Marginal Costing

1. STRATEGIC COST MANAGEMENT
Dr. Mustafa K
Visiting Faculty
School of Management Studies,
DCMS, University of Calicut
mustafapsmo@gmail.com
M B A THIRD SEMESTER
Marginal Costing

2. Marginal cost is the change in the total cost that
arises when the quantity produced is incremented by
one unit, that is, it is the cost of producing one more
unit of a good. In general terms, marginal cost at each
level of production includes any additional costs
required to produce the next unit.
What is Marginal cost ?

3.  Definition :-
Marginal Costing is defined as the amount at any given
volume of output by which aggregate costs can be
the volume of output is increased or decreased by one
Meaning :-
Marginal Costing is the technique of controlling by
out the relationship between profit & volume.

4.  The concept of Marginal Costing is also known as variable
costing because it is based on the behavior of costs that
vary with the volume of output
 Hence, Marginal Costing classifies costs into 2 :-
1. Fixed Cost
2. Variable Cost

5. Fixed Cost :-
The expenditure remains same irrespective of output. This
includes costs which a firm has to incur irrespective of units of
production
Eg :- Building rent
Variable Cost :-
As the name suggests variable cost varies directly with
output. It is directly proportional to volume of production
 Eg :- Cost of raw materials

6. Marginal cost – cost of producing an additional unit or output or
service
Marginal costing differentiates the fixed and variable costs
Basics of marginal costing

7. •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
Features of Marginal Costing

8.  Fixed cost & Variable cost
 Only variable Costs are considered to calculate
the cost per unit of a product
 Cost Controlling
 Shows the difference between sales and variable
cost known as Contribution
Fixed costs are excluded in marginal costing as they
expenses belonging to P&L a/c
Useful technique for Export firms

9. •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
Basic equation of Marginal Costing

10. Marginal Cost Sheet
•Sales Value
•Less : Variable cost
•Direct Material, Direct Labour,
•Variable FOH, AOD, S& D OH
XXXX
XXXX
CONTRIBUTION XXXX
XXXX
PROFIT XXXX
Less : Fixed Cost

11. 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 absorptio
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-
Value of Marginal Costing to Management

12.  Constant nature of marginal cost
 Pricing decisions
 Determination of profits
 Fixing responsibility
 Cost control
 Cost reporting
 Helps determine breakeven point
 Decision making

13. • 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.
Limitations of Marginal Costing

14.  Difficult to separate Fixed & Variable costs
 Over-emphasis on sales
 Fixed costs ignored
 Not suitable for long run & to huge industries
Lacks efficiency in Cost control
Not applicable to contract costing
Ignores Fixed costs in valuation of stock of WIP & finished
Not recognized by Income tax authorities

15. Contribution = Sales – Variable Cost
Contribution = Fixed Cost + Profit
Contribution

16.  Contribution is the profit before adjusting fixed cost
 It is an assumption that excess of sales over variable cost
contributes to a fund not only which covers fixed cost but
provides some profit
 If, Contribution = Fixed cost, company achieves breakeven
 This concepts helps in taking Decisions like :-
 Whether to produce or discontinue
 Fixing up selling price of bulk orders

17. 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.

18.  It is popularly known as P/V Ratio
 It expresses relationship between Contribution & Sales

19. • 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
Break-EvenPoint (BEP)

21. These are the sales beyond the break-even 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
Margin of Safety