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 Marginal Costing essay

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Marginal cost is a type of variable cost which refers to the cost of extra inputs that is required to produce a particular output. As a matter of fact, it is derived from the total production expenses with respect to the amount produced. Therefore, marginal costing is a technique in accounting whereby the variable costs are used to cover the cost units and the fixed costs are cancelled against the collective contribution.  In this case, contribution refers to the difference between sales and marginal cost.

Marginal costing is very important in decision making process of managers. It is used in fixing of selling prices and in determining whether continued production of a certain product by a firm is profitable or not. At such as a time, management can choose whether outsourcing production of the product is the best alternative or not. For instance, if a company buys or hires a machine to carry out a certain task, application of marginal costing will help to show how profitable the machine is. In case the machine lies idle, then the firm continues to incur costs on it.

Q1. Before hiring the machine;

Profit= Selling Price- Cost Price

Selling price     = 18 * 6,000

=108,000

Cost price        =fixed cost + variable cost + selling cost

=40,000 + (8 *6000) + (2 * 6000)

=100, 000

Profit    = Selling Price – Cost Price

= 108,000- 100,000

Profit    = 8,000

After hiring the machine;

Profit = Selling price – cost price

Profit remains constant

Selling price= 18x

Cost price= 10,000 + 40,000 + 6x + 2x

Profit =18x- (50,000 + 8x)

8,000 = -50,000 - 8x

10x =58,000

X = 5,800

Number of units = 5,800

Q2. Production remains the same

Therefore, number of units produced= 6,000

Profit = selling price- cost price

Profit-= (18 *6000) – (50,000- (6 * 6000) + (2 * 6000))

Profit = 108,000 -100,000

Profit = 8,000

CLIENT 1

Q1. Before hiring the machine;

Profit= Selling Price- Cost Price

Selling price     = 18 * 6,000

=108,000

Cost price        =fixed cost + variable cost + selling cost

=40,000 + (8 *6000) + (2 * 6000)

=100, 000

Profit    = Selling Price – Cost Price

= 108,000- 100,000

Profit    =8,000

After hiring the machine;

Profit = Selling price – cost price

Profit remains constant

Selling price= 18x

Cost price= 10,000 + 40,000 + 6x + 2x

Profit =18x- (50,000 + 8x)

8,000 = -50,000 - 8x

10x =58,000

X = 5,800

Number of units = 5,800

The profit/ volume chart

The profit/ volume graph shows the profit or loss at every level of sales, at a certain sales price. It shows the correlation between profit in a firm and its sales. The graph shows how different amounts of sales in the company influence its earnings. There are various factors that are depicted by this graph (Kakani, 2007). They include the amount of loss when sales are zero and the amount of fixed costs used in full.

Also, the graph shows the amount of profit or loss that can be obtained at a prescribed intensity of sales. The relative proportion of a product line to the total sales of a number of products forms the sales mix (Cheema, 2005). In case there are no hindrances, the management of any given business should focus on selling a product with high profit/ volume ratio. However, due to market constraints, production and selling of a product is controlled. The graph is important since it helps to establish sales goals and to determine whether a project that a company wishes to undertake will be successful or not.

On the other hand, a breakeven chart is a financial management tool that is used to display and predict a company’s expected revenue and calculate the time for profitability to be attained. It is also applied to forecast the effect that variation in price will have on the percentage variation in sales over a given period of time (Scarlett, 2009). Furthermore, the tool helps to evaluate the correlation that exists between fixed and variable cost and at the same time forecast the effect on profitability of these cost variations.

CLIENT 2: WHITLOW FARM HOLIDAY CENTRE

Variances

This table contains both the variances and the flexible budget. The variances are as shown in the diagram.

 Actual data Budget Variances Comments Number of guest days 11160 9600 1560 Unfavorable Food 20500 20160 340 Unfavorable Cleaning material 2232 1920 312 Unfavorable Heat, light & power 2050 2400 -350 favorable Catering wages 8400 7200 1200 Unfavorable Rent, rates, insurance & depreciation 1860 1800 60 Unfavorable

Flexible budget

 Actual data Budget Flexed Number of guest days 11160 9600 Food 20500 20160 17634 Cleaning material 2232 1920 1920 Heat, light & power 2050 2400 1763 Catering wages 8400 7200 7226 Rent, rates, insurance & depreciation 1860 1800 1600

Workings for the flexed budget

(9600 * 20500)/ 11160 = 17634

And the calculations calculated in that format.

Causes of Variances (material)

Price Variances

v  The payment of lower or higher price than was planned.

v  The gaining or losing of quantity discounts by buying in amounts not originally planned.

v  Purchase of higher or lower quality than originally planned.

v  Lack of materials that was planned; for leading to the purchase of substitute materials.

Efficiency Variance

v  The use of machinery that is not efficient.

v  A change in the amount of scrap; from the amount that was planned for

v  Change in the quality of labor; poor training or increase in quality.

Causes of Variances (Labor)

Labor Rate Variances

v  Increase in wages leading to higher rates being paid.

v  Using of a different grade of workers than planned.

v  Payment of unplanned expenses, for example, overtime or bonus.

Lab Efficiency Variances

v  Use of poorly trained personnel: this leads to the lowering of the grade of labor.

v  The increase or decrease in the planned efficiency of labor.

v  Poor supervision of labor and workshops.

v  Using of incorrect materials or even machine problems.

Part two

The second table shows the revised variances after flexing the budget                                      Variances after flexing the budget

 Actual data Flexed Variances Comments Food 20500 17634 2866 Unfavorable Cleaning material 2232 1920 312 Unfavorable Heat, light & power 2050 1763 287 Unfavorable Catering wages 8400 7226 1174 Unfavorable Rent, rates, insurance & depreciation 1860 1600 260 Unfavorable

CLIENT 3: MYMOVE

Budgeting

A budgetary report contains information about duties of persons handling the process and the key objectives of the budget. In a company that is planning to extend its networks and establish proper policies, sound annual budget preparation calls for avoiding orthodox practices and making early decisions. Many organizations prepare proper budgets but fail in the implementation of the budgets. Once a budget is prepared, it should be circulated to different heads of departments (Moeini, 2007). The main reason for this is to ensure that the budget conclusively and numerically tally with the departmental figures. Sometimes, a department may present its budgetary estimate to the accountant, but in the preparation of the budget by the accountant, he allocates a smaller amount than required. Therefore, the budgets should first be circulated to heads of departments (Moeini, 2007). If there are no questions arising from the budget, it is passed to the senior accountant who checks it to ensure if conforms to the company’s accounting concepts. Thirdly, it passes to the internal auditor who ensures all the information in the budget make reasonable estimates. Finally, it’s passed to the general manager for approval (Moeini, 2007).

Budgets serve a crucial role in providing companies with the overview of the targets they wish to acquire. Though helpful, a budget may also have several disadvantages that make managers view it as an unnecessary hindrance to their work. In so, some managers wish to avoid budgeting altogether. They view the budget as a tool that concentrates on short term financial control of a business, and placing emphasis on the formal organizational structure of a business. Therefore according to such argument, budgeting acts as trap due to the fixed targets, and managers can only concentrate on the numbers set instead of making a difference. Consequently, management can only meet the set goals instead of maximizing their potential (Hope & Fraser, 2003).

A budget totally concentrates on the short term financial control of a business and thus it is time bound. After its period expires, the manager must start planning again and come up with a new budget for the next phase. This constant planning for each period can be tiresome to the managers. They feel demotivated since they can only stick to planned figures (Hope & Fraser, 2003). The managers have no control of the budget and have to follow the budget mechanically. Budgets also emphasize on the formal organization structure of a firm. If changes have to be made or anything is to be implemented, the manager has to follow an outlined procedure. They cannot do it independently or innovatively (Hope & Fraser, 2003).

Not withstanding the above disadvantages, budgeting is more advantageous to a firm than its harm. Budgeting helps management to know if there is a deviation from the outlined goals so that a remedial action can be taken. The fact that the budget takes care of the short term financial goals, it eases the work of management as eventually, long term objectives are met (Hope & Fraser, 2003). Budgeting can be a basis for the appraisal of performance, and as a motivational factor to employees if they are used in the actual formulation of a budget. These reasons ensure the continued good flow of a business transaction without fear or uncertainty as everything has been planned in advance (Moeini, 2007).

Budgeting is a very important business management tool. The tool makes the work of the management easier as they do not have to plan their day to day business transactions and activities. Therefore, demerits of a budget can be overlooked as its advantages outweigh the disadvantages by a very large margin.

The importance of costing

In the context of a firm, cost refers to the amount of money used in the production process and hence it cannot be used anymore. In this scenario, money is the input that is used in order for a firm to acquire the intended purpose Jawaharlal, 2002). Costing, on the other hand, refers to the calculation of costs or cost estimation of a particular product, process, or even a department. There are various methods of costing which include standard and marginal costing. Costing helps management to ensure that everything is running according to the planned schedule and that there is no deviation from the outlined goals. It is with this knowledge that management can be able to correct any deviation that might occur in the production process (Jawaharlal, 2002).

Costs can in turn be classified by the management in terms of logical sequence taking into consideration their nature and the purpose they intend to fulfill. In cost classification, they are broken down to small units, which can assist, management in many ways. The management, with the help of classification, can be able to pinpoint the exact deviations in the budget, establish the most important costs in a firm, and even save time, money and effort in the correction of errors as they know exactly what costs to correct or look into. Costs can be classified according to their behavior, controllability and non-manufacturing costs. In behavior, costs can be classified into different categories, which include fixed, variable, semi-variable, semi-fixed, direct, and indirect costs (Jawaharlal, 2002). In the non-manufacturing category, costs can be classified into administrative, selling, distribution, finance, research and development costs. The controllable and non-controllable are simply the costs the management has influence on their occurrence (Bhimani, Foster, Horngren, & Datar, 2008).

Break even analysis

A break-even point is a point, in sales, whereby there is no profit gained or loss suffered by the business or firm. A break-even graph is used to display a relationship between profits and cost to volume. It then shows the profit or loss for any given sales volume within a given relevant range of sales. Break-even as a tool can be advantageous to a firm as it can be used to measure the profits and losses at different levels of sales and hence determine the optimum level of sales for a firm (Horngren, 2006). The tool is helpful to a firm management since it calculates the effect of a price change without having to change the price realistically. The firm can then be able to know whether to change the price or not. In case, there is a change in costs and efficiency, then the management can be able to see the effect on profitability. In this case, they can be able to implement the necessary measures (Horngren, 2006).

Even with the above advantages, the tool also has some limitations. Some of the limitations include the price constancy assumption in all output levels. However, this might not be the case in a real case. The other disadvantage arises from the assumption that sales and production are the same. The assumptions might thus mislead the management. The breakeven charts also take time to prepare, and they apply to an individual product or a mix of single products (Bhimani, Foster, Horngren, & Datar, 2008).

Overheads refer to the operating expenses that a firm or business incurs in their day to day activities. The overheads are exclusive of both materials used and the cost of labor. They include the rent, taxes, and cost of utilities among others (Horngren, 2006). Overheads are distributed through the various outputs of the firm, and each unit of output has to bear a certain amount of overheads. The overheads are thus used in calculation of the intended price of manufactured goods. It is assumed that the overheads are necessitated by the production of products (Horngren, 2006).

Costing is a very important management tool. It enables the management to plan, correct deviations and make decisions on what to produce, how and at what cost. Costing, as a tool, is indispensable to any firm.

CLIENT 5: MALBOROUGH INTERIORS

Part one

 OVERHEAD BASIS AMOUNT UNITS RATES DEPARTMENTS SERVICE DEPT P1 P2 P3 S4 S5 Rent and rates Area 12800 6400 2 6000 3600 1200 1200 800 Telephone charges Area 3200 6400 0.5 1500 900 300 300 200 Machine insurance Machine value 6000 163000 0.0368 883.2 368 294.4 147.2 73.6 Depreciation Machine value 18000 163000 0.11 2640 1100 880 440 220 Production supervisors salary Labour hours 24000 21860 1.097 3510.4 1974.6 1097 0 0 Heating and lighting Area 7500 6400 1.17 3510 2106 702 702 468 Totals for the department overheads 18043.6 10048.6 4473.4 4991.2 1761.6 S4s overheads Technical estimate 4991.2 50:25:25 2495.6 1247.8 1247.8 (4991.2) S5s overheads Technical estimate 1761.6 20:30:50 352.32 528.48 734 880.8 (1761.6) Totals 78252.8 20891.52 11824.88 6455.2 0 0

Part two

Costing for job X and Y

Labor rates/hour =3.80, 3.50, 3.40, 3.00, 3.00

Job X

Direct material;                           144

Direct labor;

-          Dept P1 (20 x 3.80)                   76

-          Dept 2 (12 x 3.50)         42

-          Dept 3(10 x 3.40)         34

Prime cost                                 296

Job Y

Direct material                 118

Direct labor;

-          Dept P1 (16 x 3.80)                  60.8

-          Dept 2 (10 x 3.50)      35

-          Dept 3(14 x 3.40)       47.6

Prime cost                               261.4

If it is the company’s practice to quote price that include a required profit margin of 15%, then the following calculations will have to be done. Therefore, the selling price for each job includes;

Margin = gross profit/ selling price

Mark up = gross profit/ total cost

Job x

The selling price will be 115% x 296 = 340.4

Job Y

The selling price will be 115% x 261.4 = 300.61

CLIENT 6: SNAPLOCK LTD

Variances

Variances

i)   Sales price variance = (Budgeted selling price – Actual price) Actual units sold

= (32 – 31)4850

= Sh.4850 unfavorable

ii)   Material variances

Actual Quantity x Actual price                           9800

Less

Actual Quantity x Std price

2300 x 4                                                          9200

Material price variance                         600Unfavorable

Actual Quantity x Std price                              4600

Std Quantity x Std price

(4850x0.2) x 2                                                4850

Material efficiency variance                              250Favorable

iii)   Labour rate and efficiency variances

Actual labour hrs x Actual rate             67800

Less

Actual labour hrs x std rate

8500 x 8                                                         68000

Labour rate variance                                       200 Favorable

Actual labour hrs x std rate                              64000

Less

Std labour hrs x std rate

(4850 x 2) x 8                                                 77600

Labour efficiency variance                               13600 Favorable

N.B;

Standard hours = standard hours per unit x actual production

=   4850 x 2

=    9700

iv)  Variable overhead spending and efficiency variances

Less

Actual labour hrs x VOAR

8000 x 0.3                                                      2400

Actual Labour hrs x VOAR                               2400

Less

Std Labour hrs x VOAR

(4850 x2) x 0.3                                               2910

v)         Fixed overhead under applied and efficiency variances

5100 x 7.4                                                      37740

4560 Unfavorable

Actual production x Std cost/ unit                    126100

Less

Budgeted production x Std cost/ unit               132600

6500 Unfavorable

Standard cost per hour (actual hours – standard hours)

Standard cost per hour = 26/2      = 13

Actual hours x Standard cost per hour 104000

Less

Standard hours x Standard cost per hour         126100

22100 Favorable

Actual hours x Standard cost per hour 104000

Less

Budgeted hours x Standard cost per hour        132600

(5100 x 2) x 13                                               28600 Unfavorable

Potential reasons for variances

Some of the potential reasons for variances include lack of appropriate or unrealistic estimates. Also, variances are important when errors occur in the original reporting of the statistics used in calculations. Furthermore, in case there is lack of effective communication between individuals involved in the variance analysis. Some people might ignore, others might take time to report or even give poor or wrong explanation of the observed discrepancies.

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