Marginal Costing

By-
Anmol Dhar- 022
Nand Kishore Bodu-011
Arpit Mishra-60
Nitichandra Ingle-38
Praveen Kumar-049
Deepak M.-054
 Definition of Marginal Cost

 Marginal cost is the additional cost of producing an

additional unit of a product.

 According to I.C.M.A. London as ”the amount to any given

volume of output by which aggregate costs are changed if
the volume of output is increased or decreased by one unit”.
In practice, this is measured by the total variable cost
attributable to one unit.

 Thus, Marginal Cost = Prime cost+ Total variable overheads

(or)
Total cost – Fixed cost.
Definition of Marginal Costing

 Marginal costing is a costing technique in which only

variable manufacturing costs are considered and used
while valuing inventories and determining the Cost Of
Goods Sold(COGS).
 These costs include direct material direct labor and
variable factory overhead and these are assigned to
product
 Fixed factory Overheads are not considered
 Fixed manufacturing costs are treated as period costs in
marginal costing.
Features of Marginal Costing

1.Marginal costing is a technique of control or decision

making.
2. Under marginal costing the total cost is classified as fixed
and variable cost.
3. Fixed costs are treated as period cost and charged to profit
and loss a/c for the period for which they are incurred.
4. The Variable costs are regarded as the costs of the
products.
5. The stock of finished goods and work-in-progress are
valued at marginal costs only.
6. Prices are determined on the basis of marginal cost.
Continues…..

 Marginal costing is a technique of costing fully oriented

towards managerial decision making and control.
 Marginal Costing being a technique can be used in
conjunction with any method of cost ascertainment.
 It can be used in combination with other techniques
such as budgeting and standard costing.
 Marginal costing is helpful in determining the
profitability of products, departments, processes and
cost centers.
MARGINAL COST STATEMENT
sales Description Amount Amount
(Rs) (Rs)
Less Variable Production Cost YYY
Direct Material Cost YYY
Direct Labor Cost YYY
Variable Manufacturing Overhead YYY
Costs of Good Manufactured YYY
Add Beginning Inventory YYY
Cost of Goods Available for Sale YYY
Less Closing Inventory YYY
Cost of Goods Sold YYY
Marginal Contribution YYY
Less Fixed manufacturing Overhead YYY
Variable selling and Administrative Expenses YYY
Fixed Selling and Administrative Expenses YYY
Net Income YYY
MARGINAL COST - Example
sales Description X Y Z Total
Sales(1) 40,000 54000 78000 172000
Less Variable Production Cost
Direct Material Cost 12000 15000 20000 47000
Direct Labor Cost 5000 7000 9000 21000
Direct Expenses 1000 1500 2000 4500
Variable Overhead
Factory 5000 6500 11000 22500
Administration 2000 3000 5000 10000
Selling and Distribution 2500 2500 4000 9000
Total (2) 27500 35500 51000 114000
Contribution (1-2) 12500 18500 27000 58000
Less Fixed manufacturing Overhead
Factory 11000
Selling and Distribution 4500
Administrative Expenses 14500 30000
Profit 28000
 Observations
> It can be observed that only the direct cost + Variable
Overheads will be observed into the cost of product
>The balance amount called Contribution will be used in
meeting fixe cost and any amount after meting the fixed
cost will be the profit of the concern
>In marginal costing Fixed Cost peer Unit wont be
computed to arrive at the product profitability i.e. Selling
price of product > the marginal cost
>In marginal costing fixed overheads are charged direct to
the costing profit and loss account.
Decision Making Indicators

The following are the basic decision making indicators in

marginal costing

1.Profit –Volume Ratio(PV ratio)

2.Break- Even Point(BEP)

3.Margin of Safety (MOS)

4.Indifference point

5.Shutdown Point
Cost-Volume-profit analysis

The Profit Volume ratio is the relationship between contribution and sales value

Formula : Contribution/Sales x 100

It is used to measure the effect of factor changes & management decision

alternatives on profits. Factors like selling prices, change in variable or fixed cost
etc.,

Changes in selling price.

a) If selling price is increased, P/V ratio increases & rate of fixed cost recovery is
increased. BEP declines
b) If selling price is decreased, P/V ratio decreases & rate of fixed cost recovery
declines. BEP increases
Changes in variable costs:
a)Increase in variable cost, P/V ratio decreases & rate
of fixed cost recovery is slower, BEP moves higher.
b)Decrease in variable cost, P/V ratio increases & rate
of fixed cost recovery increases, BEP moves lower.
Changes in Fixed Cost:
No change on P/V ratio
Significance:
PV ratio is considered to be the basic indicator of the
profitability of the business
It is used to compute variable cost for any volume of
sale
To decide the most profitable sales mix
Breakeven Analysis

 Introduction
 In this lesson, we will discuss in detail the highlights
associated with cost function and cost relations with the
production and distribution system of an economic entity.
 To assist planning and decision making, management
should know not only the budgeted profit, but also:
 the output and sales level at which there would neither
profit nor loss (break-even point)
 the amount by which actual sales can fall below the
budgeted sales level, without a loss being incurred (the
margin of safety)
Breakeven Analysis Equations

 Sales – Marginal cost = Contribution ......(1)

 Fixed cost + Profit = Contribution ......(2)
 Sales – Marginal cost = Fixed cost + Profit......
(3)
 P/V Ratio (or C/S Ratio) =Contribution/Sales.....
(4) 
(or)
 Contribution = Sales x P/V ratio...... (5)
(or)
 Sales =Contribution/ P/V Ratio......(6) 
Important Formula…

1. Contribution = Sales (Volume/Per unit) – Variable Cost.

2. Profit-Volume Ratio= Contribution/ Sales
(or) P/V Ratio= Change in Profit/Change in Sales
3. Break Even Point (Units) = Fixed Cost/ Contribution
Break Even Point (Sales)= Fixed Cost/ P/V Ratio
4. Margin of safety = Actual Sales – Break Even Sales
5. Sales for required profit= Fixed Cost + Required Profit
P/V Ratio
6. Profit for given Sales= Contribution-Fixed Cost
Contribution= Given Sales x P/V Ratio
7. Fixed Cost = Contribution - Profit
Advantages of Marginal Costing

1. Simplicity
2. Stock valuation
3. Meaningful reporting
4. Fixation of Selling Price
5. Profit planning.
6. Cost control and cost reduction.
7. Pricing policy.
8. Helpful to management.
9. Production Planning
10. Make or Buy Decisions
Limitations of Marginal Costing

1. Classification of cost

2. Not suitable for external reporting.

3. Lack of log-term perspective.

4. Under valuation of stock

5. Automation – Lack of Advancement

6. Production aspect is ignored.

7. Not applicable in all types of business.

8. Misleading picture -Assumptions

 Assumptions of Marginal Costing

1. All costs can be classified into two categories – Fixed and

Variable

2. Fixed costs remain constant at all levels of activity

3. Variable costs vary in total, but remain constant per unit

4. Level of efficiency of operations is uniform

5. Product risk remains unaltered, unless specified otherwise.

6. Selling price remains constant at different levels of activity.

Thanks