Ref.
- Cost Management by Jawaharlal
Cost concept in decision CMA Padmaja Buzruk
making
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Marginal costing for decision making
Application of marginal costing
Marginal costing is a decision making tool.
It provides great help to management in number of crucial situations like
• Make or Buy Decision.
• Accepting or rejecting an order decision.
• Pro t planning.
• Operating or shut down decision.
• Exploring foreign market decision.
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Selection of pro table product mix
• Product mix is the ratio in which products are produced and sold.
• Such mix should be selected very carefully.
• Every product has different marginal cost and selling price.
• The mix resulting in highest total contribution will result into high pro t to the
business.
• Selection of product mix or sales mix with optimal pro t is very important decision
in the business.
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Selection of pro table product mix
Example - 5
Find pro table product mix from the following data
A B
Direct material p.u. 10 9
Direct wages p.u. 3 2
Selling price p.u 20 15
Fixed expenses Rs.800
Variable expenses are allocated to products as 100% of direct wages.
Possible product mix
(i) 1,000 units of Product A and 2,000 units of Product B
(ii) 1,500 units of Product A and 1,500 units of Product B
(iii) 2,000 units of Product A and 1,000 units of Product B
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Selection of pro table product mix
Solution
Contribution per unit
A B
Selling price p.u 20 15
(-) Direct material p.u. 10 9
(-) Direct wages p.u. 3 2
(-) Variable expenses p.u 3 16 2 13
Contribution p u 4 2
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Selection of pro table product mix
Solution
Pro tability from possible product mix
1,000 units of A & 1,500 units of A & 2,000 units of A &
2,000 units of B 1,500 units of B 1,000 units of B
(-) Contribution (A - 4 p.u. & B - 2 p.u.) 8,000 9,000 10,000
(-) Fixed Cost 800 800 800
Pro t 7,200 8,200 9,200
Third Product mix i e 2,000 units of A & 1,000 units of B gives highest pro t so it is to be adopted.
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Pro t Planning
• Many times available production facilities are to be used alternatively.
• They may be different production methods or equipments.
• In such case marginal costing helps to calculate highest pro t earning alternative
and to take proper decisions.
• In this case key factor plays very important role.
• Marginal costing can be used for short term pro t planning by calculating required
sales for targeted pro t or nding out pro t that may result on budgeted sales.
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Pro t Planning
Example - 6
Mixy co.manufactured & sold 1,000 mixies last year at a price of Rs.800 each the cost structure is as
follows
Material 200
Labour 100
Variable cost 50
Marginal cost 350
Fixed overhead 200
Total cost 550
Pro t 250
Sales price 800
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Pro t Planning
Example - 6
Due to heavy competition the price has to be reduced to Rs.750 for the coming year.
Assuming no change in costs, state the number of mixies that would have to be sold at the new price to
ensure the same amount of total pro t as that of the last year.
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Pro t Planning
Solution
Total pro t of last year for 1,000 mixies = 1,000 x 250 = Rs.2,50,000.
Contribution required for current year = FC + Expected Pro t = 2,00,000 + 2,50,000 = Rs.4,50,000.
Contribution per mixi at new price = S P p u (-) V C p u = 750 - 350 = 400
No. of mixies to be sold get the same pro t of last year = Total Expected contribution / contribution p u
= 4,50,000 / 400
= 1,125
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Pro t Planning
Veri cation
Sales (1,125 x 750) 8,43,750
(-) Variable cost (1,125 x 350) 3,93,750
Contribution 4,50,000
(-) Fixed cost 2,00,000
Pro t 2,50,000
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Pro t Planning
Example - 7
From the following cost data calculate, units to be sold to earn a profit of Rs.1,40,000.
Total sales Rs.4,00,000
Total variable cost Rs.2,00,000
Total fixed cost Rs.1,00,000
Total units sold 1,00,000
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Pro t Planning
Solution
Total Contribution = Sales (-) V C = 4,00,000 (-) 2,00,000 = Rs.2,00,000
Total units sold 1,00,000
Contribution p u = Rs.2
Units to be sold to earn a profit of Rs. 1,40,000
FC + Expected profit / contribution p u
1,00,000 + 1,40,000 / 2 = 2,40,000 /2 = 1,20,000 units.
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Pro t Planning
veri cation
Sales (1,20,000 x 4) 4,80,000
(-) Variable cost (1,20,000 x 2) 2,40,000
Contribution 2,40,000
(-) Fixed Cost 1,00,000
Pro t 1,40,000
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Pro t Planning
Example - 8
You are given the following data for the year 2024 of ABC ltd.
Variable cost Rs.6,00,000, Fixed cost Rs.3,00,000; Sales Rs.10,00,000; Net profit
Rs.1,00,000
Find
1. Profit when sales are Rs.12,00,000
2. Sales required to earn a profit of Rs.2,00,000
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Pro t Planning
Solution
Total Contribution = Sales (-) V C
= 10,00,000 (-) 6,00,000
= Rs.4,00,000
PVR = (Contribution / Sales) x 100
= 40%
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Pro t Planning
Solution
1.Profit when sales are Rs.12,00,000
Profit = (Sales X PVR) - FC
= (12,00,000 x 40%) - 3,00,000
= 4,80,000 - 3,00,000
= Rs.1,80,000
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Pro t Planning
Solution
2.Sales required to earn a profit of Rs.2,00,000
(FC + Expected profit) / PVR
= (3,00,000 + 2,00,000) / 40%
= Rs.12,50,000.
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Operating or shut down decision
• It is a decision about temporary shut down or operating with less
pro t or loss.
• It is to determine whether in the short run a rm is better off
operating than non operating.
• As long as a product makes a contribution towards the recovery of
xed costs, it may be preferable to operate and not to shut down.
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Operating or shut down decision
• Temporary shut down does not eliminate all costs, depreciation,
interest, insurance etc are incurred during shut down also.
• However there can be saving in maintenance & repair cost, saving in
indirect labour cost during shut down.
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Operating or shut down decision
Example - 9
A paint manufacturing co. manufactures 2,00,000 tin (units) of paint per annum.
Following is the cost of manufacturing per unit
Direct Material 7.80
Direct Labour 2.10
Variable overheads 2.50
Fixed overheads 4.00
Product cost 16.40
Each unit (tin) is sold for Rs.21 with variable selling & administrative expenses of 60 paise per tin.
During next quarter only 10,000 units can be produced & sold.
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Operating or shut down decision
Example - 9
Management wants to shut down the plant estimating that the fixed manufacturing
cost can be reduced to Rs. 74,000 for the quarter.
When the plant is operating, the fixed overheads are incurred at a uniform rate
throughout the year.
Additional cost of plant shut down for the quarter are estimated at Rs.14,000.
Advice whether the plant should be shut down during the quarter.
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Operating or shut down decision
Solution
Alternative 1 to continue Alternative 2 to shut down
Sales (10,000 x 21) 2,10,000 Fixed manufacturing cost 74,000
(-) Variable cost (10,000 x13) 1,30,000
Shut down cost 14,000
Contribution 80,000
(-) Fixed cost 2,00,000
Total shut down cost 88,000
Loss 1,20,000
The decision to shut down is more advantageous to the company than decision to continue.
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Exploring foreign market decision
• When there is spare capacity available and organisation receives
export order at a price below total cost then it is necessary to decide
whether such order is to be accepted or rejected.
• Marginal costing helps in such decisions.
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Exploring foreign market decision
Example - 10
A factory can sell 2,000 units of its products in home market at Rs.20 each. The
marginal cost per unit is Rs.14 and xed overheads Rs.5,000.
It can also sell 2,000 units in the foreign market at Rs.16 each. The additional
distribution cost for export is Re. 1 per unit. Fixed overheads will remain the same.
Is the foreign market worth trying?
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Exploring foreign market decision
Solution
Home market pro t Export order pro t
Sales (2,000 x 16) 32,000
Sales (2,000 x 20) 40,000
(-) Variable cost (2,000 x 14) 28,000 (-) Variable cost (2,000 x 15) 30,000
Contribution 12,000 Contribution 2,000
(-) Fixed cost 5,000 (-) Fixed cost
Pro t 7,000 Pro t 2,000
As the pro t is increased by foreign sale, foreign market is worth trying.
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Exploring foreign market decision
Example - 11
The Everest snow company manufacturers and sells direct to consumers 10,000 jars of ‘Everest snow’
per month at Rs.1.25 per jar. The company’s normal capacity is 20,000 jars per month.
Cost of 10,000 jars is
Direct Material 1,000
Direct Labour 2,475
Power 140
Miscellaneous supplies 430
Jars 600
Fixed expenses mfg, S & D 7,955
Total 12,600
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Exploring foreign market decision
Example - 11
The company has received an offer for the export under different brand name for 10,000 jars per month at
Rs.0.75 per jar.
Should the export order be accepted? show working
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Exploring foreign market decision
Solution
Variable Cost of 10,000 jars is
Direct Material 1,000
Direct Labour 2,475
Power 140
Miscellaneous supplies 430
Jars 600
Total 4,645
Sales value = 0.75 x 10,000 = Rs. 7,500
Contribution = 7,500 - 4,645 = Rs.2,855
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Thank You
CMA Padmaja Buzruk
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