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Marginal Costing

INTRODUCTION

Marginal costing is one of the techniques of costing just like other methods of costing viz. job or process costing. It helps the management to take important decisions specifically for the price fixation and assessment of profitability. It reveals the inter-relationship between cost, volume of sales and profit. It classifies cost into two parts viz fixed and variable cost. Variable cost is considered only to find the cost of production. But fixed costs are not included so a special technique of costing is developed to find out the cost of production known as marginal costing. Marginal Costing is also used to find out the cost per unit up to a particular level or output. Marginal Costing is otherwise called as direct costing, differential costing, incremental costing, or comparative costing. 

DEFINITION OF MARGINAL COST AND MARGINAL COSTING

The Institute of Cost and Works Accountants of India defined marginal cost as “the amount at any given volume of output by which aggregate costs are changed, if the volume of output is increased or decreased by one”. In order to find out the marginal cost, we need the following elements of cost.

(i)                 Direct material.

(ii)               Direct labour.

(iii)             Other direct expenses.

(iv)             Total variable overheads.

i.e., marginal cost = prime cost + total variable overheads.

Marginal costing is defined by the ICWA as “the ascertainment by differentiating between fixed cost and variable costs of marginal costs and of the effect on profit of changes in volume of type of output”.

Batty defines marginal costing as “a technique of cost accounting which pays special attention to the behavior of costs with changes in the volume of output”.

MAIN FEATURES OF MARGINAL COSTING

  1. All costs are classified into fixed and variable.
  2. When evaluation of finished goods and work-in-progress are taken into account, they will be only variable costs.
  3. Marginal costing is a method of costing which is used in other methods of costing.
  4. Fixed cost should be subtracted/deducted from the contribution for the purpose offending out net profit or loss.
  5. Total fixed cost remains constant irrespective of the level of production but fixed cost per unit cannot be uniform.
  6. Selling price per unit and variable cost per unit remain the same.
  7. To employ the cost volume profit relationship the firm has to determine its profitability at various levels of activity possible.
  8. Contribution is otherwise called as income or profit
  9. Normally Fixed Costs are charged to the profit and loss account in which year it was actually incurred and they are not adjusted in the income of the subsequent years.
  10. In all the stages, fixed and variable costs are to be segregated. Apart from this, semi variable costs are also segregated into fixed and variable.

ADVANTAGES

1.Helps to fix selling price. Fixation of selling price is an important task of the manufacturer. Because, depending upon the price level of the product, profit of the organization is to be determined. The differentiation between fixed costs and variable costs is very helpful in fixing the selling price of the products.

2.Budgetary Control. Through the preparation of flexible budget, we have to find the total fixed cost and variable cost under different levels of activity. Without the flexible budget, it is difficult to find the total cost at various stages of activity.

3.Make or buy decisions. Sometimes the organization has to take decision to manufacture a product itself or buy a product from outside suppliers. It would take the decision to purchase from outside if the price paid recovers some of the fixed expenses.

4.Helps in production planning. Through the break even chart, each and every stage of profit is to be determined clearly. So unprofitable products can be removed from product line. Profitable products should be increased according to the required level. 

5.Effective results. The comparison of other systems of costing like process, job etc. gives better results for the Operations.

6.Benefits of overheads simplification. Fixed overheads are segregated from the production cost. With the help of this function, the problem of over absorption or under absorption is totally eliminated.

7.Constant in nature. Variable costs fluctuate from time to time. But, in the long run, marginal costs are stable irrespective of the level of production.

8.Simplicity. Marginal costing is simple to understand and easy to compute. So it does not require more time for computation, and its application.

9.Cost control. Marginal costing is combined with standard costing and budgetary control which makes the cost control mechanism more effective. 

DISADVANTAGES

1. Difficult to analyses overhead. It is difficult to segregate fixed and variable costs accurately. In real sense, a major technical difficulty arises on drawing a sharp line of demarcation between fixed and variable costs.

2. Time factor ignored. Normally, in short run periods, both fixed and variable costs were constant. But in the long run all costs are variable including fixed costs. So comparison of performance between two periods is not possible.

3. Inaccurate price fixation. Price fixation and comparison between two jobs cannot be done in an accurate manner because selling price is fixed on the basis of contribution. Suppose cost plus contract means, it is very difficult to fix the price.

4. Limited Role. Marginal costing in no way, explains the reasons for the increase or decrease in production or sales because it is difficult to combine it with other techniques like standard costing and budgetary control.

5. Claim for loss of stock. In any business organization, to follow a marginal costing technique for the stock valuation, in case of goods destroyed by fire, full loss cannot be recovered from the insurance company.

6. Problem of variable overheads. In most of the situations, marginal costing smoothly solves the problem of over and under absorption of fixed overheads. But there is a problem of variable overhead and semi variable overheads.

7. Unsuitability for certain industries. Marginal costing is found unsuitable in industries where the value of work in progress is high level as compared to its turnover. It is specifically for the ship industries and contract work. This type of industries have more work in progress. At the time of valuation of work in progress, fixed cost is ignored, so it shows manipulation in its profit.

8. Objection by income tax authorities. A concern or industry, which adopts marginal costing techniques for the valuation of inventories and profit estimation, is objected   by the income tax authorities because it does not show an accurate profit. 

                      Specimen form of marginal cost statement