Ans 1.
Pg 160
Marginal costing, often known as variable costing, is a concept in which all variable
production costs are charged to the units produced and the entire fixed cost is charged against
the contribution (total sales income minus total variable cost). This is also known as variable
costing because the cost is determined only by the variable cost. In regard to marginal
costing, the following equations are used:
Sales = Fixed Cost + Variable cost + Profit
Contribution = (Sales revenue - Variable cost) or (Selling price per unit - Variable cost per
unit)
Contribution = Fixed cost + Profit
Profit = Contribution - Fixed cost
Opening stock = Production + Closing stock - Sales
Closing stock = Opening stock + Production - Sales
Production = Sales - Opening stock + Closing stock
Sales = Opening stock + Production - Closing stock
Marginal costing is a cost-data presentation technique in which variable and fixed expenses
are shown separately for managerial decision-making. The Chartered Institute of
Management Accountants (CIMA), London, defines marginal costing as "the determination
of marginal costs and the effect on profit of changes in volume or type of output by
differentiating between fixed and variable costs." Only variable expenses are charged to cost
units (product or inventory), whereas fixed costs for the period are written off against the
period's profit. As a result, marginal costing is also known as the variable costing technique.
To prepare the Income Statement under marginal costing for production at 80,000 units, we
need to calculate the contribution per unit first.
Here, Office Products Ltd provides the Sales and the cost data for 60,000 units where at full
capacity, the plant can produce 100,000 units.
Sales Rs.
12,00,000
Costs:
Variable:
Material Rs. 2,40,000
Labour Rs. 3,60,000
Overheads Rs. 1,80,000
Fixed Cost Rs. 3,20,000
Total Rs.11,00,000
PROFIT Rs. 1,00,000
Thus,
Contribution per unit = Sales price per unit - Variable cost per unit
Sales price per unit = Sales / Units produced = Rs. 12,00,000 / 60,000 = Rs. 20
Variable cost per unit = (Material + Labour + Overheads) / Units produced = (Rs. 2,40,000 +
Rs. 3,60,000 + Rs. 1,80,000) / 60,000 = Rs. 7,80,000 / 60,000 = Rs. 13
Contribution per unit = Rs. 20 - Rs. 13 = Rs. 7
Assuming, Fixed Cost is given at full capacity and is not variable. So, it will remain same
even when production capacity is utilised at 80,000 units instead of 60,000 units.
Now, we can prepare the Income Statement for production at 80,000 units.
Therefore,
Income Statement under Marginal Costing for Production at 80,000 Units is as follows:
Income Statement (at 80000 Units)
Particulars Amount
(Rs.)
Sales (80,000 * Rs. 20) 16,00,000
Less: Variable Cost (80,000 * Rs. 13) (10,40,000)
Contribution (80,000 * Rs. 7) 5,60,000
Less: Fixed Cost (3,20,000)
Profit 2,40,000
Note: Fixed costs are not considered in the calculation of the contribution. They are deducted
from the contribution to arrive at the profit.
Ans 2. Pg 90
We can calculate the cost of the order for February using the rates of January and the given
data.
Direct material cost for the order = Rs. 4,000
Direct wages cost for the order = Rs. 3,300
Machine hours = 1,200 hours
Labour hours = 1,650 hours
We know,
Overhead charging rate = Overheads incurred / Basis
Now, Defining the relevant terms which will be used later on to find the to Overhead and
Total Cost are as follows:–
LABOR HOUR RATE: This method is superior to the percentage of direct pay basis
in that it fully recognises the importance of time in the incurring and absorption of
manufacturing overhead expenses. This strategy is ideal for procedures that do not
require a huge amount of machinery. To calculate the labour hour rate, divide the total
number of direct labour hours by the amount of manufacturing overheads. It can be
determined for each worker category. The following formula should be used with this
method:
Labour hour rate for January = Overhead chargeable to the department / Labour hours
= Rs. 48,000 / 24,000 hours = Rs. 2 per labour hour
PERCENTAGE OF DIRECT LABOR COST: Direct labor costs are the wages and
salaries paid directly to employees for their time and effort. The percentage of direct
labor cost is calculated by dividing the total cost of labor by the total sales for the
period and multiplying by 100. This will indicate what portion of the total sales is
spent on labor costs.
Thus,
Percentage of direct wages absorbed by overheads = Overhead chargeable to the
department / Direct wages = (Rs. 48,000 / Rs. 60,000) * 100 = 80%
MACHINE HOUR RATE: The machine hour rate approach charges manufacturing
overhead expenses to production based on the number of hours machines are used on
jobs or work orders. The following formula is used to calculate the machine hour rate:
Thus,
Machine hour rate for January = Overhead chargeable to the department / Machine
hours = Rs. 48,000 / 20,000 hours = Rs. 2.4 per machine hour
Now, we can prepare the comprehensive statement of cost for the order using each of the
given methods of absorption.
Method 1: Direct Labour Hours
Particulars Amount (Rs.)
Direct Material Cost 4,000
Direct Wages Cost 3,300
Overhead (Labour Hour Rate) 2 x 1,650 = 3,300
Total Cost 10,600
Method 2: Percentage of Direct Wages
Particulars Amount (Rs.)
Direct Material Cost 4,000
Direct Wages Cost 3,300
Overhead (Percentage of Direct Wages) 80% x 3,300 = 2,640
Particulars Amount (Rs.)
Total Cost 9,940
Method 3: Machine Hour Rate
Particulars Amount (Rs.)
Direct Material Cost 4,000
Direct Wages Cost 3,300
Overhead (Machine Hour Rate) 2.4 x 1,200 = 2,880
Total Cost 10,180
Note: The overheads absorbed by each method are different, which results in different total
costs for the order.
Ans 3 a. Pg 45
Economic Order Quantity (EOQ) is an inventory management system that helps companies
determine the optimal order size for restocking their inventory. It considers the cost of
ordering and holding inventory, as well as the cost of stockouts, and helps businesses
minimize these costs.
To compute the Economic Order Quantity (EOQ), we can use the following formula:
EOQ =
√ 2 AO
C
Where,
A = Annual Consumption
O = Ordering Cost per order
C = Inventory Carrying Cost per unit
Given:
Ordering Cost (O) = Rs. 50 per order
Cost of Product A (P) = Rs. 500 per unit
Inventory carrying cost (C) = 10% per annum = 500*10% = 50
Annual consumption of Product A (A) = 5000 units
Substituting the values in the formula, we get:
EOQ =
√ 2∗5000∗50
50
= 100 units
Therefore, the Economic Order Quantity is 100 units.
Now, if the inventory maintained by the company is 200 units,
Ordering Cost = (Annual Consumption / Units Ordered) * Order Cost per order
= (5000 / 200) * 50 = Rs. 1250
Carrying Cost = ½ * Inventory Maintained * Carrying Cost per unit
= ½ * 200 * 50 = Rs. 5000
Total (I) = Rs. 1250 + Rs. 5000 = Rs. 6250
But if the inventory maintained by the company is at EOQ level i.e. at 100 units,
Ordering Cost = (Annual Consumption / Units Ordered) * Order Cost per order
= (5000 / 100) * 50 = Rs. 2500
Carrying Cost = ½ * EOQ * Carrying Cost per unit
= ½ * 100 * 50 = Rs. 2500
Total (II) = Rs. 2500 + Rs. 2500 =Rs. 5000
Therefore, the company has to bear additional cost of Rs. 1250 (I – II = Rs. 6250 – Rs. 5000)
if they maintain the inventory at 200 units.
Ans 3 b. Pg
The Break Even Point is the point at which a company is able to cover its costs. It is the point
at which total revenue equals total costs. Knowing the Break Even Point can help a business
decide when to introduce a product, how to price it, and how to adjust production levels in
order to maximize profits.
To determine the breakeven point, we can use the following formula:
Breakeven Point (in units) = Fixed Costs / (Sales Price per unit - Variable Costs per unit)
Given:
Fixed Costs (FC) = Rs. 5,00,000 per annum
Sales Price per unit (SP) = Rs. 300
Variable Costs per unit (VC) = Rs. 280
Substituting the values in the formula, we get:
Breakeven Point (in units) = 5,00,000 / (300 - 280) = 25,000 units
Therefore, the breakeven point for the company is 25,000 units.
Significance of breakeven point –
Breakeven point is an important metric in business because it indicates how much sales are
required to cover all the expenses incurred by a company. This is when total revenue equals
total costs, and a company neither makes a profit nor incurs a loss. Above this point, the
company earns profits, and below this point, it incurs losses. It helps companies set their
pricing strategies, sales targets, and cost-control measures when they know the breakeven
point. It can also be used to evaluate the feasibility of a new project or investment, as well as
to analyze the impact of changes in fixed costs, variable costs, and sales price on profitability.
Knowing the breakeven point can help companies to plan their resources and budget more
efficiently. It can also help in forecasting anticipated profits from a business venture. By
understanding the breakeven point, companies can make more informed decisions about their
business.
