Lecture 3 - Marginal Costing - Key or Limiting Factor Analysis

Lecture 3 –Marginal costing -Key or limiting factor analysis:
Marginal costing can also be used in budgeting, to help management to determine what the
profit-maximizing budge. Plan should be when one or more factor of production or other
businesses sources are in short supply.
Marginal costing really shows its Merit when scarce resources are being considered example.
examples of resources restriction which may apply are as follows .
 limit to the availability of a particular grade of Labor

 shortage of raw material
 limit to machine capacity
 Shortage of working capital
If labor Supply, material availability, material capacity or cash availability limit production to
less than the volume which could be achieved , management is faced with the problem of
deciding what to produce and what not to produce, because there is insufficient resources to
make everything.
The limiting factor is often always sales demands itself. in which case business should produce
enough goods or services to meet the demand in full, provided the sales of the good earn a
positive contribution towards fixes cost and profit.
Analysis, when only one limiting factor
If fixed cost are constant, regardless of the level of output and sales with a relevant range of
output marginal cost in principle should lead us to the conclusion.
The Profit will be maximized if the total contribution is maximized. If there is a shortage of one
particular production resources it is inevitable that all the available supply of that resources will
be used up.
Total contribution will be maximized if the maximum possible contribution is obtained per unit
of the scarce resources. In other words, a business should get the best possibility value out of the
scares resources.
Dealing with limited factor, problem step are as follows:
Identify the possibility that there may be a limiting factor other than sales demand . there may be
the maximum availability of one ( more )resources, so that the sales demand cannot be met. This
is done quite simple:
a) Calculate the volume of for the resources required to produce produced enough unit to
satisfy Sales demand.
b) Calculate the volume of resources available.
c) Compare the two total. if 1) Exceed. 2) there's a key limiting factor.
If there is one such limiting factor, The next step is to calculate the contribution earned by each
product per unit of the scares resources . The product with the highest contribution per unit of
scarce resources should receive priority in the alllocation of resources in the production budget.
Analysis when more than one key limiting factor When onely one key factor is experienced, a
simple marginal costing statement can show the level of activity. Bridgeport optimize
contribution. Where two or more such key factor exist Linear programming technique is more
suitable.
1.The following information is obtained from ABC Ltd. producing Products X and Y.
Particulars Product X Rs.. Product Y Rs
Selling price 200 128
Direct materials 80 80
Direct labour (Rs. 5 per hour) 12 hrs 4 hrs
Variable overhead 50% of direct

wages
Fixed overhead Rs. 8,000

Present the above information to show the profitability of products during labour shortage.
Solution : The profitability is determined by the following formula
Particulars Product X Rs.. Product Y Rs
Selling price 200 128
Variable cost :
Direct materials 80 80
Direct wages 60 20
Variable OH 30 10
Total Vcost 170 110
Contribution i 30 18
Labour hour required 12hrs 4 hrs
Profitability i/ii 2.5 4.5
Thus during labour shortage, Product Y is more profitable than Product X.
______________________________________________________________________________
2. Anil limited manufactures and sell three products X, Y and Z
Budgeted sales demand X (300 units) Y(500 units) Z (200 units)

Unit sales price 16 18 14
Variable cost :Material labour
8 6 2
4 12 6 12 9 11
Contribution 4 6 3
The entire three products use the same direct materials and the same type of direct labour. In the
next year, the available supply of material will be restricted to Rs 4800 and the available labour
to Rs 6600. What would be the profit maximizing budget?
A )Is there a limiting factor, several limiting factor or none.
Particular Unit of demand Required material cost Required labour cost

X 300 2400 1200
Y 500 3000 3000
Z 200 400 1800
Total required 5800 6000
Total available 4800 6600
(Shortfall)/ surplus (1000) 600
From the above we identified material are key limiting factor and labour is not.
b)
Particular X Y Z
Unit contribution (i) 4.00 6.00 3.00
Cost of material(ii) 8.00 6.00 2.00
Contribution per Re 1 0.5 1.00 1.50
of material i/ii
Ranking III II I
Z should be manufactured up to the limit of sales demand and then y and x last until the material
available has been used up .
Particular Product Units Material Unit Total

cost(Rs) contribution(Rs contribution
) (Rs)
I Z 200 400 3 600
II Y 500 3000 6 3000
III X 175 1400(balance) 4 700
4800 4300
The profit maximizing budget would be to make and sell 200 units of z, 500 units of y and 175
units of X to earn a contribution of Rs 4300
_____________________________________________________________________________
3.The cost analysis of two products A and B is given below
Particulars Product A Product B

Rs. Rs.
Material Rs. 2.50 per unit 25 45
Labor @ Rs. 1 per hour 12 ‐‐‐
Labor @ Rs. 1.50 per hour ‐‐‐ 15
Variable overheads 2 5
Selling Price 70 80
On the basis of above information, which product would you recommend to be manufactured if
labor is key factor and if material is key factor?
Here first of all we have to find out contribution on the basis of both, material as a key factor and
labor as a key factor
Statement showing marginal cost and Product A Product B

contribution Particulars
Rs. Rs.
Selling price(A) 70 80
Material 25 45
Labor 12 15
Overheads 2 5
Marginal cost (B) 39 65
Contribution (A –B) 31 15
Contribution per unit of 31/10 units = 3.10 15/18 = 0.83
Material (25 units/ 2.50 = 10 units) (45 units/ 2.50 = 18 units)
Contribution per labor 2.58 1.50
Hour (31/12 hrs) (15/10 hrs)
Advise: If labor or material is key factor then product A should be produced.
______________________________________________________________________________
Reference :Ravi M Kishore –cost Accounting

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Lecture 3 –Marginal costing -Key or limiting factor analysis:

 limit to the availability of a particular grade of Labor

Analysis, when only one limiting factor

Dealing with limited factor, problem step are as follows:

Particulars Product X Rs.. Product Y Rs

Selling price 200 128

Variable overhead 50% of direct

Fixed overhead Rs. 8,000

Particulars Product X Rs.. Product Y Rs

Selling price 200 128

Budgeted sales demand X (300 units) Y(500 units) Z (200 units)

A )Is there a limiting factor, several limiting factor or none.

Particular Unit of demand Required material cost Required labour cost

Particular Product Units Material Unit Total

Particulars Product A Product B

Statement showing marginal cost and Product A Product B

Reference :Ravi M Kishore –cost Accounting

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