Cost Accounting Marginal Costing - Accounting Basics

What is marginal costing?

The change in the total cost when the quantity produced is incremented by one is defined ad Marginal cost, in other words marginal cost is the cost of producing one more unit of a good. For instance,

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

What is the need for Marginal Costing?

Marginal costing is required for the following reasons:

  • The variable cost per unit remains constant though there is any increase or decrease in the production will lead to the changes in the total cost.
  • The fixed cost remains unchanged to a certain level and beyond which does not vary with increase or decrease in the production. In terms of total cost, the fixed cost remains constant.
  • The fixed expenses are excluded from the total cost in marginal costing technique and the same cost per unit is provided at a certain level of production.

What are the features of Marginal Costing?

The features of marginal costing are as follows:

  • The impact of the variable cost on the volume of the production or output is known by Marginal Costing.
  • The important and integral part of marginal costing is Break-even analysis.
  • Contribution of each product or department is a foundation to know the profitability of the product or department.
  • Variable cost and profit is added to contribution for obtaining the selling price.
  • Marginal costing is the base of valuation of stock of finished product and work in progress.
  • From contribution, fixed cost is recovered and the variable cost is charged to the production.
  • Costs are classified either as fixed costs or variable costs and the semi-fixed prices are either converted into fixed cost or variable cost.

How to ascertain profit under Marginal Cost?

If the marginal cost is deducted from the selling price, the result is termed as ‘Contribution’. Contribution is described as:

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

What are the advantages of Marginal Costing

The following are some of the advantages associated with Marginal costing:

  • The concept of marginal costing is very simple to understand and easy to operate.
  • For planning profit, marginal costing is useful as it helps in determining the profitability at various levels of sales and production.
  • Marginal costing is useful in making decisions related to fixing of selling price, export decision, buying decision.
  • Break even analysis and P/V ratio are useful techniques of marginal costing.
  • Marginal costing also facilitates in evaluating different departments.
  • Marginal costing provides control over the variable cost by avoiding the arbitrary allocation of fixed cost.
  • Fixed overhead recovery rate is made easy by marginal costing.
  • Inventory is valuated at marginal cost. Hence illogical fixed overheads cannot be carrying forwarded from one accounting period to the next accounting period.
  • Marginal costing helps in controlling the variable cost in short period as fixed cost cannot be controlled in short period.

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