MARGINAL COSTING

It is one of the premier tools of management not only to take decisions but also to fix an appropriate price and to assess the level of profitability of the products/services. This is
a only costing tool demarcates the fixed cost from the variable cost of the product/ service in order to guide the firm to know the minimal point of sales to equate the cost of production. It is a tool of analysis highlighting the relationship in between the cost, volume of sales and profitability of the firm.
MEANING & DEFINITION OF MARGINAL COSTING
Definition: According to ICMA, London "Marginal cost is the amount at any given
volume of output, by which aggregate costs are charged, if the volume of output is
increased or decreased by one unit."
Meaning: Marginal cost is the cost nothing but a change occurred in the total cost due
to changes taken place on the level of production i.e., either an increase / decrease by
one unit of product..
The firm XYZ Ltd. incurs Rs 1000/- for the production of 100 units at one level of
operation. By increasing only one unit of product i.e. 101 units, the firm's total cost of
production amounted Rs 1010.
Total cost of production at first instance (C')=Rs. 1000/
Total cost of production at second instance (C")=Rs. 1010/-
Total number of units during the first instance (U')=100
Total number of units during the second instance (U")=101
Increase in the level of production and Cost of production:
Change in the level of production in units= U"-U'= U
Change in the total cost of production = C"-C, prime= C
WHY MARGINAL COST IS CALLED IN OTHER
WORDS AS VARIABLE COST?
Fixed Cost
It is a cost remains constant or fixed irrespective level of production.
Example: Rent Rs 5,00 is to be paid irrespective level of production. It remains constant/
fixed irrespective of changes taken place on the level of production.
Variable Cost
It is a cost which varies with level of production
X'- Units Marginal Costing
Y'- Cost in Rupees
The following are the various components of variable cost.
Direct Materials: Materials cost consumed for the production of goods
Direct Labour: Wages paid to the labourers who directly involved in the production
of goods.
Direct Expenses: other expenses directly involved in the production stream.
Variable portion of Overheads: Generally the overheads can be classified into
two categories. Viz- Variable overheads and Fixed overheads.
The variable overheads is the cost involved in the procurement of Indirect materials
Indirect labour and Indirect Expenses.
Indirect Material- cost of fuel, oil and soon
Indirect Labour- Wages paid to workers for maintenance of the firm.
From the above table -1 the marginal cost is equivalent to the variable cost per unit of the
various levels of production. The fixed cost of Rs.500 is the cost remains the same at not only
irrespective levels of production but also already absorbed at the initial level of production.
The initial absorption of fixed overhead led the marginal cost to become as variable cost.
Semi-Variable Cost
Another major classification is semi variable/fixed cost which is a cost partly fixed /
variable to the certain level of production or consumption e-g Electricity charges, telephone
charges and so on.
It jointly discards the importance of the fixed cost and the semi- variable cost for analysis
while ascertaining the marginal cost.
Marginal Costing is defined as "the ascertainment of marginal cost and of the effect on
profit of changes in volume or type of output by differentiating between fixed and variable
costs."
In marginal costing, the change in the level of cost of operation is equivalent to variable
cost due to fixed cost component which is fixed irrespective level of outputs.
Importance of Marginal costing:
The costs are classified into two categories viz fixed and variable cost.
Variable cost per unit is considered as marginal cost of the product.
Fixed costs are charged against contribution of the transaction.
Selling price of the product = marginal cost + contribution.
BREAK EVEN POINT ANALYSIS
This meaning of the analysis is explained through three different components viz Break Even Point is the point at which the Total Cost is equivalent to Total Revenue. At the break even point the business neither earns profit nor incurs a loss. It means that the firm's cost is recovered at the minimum level of production
If Sales > BEP Sales ¾® earn profit i.e. Total Sales> Total Cost which leads to earn
profit.
If Sales< BEP Sales ¾® incur loss i.e. Total Sales< Total Cost which registers incurrence
of loss.
This Break even point analysis can be interpreted into two classifications. The first classification is narrow sense of BEP, which mainly emphasizes on BE Point. The second segment is the broader sense which elucidates the role of BEP towards managerial decisions Fixation of Selling price
Acceptance of Special / Foreign order
Incremental Analysis- On cost as well as revenue
Make or Buy Decision
Key factor analysis
Selection of production mix
Maintaining the specified level of profit and so on
The enlisted decisions will be discussed immediately after the preliminary aspects of
marginal costing i.e. Break even analysis.
VERIFICATION
Selling Price Method
Under this method Break even sales volume in rupees is found out through the product
of Break Even Point in Units and Selling price per unit
BEP (Rs)=Break Even Point (units) × Selling price per unit
PV Ratio Method
Under this method, Break even sales volume in rupees can be determined through the following ratio.
What is PV ratio?
PV ratio is Profit Volume ratio which establishes the relationship in between the profit
and volume of sales. It is a ratio normally expressed in terms of contribution towards
volume of sales. It is expressed in terms of percentage.
Utility of PV ratio:
To find out the Break Even Point in sales volume
To identify the desired level of profit at any sales volume
To determine the sales volume to earn required level of profit
To identify better product mix among the alternatives available etc.
MARGIN OF SAFETY
Margin of safety is the excess volume of sales over the break even sales. It is highlighted in the
form absolute sales or in percentage. It is the difference in between the actual sales and break
even sales. It elucidates the extent in which sales can be reduced without incurring a loss.
DETERMINATION OF SALES VOLUME IN RUPEES
AT DESIRED LEVEL OF PROFIT
To determine the sales volume (Rupees) at desired level of profit, the existing formula
for finding out the break even sales has to be redesigned.
APPLICATIONS OF MARGINAL COSTING
Make or Buy Decision
The firms which are routinely in need of spares, accessories are bought from the outsiders instead of any production or manufacturing, though the requirement is at regular intervals. Most of the automobile manufacturers are usually buying the components from outside instead of producing them on their own. The Maruthi Udyog ltd had given a contract to
the Nettur Technical Training Foundation, Bangalore to design the tool for the panel and
to manufacture regularly to the tune of the orders. The leading four wheeler manufacture in India is buying the panel from the NTTF on contract basis instead of manufacturing.
SELECTING THE SUITABLE PRODUCT MIX
In the market, dealership is offered by the various companies to the individual intermediaries
in promoting the sale of products. Before reaching an agreement with the company to act as a dealer, normally every individual consider the profitability of the product mix offered by the firm. For e-g There are two different companies brought forth their advertisements in offering the dealership to the individual trading firms viz HCL and IBM. The profitability under the dealership banner should be appropriately considered prior to take decision. To take rational decision, the firm should compare the profitability of both different dealership of two different giant industrial brands. The greater the share of the profitability in volume will be selected and vice versa.
LET US SUM UP
"Marginal cost is the amount at any given volume of output, by which aggregate costs are charged, if the volume of output is increased or decreased by one unit." Marginal Costing is defined as "the ascertainment of marginal cost and of the effect on profit of changes in volume or type of output by differentiating between fixed and variable costs." In marginal costing, the change in the level of cost of operation is equivalent to variable cost due to fixed cost component which is fixed irrespective level of outputs. Break Even Point is the point at which the Total Cost is equivalent to Total Revenue. At the break even point the business neither earns profit nor incurs a loss. It means that the firm's cost is recovered at the minimum level of production. PV ratio is Profit Volume ratio which establishes the relationship in between the profit and volume of sales. It a ratio normally expressed in terms of contribution towards volume of sales. It is expressed in terms of percentage. Key factor is nothing but a limiting factor or deterring factor on sales volume, production, labour, materials and so on. The limiting factor normally differs from one to another Volume of sales- the limiting factor is that production of required number of articles In the market, dealership is offered by the various companies to the individual intermediaries in promoting the sale of products. Before reaching an agreement with the company to act as a dealer, normally every individual consider the profitability of the product mix offered by the firm.

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