Cost Accounting - Marginal Costing

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Marginal cost is the change in the total cost when the quantity produced is incremented by one. That is, it is the cost of producing one more unit of a good. For example, let us suppose:

Variable cost per unit     = Rs 25
Fixed cost                 = Rs 1,00,000
Cost of 10,000 units       = 25 × 10,000 = Rs 2,50,000
Total Cost of 10,000 units = Fixed Cost + Variable Cost
                           = 1,00,000 + 2,50,000
                           = Rs 3,50,000
Total cost of 10,001 units = 1,00,000 + 2,50,025
                           = Rs 3,50,025
Marginal Cost              = 3,50,025 – 3,50,000
                           = Rs 25

Need for Marginal Costing

Let us see why marginal costing is required:

  • Variable cost per unit remains constant; any increase or decrease in production changes the total cost of output.

  • Total fixed cost remains unchanged up to a certain level of production and does not vary with increase or decrease in production. It means the fixed cost remains constant in terms of total cost.

  • Fixed expenses exclude from the total cost in marginal costing technique and provide us the same cost per unit up to a certain level of production.

Features of Marginal Costing

Features of marginal costing are as follows:

  • Marginal costing is used to know the impact of variable cost on the volume of production or output.

  • Break-even analysis is an integral and important part of marginal costing.

  • Contribution of each product or department is a foundation to know the profitability of the product or department.

  • Addition of variable cost and profit to contribution is equal to selling price.

  • Marginal costing is the base of valuation of stock of finished product and work in progress.

  • Fixed cost is recovered from contribution and variable cost is charged to production.

  • Costs are classified on the basis of fixed and variable costs only. Semi-fixed prices are also converted either as fixed cost or as variable cost.

Ascertainment of Profit under Marginal Cost

‘Contribution’ is a fund that is equal to the selling price of a product less marginal cost. Contribution may be described as follows:

Contribution                  = Selling Price – Marginal Cost
Contribution                  = Fixed Expenses + Profit
Contribution – Fixed Expenses = Profit

Income Statement under Marginal Costing

Income Statement

For the year ended 31-03-2014
Particulars Amount Total
Sales 25,00,000
Less: Variable Cost:
Cost of goods manufactured 12,00,000
Variable Selling Expenses 3,00,000
Variable Administration Expenses 50,000
15,50,000
Contribution 9,50,000
Less: Fixed Cost:
Fixed Administration Expenses 70,000
Fixed Selling Expenses 1,30,000 2,00,000
7,50,000

Advantages of Marginal Costing

The advantages of marginal costing are as follows:

  • Easy to operate and simple to understand.

  • Marginal costing is useful in profit planning; it is helpful to determine profitability at different level of production and sale.

  • It is useful in decision making about fixation of selling price, export decision and make or buy decision.

  • Break even analysis and P/V ratio are useful techniques of marginal costing.

  • Evaluation of different departments is possible through marginal costing.

  • By avoiding arbitrary allocation of fixed cost, it provides control over variable cost.

  • Fixed overhead recovery rate is easy.

  • Under marginal costing, valuation of inventory done at marginal cost. Therefore, it is not possible to carry forward illogical fixed overheads from one accounting period to the next period.

  • Since fixed cost is not controllable in short period, it helps to concentrate in control over variable cost.

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