Smu Chapter 12 Mb0041

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Financial and Management Accounting

Unit 12

Unit 12

Marginal Costing and Break – Even Analysis

Structure: 12.1 Introduction Objectives 12.2 Marginal Costing 12.3 Assumptions of Marginal Costing 12.4 Differences Between Absorption Costing and Marginal Costing 12.5 Marginal Cost 12.6 Contribution 12.7 Cost Volume Profit (CVP) Analysis 12.8 Profit Volume Ratio (MCSR or C/S Ratio) 12.9 Break-Even Analysis 12.10 Break-Even Chart 12.11 Target Profit 12.12 Margin of Safety (MOS) 12.13 Applications of Marginal Costing 12.14 Limitations of Marginal Costing 12.15 Solved Problems 12.16 Summary 12.17 Glossary 12.18 Terminal Questions 12.19 Answers 12.20 Case Study

12.1 Introduction
In the previous unit we learnt the meaning, classification, elements, and statement of cost. We also analysed the objective, methods, and techniques of costing. Cost control is as important as cost ascertainment. If costs are not controlled, the company will not be able to make good profits and its survival becomes difficult. There are many techniques of cost control. Of them, three techniques are most important. They are marginal costing, budgetary control, and standard Sikkim Manipal University Page No.: 297

Financial and Management Accounting

Unit 12

costing. In this unit and the next unit we shall learn about the technique of marginal costing and its applications. We shall also analyse the techniques of budgetary control and standard costing in unit 14 and unit 15 respectively. Objectives: After studying this unit, you should be able to:      explain marginal costing explain the assumptions of marginal costing differentiate between marginal costing and absorption costing explain the principles of CVP analysis and break-even analysis apply the principles of business decisions CVP analysis and break-even analysis in

12.2. Marginal Costing
Marginal costing is defined as “The ascertainment of marginal cost and of the effect on profit of changes in volume or type of output by differentiating between fixed costs and variable cost.” – CIMA London “It is a special technique of costing under which the costs are separated into variable and fixed costs and only the variable costs are charged to operations, processes or products and the fixed costs are charged against the profits of the period in which they are incurred.” – B. S. Raman

12.3 Assumptions of Marginal Costing
Marginal costing is based on the following assumptions: 1. Segregation of cost into fixed and variable The whole principle of marginal costing is based on the idea that some costs vary with production while some costs don’t. Therefore, it is assumed that a clear bifurcation between fixed and variable costs is possible. Even if some costs do not entirely qualify as fixed or as variable, it is still possible to separate such mixed cost with respect to the amount, which remains fixed and the amount which varies with production. Sikkim Manipal University Page No.: 298

Financial and Management Accounting

Unit 12

2. Volume is the only factor which influences the cost It is assumed that other factors like the demands, tastes, and preferences of consumers, availability of substitute products, availability and price of inputs, etc. are constant. Hence, volume is the only factor which influences the cost. 3. Constant selling price It is assumed that the selling price will be constant for any level of sales. 4. Constant total fixed cost It is assumed that the total fixed cost will be constant for any level of production. 5. Constant variable cost per unit It is assumed that the variable cost per unit will be constant for any level of production. 6. No closing stock It is assumed that the firm will be able to sell all its production. All the units produced would be sold. Hence, there would be no opening and closing stocks. 7. Linear relationship between costs and revenues It is assumed that the costs and revenues are linearly related to volume. The change in...
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