COSTING TECHNIQUES

VIDYARUPA ACADEMY | CHENNAI | 8122756595

MARGINAL COSTING
• Marginal costing is an alternative method of costing to absorption costing.
• In marginal costing, only variable costs are charged as a cost of sale and a contribution is
calculated. Closing inventories of work in progress or finished goods are valued at marginal
(variable) production cost.
• Fixed costs are treated as a period cost, and are charged in full against profit in the accounting
period in which they are incurred. It is defined as ascertainment of cost and measuring the impact
on profit of the change in the volume of output or type of output.
• This is subject to one assumption and that is the fixed cost will remain unchanged irrespective of
the change.
• Thus, the marginal costing involves firstly the ascertainment of the marginal cost and measuring
the impact on profit of alterations made in the production volume and type.
Difference
• The impact on the profit under the two cost accounting systems is summarized below:
• Scenario one –No opening and closing stock

• In this situation, profit / loss under absorption and marginal costing will be equal.
• Scenario two – Value of opening stock is equal to value of closing stock

• In this situation, profit / loss under two approaches will be equal provided the fixed cost element in both the
• stocks is same amount.
• Scenario three – Value of closing stock is more than value of opening stock

• When production during a period is more than sales, then profit as per absorption approach will be more than that
by marginal approach. The reason behind this difference is that a part of fixed overhead included in closing stock
value is carried forward to next accounting period.
• Scenario four – Value of opening stock is more than the value of closing stock

• When production is less than the sales, profit shown by marginal costing will be more than that shown by
absorption costing. This is because, in absorption costing a part of fixed cost from the preceding period is added to
the current year’s cost of goods sold in the form of opening stock.
• The income statements under the two systems are presented in the following lines:
Absorption Costing
Particulars (₹) (₹)

Sales -----

● Direct material consumed

● Direct labour cost -----

● Variable manufacturing overhead -----
● Fixed manufacturing overhead -----
Cost of production -----

Add: Opening stock of finished goods -----

(Value at cost of previous year’s production)

Less: Closing stock of finished goods -----

(Value at production cost of current period)

Cost of Goods Sold -----

Add:(or less) Under (or Over) absorption of Fixed Manufacturing overhead -----

Add: Administration costs -----

Add: Selling and distribution costs ----- -----

Total Cost -----

Profit (Sales–Total cost) -----

 Marginal Costing
Particulars (₹)

Sales -----

Variable manufacturing costs:

● Direct material consumed -----
● Direct labour -----
● Variable manufacturing overhead -----

Cost of Goods Produced -----

Add: Opening stock of finished goods -----

(value at cost of previous period)

Less: Closing stock of finished goods -----

(Value at current variable cost)

Cost of Goods Sold -----

Add: Variable administration, Selling and distribution overhead -----

Total Variable Cost -----

Contribution (Sale–Total variable costs) -----

Less: Fixed costs (production, administration, selling and distribution) -----

Net profit -----

 Fundamental principle of marginal costing
Since fixed costs are constant within the relevant range of volume sales, the following is
the net impact of selling one extra unit:
1. Revenue will increase by the sales price of one unit.
2. Costs will only increase by the variable cost per unit.
3. The increase in profit will equal sales value less variable costs, i.e. the contribution
If the volume of sales falls by one unit, then profit will fall by the contribution of that
unit. If the volume of sales increases by one unit, profit will increase by the contribution of
that unit.
Fixed costs relate to time and is thus referred as the period cost, and do not change with
increases or decreases in sales volume. It avoids the often arbitrary apportionment of fixed cost
and highlights contribution, which is considered more appropriate for decision –making
purposes
Differential costs
• Identified the increase/decrease in costs between two activities or
projects etc
• It take into consideration change in total cost to change in total sale
CVP Analysis
• Cost- Volume – Profit Analysis, tries to analyse the impact of changes
in cost and revenue on profit.
• Tools used for analysis :
• Contribution Analysis
• Contribution per unit = Sales per unit – Variable Cost per unit
• Total Contribution = per unit contribution × number of units sold
• Total Contribution – Fixed Cost = Profit
• Break even point (units) = FC/Contribution per unit
• Break even point (value) = FC/PV ratio
CONTRIBUTION

• SALE – VARIABLE COST = CONTRIBUTION

• Variable Cost Ratio = 1 – Contribution Margin
• Variable Cost Ratio = 1 – P/V Ratio.
Angle of Incidence
• The angle formed at the break-even point by the intersection of the
sales line and the total cost line is known as the angle of incidence. It
should be the aim of the management to have a wider angle. The size
of the angle indicates the rate of profit earned after break-even point.
A wider angle means a high rate of profit accruing after the fixed costs
are absorbed. On the contrary, a narrow angle means a relatively low
rate of profit indicating that variable costs constitute a large part of
cost of sales.
Non-linear break-even analysis
• In linear break even method, it is assumed that Sale per unit and VC
per unit remains constant.
• Where variable cost is constant upto a certain level and changes
beyond that, then there will be more than one break even point
Application of Marginal Costing
• Decision making : make or buy, pricing decisions, shutdown or retain
decision, expand or contract, choosing the right product mix etc
• Cost control
• Profit planning
• Key factor analysis
Standard Costing
• Labour idle time variance = [(hours paid – hours worked) × standard
direct labour rate per hour]
• Labour cost variance = labour rate variance +labour idle time
variance + Labour efficiency variance
• Material cost variance = Material price variance + Material usage
variance
• Material usage variance = material yield variance + material mix
variance
• Net efficiency variance = actual efficiency variance + idle time
variance
Budget and forecasts
Forecasts Budgets

● Forecasts is mainly concerned with anticipated or probable events. ● Budget is related to planned events.

● Forecasts may cover for longer period (often in excess of a year). Budget is planned or prepared for a shorter period.

● Forecast is only a tentative estimate. ● Budget is a target fixed for a period.

Forecast results in planning. ● Result of planning is budgeting.

● The function of forecast ends with the forecast of likely events. The process of budget starts where forecast ends and converts it into a budget.

Forecast usually covers a specific business function. ● Budget is prepared for the business as a whole.

● Forecasting does not act as a tool of controlling measurement. ● Purpose of budget is not merely a planning device
but also a controlling tool.
Objectives of Budget
• Planning
• Control
• Co-ordination
Budgetary Control
• Budgetary Control is the systematic process where management uses
the budgets prepared at the beginning of the accounting period to
compare and analyse the actual results at the end of the accounting
period and to set improvement measures for the next accounting
year. Thus, the whole gamut of preparation of budget and using the
same for control purpose is being considered in the budgetary
control.
Difference between standard
costing and Budgetary control
Details Standard Costing Budgetary Control

Meaning It is a system of accounting where predeter- mined costs are used It is planning exercise made by the manage- ment in setting budget
for analysis of variance and control of the entire organisation. for the forthcoming period and analysis of actual with budgeted
figure.

Expressed It may be expressed both in terms of quantita- tive and monetary It is expressed in monetary terms only.
measure.

Objective It is ascertained and control of cost. It is concerned with the overall profitability and financial
position of the concern.

Emphasis It emphasizes on what should be the cost. It emphasizes on the level of cost not to be ex- ceeded.

Projection It is projection of cost accounts. It is projection of financial accounts.

Used by Standards are usually limited to manufactur- ing activities only. Budgets are used by all departments.
Types of Budgets
• Bottom-Up Budgeting – this is the budgeting process where all budget holders have the
opportunity to participate in setting their own budgets.
• Imposed/Top-Down Budgeting – this is the budgeting process where budget allowances are set
without permitting ultimate budget holders the opportunity to participate in the process.
• Negotiated Budget – this is the budgeting process in which budget allowances are set largely on the basis of
negotiations between budget holders and those to whom they report.
• Participative Budgeting – Participative budgeting involves employees from lower levels who give their input
about the cost allocation. It allows lower-level employees to feel a sense of ownership and belonging to the
organisation, as they feel that they are an important part of the budgeting process. Thus, it is often reffred as
bottom – up budgeting.
Stages in Budgeting process
• The important stages of the budgeting process are as follows:
• communicating details of budget policy and guidelines to those
people responsible for the preparation of budgets;
• determining the factor that restricts output;
• the order of preparation of budget;
• negotiation of budgets with superiors;
• final acceptance of budgets;
• ongoing review of budgets.
Cash Budget
• A cash budget is a statement in which estimated future cash receipts and
payments are tabulated in such a way as to show the forecast cash balance of
a business at defined intervals. It is an estimate of cash receipts and cash
payments prepared for each month.
• It can also give management an indication of potential problems that could
arise and allows them the opportunity to take action to avoid such problems.
A cash budget can show four positions:
• Short term surplus
• Short-term shortfall
• Long-term surplus
• Long-term shortfall
Zero rated supply
• Zero Base Budgeting (ZBB) is method of budgeting whereby all
activities are revaluated each time budget is formulated and every
item of expenditure in the budget is fully justified.
• In ZBB, the beginning is made from scratch and each activity and
function is reviewed thoroughly before sanctioning the same and all
expenditures are analyzed and sanctioned only if they are justified
Performance based budgeting
• It is budgetary system where the input costs are related to the performance
i.e. the end results. This budgeting is used extensively in the Government
and Public Sector Undertakings. It is essentially a projection of the Govern-
ment activities and expenditure thereon for the budget period. This
budgeting starts with the broad classification of expenditure according to
functions such as education, health, irrigation, social welfare etc. Each of
the functions is then classified into programs sub classified into activities or
projects. The main features of performance budgeting are as follows:
• Classification into functions, programs or activities
• Specification of objectives for each program
• Establishing suitable methods for measurement of work as far as possible
• Fixation of work targets for each program.