 1
|
Period 2
|
|||
|
|
D
|
D
|
D
|
D
|
|
Sales@D1.50 per unit
|
|
15,000
|
|
22,500
|
|
Less: Cost of Sales
|
|
|
|
|
|
Production cost
@D0.80 per unit
|
16,000
|
|
4,000
|
|
|
Add : Opening
stock (Full cost)
|
0
|
|
8,000
|
|
|
|
16,000
|
|
12,000
|
|
|
Less: Closing
stock (Full cost)
|
(8,000)
|
|
(0)
|
|
|
|
|
(8,000)
|
|
(12,000)
|
|
Gross Profit
|
|
7,000
|
|
10,500
|
|
Less : Expenses
|
|
|
|
|
|
Selling &
Admin. Expenses (note 1)
|
(2,000)
|
|
(2,500)
|
|
|
Unabsorbed fixed
overhead (note 2)
|
0
|
|
(4,500)
|
|
|
|
|
(2,000)
|
|
(7,000)
|
|
Net Profit
|
|
5,000
|
|
3,500
|
Notes:
1. Selling & Admin Expenses
|
|
Period 1
|
Period 2
|
|
|
D
|
D
|
|
Variable (D0.10 per unit)
|
1,000
|
1,500
|
|
Fixed
|
1,000
|
1,000
|
|
|
2,000
|
2,500
|
2. Unabsorbed Fixed Overhead
|
|
Period 1
|
Period 2
|
|
Units produced
|
20,000
|
5,000
|
|
Absorption rate
|
D0.30
|
D0.30
|
|
Overhead Absorbed
|
(6,000)
|
(1,500)
|
|
Overhead incurred
|
6,000
|
6,000
|
|
Under / (Over) absorbed Overhead
|
0
|
4,500
|
Marginal
Cost Statement
|
Period 1
|
Period 2
|
|||
|
|
D
|
D
|
D
|
D
|
|
Sales @ D1.50 per unit
|
|
15,000
|
|
22,500
|
|
Less: Cost of
Sales
|
|
|
|
|
|
Variable Production cost @D0.50 per unit
|
10,000
|
|
2,500
|
|
|
Add : Variable
Cost Opening stock @D0.50 per unit
|
0
|
|
5,000
|
|
|
|
10,000
|
|
7,500
|
|
|
Less: Variable
Cost Closing stock
|
(5,000)
|
|
(0)
|
|
|
|
|
(5,000)
|
|
(7,500)
|
|
Gross Margin
|
|
10,000
|
|
15,000
|
|
Less: Variable Selling & Admin Expense
|
|
(1,000)
|
|
(1,500)
|
|
Contribution Margin ( Note 1)
|
|
9,000
|
|
13,500
|
|
Less : Fixed Expenses
|
|
|
|
|
|
Production
Overhead (note 2)
|
(6,000)
|
|
(6,000)
|
|
|
Selling & Admin. Expenses
|
(1,000)
|
|
(1,000)
|
|
|
|
|
(7,000)
|
|
(7,000)
|
|
Net Profit
|
|
2,000
|
|
6,500
|
Notes:
1. Contribution margin = Sales less all variable costs
2. Fixed production overhead is treated as period cost. It is
fully written off during the period.
Observations
(a) net profit reported:
- Absorption costing is
illogical for period 2 sales is better than that of Period 1; yet the operation
of Period 2 reported a lower profit than
that of Period 1.
- Marginal costing is logical; Period 1
reported a lower profit than that of Period 2, reflecting the sales made.
(b) Relationship of profits
to production:
- Absorption costing: management could raise the profit figure of
Period 2 by increasing its production to
20,000 units. Reported profit would then become D8,000 ; the D4,500 overhead
would be carried forward to Period 3. Profit is thus subject to the influence
of management by the manipulation of production figures.
( c) Stock value:
- Absorption costing:
higher stock value
- Marginal costing: lower
stock value because fixed overhead costs are excluded.
2. The following data have
been extracted from the budgets and standard cost of UTG Ltd, a company which manufactures and
sells a single product.
|
|
D per unit
|
|
Selling price
|
45.00
|
|
Direct materials cost
|
10.00
|
|
Direct wage cost
|
4.00
|
|
Variable overhead cost
|
2.50
|
Fixed production overhead costs are budgeted at D400,000 per
annum. Normal production levels are thought to be 320,000 units per annum.
Budgeted selling and distribution costs are as follows:
|
Variable
|
D1.50 per unit sold
|
|
Fixed
|
D80,000 per annum
|
Budgeted administration costs are D120,000 per annum.
The following pattern of sales and production is expected during
the first six months of 2010.
|
|
January - March
|
April – June
|
|
Sales (units)
|
60,000
|
90,000
|
|
Production (units)
|
70,000
|
100,000
|
There is to be no stock on 01st January 2010.
You are
required :
(a) to prepare profit statements for each of the two quarters, in
a columnar format, using :
(i) marginal costing, and
(ii) absorption costing
(b) to reconcile the profits reported for the quarter January –
March 2010 in your answer to (a) above.
(c ) to state and explain briefly the benefits of using marginal
costing as the basis of management reporting.
Solution
(a) Calculation of unit costs
|
|
D
|
|
Direct material cost
|
10.00
|
|
Direct wages cost
|
4.00
|
|
Variable overhead cost
|
2.50
|
|
Variable manufacturing cost
|
16.50
|
|
Fixed manufacturing overhead (D400,000 ÷ 320,000 units)
|
1.25
|
|
Total manufacturing cost
|
17.75
|
Profit
Statements
(i) Marginal costing
|
|
Jan – March
(D’000)
|
April – June
(D’000)
|
|
Opening stock
|
-
|
165
|
|
Production
costs:
|
|
|
|
Variable (70,000
x D16.50 /100,000 x D16.50)
|
1,155
|
1,650
|
|
Closing stock
(10,000 x D16.50 / 20,000 x D16.50)
|
(165)
|
(330)
|
|
|
990
|
1,485
|
|
Selling & distribution cost : Variable
|
90
|
135
|
|
|
1,080
|
1,620
|
|
Revenue from sales
|
2,700
|
4.050
|
|
Contribution
|
1,620
|
2,430
|
|
Fixed production costs
|
(100)
|
(100)
|
|
Fixed selling & distribution costs
|
(20)
|
(20)
|
|
Fixed administration costs
|
(30)
|
(30)
|
|
Budgeted
profit
|
1,470
|
2,280
|
(i) Absorption costing
|
|
Jan– March
(D’000)
|
April– June
(D’000)
|
|
Opening stock
|
-
|
177.50
|
|
Total Production costs
(70,000 x D17.75
/100,000 x D17.75)
|
1,242.50
|
1,775.00
|
|
|
1,242.50
|
1,952.50
|
|
Closing stock
(10,000 x D17.75 / 20,000 x D17.75)
|
(177.50)
|
(355)
|
|
|
1,065.00
|
1,597.50
|
|
Add under absorption of production overhead
(10,000 x D1.25)
|
(12.50)
|
-
|
|
Total Selling & distribution cost
|
110
|
155
|
|
Total Administration cost
|
30
|
30
|
|
|
1,217.50
|
1.757.50
|
|
Revenue from sales
|
2,700.00
|
4,050.00
|
|
Budgeted
profit
|
1,482.50
|
2,292.50
|
(b) The difference in profit of D12,500 is due to the fact that
part of the fixed production overheads (10,000 units @ D1.25 per unit) are
included in the costing stock valuation and not recorded as an expense during
the current period. With the marginal costing system all of the fixed
manufacturing costs incurred during a period are recorded as an expense of the
current period.
(c ) The benefits of using marginal costing
as a basis of management reporting are :
Ø It assists
in the provision of relevant costs for decision-making.
Ø It
eliminates the need to allocate and absorb fixed overhead.
Ø It
integrates with other aspects of management accounting, e.g. cost-volume-profit
analysis, flexible budgeting and standard costing.
Ø Period
reports are more easily understood.
Ø There is a
close relationship between variable costs and the controllable cost
classification. This relationship assists the control function.
Ø It
emphasizes the significance of key factors affecting the performance of the
business in the profit planning and decision making areas.
Without marginal costing data, the information for
management may be misleading.
BREAK-EVEN ANALYSIS
The term break-even analysis is given to the
interrelationships between costs, volume and profit at various levels of
activity. The level of activity which
produces neither profit nor loss is referred to as the break even point.
An alternative term of break even analysis is the
cost-volume-profit analysis or C-V-P analysis, is frequently used. C-V-P
analysis uses many of the principles of marginal costing and is an important
tool in short-term planning. It explores the relationship which exist between
costs, revenue, output levels and resulting profit and is more relevant where
the proposed changes in the level of activity are relatively small.
Typical short-term decision where C-V-P analysis can be
useful include; choice of sales mix, pricing policies, multi-shift working ,
and special order acceptance.
Assumptions Behind
C-V-P Analysis
-
All cost can be resolved into fixed and variable
elements.
-
Fixed cost will remain constant and variable costs vary
proportionately with activity.
-
Over the activity range being considered costs and
revenues behave in a linear fashion.
-
That technology , production methods and efficiency
remain unchanged.
-
Particularly for graphical methods that the analysis
relates to one product only or to a constant product mix.
-
There are stock level changes or that stocks are valued
at marginal cost only.
C-V-P Analysis By
Formula
C-V-P analysis can be undertaken by a simple formulae or
graphical means. Below are some formulae to learn:
1. Break-even-point (in units) = Fixed Costs ÷
Contribution per unit
2. Break-even-point (GMD Sales) = (Fixed Costs ÷
Contribution per unit) x Sales Price per unit
= Fixed Costs x ( C/S ratio)
Where,
C / S Ratio
= ( Contribution per unit ÷ Sales Price per unit ) x 100
3. Level of Sales to results in target profit ( in units) =
( Fixed Costs + Target Profit ) ÷ Contribution per unit
4. Level of Sales to results in target profit after tax
(units) = {( Fixed Cost + ( Target Profit ÷ (1 – Tax Rate))} ÷ Contribution per
unit
Note : The above
formulae relate to a single product firm or one with an unvarying mix of sales.
With a multi product firm it is
possible to calculate the break even point as follows:
Break-even-point (GMD
Sales) = (Fixed Costs ÷ Contribution per unit) x Sales Value
Example One
A company makes a single product with a sales price of GMD10
and a marginal cost of GMD6. Fixed costs are GMD60,000 per annum.
Calculate
- Number of units to break even
- Sales at break-even-point
- C /S Ratio
- What number of units will need to be sold to achieve a profit of GMD20,000 p.a.
- What level of sales will achieve a profit of GMD20,000 p.a.
- If the taxation rate is 40% how many units will need to be sold to make a profit after tax of GMD20,000 p.a.
- Because of increasing costs the marginal cost is expected to rise to GMD6.50 per unit and fixed costs to GMD70,000 p.a. If the selling price cannot be increased what will be the number of units required to maintain a profits of GMD20,000 p.a. (Ignore tax)
Answer:
Contribution =
Selling price – marginal cost = GMD10 - GMD6
= GMD4
a. Break-even-point
(in units) = Fixed Costs ÷ Contribution per unit
Break-even-point (units) = GMD60,000 ÷ GMD4 = 15,000 units
b. Break-even-point
(GMD Sales) = (Fixed Costs ÷ Contribution per unit) x Sales Price per unit
= 15,000 x GMD10 = GMD150,000
c. C / S Ratio = (GMD4
x 100 ) ÷ GMD10 = 40 %
d. Number of units
for target profit = ( Fixed Costs + Target Profit ) ÷ Contribution per unit
= ( GMD60,000 + GMD20,000 ) ÷ GMD4 = 20,000 units
e. Sales for target
profit = Number of units for target profit x Sales price per unit
=
20,000 x GMD10 = GMD200,000
f. Number of units
for target profit after tax = {( Fixed Cost + ( Target Profit ÷ (1 – Tax
Rate))} ÷ Contribution per unit
= {( GMD60,000
+ ( GMD20,000 ÷ (1 – 0.4))} ÷ GMD4 = 23,333
units
g. With changes in
the fixed costs, marginal cost and contribution,
Number of units
for target profit = (GMD70,000 + GMD20,000) ÷ GMD3.5 = 25,714
units
PRACTICE
QUESTIONS
1.
Show
the absorption and marginal costing statements using the following
information:
(20)
|
|
Period 1
|
Period 2
|
|
Production (units)
|
20,000
|
5,000
|
|
Sales @ GMD1.50 per unit
|
GMD15,000
|
GMD22,500
|
|
Variable production cost per unit
|
GMD0.50
|
GMD0.50
|
|
Fixed production cost (total)
|
GMD6,000
|
GMD6,000
|
|
Foxed production cost per unit assuming a
normal capacity of 20,000 units
|
GMD0.30
|
GMD0.30
|
|
Opening stocks (units)
|
0
|
10,000
|
|
Closing stocks (units)
|
10,000
|
0
|
|
Variable selling & admin expenses per
unit
|
GMD0.10
|
GMD0.10
|
|
Fixed selling & admin expenses (total)
|
GMD1,000
|
GMD1,000
|
2.
The
following data have been extracted from the budgets and standard costs of
Strong Heart Corporation Ltd, a company which manufactures and sells a single
product.
|
|
GMD per unit
|
|
Selling price
|
45.00
|
|
Direct materials cost
|
10.00
|
|
Direct wage cost
|
4.00
|
|
Variable overhead cost
|
2.50
|
Fixed production overhead costs are budgeted
at GMD400,000 per annum. Normal production levels are thought to be 320,000
unitd per annum.
Budgeted selling and distribution costs are
as follows:
Variable
GMD1.50 per unit sold
Fixed GMD80,000 per annum
Budgeted administration costs are GMD120,000
per annum.
The following pattern of sales and
production is expected during the first six months of 2010.
|
|
January - March
|
April – June
|
|
Sales (Units)
|
60,000
|
90,000
|
|
Production (units)
|
70,000
|
100,000
|
There is to be no stock on 01 January 2010.
You are required:
(a)
to prepare
profit statements for each of the two quarters, in a columnar format, using:
i)
marginal
costing and
ii)
absorption
costing.
(15)
(b) to reconcile the profits reported for the quarter January – March
2010 in your answer to (a) above.
(5)
( c) to state and explain briefly the benefits of using marginal costing
as the basis of management reporting.
(5)
3. You work as an accountant for a production
company which is about to bring a new product to the market.
Original
budgeted data is as follows:
Sales
100,000 items at GMD160 each.
Variable
costs per item: GMD
Direct
material 40
Direct
wages 20
Overheads
40
The
associated fixed overheads are estimated at GMD3,500,000.
The
company has the capacity to make 145,000 items without increasing the cost of
fixed overheads.
There
are a number of proposals/suggested alternatives to consider.
Proposal
1: Increase the selling price by 10%;
improve the product quality by spending an extra GMD3 per item on direct
material. The expected sales would then be 130,000 items.
Proposal
2. Decrease the selling price to GMD155
per item, and sell 140,000 items.
Proposal
3. Increase the selling price to GMD180,
and also spend GMD250,000 extra on marketing, and sell 115,000
items.
REQUIRED
a) Calculate the profit for the
original budget. [3]
b) Calculate the breakeven point for the original
budget. [2]
c) Calculate the profit AND breakeven point for
Proposal 1. [4]
d) Calculate the profit AND breakeven point for
Proposal 2. [4]
e) Calculate the profit AND breakeven point for
Proposal 3. [4]
f) Explain briefly which of the four plans/proposals
you would recommend. [3]
No comments:
Post a Comment