Marginal Costing - Basics

Marginal Costing Definition

This article introduces you to Marginal Costing and its basics. The objective of this article is to help you understand the meaning of marginal costing accounting system and the basics of all other costs and their associations.

Marginal Costing is an accounting system in which variable costs are charged to units and fixed costs of the period are written in full against aggregate contribution.

Marginal Cost

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 unit.

It is the change in total cost that arises when the quantity produced changes by one unit.

Marginal Costing

The ascertainment of marginal costs and of the effect on profit of changes in volume or type of output by differentiating between fixed costs and variable costs.

The cost of an item includes only the variable costs incurred in its production.

• Revenue (per product) - Variable Costs (per product) = Contribution (per product)
• Total Contribution - Total Fixed Costs = Total Profit or (Total Loss)

1. It does not attempt to allocate fixed costs in an arbitrary manner to different products.
2. This method is used particularly for short-term decision-making.
3. The short-term objective is to maximize contribution per unit.
4. If constraints exist on resources, then Marginal Cost analysis can be employed to maximize contribution per unit of the constrained resource

Direct Costing

The practice of charging all direct costs to operations, processes or products, leaving all indirect costs to be written-off against profit in the period in which they arise is called Direct Costing.

This differs from marginal costing in that some fixed costs could be considered to be direct costs in appropriate circumstances.

Contribution

Contribution is the difference between the sales and the marginal cost of sales. It contributes towards fixed expenses and profit.

The contribution margin is sales minus variable expenses.

Contribution margin = Sales - Variable Expenses

When the contribution margin is expressed as a percentage of sales it is referred to as the contribution margin ratio. The contribution margin per unit is the product’s selling price minus its variable costs and expenses.

Variable Cost

Variable Cost is a cost which tends to vary directly with volume of output.

Variable costs are sometimes referred to as direct costs in system of Direct Costing.

Variable Expenses mean the total of the company’s variable costs plus its variable expenses.

Fixed Cost

Fixed Cost is a cost which tends to be unaffected by variations in volume of output. Fixed costs depend mainly on the efflux ion of time and do not vary directly with volume or rate of output.

Fixed costs are sometimes referred to as period costs in system of Direct Costing.

Fixed Expenses

mean the company’s total amount of fixed costs plus its fixed expenses.

Fixed costs and Fixed expenses

Fixed costs and fixed expenses are those which do not change as volume changes.

Variable costs and Variable expenses

1. Variable cost per unit remains constant.
2. Fixed costs remain the same.
3. Selling price per unit does not change.

The cost per unit of an item is important for

• Setting the selling price
• Valuing stocks
• Calculating profitability