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Marginal Costing

Discuss Marginal Costing within the Financial Management ( FM ) forums, part of the Resolve Your Query - Get Help and discuss Projects category; Marginal Costing & Decision Support System Nature and Scope of Marginal Costing Marginal Costing is the technique of segregating fixed ...

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Marginal Costing
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Sunanda K. Chavan
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Marginal Costing - September 8th, 2010

Marginal Costing & Decision Support System


Nature and Scope of Marginal Costing

Marginal Costing is the technique of segregating fixed and variable costs and thereafter arriving at the cost which would vary in proportion to the volume of production or sales.

Experts defines the Marginal Costing as “The amount at any given volume of output by which aggregate cost is change, if the volume of the output is increased or decreased by one unit.”

For Example: If the Cost Of production of 10,000 Units = Rs. 1,00,000
And for 10,001 Units = Rs. 1,00,008 Then Rs.8 is the Marginal Cost of 1 additional unit.

If the increase in output is more than one, the total increase in cost divided by the total increase in output will give the average marginal cost per unit.

Nature and Scope of Marginal Costing
For Ex: If the Cost Of production of 10,000 Units = Rs. 1,00,000
And for 10,020 Units = Rs. 1,00,100 Then Rs.5 is the Marginal Cost of 1 additional unit.
Additional cost Rs.100 = Rs.5.00
Additional units 20

Marginal cost means the cost of the marginal or last unit produced.

Marginal cost varies directly with the volume of production and marginal cost per unit remains the same.

It Involves Following
Fixed Cost = Rents, Taxes, Interest etc.
Variable Cost = Direct Material, Direct Wages etc.
Contribution = Fixed Cost + Profit
Features Of Marginal Costing
Cost Classification

Inventory Valuation

Marginal Contribution
Marginal Cost Statement
Illustration : -
Sales = Rs. 2,00,000
Fixed Cost = Rs.80,000 Variable Cost = Rs. 40,000

Then Profit will be…

Sales 2,00,000
Less Variable Cost 40,000
Contribution 1,60,000
Less Fixed Cost 80,000
= Profit 80,000
Distinguish between Fixed and Variable cost

Profit/Volume Ratio
Popularly known as the P/V ratio expenses, the relation of contribution to sales and Marginal Income ratio.
Symbolically,

P/V Ratio = Contribution *100
Sales

As long as unit selling price & unit variable cost remain constant, P/V ratio can as be found out by expressing change in contribution in relation to the change in sales.

Lets say Contribution = Rs 100
Sales = Rs 500

P/V Ratio = 100 * 100 = 20%
500
Break-Even Analysis

Problems On Marginal Costing

Illustration

Profit Volume ratio of a company is 50%, while its margin of safety is 40%. sales volume of the company is Rs. 50 lakhs, find out its break-even point and net profit.
Solution
Rs.
Sales 50,00,000
Less: Margin of Safety (40% of Rs. 50,00,000) 20,00,000
Break-even Sales Rs.30,00,000
Margin of Safety = Profit
P/V ratio
Rs. 20,00,000 = Profit
50%
Rs. 20,00,000 x 50% = Profit
Profit = Rs. 10,00,000

Alternatively,
Break even Sales = Fixed Cost
P/V ratio
Rs. 30,00,000 = Fixed Cost
50%
Rs. 30,00,000 x 50% = Fixed Cost
Fixed Cost = Rs. 15,00,000
Profit= Contribution – Fixed Cost
= Rs. 25,00,000 – 15,00,000
= Rs. 10,00,000

Application of Marginal Costing
Diversification Of Products : -

Introduction of new product In Market with Existing product of the same company. So company wants to know the profitability of the new product in market.

Illustration – Product (X)
Sales: - 50,000 Direct Material – 20,000 Direct Labour – 10,000
Variable Cost – 5,000 Fixed OV – 10,000

In New Product following cost increase as follows : - Product (Z)
Sales: - 10,0000 Direct Material –4,800 Direct Labour – 2,200
Variable Cost – 1,400

Company wants to know whether Product Z will be profitable or not ?

Solution:
Application of Marginal Costing
Fixation of Selling Prices : -

Important function in Modern Business Management.
Price Under normal circumstances for long period should be preferably based on total cost.
It can be based on the Marginal Cost if the high profit Margins is added to marginal cost to contribute towards fixed cost and profits.
When MC Tech use for Pricing the principle is that price should be marginal cost + certain amount. (Amount Depend on various Factors)
If Price = Marginal Cost, the Amount of Loss will be = Total Fixed Cost
The figure of Loss will be the same, or even lower if production discontinues.
Therefore SP should be slightly Higher than Marginal Cost in Short period
Application of Marginal Costing

Selection of profitable Product Mix : -

Suitable Product Mix will denote the ratios in which the various products are produced and sold.
In absence of limiting factor, contribution under each mix is considered, the mix will give highest Contribution will be profitable.
So long the fixed cost remains the constant the profitable sales mix is determined on the basis of contribution only.
If FC changes, the product mix is associated with the change in fixed cost.
The relatively profitability of Mix will have to be assessed on the basis of Net Profit and not on Contribution Basis.
Application of Marginal Costing
Alternative Methods of Manufacture : -
Whether One Machine to be employed or another for the same production.
The method of manufacture that will give the largest contribution is to be selected.

Illustration : -
Product A can be produced on Machine X or Machine Y
Machine X gives 10 units ph. & Machine Y gives 20 units ph
Total Machine Hours available - 3000 Hrs

Solution: -
Application of Marginal Costing
Make or Buy Decision: -

A Company may have unused capacity which may utilised for making component parts or similar item instead of buying them from market.
In this decision MC should be compared with outside price.
If MC < Purchase it is profitable to Manufacture product in factory.
Fixed cost are excluded in this process.
If Fixed cost it is necessary to include in cost.
Under such situation knowing Minimum Value is must to take a decision. That can be determined by: -
Increase in Fixed Cost
Contribution per unit

Other Applications

Cost Volume Profit Relationship
Cost volume profit analysis is a simple but powerful tool for planning of profits and therefore of commercial operations.

Marginal cost vary directly with volume of production or volume of output.

Fixed cost remain unaltered regardless of the volume of output with in the scale of production fixed by the management.

When cost behavior is related to sales, income shows the cost volume profit relationship

The relationship can be expressed in graphs such as, break-even charts or profit volume graphs or in various statement forms.

Cost volume profit (C V P) is relevant to virtually all decision making areas particularly in short run.
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Re: Marginal Costing - June 25th, 2015

Meaning and Definition of Marginal Costing

Marginal cost is the cost of the next unit or one additional unit of volume or output. To illustrate marginal cost let's assume that the total cost of producing 10,000 units is $50,000. If you produce a total of 10,001 units the total cost is $50,002.

Advantage of Marginal Costing

Cost control

Short-term profit planning

Accurate overhead recovery rate

Maximum return to the business

Simplicity
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