WHY MARGINAL COST IS CALLED IN OTHER WORDS AS VARIABLE COST? - Accounts and Finance for Managers

From the following classifications of cost, the inter twined relationship in between the variable cost and marginal cost is explained as below

Statement-of-Fixed,-variable-and-total-costs-and-per-unit

Fixed Cost

It is a cost remains constant or fixed irrespective level of production.

Example: Rent Rs 5,00 is to be paid irrespective level of production. It remains constant / fixed irrespective of changes taken place on the level of production.

Fixed Cost

Variable Cost

It is a cost which varies with level of production.

Variable Cost

The following are the various components of variable cost.

  • Direct Materials: Materials cost consumed for the production of goods
  • Direct Labour: Wages paid to the labourers who directly involved in the production of goods.
  • Direct Expenses: other expenses directly involved in the production stream.
  • Variable portion of Overheads: Generally the overheads can be classified into two categories. Viz- Variable overheads and Fixed overheads.

The variable overheads is the cost involved in the procurement of Indirect materials

Indirect labour and Indirect Expenses.

Indirect Material- cost of fuel, oil and soon

Indirect Labour- Wages paid to workers for maintenance of the firm.

From the above table -1 the marginal cost is equivalent to the variable cost per unit of the various levels of production. The fixed cost of Rs.500 is the cost remains the same at not only irrespective levels of production but also already absorbed at the initial level of production. The initial absorption of fixed overhead led the marginal cost to become as variable cost.

Semi-Variable Cost

Another major classification is semi variable/fixed cost which is a cost partly fixed / variable to the certain level of production or consumption e-g Electricity charges, telephone charges and so on.
It jointly discards the importance of the fixed cost and the semi- variable cost for analysis while ascertaining the marginal cost.

Marginal Costing is defined as "the ascertainment of marginal cost and of the effect on profit of changes in volume or type of output by differentiating between fixed and variable costs."

In marginal costing, the change in the level of cost of operation is equivalent to variable cost due to fixed cost component which is fixed irrespective level of outputs.
Importance of Marginal costing:

  • The costs are classified into two categories viz fixed and variable cost.
  • Variable cost per unit is considered as marginal cost of the product.
  • Fixed costs are charged against contribution of the transaction.
  • Selling price of the product = marginal cost + contribution.

Semi-Variable Cost

Marginal costing profitability statement as follows:
Marginal costing profitability

Semi-variable-co
Sales Rs.100,000/-, variable cost Rs.25,000/- and fixed cost Rs.20,000/- find-out the contribution and profit.
Contribution

Method of Difference

Under this method, the contribution can be computed through finding the differences in between Sales and Variable Cost
i.e. Contribution= Sales – Variable Cost= Rs.1,00,000 – 50,000= Rs.50,000

Method of Coverages

In this method, the contribution is equated with the summation of Fixed cost and Profit.
i.e. Contribution=Fixed Cost+ Profit =Rs.20000+30000=Rs.50,000

Method of Coverages


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