Marginal costing

Marginal costing: The technique of Marginal Costing is a definite improvement over the technique of Absorption Costing. According to this technique, only the variable costs are considered in calculating the cost of the product, while fixed costs are charged against the revenue of the period. The revenue arising from the excess of sales over variable costs is technically known as Contribution under Marginal Costing.

The following example will help you in understanding the technique.

Example (i) :   From the following data, Let us prepare a statement of cost and profit according to Marginal Costing Technique.

Statement of Cost and Profit

(According to Marginal Costing Technique)

	Product A		Product B		Product C
	Per Unit	Total	Per unit	Total	Per unit	Total
	Rs.	Rs.	Rs.	Rs.	Rs.	Rs.
Direct Material	3	3,000	4	4,000	5	5,000
Direct Labour	2	2,000	3	3,000	4	4,000
Variable overheads	1	1,000	1	1,000	1	1,000
Total marginal cost	6	6,000	8	8,000	10	10,000
Contribution	4	4,000	7	7,000	10	10,000
Selling price	10	10,000	15	15,000	20	20,000

Thus, the total contribution from the three products A, B and C is Rs. 21,000. The profit will now be computed as follows:

Total Contribution:                                                               Rs. 21,000

Fixed costs:                                                                          Rs.   9,000

                                                                                                --------------

Profit                                                                                       Rs. 12,000

                                                                                                ---------------

Example (ii): Let us prepare the statement profit or loss account for the following data by using Marginal costing technique.

Profit loss account for first year

               

	Rs.		Rs.
Direct Material A B C Direct Labour A B C Variable Fixed overheads	3,000 4,000 5,000      12,000 2,000 3,000 4,000       9,000 -----------------------------                 3,000                 9,000	Sales Closing stock Loss	-- 24,000 9,000
	33,000		33,000

Profit loss account for second year

                                                                Rs.                                                          Rs.

                Opening stock                      24,000                   Sales

                Fixed overheads                    9,000                    A                              10,000

                                                                                                B                             15,000

                Profit                                       12,000                   C                             20,000                   45,000

                                                                ---------                                                    --------                     ---------

                                                                45,000                                                                                   45,000

The above statement shows that the company suffers a loss of Rs. 9,000 in the first year because of non-recovery of fixed overheads, while in the second year it makes a profit of Rs. 12,000. It may be seen from the two years ` Profit and Loss Accounts that the fixed cost of one year has not been carried forward to the next year, Thus, the profit and Loss Account gives a correct picture. 

Explain briefly the technique of marginal costing. In what ways do you consider this technique useful in management accounting?

Explain briefly the technique of marginal costing. In what ways do you consider this technique useful in management accounting?

Answer. It is a costing technique where only variable cost or direct cost will be charged to the cost unit produced. Marginal costing also shows the effect on profit of changes in volume/type of output by differentiating between fixed and variable costs.

™ Marginal costing involves ascertaining marginal costs. Since marginal costs are direct

cost, this costing technique is also known as direct costing;

™ In marginal costing, fixed costs are never charged to production. They are treated as period charge and is written off to the profit and loss account in the period incurred;

™ Once marginal cost is ascertained contribution can be computed. Contribution is the excess of revenue over marginal costs.

™ The marginal cost statement is the basic document/format to capture the marginal costs.

Marginal  costing  may  be  defined  as  the  technique  of  presenting  cost  data  wherein variable costs and fixed costs are shown separately for managerial decision-making. It should be clearly understood that marginal costing is not a method of costing like process costing or job costing. Rather it is simply a method or technique of the analysis of cost information for the guidance of management which tries to find out an effect on profit due to changes in the volume of output.

Marginal costing technique has given birth to a very useful concept of contribution where contribution is given by: Sales revenue less variable cost (marginal cost)

Contribution may be defined as the profit before the recovery of fixed costs. Thus, contribution goes toward the recovery of fixed cost and profit, and is equal to fixed cost plus profit (C = F + P).

In case a firm neither makes profit nor suffers loss, contribution will be just equal to fixed cost (C = F). this is known as break even point.

The concept of contribution is very useful in marginal costing. It has a fixed relation with sales. The proportion of contribution to sales is known as P/V ratio which remains the same under given conditions of production and sales.

Features of Marginal Costing

1. Cost Classification

The marginal costing technique makes a sharp distinction between variable costs and fixed costs. It is the variable cost on the basis of which production and sales policies are designed by a firm following the marginal costing technique.

2. Stock/Inventory Valuation

Under marginal costing, inventory/stock for profit measurement is valued at marginal cost. It is in sharp contrast to the total unit cost under absorption costing method.

3. Marginal Contribution

Marginal costing technique makes use of  marginal contribution for marking various decisions. Marginal contribution is the difference between sales and marginal cost. It forms the basis for judging the profitability of different products or departments.

Advantages

1. Marginal costing is simple to understand.

2. By not charging fixed overhead to cost of production, the effect of varying charges per unit is avoided.

3. It prevents the illogical carry forward in stock valuation of some proportion of current year’s fixed overhead.

4. The effects of alternative sales or production policies can be more readily available and assessed, and decisions taken would yield the maximum return to business.

5. It eliminates large balances left in overhead control accounts which indicate the difficulty of ascertaining an accurate overhead recovery rate.

6. Practical cost control is greatly facilitated. By 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.

7. It helps in short-term profit planning by breakeven and profitability analysis, both in terms of quantity and graphs. Comparative profitability and performance between two or more products and divisions can easily be assessed and brought to the notice of management for decision making.