Marginal Costing

 MARGINAL COSTING

Marginal Costing may be 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 cost and variable cost. Marginal cost refers to the amount at any given volume of output by which the aggregate costs are charged if the volume of the output is changed by one unit. It is concerned with changes in variable costs and fixed cost is treated as period cost.

Features of Marginal Costing:

• All elements of costs are classified into fixed and variable costs
• It is a technique of cost control and decision making
• The fixed costs are written off soon after they are incurred and do not find place in product cost or inventories
•  Variable costs are charged as the cost of production
• Valuation of stock of work in progress and finished goods is done on the basis of variable costs
• Profit is calculated by deducting the fixed cost from the contribution

Advantages of Marginal Costing:

•   It is simple to operate than absorption costing because they do not involve the problems of overhead apportionment and recovery.
• It is essentially useful to management as a technique in cost analysis and cost presentation
• It is helpful in forecasting and hence future profit planning of the business enterprises can we carried out well
• When there are different products the determination of number of units of each product to get maximum profit can be determined as Optimum Product Mix or Optimum Sales Mix with the help of marginal costing
• Numerous managerial decisions can be taken with the help of marginal costing

Absorption Costing is also termed as Full Costing or Total Costing or Conventional Costing. It is a technique of cost ascertainment in which both the fixed and variable costs are charged to product or process or operation.

Differential costing, also termed as Relevant Costing or Incremental Analysis is a technique based on preparation of adhoc information in which only cost and income differences between two alternatives/ courses of actions are taken into considerations.

COST VOLUME PROFIT ANALYSIS

Cost Volume Profit Analysis (CVP) is a systematic method of examining the relationship between changes in the volume of output and changes in total sales revenue, expenses and net profit.

Marginal Cost Equation:

Sales= Variable Cost+ Fixed Cost ± Profit/Loss

Sales – Variable Cost = Fixed Cost ± Profit/Loss

Contribution = Fixed Cost ± Profit/Loss

Profit = Sales – Variable Cost - Fixed Cost (Profit Equation)

Contribution refers to the difference between the Sales and the Marginal Cost of Sales, also termed as Gross Margin. The contribution margin per unit measures the amount of incremental profit generated by adding an additional unit.

Contribution = Fixed Cost ± Profit/Loss = Sales – Variable Cost

Contribution Margin Ratio measures the amount of incremental profit generated by an additional unit of sales

Contribution Margin Ratio = (Sales – Variable Cost)/ Sales

Break Even Analysis also called Cost Volume Profit analysis in which a break-even point is considered at which the total sales are equal to its costs. This is a point when contribution is equal to fixed cost and there is no profit or no loss.

Break-Even Point in Units = Total Fixed Cost/ Contribution per unit

 
Break-Even Point in Sales = (Fixed Cost x Sales)/ (Sales – Variable Cost)
    
                                               (Or)

Break-Even Point in Sales = Fixed Cost/ Profit – Volume Ratio

(Profit Volume Ratio = (Contribution/ Sales) x 100)

Unit Sales needed to attain specified profit

= (Total Fixed Cost + Profit) / Contribution margin per unit

Break-Even chart is a graphical representation which indicates the relationship between cost, sales and profit. The chart also indicates the estimated cost and estimated profit or loss at various levels of activity.

Margin of Safety is the difference between the expected level of sales and the break-even sales. Margin of Safety can be improved by

• Increasing the selling price
• Reducing the variable cost
• Selecting a product mix of larger P/V Ratio
• Reducing fixed cost
• Increasing the output

Margin of Safety = Total Sales – Break-Even Sales

Margin of Safety =Profit/ (P/V Ratio)

Margin of Safety = (Profit / Contribution) x Sales

Margin of Safety Ratio = (Margin of Safety / Total Sales) x 100

Calculations:

The P/V Ratio of XYZ Company is 60%; Sales – Rs.1, 50,000; Fixed Cost- Rs.15, 000. Total Units sold – 2000Units. Calculate:

• Total Variable expenses and Variable Cost per Unit
•  Total Contribution and Unit Contribution
• Profit
• Break Even Point in sales
• Margin of Safety  
• Number of units to be sold to attain an additional profit of 45,000

P/V Ratio = (Contribution / Sales) x 100

60 = (Contribution / 1, 50,000) x 100

Total Contribution = (1, 50,000 x 60) /100 = Rs. 90,000

Contribution per unit = 90,000/ 2000 = Rs. 45

Contribution = Sales – Variable Expenses

Total Variable Expenses = 1, 50,000 – 90,000 = Rs. 60,000

Variable Cost per Unit = 60,000/ 2000 = Rs. 30

Profit = Sales – Variable Expenses -Fixed Cost (OR) Contribution – Fixed Cost = 1, 50,000 - 60,000 -15,000 = Rs. 75,000

Break Even Point in sales = (Fixed Cost x Sales)/ (Sales – Variable Cost) = (15,000 x 1, 50,000)/ (1, 50,000 – 60,000) = Rs. 25,000

Margin of Safety =Total Sales – Break-Even Sales = Rs. 1, 25,000

Unit Sales needed to attain an additional profit of Rs.45, 000

= (Total Fixed Cost + Profit) / Contribution per unit

= (15, 000 +1, 20,000)/ 45 = 3000Units

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Group Behavior: Leadership

Group Behavior: Leadership

Leadership: The process of guiding and directing the behavior of people in the work environment is known as leadership.

I.           Early trait theories: These theories attempted to identify what physical attributes, personality characteristics, and abilities distinguished leaders from other members of a group. The trait theories have had very limited success in being able to identify the universal, distinguishing attributes of leaders.

II.             Behavioral theories:

1.     The Lewin, Lippit and White Studies: Styles of leadership

Autocratic style	Democratic style	Laissez-faire style
A style of leadership in which the leader uses strong, directive, controlling actions to enforce the rules, regulations, activities and relationships in the work environment.	A style of leadership in   which the leader takes collaborative, responsive, interactive actions with followers concerning the work and work environment.	A style of leadership in which the leader fails to accept the responsibilities of the position.

 

2.    The Ohio State Studies: Dimensions of Leader behavior

Initiating structure	Consideration
A leader behavior aimed at  defining and organizing work relationships and roles, as well as establishing clear patterns of organization, communication, and ways of getting things done	A leader behavior aimed at nurturing friendly, warm working relationships as well as encouraging mutual trust and interpersonal respect within the work unit

3.    The Michigan Studies: Leadership styles

Employee oriented	Production oriented
·  A work environment that focuses on relationships ·  The leader exhibits less direct or less close supervision and establishes fewer written or unwritten rules and regulations for behavior ·  Concern for people and their needs	·     A work environment which focus on getting things done ·     The leader exhibits direct, close supervision and many written and unwritten rules and regulations to control behavior ·     Concern for profit and production

 

III. Contingency theories: These theories involve the belief that leadership style must be appropriate for the particular situation.

1.     Fiedler’s Contingency theory: proposes that the fit between the leader’s need structure and the favorableness of the leader’s situation determine the team’s effectiveness in work accomplishment. The theory classifies the favorableness of the leader’s situation according to the leader’s position power, the structure of the team’s task, and the quality of the leader-follower relationships. Fiedler classifies leaders using the Least Preferred Coworker (LPC) Scale, which is a projective technique through which a leader is asked to think about the person with whom he or she can work least well.

              High LPC- Relationship oriented; Low LPC- Task oriented

2.   Path-Goal Theory- Robert House: based on an expectancy theory of motivation. The path-goal theory assumes that leaders adapt their behavior and style to fit the characteristics of the followers and the environment in which they work. The basic goal of the leader is to clear the follower’s path to the goal. A leader selects from the four leader behavior styles –

• Directive style- When the leader must give specific guidance about work tasks, schedule work
• Supportive style- When the leader needs to express concern for followers’ well-being and social status
•  Participative style- When the leader must engage in joint decision-making activities with followers
• Achievement-oriented style- When the leader must set challenging goals for followers

3. The Situational Leadership Model – Paul Hersey and Kenneth Blanchard: suggests that the leader’s behavior should be adjusted to the maturity level of the followers

4.   Vroom-Yetton-Jago Normative decision model: This model helps managers and leaders determine the appropriate level of employee participation in decision making. Five forms of decision making are described in the model:

• Decide: Manager makes the decision alone
• Consult individually: with each group member and then makes the decision
• Consult group: in a meeting and then makes the decision
• Facilitate: the group in a meeting to make decision by the members
• Delegate: the authority to the group members to make decision within the prescribed limits

5.    Leadership Grid – Robert Blake and Jane Mouton: developed with a focus on attitudes. The two underlying dimensions are concern for people and concern for results.

•  Organization-man manager (5, 5) is a middle of the road leader who attempts to balance a concern for both people and production without commitment to either
•  Authority-compliance manager (9, 1) has great concern for production and little concern for people who desires to keep people in tight control in order to get tasks done efficiently
•  Country club manager (1, 9) who has a great concern for people and little concern for production attempts to avoid conflict, and seeks to keep people happy through good interpersonal relations.
• Team manager (9, 9) is considered ideal and has great concern for both people and production
•  Impoverished manager (1, 1) has little concern for people or production, avoids taking sides, and stays out of conflicts –laissez faire leader
•  The paternalistic” father know best” manager (9+9) promises reward for compliance and threatens punishment for non compliance
• The opportunistic “what’s in it for me’ manager uses the style that he or she feels will return him or her greatest self -benefits  

 IV.          Recent Leadership theories:

1.     Leader-Member Exchange Theory (LMX): recognizes that leaders may form different relationships with followers. The leaders form two groups of followers: in-groups and out-groups.

• In-group members tend to be similar to the leader and given greater responsibilities, more rewards, and more attention.
• Out-group members are outside the circle and receive less attention and fewer rewards and are managed by formal rules and policies. 

2.    Inspirational Leadership Theories:

• Transformational leadership: Transformational leaders inspire and excite followers to high levels of performance as they rely on their personal attitudes consisting of four dimensions as follows:
•  Charisma
•  Individualized Consideration
• Inspirational Motivation and
•  Intellectual Stimulation
• Charismatic Leadership: Charismatic leaders use the force of personal abilities and talents in order to have profound and extraordinary effects on followers.
• Authentic Leadership: Authentic leaders arouse and motivate followers to higher levels of performance by building a workforce characterized by high levels of hope, optimism, resiliency and self-efficacy.

            Along with the recent developments in theory, some exciting issues such as emotional intelligence, trust, women leaders, and servant leadership have emerged of which leaders must be aware to be competent and efficient as these traits can affect leaders’ decisions- making skills, strategy implementation, and ability to build organizational citizenship behaviors.