Marginal costing

It describes Marginal cost and Marginal costing and also compares Absorption costing with Marginal costing.

1. Marginal costing

2. Marginal Cost is defined as, ‘ T he change in aggregate costs due to change in the volume of production by one unit’. For example, T otal number of units produced - 800 T he total cost of production - Rs.12 , 000, I f one unit is additionally produced the total cost of production may become Rs.12, 010 I f the production quantity is decreased by one unit the total cost may come down to Rs.11, 990. C hange in the total cost is by Rs.10 The Marginal cost is Rs.10. The increase or decrease in the total cost is by the same amount because the variable cost always remains constant on per unit basis

3. Marginal Costing has been defined as, ‘Ascertainment of cost and measuring the impact on profits of the change in the volume of output or type of output. This is subject to one assumption and that is the fixed cost will remain unchanged irrespective of the change.’

4. helps with short-term decision-making . Marginal costing is not concerned with fixed period costs I nstead it is concerned with variable product costs D irect materials D irect labor D irect expenses A nd variable production overheads

5. The contribution is the sales revenue after marginal/variable product costs have been paid. Selling price less variable cost = Contribution Total contribution less total fixed costs = P rofit A marginal costing statement can be prepared in the following format: Sales revenue x less Variable costs (x) equals Contribution x less Fixed costs (x) equals PROFIT x

6. Absorption costing Absorption costing (full costing), all production costs are absorbed into products. The unsold inventory is measured at total cost of production. Fixed production overhead costs are treated as a product cost. The absorption cost of a unit of output is made up of the following costs: Direct materials x add Direct labor x add Direct expenses x add Production overheads (fixed and variable) x equals ABSORPTION COST x Note that the production overheads comprise the factory costs of indirect materials, indirect labor , and indirect expenses.

7. Features of Marginal Costing In marginal costing, costs are segregated into fixed and variable. Only variable costs are charged to the production. T he valuation of inventory is done at variable cost only. The profitability of products or process is determined on the basis of contribution . Profit is ascertained by reducing the fixed cost from the contribution of all the products or departments or process or division etc.

8. ADVANTAGES OF MARGINAL COSTING Marginal costing is simple to understand By not charging fixed overhead to cost of production, the effect of varying charges per unit is avoided . It prevents the illogical carry forward in stock valuation of some proportion of current year’s fixed overhead. Practical cost control is greatly facilitated avoiding arbitrary allocation of fixed overhead, efforts can be concentrated on maintaining a uniform and consistent marginal cost. It is useful to various levels of management. It helps in short-term profit planning by breakeven graphs and profitability analysis.

9. Disadvantages of marginal costing The separation of costs into fixed and variable is difficult and sometimes gives misleading results. Normal costing systems also apply overhead under normal operating volume and this shows that no advantage is gained by marginal costing.

10. Marginal Costing VS Absorption Costing Absorption Costing Costs are classified as direct and indirect The year-end inventory of is valued at total cost. The fixed overhead absorption may create some problems like over/under absorption. Marginal Costing Costs are classified as fixed and variable . The year-end inventory is valued at variable cost only. The fixed overheads are charged directly to the Costing Profit and Loss Account and not absorbed in the product units.

11. Due to the inventory valuation, the costs relating to the current period are carried forward to the subsequent period. This will distort the cost of production . The selling price is thus fixed on the basis of total costs . Fixed costs are not taken into consideration while valuing the inventory and hence there is no distortion of profits . Only variable costs are charged to the cost of production and therefore the selling price is also based on only variable costs.