APPLICATIONS OF MARGINAL COSTING AND COST VOLUME-PROFIT ANALYSIS

The present Indian economic scenario which is poised for a great surge forward with series of reform process, liberation and globalization. In this background the application of marginal costing techniques assumes a special significance as it helps to insure globally competitive prices by way of differentiation between fixed and variable costs. Marginal costing is a very useful tool for management because of its following applications:-

1. 2. 3. 4.

COST CONTROL PROFIT PLANNING EVALUATION OF PERFORMANCE DECISION MAKING

a. fixation of selling price b. key or limiting factor c. make or buy decision d. selection of suitable product mix e. effect of changing price f. maintaining desired level of profit g. alternative method of production h. diversification of products i. closing down of activities j. alternative cause of action k. cost in different point

COST CONTROL:- Break even analysis divides the total cost

into :Fixed Cost:- Fixed cost can be controlled by the top management and that to limited extent whereas Variable Cost:- Variable cost is controlled by the lower level of management. Break even analysis provides a tool to the management by concentrating all the efforts on the variable cost also it brings out the reasons why the profits are decreasing inspite of increasing sales.

PROFIT PLANNING:-Marginal costing helps the profit planning

i.e., planning for futures in such a way as to maximize the profits or to maintain the specified level of profit. Absorption costing fails to bring out the correct effect of change in sale price; variable cost or product mix on the profits on the concern but that is possible with the help of marginal costing. Profits are increased or decreased as a consequence of fluctuations in selling prices , variable costs and sales quantities in case there is fixed capacity to produce and sell.

EVALUATION OF PERFORMANCE: - Break even analysis helps

in the performance of different products, departments, market, sales division of a firm having diff. profit earning potentials. A product department or market or sales division with higher contributions should be selected.

DECISION MAKING: - Under the normal circumstances the price

fixed must cover the total cost and otherwise profits cannot be earned but prices in depression falls and the product may be sold below the total cost. If the selling price at which the goods are sold is equal to the marginal cost or more than the marginal cost should be continued.

KEY OR LIMITING FACTORS: - It is the factor which is of limited

supply for ex. Material labour, so the product will limited due to the limited supply of that factor. In such a case the product with higher contribution per unit will be selected.

MAKE OR BUY DECISION: - A concern can utilize the ideal

capacity by making the component parts instead of buying them from market. In arriving at such decision the price asked by the outside supplies should be compared with the marginal cost of using the component parts. If he is lower, then the price demanded by the outside supplies, the component part should be manufactured in the factory to utilize unused capacity.

SELECTION OF SUITABLE PRODUCT MIX: - When a factory

manufacturers move than one product problem is faced by the

management as to which product mix will give the maximum profit the. The best product mix is that which gives maximum contribution. EFFECT OF CHANGING SALES PRICE: - The management is confronted with the problem of cutting prices of products time to time on account of competition, expansion programme or govt. regulations. It is therefore necessary to know the cut in prices of the product s which can be calculated by calculating contribution per unit.

MAINTAINING

DESIRED

LEVEL

OF

PROFITS:

Management may be interested in maintaining a desired level of profits. The volume of sales needed to have a desired level of profits can be ascertained by the marginal costing technique.

ALTERNATIVE METHOD OF PRODUCTION:Marginal costing is helpful in comparing the alternative methods of production, i.e., machine work or hand work. The method which gives the greatest contribution is to be adopted keeping, of course, the limiting factor in view. Where however fixed expenses change, the decision will be taken on the basis of profit contributed by each.

DIVERSIFICATION OF PRODUCTS: - Sometimes it becomes

necessary for a concern to introduce a new product to the existing product in order to utilise the idle capacity or to capture a new market or for other purposes. The new product must be profitable. In order to decide about the profitability of the new product, it is assumed that the manufacture of the new product will not increase fixed costs of the concern and if the price realised from the sale of such product is more than its variable cost of productions it is for worth trying.