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
For the year ended 31-03-2014
|Less: Variable Cost:|
|Cost of goods manufactured||12,00,000|
|Variable Selling Expenses||3,00,000|
|Variable Administration Expenses||50,000|
|Less: Fixed Cost:|
|Fixed Administration Expenses||70,000|
|Fixed Selling Expenses||1,30,000||2,00,000|
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.