Reading Material Mod 4 Marginal Costing

Course Name: Cost and Management
Accounting
Module 4: Marginal Costing
Introduction
• Marginal Costing is a costing technique wherein the marginal cost, i.e.
variable cost is charged to units of cost, while the fixed cost for the
period is completely written off against the contribution.
• The term marginal cost implies the additional cost involved in
producing an extra unit of output, which can be reckoned by total
variable cost assigned to one unit.
• Marginal Cost =
Direct Material + Direct Labor + Direct Expenses + Variable Overheads
Characteristics
Need for Marginal Costing
• Variable cost per unit remains constant; any increase or decrease in
production changes the total cost of output.
• Total fixed cost remains unchanged up to a certain level of production
and does not vary with increase or decrease in production. It means the
fixed cost remains constant in terms of total cost.
• Fixed expenses exclude from the total cost in marginal costing technique
and provide us the same cost per unit up to a certain level of
production.
Advantages of Marginal Costing
• Easy to operate and simple to understand.
• Marginal costing is useful in profit planning; it is helpful to determine profitability at
different level of production and sale.
• It is useful in decision making about fixation of selling price, export decision and
make or buy decision.
• Break even analysis and P/V ratio are useful techniques of marginal costing.
• Evaluation of different departments is possible through marginal costing.
• By avoiding arbitrary allocation of fixed cost, it provides control over variable cost.
• Fixed overhead recovery rate is easy.
• Under marginal costing, valuation of inventory done at marginal cost. Therefore, it is
not possible to carry forward illogical fixed overheads from one accounting period to
the next period.
• Since fixed cost is not controllable in short period, it helps to concentrate in control
over variable cost.
Absorption costing Vs Marginal costing
• Cost application. Only the variable cost is applied to inventory under marginal
costing, while fixed overhead costs are also applied under absorption costing.
• Profitability. The profitability of each individual sale will appear to be higher
under marginal costing, while profitability will appear to be lower under
absorption costing.
• Measurement. The measurement of profits under marginal costing uses the
contribution margin (which excludes applied overhead), while the gross
margin (which includes applied overhead) is used under absorption costing.
• Overhead costs are charged to expense in the period under marginal costing,
whereas they are applied to products under the absorption costing method
(which may defer expense recognition to a later period).
Cost volume profit (CVP) Analysis
• CVP analysis is concerned with the level of activity where total sales
equals the total cost and it is called as the break-even point.
• CVP analysis highlights the relationship between the cost, the sales
value, and the profit.
• With the help of CVP analysis, the management studies the co-relation
of profit and the level of production.
• It is used to determine how changes in costs and volume affect a
company's operating income and net income.
Contribution margin
• The contribution margin is the excess between the selling price of the
product and total variable costs.
• The contribution margin is the amount of money a business has to cover
its fixed costs and contribute to net profit or loss after paying variable
costs.
• Additionally, the contribution margin is used to determine the break-
even point, which is the number of units produced or revenues
generated to break even.
• Contribution = Sales – Marginal Cost
Profit-Volume Ratio
• Profit / Volume (P/V) ratio is calculated while studying the profitability
of operations of a business and to establish a relation between Sales
and Contribution.
• The P/V Ratio shares a
direct relation with profits.
Higher the P/V ratio, more
the profit and vice-a-versa.
Break Even Analysis
• The break‐even point represents the level of sales where net income
equals zero.
• When the total cost of executing business equals to the total sales, it is
called break-even point. Contribution equals to the fixed cost at this
point.
• Composite Break Even Point: A company may have different production
units, where they may produce the same product. In this case, the
combined fixed cost of each productions unit and the combined total
sales are taken into consideration to find out BEP.
Break Even Analysis
Margin of Safety
• In break-even analysis, from the discipline of accounting, margin of
safety is how much output or sales level can fall before a business
reaches its break-even point.
• Margin of safety (MOS) is the difference between actual sales and
break even sales. In other words, all sales revenue that a company
collects over and above its break-even point represents the margin of
safety.
• Excess of sale at BEP is known as margin of safety.
Margin of safety = Actual sales – Sales at BEP
Margin of Safety
• Margin of safety is also expressed in the form of ratio or percentage that
is calculated by using the following formulas/equations:
• MOS ratio = MOS/Actual or budgeted sales
• MOS percentage = (MOS/Actual or budgeted sales) × 100

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Course Name: Cost and Management

• MOS ratio = MOS/Actual or budgeted sales

• MOS percentage = (MOS/Actual or budgeted sales) × 100

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