MARGINAL COSTING

Specific technique of cost analysis in which cost information's are presented in such a manner so
that it may help the management in cost control and managerial decision.
In this technique, total cost is divided into fixed and variable components.
Fixed expenses remain constant in aggregate amount and do not vary with the increase or
decrease upto a particular level of output.
Variable expenses increase or decrease in proportion to increase or decrease in output and
remain constant per unit of output.
In this context, a special technique known as ‘ MARGINAL COSTING’ has been developed
which excludes fixed cost and help in decision making on the basis of variable or marginal cost.
MARGINAL COSTING
DIRECT MATERIAL
COST
PRODUCT COST
VARIABLE
DIRECT LABOUR
COST
COST
MANUFACTURING
MANUFACTURING
CONCERNS TOTAL
OVERHEAD
COST

SELLLING COST
PERIODS COST
ADMINSTRATION FIXED COST
COST
MANUFACTURING
OVERHEAD
MEANING OF MARGINAL
COSTING
Marginal costing is a costing method which charge the product with only those
costs that vary directly with volume
The ascertainment of marginal cost and the effect on profit of change in volume or
type of output by differentiating between fixed cost and variable cost is known as
marginal costing
Marginal costing is a technique of determining the amount of change in aggregate
cost due to an increase in one unit over the existing level of production.
FEATURES OF MARGINAL
COSTING
Techniques of cost analysis and presentation
Division of cost into fixed and variable cost
Period cost and product cost
Valuation of stock
Determination of profit
Calculation of profit
Recovery of cost
Break even analysis
ASSUMPTION OF MARGINAL
COSTING
All element of cost i.e manufacturing ,administration and selling and distribution
expenses can be divided into fixed and variable component
Per unit variable cost of a product remains constant at all level of output. In other
words total variable cost varies in proportion to volume of output
Per unit selling price remain constant at all level of operating activity
Total fixed cost remains unchanged at all levels of output
In case of production in addition to present level , only marginal or variable cost is
incurred as additional cost
In period cost , total cost amount to ₹ 40,000 and ₹ 50,000 against production of 15,000
units and 20,000 units respectively . How much is marginal cost per unit and how much
fixed cost ?
Total cost amount to ₹ 1,12,000 and ₹1,69,000 for 20,000 units and 36000 units respectively in two periods. Calculate
marginal cost per unit and fixed cost?
The cost of production of 1000 unit is given below:

Materials ₹20000
Labour ₹10,000
Overhead ₹20,000 (60% fixed)
Find out marginal cost in total and per unit and test the equation TC= VQ+F
DETERMINATION OF PROFIT UNDER MARGINAL
COSTING
CONTRIBUTION=SALES –VARIABLE COST
C=S - VC (1)
CONTRIBUTION=FIXED COST+PROFIT
C=F + Pt(2)
S – VC= F + Pt (3)
SOME OTHER EQ. OF VITAL SIGNIFICANCE DERIVED FROM ABOVE EQ.
S= VC + F + Pt
VC= S-C
F= C-Pt
Pt= C+F
FORMULA OF PROFIT
Sales (units) s 100
LESS: variable cost(marginal cost) vc 20
contribution c 80
LESS: fixed cost f 30
profit 50
SALIENT POINT OF
CONTRIBUTION ANALYSIS
IF CONTRIBUTION IS ZERO ,ONLY MARGINAL COST IS COVERED ,THE
LOSS WILL BE EQUAL TO FIXED COST(PERIOD COST)

C= ZERO, there is loss equal to F (100-100=0-50=50)

IF CONTRIBUTION IS NEGATIVE ,THE LOSS WILL BE MORE THAN

FIXED COST, BECAUSE MARGINAL COST WILL NOT BE COVERED
C= NEGATIVE, loss>F
When contribution is positive and more than fixed cost , there will be profit because
fixed cost will be fully covered and the balance will represent profit
C>F, there will be profit

When contribution is positive but less than fixed cost, there will be loss but at any
rate, it will be less than FC , because some portion of FC will be recovered
c <f , there will be loss less than F
When contri. Is positive but equal to FC ,there will be neither profit nor loss(break
even point) because contri. will just be sufficient to absorb fixed cost leaving no
surplus
C = F, no profit no loss or BEP
From the following information, compute the amount of profit earned using the technique of marginal costing :

Production- 100,000 units

Fixed cost - 2,00,000 units
Selling price - ₹ 10 p.u
Variable cost - ₹ 6 p.u
Solution :

Sales : 1,00,000 units @ ₹10 p.u 10,00,000

Less : variable cost @ 6 p.u 6,00,000

contribution 4,00,000
Less : fixed cost 2,00,000
profit 2,00,000
A company manufacture two products -- A and B . The cost of manufacture are as under

A B
₹ ₹
Direct material per unit 7 9
Direct labour per unit 3 5
Selling price per unit 20 30
Output 2000 units 2000 units

Total overhead are ₹16000 out of which ₹12000 are fixed and rest are variable. These overhead are to be apportioned in
the ratio of output.
Meet & company Ltd. has three divisions each of which makes a different product.
The budgeted data for the next year is as follows:
Divisions A B C
Rs. Rs. Rs.
Sales- 1, 12, 000 56, 000 84, 000
Direct material - 14, 000 7, 000 14, 000
Direct labor- 5, 600 7, 000 22, 400
Variable overhead - 14, 000 7, 000 28, 000
Fixed cost- 28, 000 14, 000 28, 000
Total cost- 61, 600 35, 000 92, 400
The management is considering closing down division C. There is no possibility of
reducing variable costs. Advice whether or not division C should be closed down.
 Marginal Cost Statement
Division A B C
Rs. Rs, Rs.
Sales 1, 12, 000 56, 000 84, 000
Marginal cost
(Direct material + Direct cost +
Variable overheads)
33, 600 21, 000 64, 400
Contribution 78, 400 35, 000 19, 600
Fixed cost 28, 000 14, 000 28, 000
Profit 50, 400 21, 000 (8, 400)
MARGINAL COST
MARGINAL COST REFER TO VARIABLE COST
VARIABLE COST CONSIST OF DIRECT MATERIALS,DIRECT
LABOUR,VARIABLE DIRECT EXPENSES AND ALL VARIABLE OVERHEAD.
VC IS INC $ DEC IN TOTAL COST ON ACCOUNT OF INC AND DEC OF
OUTPUT BY ONE UNIT.

This Photo by Unknown Author is licensed under CC BY-SA

DEFINITION
Marginal cost is amount of any given volume of output by which aggregate costs are
changed if volume of output is inc or dec by one unit.
Ex- if total cost of 100 units is 5000rs. And those of 101 units is 5030rs., then inc in
30 rs. In total cost will be considered as marginal cost
FORMULA OF MARGINAL
COST
Marginal cost= Prime cost+ all variable overheads
OR (Direct material + direct labour +direct expenses) + All variable
overhead
OR (total cost) - (all fixed overhead)
OR (total cost) – (fixed works expenses + fixed office expenses + fixed

selling and distribution expenses)

In two periods, total cost amount to ₹40,000 and ₹ 50000 against production of 15000 units and 20,000 units resp. how
much is marginal cost per unit and how much is fixed cost?
Sol.. MC+FC=total cost
if per unit marginal cost is assumed as V and total fixed cost as F
15000V+F=40,000 (1)
20,000V+F=50000 (2)
Solving 1$2
15000V+F=40,000 (1)
20,000V+F=50000
- - -
5000V=10000

V=10000
5000 =₹2

Substituting value of V in eq 1
15000x 2+f=40000
₹10000
ADVANTAGES OF MARGINAL
COSTING
Easiness
Helpful in profit planning
Meaningful managerial reporting
Profitability
Useful to standard and budgetary costing
Convenience in computing fixed overheads
Role in cost control
Helpful in managerial decision
DISADVANTAGES OF
MARGINAL DECISION
Difficulties in division of cost
Ignoring time element
Role of fixed expenses with development of technology
Not suitable for all concerns
Availability of other better techniques of cost control
Inappropriate basis of pricing
MARGINAL COSTING AS A
TOOL FOR DECISION MAKING
Make or buy decision
Change in product mix
Pricing decision
Exploring a new market
Shut down decision
MAKE OR BUY DECISION
stopping the production of the part and buying it from the market
Stopping the purchase of a component and to produce it in own
factory
STOPPING THE PRODUCTION
OF THE PART AND BUYING IT
FROM HE MARKET
A comparison of marginal cost of such production with that of buying price should
be made.
If MC is less than buying price, additional req of the component should be met by
making rather than buying .
If buying price is less MC , it will advantageous to purchase it from market .
Opportunity cost should also be taken into account
When decision goes “making on the basis of MC being less than buying price , the
amt of revenue from the alternative use of production facilities , if released , should
be taken an opportunity cost of making the component
Suppose a component is being manufactured with the help of a machines and 10,000 unit at a cost of ₹ 10 per unit ( of
which ₹ variable) are produced. The same component can be obtained from market @ ₹ 9.50 per unit .

But if machine is released from production (a case of buying the component from the market)and can be hired at an annual
rent of ₹6000

Example : if the item to made :

MC of ₹10000 units @ ₹9 90000
buying price of ₹10000 units @ ₹9.50 95000
saving if made 5000

if the item is brought and machine is let out on hire:

buying price 10000 unit @ ₹ 9.50 95000
less= hire machine 6000

89000
Marginal cost of 10000 units @₹9 90000
saving if brought and machine is hired 1000
• decision whether to manufacture a component or to buy from outside is
“lost opportunity “
• When a component is produced a part of plant capacity is utilized i.e
some contribution is earned
• if company is running in full capacity ,the contribution thus earned will be
lost by not manufacturing the component .
• If company is not working at full capacity , the question of lost
contribution become irrelevant.
STOPPING THE PURCHASE OF
A COMPONENT AND TO
PRODUCE IT IN OWN
FACTORY
If decision for making req the setting up of new and separate factory, supervisory
staff may also needed. It req additional cost.
The price being paid to outsiders should be compared with additional cost which will
have to incurred in the form of raw material wages etc. If such additional cost are
less than the buying price, the component should be manufactured and vice-versa.
NON COST FACTORS ARE REQ
TO BE TAKEN INTO ACCOUNT
1. No compromise with respect of quality
2. Reliability of regular supply should definitely be ensured
3. If there are large fluctuation in demand = purchase from outside
4. If demand is likely to inc , own production may be preferred because it will lead
to lower cost in future
Q. A radio manufacturer finds that while its cost ₹6.25 per unit to make component XX-09 the same is available in the
market at ₹ 5.75 each. Continuous supply is also fully assured . The break- down of cost is:

per unit
Materials ₹2.75
Labour ₹1.75
Other variable exp ₹0.05
Depreciation and other fixed cost ₹1.25
6.25
1- will you make or buy ?
2- what would be your decision , if supplier offered the component at ₹4.85 per unit?

Ans: case1 – case 2:

Marginal cost of “making”: marginal cost of making:5.00
Material 2.75 cost of buying :4.85
Labour 1.75
V EXP 0.05 saving when brought 0.15
5.00
Cost of buying 5.75
Thus buying will not be profitable and in this situation manufacturing will not be profitable
component should be manufactured and it will be profitable to buy it.
CHANGE IN PRODUCT MIX
Introducing a new line or department
Selection optimum product - mix
INTRODUCING A NEW LINE OR
DEPARTMENT
Whether a new product or line should be added to the existing production or not
If it should be introduced , then what should be the model or design or shape of new
product .
Not only contribution but marginal cost of new product in all its possible models
should be considered.
Fixed overhead should also be considered.
SELECTING OPTIMUM
PRODUCT MIX
Calculate contribution per unit of key factor.
Assign rank on the basis of highest contribution per unit of key factors..
Available key factor should be utilized in manufacturing of that product which has
been assigned first rank; then in the production of product having second rank and so
on.
PRICING DECISION
In competitive market , price is not determine by the individual concerns but is govern
by the market force.
Thus marginal costing is helpful in price determination only in short term and monopoly
conditions.
Various aspect of pricing policies-
1. Normal price
2. Minimum price
3. Depression price
4. Special price
5. Price change
• NORMAL PRICE- sales – marginal cost + contribution
marginal cost+(fixed cost + profit)

• MINIMUM PRICE- variable cost + fixed cost

• DEPRESSION PRICE- profitability can be improved (in sense of minimisation of

loss)
by fixing a price equal to variable cost plus some portion of fixed overhead.

• SPECIAL PRICE- when price> marginal cost, accept the order

when price< marginal cost, reject the order

• PRICE CHANGE – a careful analysis of the possible changes in demand (quantity

sold) must be made and its probable impact on profit should be estimated through the
technique of MC.
EXPLORING A NEW MARKET
Sales volume can be inc by taping new territories.
Some initial exp will have to be incurred in organising sales channels in new
territories
Marginal costing will provide adequate and relevant data for taking a decision in this
reagrds
SHUT DOWN DECISION
This is of two types:
1. closure of entire business
2. Dropping a line or product or department
CLOSURE OF ENTIRE
BUSINESS
Temporary closure of business or shut down for short period – recession or
depression
Permanent closure
TEMPORARY CLOSURE
When trading activity particularly plant operation is suspended for a short period of time.
It is necessary either due to depression / recession or due to ensuring off season .
For period of recession /depression trading activity should not be suspended for short
period of time till there is contribution on that level of trading activity.
But there is need for re examination of fixed cost
There may be few items of fixed cost which can be eliminated or saved by suspending the
trading activity called escapable or avoidable FC
But there are some FC which cannot be avoided called unescapable or unavoidable FC
Additional expenses would have to incurred in setting up the plant again after shut down
period . Such FC are known as special cost.
• Thus escapable fixed cost minus special cost is known as net escapable fixed cost and the amount of
contribution should be compared with net escapable fixed cost.

Shut down point= net escapable fixed cost/ contribution per unit

• It is also significant to note that a decision regarding temporary closure should not only be based on cost
data ,some other economic and social factor may also be considered.

SOMETIMES, TEMPORARY CLOSURE IS WARRANTED BY OFF SEASON.

• if supply of raw material fall below economic quantity, the plant is declared closed for off season.

• SHUT DOWN POINT= avoidable expenses / contribution per unit raw material
PERMANENT CLOSURE
If a business concern may not run profitably and reasonable or minimum return is
not forthcoming on capital employed in the business in the business in spite of
possible efforts being taken to improve it, it may be wise as well as profitable to
close the factory permanently
While taking this decision management should compare the income comingforth
from the following income
1. Income from continuance of the business operation
2. Income from sale or otherwise use of plant , building, etc. in case of complete
closure.
DROPPING A LINE OR
PRODUCT OR DEPARTMENT
Management has to decide whether the production of one or more product or line
should be dropped or curtailed.
If a product /line is dropped ,there will be some disengaged capacity , which may be
left unused or may be used to inc the production of product/line selected to be
continued
If any factor of production is key factor(available in restricted quantity or supply is
short), then contribution should be expressed in terms of per unit of key factor.
Product yielding highest contribution should be accorded top priority in production
programme
No product/ line should be dropped ,if it yield any amount of positive contribution.
VOLUME AND PROFIT RATIO
Profit-volume ratio indicates the relationship between contribution and sales and is
usually expressed in percentage.
The ratio shows the amount of contribution per rupee of sales
Since, in the short-term, fixed cost does not change, the profit-volume ratio also
measures the rate of change of profit due to change in the volume of sales.
P/V ratio helps in studying the profitability of operation of a business.
It is also useful to calculate the break even point , the profit at a given volume of
sales, the sales volume required to earn a desired profit and volume of sales
required to maintain the existing profits if selling price is reduced by a specific
percentage.
• Comparison of P/V ratio for different product can be used to find out which product is more
profitable
• Higher the P/V ratio ,more will be the profit and lower P/V ratio ,lesser will be the profit.
• Thus every concern aims at inc the P/V ratio

• The ratio can be improved by

1. Increasing the selling price per unit per unit
2. Reducing variable cost
3. Changing the sales-mix by switching the production to product showing higher P/V ratio.

Formula used for calculation of P/V ratio:

P/V ratio= contribution x 100 or C x 100 = fixed cost + profit x 100
sales S sales
= sales – variable cost x 100 = contribution per unit x100
sales sales per unit
Find out:
(i) P/V ratio,
(ii) Fixed Cost
(iii) Sales Volume to earn a Profit of Rs. 40,000

Solution:
Sales 50000
Profit 5000
Fixed cost 15000

Find out P/V ratio in following cases:

1. Selling price is increased by 20%
2. Variable cost is decreased by 10%
BREAK EVEN POINT
It is that point of production or sales at which firm neither earns profits nor incur loss .
It is also known as NO PROFIT POINT or ZERO LOSS POINT
The break even point is that point of sales volume where total revenue and total sales are
equal, it is said as the point of zero or zero loss.
The break even point of a company is that level of sales income which will equal the sum
of its fixed cost and its variable cost
Characteristics pf B.E.P
1. There is no profit and no loss to the firm
2. Total revenue is equal to total cost
3. Contribution(sales- variable cost) is equal to fixed cost
ASSUMPTIONS OF B.E.P
1. Fixed and variable cost
2. Proportionate variable cost
3. Certain and constant fixed cost
4. Unchanged selling price
5. Linear behaviour
6. Technological stability
7. No role of stock
8. No change in general price level
9. Unchanged sales price
10. Relationship between volume and cost
LIMITATIONS OF B.E.P
division in fixed and variable cost
Statics concept
Limitation of linear behaviour of cost
Difference in production and sales
Change in sales mix
Maximum and optimum production
Capital employed is ignored
Limitation of lack of perfect competition
 sales of many products
USES OR APPLICATION OF
B.E.P ANALYSIS
Determination of B.E.P
Calculation of profit at different level of sales
Determination of sales to earn desired profit
Fixation of new selling price at a particular B.E.P
Estimation of margin of safety
Estimation of effect of change in fixed cost and variable cost on B.E.P and sales
Calculation of necessary sales to cover proposed expenses
Make and buy decision
Determination of optimum sales mix
Decision of change of capacity
CONTRIBUTION METHOD
•It is also known as CONTRIBUTION MARGIN , GROSS MARGIN
•Excess of sales over its VC which is available to cover FC and to earn profit
•If amount of contribution is less than FC = loss
•If contribution is equal to FC = no profit no loss
CONTRIBUTION CAN HELP THE MANAGEMENT IN FOLLOWING CALCULATION:
1. Determination of B.E.P
2. Determination of selling price
3. Make or buy decision
4. Selection of best option among various alternative of product
5. Optimum product mix for maximising the profit
AMOUNT OF CONTRIBUTION
CAN BE COMPUTED
1. Sales – variable cost
2. Fixed cost + profit(-loss)
3. Sales x P/V ratio
4. Per unit contribution: sales per unit- VC per unit
DIFFERENCE BETWEEN
CONTRIBUTION AND PROFIT
Contribution includes profit and FC both, while profit does not include FC
Contribution is based on the concept of marginal cost , while profit is based
common man concept of sales and cost
Contribution above break even point become profit, while profit is expected only
after covering variable and fixed costs
CALCULATION OF B.E.P
B.E.P IN ₹
1. FC x sales / contribution
2. FC x selling price per unit / contribution per unit
3. FC / PV ratio
4. Sales – margin of safety
B.E.P in units
1. FC / contribution per unit
2. B.E.P / selling price per unit
MARGIN OF SAFETY
It is the difference between actual total sales and BEP sales and may be calculated in
rupees , units or even in percentage form
1. MOS in rupees : 1. It is clear that MOS is that sales
which is above BEP
Sales ₹ - BEP₹ 2. All fixed expenses are recovered at
BEP , so fixed expenses have been
Profit/ PV ratio ignored in the formula of MOS
2. MOS in units: 3. MOS is that sales which give us
profit after meeting fixed cost,
Sales(unit) – BEP (units) therefore , formula of its calculation
takes only profit into consideration
Profit/ contribution per unit
3. MOS in percentage
MOS ratio= MOS / total actual sales x 100
 IMPORTANCE OF MARGIN OF
SAFETY
•Strength of the business.
•If MOS is large , the position of business will be sound and easily resist the situation of
reduction of sales. More opportunity to earn profit
•If MOS is small , a small reduction in sales can be serious mater and may result in even loss
•It is a cushion between profit position and loss position
Therefore effort should be made by management to increase MOS in order to earn more and
more profit.
1. Inc in selling price
2. Inc in volume of production
3. Reduction in fixed or the variable cost or both
4. Substitution of loss profitable product by more profitable product
COST VOLUME PROFIT
ANALYSIS
Ultimate goal of almost all business enterprises is profit maximization
The amount of profit on sales of a product depends upon volume of production and
its cost
The study of relationship among these three important factors are cost, volume and
profit is known as cost –volume- profit is known as cost volume and profit analysis
It is a logical extension of concept of marginal costing in which cost of production
is divided into two parts i.e FC and VC .
ASSUMPTIONS
Every cost can be classified as FC and VC
Selling price of product remains constant even if volume varies
There is only one product . If there is more than one product the product mix is
assumed to be constant .
Relationship among cost volume profit
1. There is negative relationship between volume of production and cost of
production i.e with inc in volume of production there are chance of decrease in
cost per unit
2. There is negative relationship between cost of production and amount of profit i.e
decrease in cost of production result in increase in amount of profit
3. There is positive relationship b/w volume of production and amount of profit i.e
amount of profit inc with inc in volume of production
IMPORTANCE OR OBJECTIVE
Setting up flexible budget
Determination of BEP
Profit planning
Decision relating to selection of alternative
Performance evaluation for control
Helpful in price fixation
Allocation of overhead cost
Analysis of effect of change in cost
LIMITATION
VC per unit may not be constant
Selling price may be lower at high volume because sales discount may be given in
order to sale the high volume of production
FC may not be remain static at high level of production volume
Change in working efficiency may also affect the cost volume profit relatioship
ANGLE OF INCIDENCE OF A
FIRM
This is an angle where sales line intersects the total cost line which indicates profit-
earning capacity over the Break-Even Point.
It should be remembered that a large angle indicates high margin of profit after
covering fixed cost.
Similarly, a small angle indicates low margin of profit which reveals that variable
cost is more in total cost. If margin of safety is considered along with angle of
incidence it may be suggested that a large angle of incidence with high margin of
safety indicates extremely favourable condition