Term Paper

On
Applicability of Variable Costing in Short-Term Decision Making
Course: Managerial Accounting
Section : 1
Semester : Fall 2020

Submitted To:
Dr. Nikhil Chandra Shil
Assistant Professor
Department of Business Administration
East West University

Submitted By:
Sazid Al Kabir 2017-2-10-037
Jahid Refat (****-*-**-***)
Akash Saha 2018-1-10-302
 LETTER OF TRANSMISSION
25th December, 2020

Dr. Nikhil Chandra Shil

Assistant Professor
Department of Business Administration
East West University

Subject: Submission of Group Termpaper

Honorable Faculty,
We would like to take this opportunity to thank you for the guidance and support you
have provided us during the course and this assignment. Without your help this
assignment would be difficult to complete. To prepare the assignment we collected what
we believe to be most relevant information to make our assignments as reliable as
possible. We have concentrated our best effort to achievement the objectives of the
assignment. The practical knowledge and experience gathered during assignment
preparation will help us in future life. We requested you to excuse that may occur in the
assignment despite of our best effort.

Again, thank you very much for your guidance and support.

Sincerely Yours,
____________
Sazid Al Kabir (2017-2-10-037)
Jahid Refat ()
Akash Saha (2018-1-10-302)
 ACKNOWLEDGEMENT
First and foremost, praises and thanks to the God, the Almighty, for His showers of
blessings throughout my research work to complete the research successfully.

We would like to express our deep and sincere gratitude to our termpaper supervisor,
Dr. Nikhil Chandra Shil, Assistant Professor, East West University, for giving us the
opportunity to do research and providing invaluable guidance throughout this research.
His dynamism, vision, sincerity and motivation have deeply inspired us. It was a great
privilege and honor to work and study under his guidance. We are extremely grateful for
what he has offered us. We would also like to thank him for his friendship, empathy, and
great sense of humor.
 EXECUTIVE SUMMURY
This termpaper provides an analysis and evaluation of the implementation of variable
costing in the management of profitability of sales in trade companies. Variable costing
is a concept used in managerial and cost accounting in which the fixed manufacturing
overhead is excluded from the product-cost of production. The method is in contrast
with absorption costing, in which the fixed manufacturing overhead is allocated to
products produced. In accounting frameworks such as GAAP and IFRS, variable
costing is not allowed in financial reporting. The identification and classification of costs
as either fixed or variable, with semi-variable expenses properly subdivided into this
fixed and variable component, provide useful framework for the accumulation and
analysis of costs and further for making decisions. Relevant costs are required for a
variety of short-term decision such as changes in production levels, make or buy, entry
into new markets, product mix, plant expansion or contraction or special promotional
activities. These decisions require that costs be split into their fixed and variable
components and this is possible only under variable costing. Methods of analysis
include trend, horizontal and vertical analyses as well as ratios such as direct material,
direct labor, variable manufacturing overhead. Variable costing provides managers with
the information necessary to prepare a contribution margin income statement, which
leads to more effective cost-volume-profit (CVP) analysis.
 CONTENTS
1.0 SITUATION ANALYSIS:..............................................................................................4

2.0 WHAT IS VARIABLE COSTING?................................................................................6

2.1 APPLICABILITY OF VARIABLE COSTING:............................................................6

3.0 CONTRIBUTION MARGIN INCOME STATEMENT:..................................................6

3.1 LEVELS OF CONTRIBUTION MARGIN INCOME STATEMENT:..........................7

3.2 MULTI-LEVEL CONTRIBUTION MARGIN INCOME STATEMENT:......................7

3.3 ADVANTAGES OF CONTRIBUTION MARGIN INCOME STATEMENT:...............8

4.0 HOW CONTRIBUTION MARGIN INCOME STATEMENT CAN BENEFIT TRADE

COMPANIES?...................................................................................................................9
1.0 SITUATION ANALYSIS:
In modern enterprises, the importance of the role of managerial accountancy and IT
systems in management have increased, both at the strategic and operational levels.
Management accounting concentrates mainly on the sources and trends of revenues,
costs and financial results.

In management accounting, the reports on the return on sales are important as they
facilitate the introduction of adequate sales strategies. These reports comprise the
information on revenues, costs and financial results. In order to create them, in many
enterprises the absorption costing approach is implemented. Thus, reporting is limited
to the presentation of the information prepared for the external needs only.

Adopting a broad approach to profitability of sales involves using management

accounting methods, especially a developed system of variable costing. On its basis, it
is possible to prepare multi-profile analyses of profitability based on the margin for
covering the fixed costs and generating operational profits. The contribution income
statement on the basis of variable costing enables its implementation in various
branches of business, including trading activity, due to the universal rules used for its
creation.

2.0 WHAT IS VARIABLE COSTING?

Variable costing is a costing method that includes only variable manufacturing costs
direct materials, direct labor, and variable manufacturing overhead in the cost of a unit
of product. Variable costing is also referred to as direct costing.

2.1APPLICABILITY OF VARIABLE COSTING:

 To conduct a break-even analysis to determine the number of units needed to be

sold to begin earning a profit.
 To determine the contribution margin on a product, which helps to understand
the relationship between cost, volume, and profit.
 To facilitate decision-making by excluding fixed manufacturing overhead costs,
which can create problems due to how fixed costs are allocated to each product.

3.0 CONTRIBUTION MARGIN INCOME STATEMENT:

The contribution margin income statement based on variable costing is a very useful
tool in planning and decision making. While it cannot be used for GAAP financial
statements, it is often used by managers internally. Rather than separating product
costs from period costs, like the traditional income statement, this statement separates
variable costs from fixed costs.

In variable costing, operational activity costs are classified according to their reaction to
the changes of the extent of the enterprise activity. The costs are divided into two
groups:
1. Variable costs &
2. Fixed costs.
The contribution margin achieved by the entity covers fixed period costs, and the
remaining part constitutes return on sales. Thus, the profitability of an enterprise is
evaluated on the basis of contribution margin. The advantage of contribution margin
income statement based variable costing is the possibility of immediate evidence
demonstrating the influence of the fixed costs on the financial result, which is not
possible if absorption costing is used.

3.1 LEVELS OF CONTRIBUTION MARGIN INCOME STATEMENT:

There are subsequent levels of contribution margin;

 The first-level margin is determined as a difference between revenues from sale

of goods and variable costs of production sold. This level of the margin is the
contribution to all fixed costs and profit. It also provides the information on the
products which ensure the highest growth of margins.
 The second-level margin either confirms the profitability or it may change the list
of the most profitable products, since covering individual fixed costs per product
was included.

3.2 MULTI-LEVEL CONTRIBUTION MARGIN INCOME STATEMENT:

Further division of fixed costs into subgroups resulted in the creation of more
contribution margin levels for covering them and the report is called a multi-level or
multi-block contribution income statement.

In multi-level profitability accounts, a detailed division of indirect fixed costs into various
groups is conducted. The most commonly distinguished groups are the following:

 Individual costs related to particular products,

  Fixed costs of groups of products,
 Fixed costs of responsibility centers,
 Fixed costs of activity areas &
 Fixed costs related to managing an enterprise.
Multi-level contribution income statement can foster planning and controlling of financial
liquidity by separating the fixed costs incurring expenditure from the costs not resulting
in expenditure in a short period of time.

3.3 ADVANTAGES OF CONTRIBUTION MARGIN INCOME

STATEMENT:

 On the basis of the contribution margin income statement, it is possible to make

a ranking list of products and to choose those which bring more profits.

 The contribution margin income statement based on variable costing is a tool

which provides information which is useful for managers when taking adequate
economic decisions which are oriented on the maximization of income.

 The generated information is necessary for operational management and it can

be used for elaborating on the details of strategic activities, decisions which are
oriented on the maximization of income.

 The aim of this statement is to improve the steering of profitability in various

dimensions, depending on the adopted criteria of segments distinguished as well
as to enhance the management of revenues and costs of the enterprise.

 This statement shows the influence of various factors on the financial results of
the enterprise, demonstrating the most profitable and critical areas of enterprise
activity. It is useful both in production enterprises and in trade companies.
  The contribution margin is considered to be the more adequate measurement
than profit because of its properties: the margin is not affected by imperfect
methods of fixed costs accounting and it can be calculated for various segments
of enterprise activity.

4.0 HOW CONTRIBUTION MARGIN INCOME STATEMENT

CAN BENEFIT TRADE COMPANIES?