The basic assumptions made by marginal costing are following:
- Total variable cost is directly proportion to the level of activity. However, variable cost per unit remains constant at all the levels of activities.
- Per unit selling price remains constant at all levels of activities.
- All the items produced by the organisation are sold off.
Features of Marginal costing:
- It is a method of recoding costs and reporting profits.
- It involves ascertaining marginal costs which is the difference of fixed cost and variable cost.
- The operating costs are differentiated into fixed costs and variable costs. Semi variable costs are also divided in the individual components of fixed cost and variable cost.
- Fixed costs which remain constant regardless of the volume of production do not find place in the product cost determination and inventory valuation.
- Fixed costs are treated as period charge and are written off to the profit and loss account in the period incurred.
- Only variable costs are taken into consideration while computing the product cost.
- Prices of products are based on variable cost only.
- Marginal contribution decides the profitability of the products.
What are the limitations of Marginal Costing?
The limitations of Marginal Costing:
- The classification of total costs into fixed and variable cost is difficult.
- In this technique fixed costs are totally eliminated for the valuation of inventory of finished and semi-finished goods. Such elimination affects the profitability adversely.
- In marginal costing historical data is used while management decisions are related to future events.
- It does not provide any standard for the evaluation of performance.
- Selling price fixed on the basis of marginal cost will be useful only for short period of time.
- Assessment of profitability on the marginal cost base can be used only in the short period of time. What is Cost Volume-Profit relationship?
Cost Volume-Profit (CVP) relationship is an analysis which studies the relationships between the following factors and its impact on the amount of profits.
-Selling price per unit and total sales amount • Total cost which may be in any form i.e. fixed cost or Variable cost. -Volume of sales
In simple words, CVP is a management accounting tool that expresses relationship among total sales, total cost and profit. Cost Volume-Profit relationship is one of the important techniques of cost and management accounting. It is a powerful tool which furnishes the complete picture of the profit structure and helps in planning of profits. It can also answer what if type of questions by telling the volume required to produce. This concept is relevant in all decision making areas, particularly in the short run.
Explain P/V ratio and Contribution.
P/V Ratio (Profit Volume Ratio) is the ratio of contribution to sales which indicates the contribution earned with respect to one rupee of sales. It also measures the rate of change of profit due to change in volume of sales. Its fundamental property is that if per unit sales price and variable cost are constant then P/V Ratio will be constant at all the levels of activities. A change in fixed cost does not affect P/V Ratio. It is calculated as under:
(Contribution * 100) / Sales
(Change in profits * 100) / (Change in sales)
A high P/V Ratio indicates that a slight increase in sales without increase in fixed costs will result in higher profits. A low P/V ratio which indicates low profitability can be improved by increasing selling price, reducing marginal costs or selling products having...