Cost and management accounting concept marginal costing

Meaning & definition of marginal costing:

                The increase in unit of output the total cost is increased and this total cost is increase in total cost from existing to new level is known as variable cost.

                The amount at any given value of adopt is increase or decreased by one unit in practice this is measured by the total variable attributable to one unit.

Definition:

                The institute of cost & mgt accounts London as define as “The ascertainment of variable cost and of the effect on profit of changes in volume are type of output by differentiating between fixed cost & variable cost”.

Characteristics of marginal costing:

●      It is a technique of analysis & presentation of costs which help mgt in taking many managerial decisions and is not an independent system of costing such as process costing or job costing.

●      All elements of cost  production, administration & selling & distribution  are classified into fixed & variable components even semi-variable cost & analysed into fixed & variable.

●      The variable costs[marginal cost] are regarded as the costs of the products.

●      Fixed costs are treated as period costs and are charged to P & L a/c for the period for which they are incurred.

●      The stocks of finished goods & work-in process are valued at variable cost only.

●      Prices are determined on the basis of variable cost by adding  “contribution” which is the excess of sales or selling price over variable cost of sales.

●      Profitability of debts & product is determined with reference to their contribution margin.

●      Closing stock is valued or variable cost.

Assumptions of marginal costing

●      Elements of cost production administration & selling & distribution can be segregated into fixed & variable components.

●      Variable cost remains constant per unit of out put irrespective of the level of output & thus fluctuates directly in proportion to changes in the volume of output.

●      The selling price per unit remains unchanged or constant at all levels of activity.

●      Fixed costs remains unchanged or constant for the entire volume of production.

●      The volume of production or output is the only factor which influences the costs.

Advantages of marginal cost:

Simple to operate & easy to understand:

                It is very simple to operate & easy to understand. It is constant in nature. Complications involved in allocation, apportionment and absorption of overheads are avoided.

Cost control:

                In marginal costing costs are divided into fixed & variable costs. Variable costs are always controllable. Thus greater control may be exercised over these costs.

Helps management in decision making:

                This technique help the mgt in taking various decisions. Marginal costing is most helpful in taking decision like price fixation make or by introduction of new product line.

Relationship of net income with sales:

                Marginal costing system establishes direct relationship of net income with the sales. The marginal contribution technique. Provides a better & more logical basis for the fixation of sales price with intending profits.

Helps in preparing flexible budget:

                Marginal costing facilitates the preparation of flexible budget by differentiating variable costs and fixed costs . It is also helps in the evaluation of the performance of responsible personnel.

Helps in Pricing:

             Marginal costing is very helpful in fixation of selling  price of the products under various conditions .It gives a better and more logical base for the fixation of sales price as well as in the tendering for contracts when business is at low level.

●      Limitations of Marginal costing:

●      Time factor ignored:

                Marginal costing techniques does not attach much importance to time factor . If time taken for completing two different  jobs is not the same costs will naturally will be higher. For the job which has taken longer time.Through marginal cost may be the same for both the jobs.

●      Not suitable to all industries:

       Marginal costing technique is not effective in all type of industries.

For example:

       In capital intensive industries fixed cost like depreciation is more.If fixed costs are ignored proper results cannot be ascertained.

●      Fluctuations in profits:

      Marginal costing technique cannot be applied in industries where there is large stock of work in progress . As fixed overheads are not included in the value of stock  firm will get losses in some years.This results in wide fluctuations in profits.

●      Difficulty in fixation of price:

       Under marginal costing selling price is fixed on the basis of contribution. In case of cost plus contract it is very difficult to fix price.

●      Full cliam cannot be claimed:

       Since stock is valued at marginal cost incase of fixfull  amount &loss cannot be recovered from the insurance company.

●      Not suitable for external reporting:

       This technique is not suitable for external reporting for tax        authorities where marginal income  is not considered to be taxable profit.

●      Contribution:

                         The difference between sales and variable cost is known as marginal cost. It contributes fixed cost and profits.

                         The concept of contribution helps to determine break-even point profitability of production department & to select product mains for profit maximization & to firm the selling price under different circumstanceous.

●      Contribution =Sales-Variable cost

●      Contribution =Fixed cost -profit

●      Contribution =Fixed cost –loss

●      Contribution (per unit)=Selling price per unit-Variable cost.

●      Advantages of contribution:

●      It  helps  the management in the fixation of selling price.

●      It assists in determining break even point.

●      It  helps the management in the selection of suitable product  mine for profit maximization.

●      It  helps in choosing from  among alternative methods of production,the method which gives highest contribution for limiting factor is adopted.

●      It helps in taking a decision regarding to adding a new product in the market.

●      PV ratio:

                Profit volume ratio is popularly known as PV ratio. It is the ratio of contribution to sales. It establishes the relationship between contribution &sales values. It helps to study the profitability on operations of business. It can be calculated through any of the following formula.

●      PV ratio = Contribution    

                       Sales             *    100

●      Pv ratio =Fixed cost + profit

                                                       Sales                      *   100

●      PV ratio= sales – variable cost

                     Sales                                             *   100

●      PV ratio = Change in profit or contribution

                                          Change in Sales      

                    

Problems:

1.From the following information relates to a factory .       

Total cost	Production units	Other variable  cost	Fixed cost
3250 5500 7750 10000 12250	500 1000 1500 2000 2500	500 1000 1500 2000 2500	1000 1000 1000 1000 1000

Calculate marginal cost of procuction.

Answer:

Production units	Total cost		Fixed cost Per                       total Unit          cost		Variable cost
	Per unit	Total cost			Per unit	Total cost
500 1000 1500 2000 2500	6.5 5.5 5.1 5 4.9	3250 5500 7750 10000 12250	2.00 1.00 0.66 0.50 0.40	1000 1000 1000 1000 1000	4.5 4.5 4.5 4.5 4.5	2250 4500 6750 9000 11250

                                                 

                                                           3250

                                                --------------------  = 6.5

                                                                500

Variable cost = total cost – fixed cost.

Absorption or marginal costing:

                Absorption costing tech is also known as traditional or full cost method. In this method both fixed and variable cost are recovered from production. The variable cost such as direct materials, direct labor extra are directly charged to the products. While fixed cost and are apportion on a suitable bases over various products manufacturer during period.