Marginal

Costing

Marginal Costing
The term cost can be viewed from two angles basically.
Direct Cost and Indirect Cost
Fixed Cost and Variable Cost

If fixed cost is included in the total cost, the per-unit cost

varies from one cost period to another with the fluctuations
in level of activities in two cost periods.
Thus, per unit cost becomes incomparable between two
periods.
To avoid this, it will be necessary to eliminate the fixed
costs from the determination of total cost.
This has resulted into concept of Marginal Costing

Basics of marginal costing

Marginal cost cost of producing an
additional unit or output or service
Marginal costing differentiates the fixed
and variable costs

Features Of Marginal Costing

Semi-variable costs are included in
comparison of cost
Only variable costs are considered
Fixed costs are written off
Prices are based on variable and marginal
contribution

Marginal Cost
Marginal cost is defined as the amount at
any given volume of output by which
aggregate costs are changed if the
volume of output is increased or
decreased by one unit.

Basic equation of Marginal Costing

Profit = Sales Total cost
Profit = Sales (Variable cost + Fixed
cost)
Profit + Fixed cost = Sales Variable cost
Sales Variable cost = Contribution =
Fixed cost + Profit
Contribution Fixed cost = Profit

Determination Of Marginal Cost

Marginal cost is the additional cost for
manufacturing one additional unit, which is
nothing else but the variable cost per unit,
and per-unit variable cost remains the
same at all the levels of activity.

Value Of Marginal
Costing To Management
It integrates with other aspects of management
accounting.
Management can easily assign the costs to
products.
It emphasizes the significance of key factors.
The impact of fixed costs on profits is emphasized.
The profit for a period is not affected by changes
in absorption of fixed expenses.
There is a close relationship between variable
costs and controllable costs classification.
It assists in the provision of relevant costs for
decision-making.

Limitations Of Marginal Costing

To segregate the total cost into fixed and variable components
is a difficult task
Under marginal costing, the fixed costs are eliminated for the
valuation of inventory , in spite of the fact that they might have
been actually incurred.
In the age of increased automation and technological
development, the component of fixed costs in the overall cost
structure may be sizeable.
Marginal costing technique does not provide any standard for
the evaluation of performance.
Fixation of selling price on marginal cost basis may be useful
for short term only.
Marginal costing can be used for assessment of profitability
only in the short run.

CVP Analysis
The intention of every business activity is to earn
profit and maximize it.
CVP analysis, also known as CVP relationship
aims at studying the relationships existing
among following factors and its impact on the
amount of profits:
Selling price per unit and total sales amount
Total cost, which may be fixed or variable, and
Volume of sales

Relationship Of Costs
And Profits With Volume
In Management Accounting, it is very important
to find out how costs and profits vary in relation
to changes in volume, i.e. quantity of the product
manufactured and sold. Under certain
assumptions, the relationships are usually found
to be linear.
This means that if we draw a graph with volume
on the X-axis and costs or profits on the Y-axis,
the graph will be a straight line.

Relationship Of Costs
And Profits With Volume
Assumptions for linear relationships
Every cost can be classified as fixed or
variable
Selling price remains same
There is only one product and in case of more
than one product, product mix is assumed to
be same.

Contribution
Contribution = Sales Variable Cost
Contribution = Fixed Cost + Profit

Profit Volume (P/V) Ratio

This ratio indicates the contribution earned
with respect to one rupee of sales.
It is also known as Contribution Volume or
Contribution sales ratio.
Fixed costs remain unchanged in the short
run, so if there is any change in profits,
that is only due to change in contribution.

Break-even Point (BEP)

This is a situation of no profit and no loss.
It means that at this stage, contribution is
just enough to cover the fixed costs, i.e.

Contribution = Fixed cost

Margin Of Safety
These are the sales beyond the breakeven point.
A business will like to have a high margin
of safety because this is the amount of
sales which generates profits.
Margin of Safety = Sales Break-even
Sales

Uses Of CVP Analysis

It enables the prediction of costs and profits
for different volumes of activity.
It is useful in setting up flexible budgets.
It helps in performance evaluation for the
purpose of control.
It helps in formulating price policies by
projecting the effect on costs and profits.
The study of CVP analysis is necessary to
know the amount of overhead costs, which
could be charged to products costs at various
levels of operation.

Limitations Of CVP Analysis

Variable cost per unit may not be constant.
Fixed costs may stabilize at higher levels
as volume increases.
Selling prices may be lower at high
volumes because of sales discounts
allowed.
Changes in efficiency will affect the CVP
relationship.