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Marginal Costing 300 Level-1

The document discusses marginal costing and absorption costing. It defines marginal costing as ascertaining marginal costs and analyzing the effect of changes in volume or output by differentiating between fixed and variable costs. Absorption costing values inventory at full production costs including fixed overhead. The document outlines the key features, advantages, and limitations of both marginal costing and absorption costing.

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0% found this document useful (0 votes)
48 views23 pages

Marginal Costing 300 Level-1

The document discusses marginal costing and absorption costing. It defines marginal costing as ascertaining marginal costs and analyzing the effect of changes in volume or output by differentiating between fixed and variable costs. Absorption costing values inventory at full production costs including fixed overhead. The document outlines the key features, advantages, and limitations of both marginal costing and absorption costing.

Uploaded by

simon daniel
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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MARGINAL COSTING (BREAK-EVEN AND COST-VOLUME-PROFIT ANALYSIS).

Introduction:
Marginal Cost is defined as “the amount at any given volume of output by which aggregate
costs are changed if the volume of output is increased or decreased by one unit.” Marginal
Cost also means Prime Cost plus Variable Overheads. Marginal Cost is a constant ratio
which may be expressed in terms of an amount per unit of output. On the other hand, fixed
cost which is not normally traceable to particular unit denotes a fixed amount of expenditure
incurred during an accounting period. Fixed cost is, therefore, also called time cost, period
cost, standby cost, capacity cost, or constant cost. Variable cost or marginal cost is also
termed as direct cost, activity cost, volume cost or out-of-pocket cost.

From the above definition and analysis of marginal cost, we can understand that is the cost
which varies according to the variations in the volumes of output. However, by definition
marginal cost is the change in the total cost for addition of one unit. It is to be noted that for
an economist marginal cost and variable cost would be different. But for an accountant both
marginal cost and variable cost are same and are interchangeably used. Therefore, for our
study, we use marginal cost and variable cost synonymously.

MARGINAL COSTING
Marginal costing is “the ascertainment of marginal costs and of the effect on profit of
changes in volume or type of output by differentiating between fixed costs and variable
costs.” Several other terms in use like direct costing, contributory costing, variable costing,
comparative costing, differential costing and incremental costing are used more or less
synonymously with marginal costing. It is a process whereby costs are classified into
fixed and variable and with such a division so many managerial decisions are taken. The
essential feature of marginal costing is division of total costs into fixed and variable,
without which this could not have existed. Variable costs vary with volume of
production or output, whereas fixed costs remains unchanged irrespective of changes in
the volume of output. It is to be understood that unit variable cost remains same at
different levels of output and total variable cost changes in direct proportion with the
number of units. On the other hand, total fixed cost remains same disregard of changes
in units, while there is inverse relationship between the fixed cost per unit and the
number of units.

FEATURES OF MARGINAL COSTING

The main features of Marginal Costing may be summed up as follows:

1. Appropriate and accurate division of total cost into fixed and variable by
picking out variable portion of semi variable costs also.

2. Valuation of stocks such as finished goods, work-in-progress is valued at variable


cost only.

3. The fixed costs are written off soon after they are incurred and do not find place
in product cost or inventories.

4. Prices are based on Marginal Cost and Marginal Contribution.

5. It combines the techniques of cost recording and cost reporting.

ADVANTAGES OR MERITS OR APPLICATIONS OF MARGINAL COSTING

1. Marginal costing system is simple to operate than absorption costing because


they do not involve the problems of overhead apportionment and recovery.

2. Marginal costing avoids, the difficulties of having to explain the purpose and
basis of overhead absorption to management that accompany absorption costing.
Fluctuations in profit are easier to explain because they result from cost volume
interactions and not from changes in inventory valuation.

3. It is easier to make decisions on the basis of marginal cost presentations, e.g.,


marginal costing shows which products are making a contribution and which are failing
to cover their avoidable (i.e., variable) costs. Under absorption costing the relevant
information is difficult to gather, and there is the added danger that management may be
misled by reliance on unit costs that contain an element of fixed cost.

4. Marginal costing is essentially useful to management as a technique in cost


analysis and cost presentation. It enables the presentation of data in a manner useful to
different levels of management for the purpose of controlling costs. Therefore, it is an
important technique in cost control.

5. Future profit planning of the business enterprises can well be carried out by
marginal costing. The contribution ratio and marginal cost ratios are very useful to
ascertain the changes in selling price, variable cost etc. Thus, marginal costing is greatly
helpful in profit planning.

6. When a business concern consists of several units and produces several


products and evaluation of performance of such components can well be made with
the help of marginal costing.

7. It is helpful in forecasting.

8. When there are different products, the determination of number of units of each
product, called Optimum Product Mix, is made with the help of marginal costing.

9. Similarly, optimum sales mix i.e., sales of each and every product to get
maximum profit can also be determined with the help of marginal costing.
Apart from the above, numerous managerial decisions can be taken with the help of
marginal costing, some of which may be as follows:-

(a) Make or buy decisions,

(b) Exploring foreign markets,

(c) Accept an order or not,

(d) Determination of selling price in different conditions,

(e) Replace one product with some other product,

(f) Optimum utilization of labour or machine hours,

(g) Evaluation of alternative choices,

(h) Subcontract some of the production processes or not,

(i) Expand the business or not,

(j) Diversification,

(k) Shutdown or continue,


LIMITATIONS OF MARGINAL COSTING

a. The separation of costs into fixed and variable present’s technical difficulties and
no variable cost is completely variable nor is a fixed cost completely fixed.
b. Under the marginal cost system, stock of finished goods and work-in-progress
are understated. After all, fixed costs are incurred in order to manufacture products and
as such, these should form a part of the cost of the products. It is, therefore, not correct
to eliminate fixed costs from finished stock and work-in-progress.

c. The exclusion of fixed overhead from the inventories affects the Profit and Loss
Account and produces an unrealistic and conservative Balance Sheet, unless
adjustments are made in the financial accounts at the end of the period.

d. In marginal costing system, marginal contribution and profits increase or


decrease with changes in sales volume. Where sales are seasonal, profits fluctuate from
period to period. Monthly operating statements under the marginal costing system will
not, therefore, be as realistic or useful as in absorption costing.

e. During the earlier stages of a period of recession, the low profits or increase in
losses, as revealed in a magnified way in the marginal costs statements, may unduly
create panic and compel the management to take action that may lead to further
depression of the market.

f. Marginal costing does not give full information. For example, increased
production and sales may be due to extensive use of existing equipment’s (by working
overtime or in shifts), or by an expansion of the resources, or by the replacement of
labour force by machines. The marginal contribution fails to reveal these.

g. Though for short-term assessment of profitability marginal costs may be useful,


long term profit is correctly determined on full costs basis only.

h. Although marginal costing eliminates the difficulties involved in the apportionment


and under and over-absorption of fixed overhead, the problem still remains so far as the
variable overhead is concerned.

i. With increased automation and technological developments, the impact on fixed


costs on products is much more than that of variable costs. A system which ignores fixed
costs is therefore, less effective because a major portion of the cost, such as not taken care
of.

j. Marginal costing does not provide any standard for the evaluation of
performance. A system of budgetary control and standard costing provides more
effective control than that obtained by marginal costing.

LIMITATIONS OF ABSORPTION COSTING

1. Being dependent on levels of output which vary from period to period, costs are
vitiated due to the existence of fixed overhead. This renders them useless for purposes
of comparison and control. (If, however, overhead recovery rate is based on normal
capacity, this situation will not arise).

2. Carryover of a portion of fixed costs, i.e., period costs to subsequent accounting


periods as part of the cost of inventory is a 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.

3. Profits and losses in the accounts are related not only to sales but also to
production, including the production which is unsold. This is contrary to the principle
that profits are made not at the stage when products are manufactured but only when
they are sold.

4. There is no uniformity in the methods of application of overhead in absorption


costing. These problems have, no doubt, to be faced in the case of marginal costing also
but to a less extent because of the exclusion of fixed costs, as different assumptions
made in the matter of application of fixed overhead will not arise in the case of marginal
costing.

5. Absorption costing is not always suitable for decision making solutions to various
types of problems of management decision making, where the absorption cost method
would be practically ineffective, such as selection of production volume and optimum
capacity utilisation, selection of production mix, whether to buy or manufacture, choice of
alternatives and evaluation of performance can be had with the help of marginal cost
analysis. Sometimes, the conclusion drawn from absorption cost data in this regard may be
misleading and lead to losses.
DIFFERENCES BETWEEN ABSORPTION COSTING AND MARGINAL COSTING
Absorption Costing Marginal Costing
1. Both fixed and variable costs are Only variable costs are considered for
considered for product costing and product costing and inventory valuation.
inventory valuation.
2. Fixed costs are charged to the cost of Fixed costs are regarded as period costs.
production. Each product bears a reasonable The profitability of different products is
share of fixed cost and thus the profitability judged by their P/V ratio.
of a product is influenced by the
apportionment of fixed costs.
3. Cost data are presented in conventional Cost data are presented to highlight the
pattern. Net profit of each product is total contribution of each product.
determined after subtracting fixed cost
along with their variable cost.
4. The difference in the magnitude of opening The difference in the magnitude of opening
stock and closing stock affects the unit cost stock and closing stock does not affect the
of production due to the impact of related unit cost of production.
fixed cost.
5. In case of absorption costing the cost per In case of marginal costing the cost per unit
unit reduces, as the production increases as remains the same, irrespective of the
it is fixed cost which reduces, whereas, the production as it is valued at variable cost.
variable cost remains the same per unit.

BREAK-EVEN ANALYSIS

THE CONCEPT OF BREAK-EVEN ANALYSIS


Break-even is a situation of neither profit nor loss; it is about a win-win or loss- loss position as
two competing things or persons are put together to realize a result. In Accounting, especially
Management Accounting, break-even is normally studied taken the point of intersection between
cost and revenue into consideration. That point of intersection is called breakeven point and it
shows a situation of neither profit nor loss.
The study of Cost-Volume-Profit relationship is frequently referred to as 'break-even analysis', but
break even analysis is only incidental to the study of the relationship between cost, sales, profit/loss
and sound management. Up to the point of activity where total revenues equal total expenses, the
study can be termed as 'break-even analysis', while, beyond this point, it is the application of Cost-
Volume-Profit relationship. Thus, the term 'break-even analysis' may be interpreted in two senses -
narrow sense and broad sense. In its narrow sense, it refers to a system of determining that level of
operations where total revenues equal total expenses, i.e. the point of zero profit. Taken in its broad
sense, it denotes a system of analysis that can be used to determine the probable profit at any level
of operations.
ASSUMPTIONS OF BREAK-EVEN ANALYSIS

Break even analysis and Cost-Volume-Profit analysis are based upon certain assumed conditions
which are to be rarely found in practice. Some of these basic assumptions are as follows:
i. The principle of cost variability is valid.

ii. Costs can be resolved into their fixed and variable components.

iii. Fixed costs remain constant.

iv. Variable costs vary proportionally with volume.

v. Selling price does not change as volume changes.

vi. There is only one product or, in the case of multiple products, sale mix remains constant.
vii. There will be no change in general price level.

viii. Productivity per worker remains mostly unchanged.

ix. There is synchronization between production and sales.

x. Revenue and costs are being compared with a common activity base, e.g. sales value of
production or units produced.
xi. The efficiency of plant can be predicted.

A change in any one of the above factors will alter the break-even point so that profits are affected
by changes in factors other than volume. Thus, the break-even chart must be interpreted in the
light of the limitations of underlying assumptions, especially with respect to price and sale mix
factors.
PRESENTATION OF BREAK-EVEN ANALYSIS

Usually, 'break-even analysis' is presented graphically as this method of visual presentation is


particularly well-suited to the needs of business owing to the manager being able to appraise the
situation at a glance. Thus, it removes the danger accompanying many accounting reports, a danger
that the reader would get bogged down with unnecessary details in such a way that he may never
come to grips with the heart of the matter. The graphical break-even analysis eliminates the details
and presents the information in a simplified way. To that extent, it is especially attractive for a
person of non-accounting background. When presented graphically the break-even analysis takes
the shape of 'break-even‟ chart or charts.

A break-even chart shows the profitability, or otherwise, of an undertaking at various levels of


activity and, as a result, indicates the point at which neither profit is made nor loss is incurred.
Break-even charts are frequently used and needed where a business is new or where it is
experiencing trade difficulties. In these cases, the chart assists management in considering the
advantages and disadvantages of marginal sales. However, in a highly profitable enterprise, there is
little need of break-even charts except when studying the implications of a major Total
expansion
Sales scheme
involving a heavy increase in fixed charges.

b Total Cost
The formal break even chart is as follows:
Y Angle of Incidence

FC
a
Cost & Revenue

O
Unit X
a = Losses b = Profits

When no. of units are expressed on X-axis and costs and revenues are expressed on Y-
axis, three lines are drawn i.e., fixed cost line, total cost line and total sales line. In the
above graph we find there is an intersection point of the total sales line and total cost
line and from that intersection point if a perpendicular is drawn to X-axis, we find break
even units. Similarly, from the same intersection point a parallel line is drawn to X-axis
so that it cuts Y-axis, where we find Break Even point in terms of value. This is how,
the formal pictorial representation of the Break Even chart.

At the intersection point of the total cost line and total sales line, an angle is formed
called Angle of Incidence, which is explained as follows:

Angle of Incidence:

Angle of Incidence is an angle formed at the intersection point of total sales line and
total cost line in a formal break even chart. If the angle is larger, the rate of growth of
profit is higher and if the angle is lower, the rate of growth of profit is lower. So, growth
of profit or profitability rate is depicted by Angle of Incidence.

THE PROFIT/VOLUME GRAPH

The profit/volume (P/V) graph is similar to the break-even chart, and it records the profit or loss at
each level of sales; at a given sales price. It is a straight line graph, drawn most simply by
recording:
(a) loss at zero sales, which is the full amount of fixed costs; and

(b) profit (or loss) at the budgeted level of sales; and joining up the two points by a line.

P/V Chart
N
Profit
Margin of
safety
safety
MATHEMATICAL COMPUTATION OF BEP EXPRESSION
FC
(1) Break-even point (in N=)
CMR
Where FC= Fixed Cost
CMR= Contribution Margin Ratio = Sales less Variable cost divided by sales
FC
(2) Break even in unit
CM
Where FC= Fixed Cost
CM= Contribution Margin = Sales less Variable cost

(3) Level of sales to result in target profit (in units)

FC +Targeted Profit( 1−t)


CM
Where FC= Fixed Cost
Targeted Profit (1- t) = Targeted profit after tax
CM= Contribution Margin = Sales less Variable cost divided by sales

(4) Level of sales to result in target profit (in units)

FC +Targeted Profit( 1−t)


CMR
Where FC= Fixed Cost
Targeted Profit (1- t) = Targeted profit after tax
CMR= Contribution Margin Ratio = Sales less Variable cost divided by sales
USES AND APPLICATIONS OF BREAK EVEN ANALYSIS (OR) PROFIT CHARTS (OR) COST
VOLUME PROFIT ANALYSIS:

The important uses to which cost-volume profit analysis or break-even analysis or profit
charts may be put to use are:

a. Forecasting costs and profits as a result of change in Volume determination of


costs, revenue and variable cost per unit at various levels of output.

b. Fixation of sales Volume level to earn or cover given revenue, return on capital
employed, or rate of dividend.

c. Determination of effect of change in Volume due to plant expansion or


acceptance of order, with or without increase in costs or in other words,
determination of the quantum of profit to be obtained with increased or decreased
volume of sales.

d. Determination of comparative profitability of each product line, project or profit


plan.

e. Suggestion for shift in sales mix.

f. Determination of optimum sales volume.

g. Evaluating the effect of reduction or increase in price, or price differentiation in


different markets.

h. Highlighting the impact of increase or decrease in fixed and variable costs on


profit.

i. Studying the effect of costs having a high proportion of fixed costs and low
variable costs and vice-versa.

j. Inter-firm comparison of profitability.

k. Determination of sale price which would give a desired profit for break-even.

l. Determination of the cash requirements as a desired volume of output, with the


help of cash break- even charts.

m. Break-even analysis emphasizes the importance of capacity utilization for


achieving economy.

n. During severe recession, the comparative effects of a shutdown or continued


operation at a loss are indicated.

o. The effect on total cost of a change in the fixed overhead is more clearly
demonstrated through break-even charts.
LIMITATIONS OF BREAK-EVEN ANALYSIS

a. That Costs are either fixed or variable and all costs are clearly segregated into
their fixed and variable elements. This cannot possibly be done accurately and the
difficulties and complications involved in such segregation make the break-even
point inaccurate.

b. That the behavior of both costs and revenue is not entirely related to changes in
volume.

c. That costs and revenue patterns are linear over levels of output being considered.
In practice, this is not always so and the linear relationship is true only within a short
run relevant range.

d. That fixed costs remain constant and variable costs vary in proportion to the
volume. Fixed costs are constant only within a limited range and are liable to change at
varying levels of activity and also over a long period, particularly when additional
plants and equipments are introduced.

e. That sales mix is constant or only one product is manufactured. A combined


analysis taking all the products of the mix does not reflect the correct position
regarding individual products

a. That production and sales figures are identical or the change in opening and
closing stocks of the finished product is not significant.

b. That the units of production on the various product range are identical.
Otherwise, it is difficult to find a homogeneous factor to represent volume.

c. That the activities and productivity of the concern remain unchanged during
the period of study.
d. As output is continuously varied within a limited range, the contribution margin
remains relatively constant. This is possible mainly where the output is more or less
homogeneous as in the case of process industries.

MARGIN OF SAFETY

It is the sales point beyond the breakeven point. Margin of safety can be obtained by
subtracting break even sales from Total sales. It is useful to determine financial soundness
of business enterprise. If margin of safety is high, then the financial position of the
enterprise is sound.

Margin of Safety = Total Sales – Break Even Sales (1)

Total Sales = Break Even Sales + Margin of Safety Sales (2)

 Margin of safety can also be computed as follows:

Margin of Safety = Profit / P/V ratio (3)

A relative measure to the margin of safety is its ratio to total sales.

 Margin of safety ratio is the ratio of Margin of safety sales to Total sales.

Margin of safety ratio = [Margin of safety / Total sales] x 100 (4)

 Margin of safety ratio and Break even sales ratios are complements of each other.

 If the sales amount, P/V ratio and M/S ratio are given, then profit can be
computed as follows:

Profit = Total sales x P/V ratio x M/S ratio (5)

ILLUSTRATION
The sports material manufacturing company budgeted the following data for the
coming year.

N`
Sales (1,00,000 units) 1,00,000
Variable cost 40,000
Fixed cost 50,000
Find out

(a) P/V Ratio, B.E.P and Margin of Safety


(b) Evaluate the effect of

(i) 20% increase in physical sales volume

(ii) 20% decrease in physical sales volume

(iii) 5% increase in variable costs

(iv) 5% decrease in variable costs

(v) 10% increase in fixed costs

(vi) 10% decrease in fixed costs

(vii) 10% decreases in selling price and 10% increase in sales volume

(viii) 10% increase in selling price and 10% decrease in sales volume

(ix) N5,000 variable cost decrease accompanied by N15,000 increase in fixed costs.
Solution:

(a) P/V ratio, B.E.P and Margin of Safety Contribution = Sales – Variable cost
= 100,000 – 40,000

= N60,000

P/V Ratio = (Contribution / Sales) x 100

= (60,000 / 100,000) x 100

= 60%

B.E.P sales = Fixed cost / PV ratio

= 50,000 / 60%

= 83.333

Margin of Safety = Total sales – B.E.P sales

= 100,000 – 83,333

= 16,667

(b)
Contribution P/V ratio BE Sales Margin of safety
` (N) (N)
(i) Increase in volume by1,20,000 – (72,000 / 1,20,000) x (50,000 / 60%) 1,20,000 –
48,000 100 83,333
20% = 72,000 = 60% = 83,333 = 36,667
(ii) Decrease in volume 80,000 – 32,000 (48,000 / 80,000) x (50,000 / 60%) 80,000 – 83,333
by 100
20% = 48,000 = 60% = 83,333 = (3,333)
(iii) 5% increase in variable1,00,000 – (58,000 / 1,00,000) x (50,000 / 58%) 1,00,000 –
42,000 100 86,207
Cost = 58,000 = 58% = 86,207 = 13,793
(iv) 5% decrease in variable1,00,000 – (62,000 / 1,00,000) (50,000 / 62%) 1,00,000 –
38,000 x100 80,645
Cost = 62,000 = 62% = 80,645 = 19,355
(v) 10% increase in fixed1,00,000 – (60,000 / 1,00,000) x (55,000 / 60%) 1,00,000 –
40,000 100 91,667
Cost = 60,000 = 60% = 91,667 = 8,333
(vi) 10% decrease in fixed1,00,000 – (60,000 / 1,00,000) x (45,000 / 60%) 1,00,000 –
40,000 100 75,000
Costs = 60,000 = 60% = 75,000 = 25,000
(vii) 10% decreases in selling 99,000 – 44,000 (55,000 / 99,000) x (50,000 / 99,000 – 90,009
100
price and 10% increase = 55,000 = 55.55% 55.55%) = 8,991
in sales volume = 90,009
(viii) 10% increase in selling99,000 – 36,000 (63,000 / 99,000) x (50,000 / 99,000 – 78,579
100
price and 10% decrease = 63,000 = 63.63% 63.63%) = 20,421
in sales volume = 78,579
(ix) ` 5,000 variable cost1,00,000 – (65,000/1,00,000) x (65,000 / 65%) 1,00,000 –
35,000 100
1,00,000
decrease accompanied = 65,000 = 65% = 1,000,000 =0
by N15,000 increase in
fixed costs.

ILLUSTRATION
Two businesses AB Ltd and CD Ltd sell the same type of product in the same market.
Their budgeted profits and loss accounts for the year ending 30th June, 2016 are as
follows:

AB Ltd (`) CD Ltd (`)


Sales 150,000 150,000
Less: Variable costs 120,000 100,000
135,000
Fixed Cost 15,000 135,000 35,000
Profit 15,000 15,000
You are required to calculate the B.E.P of each business and state which business is likely to
earn greater profits in conditions.

(a) Heavy demand for the product

(b) Low demand for the product.


SOLUTION
Statement Showing Computation of P/V ratio, BEP and Determination of Profitability in Different
conditions:
Particulars AB Ltd CD Ltd
N N
I. Sales 150,000 150,000
II. Variable cost 120,000 100,000
III. Contribution 30,000 50,000
IV. P/V ratio [(30,000/1,50,000) x 100] 20% 33 1/3%
[(50,000/1.50,000) x 100]
V. Fixed cost 15,000 35,000
VI. Profit 15,000 15,000
VII. Breakeven sales (V/IV) 75,000 105,000
From the above computation, it was found that the product produced by CD Ltd is more
profitable in conditions of heavy demand because its P/V ratio is higher. On the other
hand, in the condition of low demand, the product produced by AB Ltd is more
profitable because its BEP is low.

ILLUSTRATION
The following results of a company for the last two years are as follows:
Year Sales ( N) Profit ( N)
2014 150,000 20,000
2015 170,000 25,000
You are required to calculate:
(i) P/V Ratio
(ii) B.E.P
(iii) The sales required to earn a profit of N40,000
(iv) Profit when sales are N 250,000
(v) Margin of safety at a profit of N50,000 and
(vi) Variable costs of the two periods.
SOLUTION
(i) P/V ratio = (Change in profit / Change in sales) x 100
= (5,000 / 20,000) x 100 = 25%
Fixed cost = (Sales x P/V ratio) – Profit
= (150,000 x 25%) – 20,000 = N17,500
(ii) Break even sales = Fixed cost / PV ratio
= 17,500 / 25% = 70,000
(iii) Sales required to earn a profit of 40,000
= Fixed cost + desired profit
P/V ratio
= (17,500 + 40,000) / 25% = 230,000
(iv) Profit at sales ` 2,50,000
= (Sales x P/V ratio) – Fixed cost
= (250,000 x 25%) – 17,500 = 45,000
(v) Margin of safety at profit of 50,000
= Profit / PV ratio
= 50,000 / 25% = 200,000
(vi) Variable cost for 2011 = 150,000 x 75% = N112,500
Variable cost for 2012 = 170,000 x 75% = N127,500

Multiple Products
Faith limited has prepared a budget for the next twelve months when it intends to make and sell
four products, details of which are shown below
Products Sale in units ‘000
Selling price per Variable cost per unit
unit (N) (N)
NTA 10 20 14.00
NTB 10 40 8.00
RST 50 5 4.20
BST 20 10 7.00
Budgeted fixed costs for NTA, NTB, RST and BST; are 40,000, 100,000, 30,000 and 70,000
respectively. You are required to;
1- The break even sale in KG for RST and BST assuming the facilities are not used jointly

are………………….……………………and ………………………. ……respectively.

2- The break even sale in KG for NTA and NTB to achieve a profit of N 100,000 naira
assuming the facilities are not used jointly are
…………...and………………..respectively

3- The break even sale in naira for RST and BST assuming the facilities are not used jointly

are…………………………………………………and………………………..respectively

4- The composite quantity contribution margin, assuming that consumers composite of 30

KG of NTA, 20 KG of NTB, 25 KG of RST and 25 KG of BST is ……………………

5- The breakeven in quantity for all products, assuming that consumers composite of 30
KG

of NTA, 20 KG of NTB, 25 KG of RST and 25 KG of BST is…………………………..

6- Composite contribution margin ratio, assuming that a composite quantity is defined as

equal for NTA, NTB, RST and BST is ……………………………………………..


7- The breakeven sales in Naira for the four products, assuming that a composite quantity is

defined as equal for NTA, NTB, RST and BST is ………………………………………


SUGGESTED SOLUTION

Product NTA NTB RST BST TOTAL


Selling price 20 40 5 10 75
Variable 14 8 4.2 7 33.2
cost
Contributio 6 32 0.8 3 41.8
n
Fixed cost 40,000 100,000 30,0000 70,000 240,000

1- Breakeven point in Kg = Fixed Cost / Contribution Margin


RST = 30,000/0.8 = 37,500 kg
BST= 70,000/3= 23.333 kg
(2marks)
2- Breakeven point in Kg to achieve a profit of N 100,000= ( FC + profit )/ contribution
margin
NTA= (40,000 +100,000)/ 6= 23,333 kg
NTB= (100,000 +100,000)/32= 6250 kg
(2marks)
3- Breakeven point in Naira= Fixed Cost / Contribution Margin ratio
RST=30,000/0.16 = N 187,500
BST=70,000/0.3 = N 2,333,333 (2marks)

4- Composite contribution margin= sum of (cm of a x proportion of a + cm of b x


proportion of b)
= 30% x 6 + 20% x 32 + 25% x 0.8 + 25% x 3 = 9.15 (2marks)

5- Composite Breakeven point in Kg = total fixed cost / Composite contribution margin


=240,000/9.15 = 26,230 kg (2marks)

6- Composite contribution margin ratio = total contribution/ total selling price


=41.8/75 = 0.56 (2marks)

7- Composite Breakeven point in Naira= total fixed cost / Composite contribution margin
ratio
=240,000/0.56= N 428,571 (2marks)

MODERN METHOD IN COST ACCOUNTING


INTRODUCTION

I believe by now you should have read through the course guidelines which are in your tablet or

the hard copy sent to you. If you have not, I strongly recommend you to do so right now before

reading your study materials. It is important that you do so because it provides a

comprehensive outline of the materials you will cover on a Session-to-Session basis, starting

with the topic you are about to study: topical issues in cot accounting . The Session guides you

through several topical issues in cost accounting.

JUST-IN-TIME (JIT) SYSTEM

JIT System was developed in Japan, and has been widely acclaimed as a major contributor to the

country’s success in manufacturing processes. As the name suggests, it seeks to eliminate the need to

keep inventories thereby saving the costs associated with stockholding. The overall objective is to

produce or procure inventory right at the time they are required without compromising on quality.

The followings are the main goals of JIT:


1. No opening or closing stocks. Items are purchased or produced “just in time” in

the required quantities and quality.

2. Elimination of non-value adding activities

3. No production wastages

4. 100% on time deliveries

5. Batch sizes of one

6. Demand-pull manufacture i.e. the production chain is activated real-time by

demand.

7. No breakdowns

8. Short set-ups

JIT System can be subdivided into two, namely:

(a) Just in time purchasing

(b) Just in time production

Under JIT Purchasing, arrangements subsists with reliable suppliers for regular or frequent deliveries of

stock items as and when they are required, thereby eliminating the need to tie down capital on

stockholding. By so doing, raw material stocks, work in progress stocks and their associated costs are

saved. Also saved are factory space and paperwork relating to large and long-term orders.

However, a successful JIT Production system is predicated upon two assurances;

(a) Prompt delivery by the supplier at the exact time required, and

(b) 100% quality with zero rejects.

JIT Production works on exactly similar principles with JIT Purchasing. Production is triggered by a

confirmed order from the customer, hence the term “demand-pull”. As soon as the order us received,

production set-up time is short, material supplier is notified and the order is executed within the shortest

possible time.
JIT Systems have two major limitations namely:

(a) Its lack of flexibility makes it vulnerable to possible disruptions in the supply chain

(b) It makes it difficult to predict demand patterns.

KANBAN INVENTORY CONTROL

In contexts where supply time is lengthy and demand time is difficult to forecast, the best one can do is to

respond quickly to observed demand. This is the main function of Kanban system. Kanban system is a

variant of Just-In-Time system but a step ahead of it. It is used as a demand signal which immediately

propagates through the supply chain. This can be used to ensure that intermediate stocks held in the

supply chain are better managed, usually smaller.

Kanban is a concept which attempts to maintain minimum inventory. It involves more than fine-tuning

production and supplier scheduling systems, where inventories are minimized by supplying them when

needed in production, and work in progress is closely monitored.

The issue is that a supplier or the warehouse should only deliver components to the production line as

and when they are needed, so that there is no storage in the production area. In order to be effective,

Kanban must follow strict rules of use and that close monitoring of these rules is a never –ending problem

to ensure that kanban does what is required.

To make the monitoring process simpler, many manufacturers implemented electronic Kanban (e-

Kanban) systems, thereby eliminating common manual entry errors, providing quick and precise

information, responding more quickly to changes, avoiding overproduction, minimizing waste, and

maintaining low costs associated with information transfer. Traditionally, Kanban systems have been used

by manufacturers to control the amount of stock held on the production line – The manufacturing process

is made quicker due to on-time delivery of stock to production from the warehouse. The use of the kanban

system in the warehouse for just-in-time replenishment of pick bins makes perfect sense. Taking the

manufacturing/production process JIT principle one steps further to encompass warehouse replenishment

process means the same benefits are reaped by the warehouse as they are in manufacturing.

The warehouse does not overstock goods; suppliers have an instantaneous picture of stock levels held,

the process moves from one of stocking goods to one of perpetual inventory. Visibility of stock
movements is available to management, operators and suppliers alike. The aim of taking kanban

principles into the warehouse is to make the processes as lean as possible. Stock is only being delivered

when absolutely necessary. Integrating e-kanban systems into warehouse management systems allows

for real- time demand signaling across the supply chain and improved visibility – Data pulled from e –

kanban systems can be used to optimize inventory levels by better tracking supplier lead and

replenishment times.

BACKFLUSH ACCOUNTING (BACKFLUSH COSTING)

Backflush Accounting is defined as a method of costing, associated with a JIT production system, which

applies cost to the output of a process. Costs do not mirror the flow of products through the production

process, but are attached to output produced (finished goods stock and cost of sales), on the assumption

that such backflushed costs are a realistic measure of the actual costs incurred. In a nutshell, backflush

accounting is a simpler cost accounting system designed to reduce or eliminate detailed accounting

entries. Instead of the traditional detailed, tracking of material movement through stores and production,

backflush costing starts from the finished goods and works backwards to attribute costs between cost of

goods sold and finished goods inventory and/or materials inventory with no separate accounting for WIP.

LIFE CYCLE COSTING

The total “life cycle” cost of a product captures all costs incurred on that product form “cradle to grave”,

from costs of research and development, plant and equipment, manufacturing costs, product

development costs and promotion costs. The purpose of lifecycle costing is to ensure that the firm should

recover all such costs over the estimated number of the units that it expects to sell over the lifecycle of the

product. This helps the firm to compete on price when similar products are introduced by competitors

TARGET COSTING

A Target cost is defined as a product cost estimate derived by subtracting a desired profit margin form a

competitive market price. Target costing is widely used in Japan and is gradually gaining ground in

Europe and the USA. It is a market-driven approach where the target selling price of a proposed product

is determined with a focus on gaining the desired market share. The required profit margin is deducted

from the target selling price to arrive at the target cost for the product. To enable this target cost to be
achieved, much emphasis is laid on the design stage since this is the stage that consumes the major

chunk of the costs, prior to the release to manufacturing. Therefore, product designers, purchasing and

manufacturing specialists work together to determine the product and process features which will enable

the long-run target costs to be achieved.

ADVANCED MANUFACTURING TECHNIQUE (AMT)

AMT is a general term for manufacturing techniques which differ from the traditional production methods

generally believed by modern day management accountants to have become obsolete because they

accommodate or even reward inefficiencies, and provide no incentives for improvement. AMT

encompasses techniques like Computer Aided Design and Manufacturing (CAD/CAM), Flexible

Manufacturing System (FMS), Total Quality Management (TQM), Material Resources Planning (MRP),

Just-In-Time (JIT) and others. The use of various AMT techniques helps companies to effectively

compete in today’s fast moving and sophisticated world market because of their capability to produce high

quality goods at low cost, thereby maximizing customer satisfaction.

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