Page 114 - DMGT202_COST_AND_MANAGEMENT_ACCOUNTING

Unit 6: Marginal Costing and Absorption Costing

On the basis of above information, we understand that the company management is thinking Notes
to discontinue with the production of product Z which has shown loss. The management seeks

your expert opinion on the issue before they take a final decision. You are required to comment

on the relative profitability of the products.
Solution:
The information contained in the budget may be rearranged in the form of a marginal cost
statement as shown below:
Marginal Cost Statement
Particulars Total Product X Product Y Product Z
Sales 4,20,000 80,000 2,50,000 90,000
Variable Costs:
Factory Cost 2,90,500 40,000 1,74,000 76,500
Selling and Admn. Cost 35,000 14,000 14,000 7,000
Total Marginal Cost 3,25,500 54,000 1,88,000 83,500
Contribution 94,500 26,000 62,000 6,500
Fixed Costs 37,500 8,500 19,200 9,800
Profi t 57,000 17,500 42,800 -3,300 (loss)
Profi t-Volume Ratio 22.5% 32.5% 24.8% 7.2%

Profit-Volume (P/V) ratio is the ratio of contribution to sales. It is expressed in terms of
percentage. After preparing the above statement and analysis, we can make the following
recommendations:
As discussed in the marginal cost statement, the contribution of product Z is ` 6,500 which goes

toward the recovery of fixed cost of ` 9,800. If the production of product Z is discontinued, the
company will lose the marginal contribution of ` 6,500 while it will have to incur the fixed cost of

` 9,800. The total profi t of ` 57,000 will be reduced to ` 50,500 (57,000 - 6,500). Thus, it is advisable
that the production of Z should not be discontinued. As regards the relative profi tability, product

X is more profitable than Y and Z as the P/V ratio in this case is highest. The production and sales
of product X should, therefore, be encouraged.
Self Assessment

Fill in the blanks:
19. Marginal cost helps management to make decision involving consideration of
.........................
20. A decision involves the act of choice and the ...................... chosen out of the available
alternatives.
21. Marginal costing furnishes information regarding ...................... to be incurred if an
additional activity is to be taken up or the saving in costs which may be expected if an
activity is given up.
22. In the market, dealership is offered by the various companies to the individual intermediaries
in promoting the ...................... of products.
23. The firms, which are routinely in need of spares, accessories are bought from the outsiders

instead of any ......................, though the requirement is at regular intervals.
24. Under sales mix, the level has to be found out which is having lesser selling price, cost of
operations and greater profits known as ...................... of operations.

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