MARGINAL COSTMARGINAL COST

Meaning of marginal cost-Meaning of marginal cost-CIMA defines;CIMA defines;

Amount at any given volume of output by Amount at any given volume of output by which aggregate costs are changed if which aggregate costs are changed if

volume of output is increased or decreased volume of output is increased or decreased by one unit .It relates to change in output by one unit .It relates to change in output

in particular circumstances under in particular circumstances under consideration.consideration.

Meaning of marginal costing Meaning of marginal costing –A/C to CIMA,–A/C to CIMA,

Marginal costing is the ascertainment of marginal Marginal costing is the ascertainment of marginal cost and of the effect on profit of changes in cost and of the effect on profit of changes in

volume or type of output by differentiating fixed volume or type of output by differentiating fixed cost &variable cost .In this technique of costing cost &variable cost .In this technique of costing

only variable cost are charged to only variable cost are charged to operation ,processes or products leaving all operation ,processes or products leaving all

indirect cost to be written off against profits in indirect cost to be written off against profits in period in which they arise. period in which they arise.

Difference Between Absorption Difference Between Absorption costing & Marginal costingcosting & Marginal costing

All costs fixed &variable are included for All costs fixed &variable are included for ascertaining the cost.ascertaining the cost.

Different unit costs are obtained at different Different unit costs are obtained at different levels of output because of fixed expenses levels of output because of fixed expenses remaining same.remaining same.

Difference between sales &total cost is profit.Difference between sales &total cost is profit. A portion of fixed costs is carried forward to the A portion of fixed costs is carried forward to the

next period because closing stock of work -in -next period because closing stock of work -in -progress & finished goods is valued at cost of progress & finished goods is valued at cost of production which is inclusive of fixed cost. In production which is inclusive of fixed cost. In this way costs of a particular period are vitiated this way costs of a particular period are vitiated because fixed cost being period cost should be because fixed cost being period cost should be charged to the period concerned & should not charged to the period concerned & should not be carried over to next period .be carried over to next period .

The apportionment of fixed expenses on an The apportionment of fixed expenses on an arbitrary basis given rise to over or under arbitrary basis given rise to over or under absorption which ultimately makes the product absorption which ultimately makes the product cost inaccurate and unreliable.cost inaccurate and unreliable.

Absorption costing is not very helpful in taking Absorption costing is not very helpful in taking managerial decision such as whether to accept managerial decision such as whether to accept the export order or not ,whether to buy or the export order or not ,whether to buy or manufacture ,the minimum price to be charged manufacture ,the minimum price to be charged during depression etc.during depression etc.

Costs are classified according to functional basis Costs are classified according to functional basis such as production cost ,office and such as production cost ,office and administrative cost and selling and distribution administrative cost and selling and distribution cost.cost.

Absorption costing fails to establish relationship Absorption costing fails to establish relationship of cost volume and profit as costs are seldom of cost volume and profit as costs are seldom classified into fixed &variable.classified into fixed &variable.

Only variable cost are included .fixed cost are Only variable cost are included .fixed cost are recovered from contribution.recovered from contribution.

Marginal cost per unit will remain same at Marginal cost per unit will remain same at different levels of output because variable different levels of output because variable expenses vary in the same proportion in which expenses vary in the same proportion in which output varies.output varies.

Difference between sales and marginal cost is Difference between sales and marginal cost is contribution and difference between contribution and difference between contribution and fixed cost is profit or loss.contribution and fixed cost is profit or loss.

Stock of work- in-progress and finished goods Stock of work- in-progress and finished goods are valued at marginal cost which does not are valued at marginal cost which does not include fixed cost .Fixed cost of a particular include fixed cost .Fixed cost of a particular period is charged to that very period and is period is charged to that very period and is not carried forward to next period by including not carried forward to next period by including in closing stock .Being so ,cost of a particular in closing stock .Being so ,cost of a particular period are not vitiated.period are not vitiated.

Only variable cost are charged to Only variable cost are charged to products .marginal cost technique does not products .marginal cost technique does not lead to over or under absorption of fixed lead to over or under absorption of fixed overheads.overheads.

The technique of marginal costing is very The technique of marginal costing is very helpful in taking managerial decisions because helpful in taking managerial decisions because it takes into consideration the additional cost it takes into consideration the additional cost involved only assuming fixed expenses involved only assuming fixed expenses remaining constant.remaining constant.

Cost are classified according to the behaviour Cost are classified according to the behaviour of cost i.e. fixed cost and variable cost.of cost i.e. fixed cost and variable cost.

Cost ,volume and profit relationship is an Cost ,volume and profit relationship is an integral part of marginal cost studies as costs integral part of marginal cost studies as costs are classified into fixed and variable costs. are classified into fixed and variable costs.

IMPORTANCE;IMPORTANCE;

Fixed expenses are not allocated to Fixed expenses are not allocated to cost units but are charged against cost units but are charged against ‘fund’ which arises out of excess of ‘fund’ which arises out of excess of sales price over total variable costs.sales price over total variable costs.

LIMITATIONS;LIMITATIONS;

Technical difficulties.Technical difficulties. Time taken for completion of jobs is not given due Time taken for completion of jobs is not given due

attention.attention. Less effective.Less effective. Balance sheet will not exhibit true and fair view.Balance sheet will not exhibit true and fair view. Problem of apportionment of variable cost still Problem of apportionment of variable cost still

arises.arises. Difficulty to apply in contract or ship building Difficulty to apply in contract or ship building

industry.industry. Does not provide any standard.Does not provide any standard. General reduction in selling price and thus losses.General reduction in selling price and thus losses.

COST–VOLUME –PROFIT COST–VOLUME –PROFIT ANALYSISANALYSIS

Assumptions;Assumptions;

Fixed cost remain static & marginal costs are Fixed cost remain static & marginal costs are completely variable at all levels of output.completely variable at all levels of output.

Selling prices are constant at all sales volume.Selling prices are constant at all sales volume. Factor prices are constant at all sales volume .Factor prices are constant at all sales volume . Efficiency and productivity remain unchanged. In Efficiency and productivity remain unchanged. In

a multi product situation ,there is constant sales a multi product situation ,there is constant sales mix at all level of sales.mix at all level of sales.

Turnover level is only relevant factor affecting Turnover level is only relevant factor affecting cost & revenue.cost & revenue.

Value of production is equal to volume of sales.Value of production is equal to volume of sales.

ELEMENTS-ELEMENTS-

MARGINAL COST EQUATION MARGINAL COST EQUATION CONTRIBUTION MARGIN .CONTRIBUTION MARGIN .PROFIT /VOLUME RATIO .PROFIT /VOLUME RATIO .BREAK EVEN POINT .BREAK EVEN POINT .MARGIN OF SAFETY.MARGIN OF SAFETY.

MARGINAL COST EQUATIONMARGINAL COST EQUATION

SALES=VARIABLE COSTS +FIXED SALES=VARIABLE COSTS +FIXED EXPENSES+P/LEXPENSES+P/L

ORORS-V=F+P/LS-V=F+P/L

CONTRIBUTION MARGIN-CONTRIBUTION MARGIN-

CONTRIBUTION =SELLING PRICE –MARGINAL CONTRIBUTION =SELLING PRICE –MARGINAL COSTCOSTOROR

C=F+P/LC=F+P/LOROR

C-F=P/LC-F=P/L

PROFIT /VOLUME RATIO;PROFIT /VOLUME RATIO;

P/V=CONTRIBUTION /SALESP/V=CONTRIBUTION /SALESOR OR

F+P/L/V.C+F.C+P/L=[F+P/S]F+P/L/V.C+F.C+P/L=[F+P/S]OROR

S-V/S=CHANGE IN PROFITS OR S-V/S=CHANGE IN PROFITS OR CONTRIBUTION/CHANGE IN SALESCONTRIBUTION/CHANGE IN SALES

BREAK EVEN POINT;BREAK EVEN POINT;

B.E.P=FC/P/VB.E.P=FC/P/VOROR

TOTAL FIXED EXPENSES/S.P PER UNIT-MC PER TOTAL FIXED EXPENSES/S.P PER UNIT-MC PER UNITUNITOROR

TOTAL FIXED EXPENSES/CONTRIBUTION PER TOTAL FIXED EXPENSES/CONTRIBUTION PER UNITUNIT

VALUE OF SALES TO EARN VALUE OF SALES TO EARN DESIRED AMOUNT OF PROFIT ;DESIRED AMOUNT OF PROFIT ;

SALES=F.C+D.P/P/V RATIOSALES=F.C+D.P/P/V RATIO

MARGIN OF SAFETY ;MARGIN OF SAFETY ;

MOS=PROFIT/P/V RATIOMOS=PROFIT/P/V RATIO

DIFFERENCE BETWEEN CONTRIBUTION DIFFERENCE BETWEEN CONTRIBUTION &PROFIT&PROFIT

Includes fixed cost & Includes fixed cost & profit .profit .

Based on marginal Based on marginal cost concept.cost concept.

Contribution above Contribution above break even break even contributes to profit.contributes to profit.

Contribution analysis Contribution analysis requires a knowledge requires a knowledge of break even of break even concept.concept.

Does not include fixed Does not include fixed cost.cost.

Based on common Based on common man concept.man concept.

Profit is expected only Profit is expected only after covering variable after covering variable and fixed cost.and fixed cost.

Profit does not require Profit does not require any such concept.any such concept.

APPLICATION OF MARGINAL COST & APPLICATION OF MARGINAL COST & COST, VOLUME & PROFIT ANALYSIS-COST, VOLUME & PROFIT ANALYSIS-

COST CONTROL.COST CONTROL.PROFIT PLANNING.PROFIT PLANNING.EVALUTION OF PERFORMANCE.EVALUTION OF PERFORMANCE.DECISION MAKING.DECISION MAKING.FIXATION OF SELLING PRICE.FIXATION OF SELLING PRICE.KEY LIMITING FACTOR.KEY LIMITING FACTOR.SUITABLE PRODUCT MIX. SUITABLE PRODUCT MIX.