Marginal Costing

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Marginal Costing : 

Marginal Costing Marginal cost means the cost of the marginal or last unit produced. It is also defined as the cost of one more or one less unit produced besides existing level of production. For example, if a manufacturing firm produces X unit at a cost of Rs.300 and X+1 units at a cost of Rs.320, the cost of an additional unit will be Rs.20 which is marginal cost. Similarly if the production of X-1 units comes down to Rs. 280, the cost of marginal unit will be Rs.20 (300–280). The marginal cost varies directly with the volume of production/ Sales. It consists of prime cost, i.e. cost of direct materials, direct labor and all variable overheads. It does not contain any element of fixed cost which is kept separate under marginal cost technique.

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Costs can be broadly classified as: Fixed Cost - Cost which remains constant at all levels of production/ output/sales & cost which doesn’t vary with the variation in sales/output. E.g. Rent, Depreciation, Insurance premium. 2. Variable Cost: Cost which varies with the changes in sales/output/ level of production. i.e. if production will increase, VC will also increase & vice versa. E.g. Raw Material, Labour, Power, fuel,etc. Semi variable cost: That cost which remains constant upto specific level of output & it shows increase / decrease beyond this level along with the Sales/ output. E.g. Telephone bill, repairs & maintenance.

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Marginal Costing: Marginal costing distinguishes between fixed costs and variable costs as conventionally classified. The marginal cost of a product –“ is its variable cost”. This is normally taken to be; direct labour, direct material, direct expenses and the variable part of overheads. Marginal costing is formally defined as:‘the accounting system in which variable costs are charged to cost units and the fixed costs of the period are written-off in full against the aggregate contribution. Its special value is in decision making’. The term ‘contribution’ mentioned in the formal definition is the term given to the difference between Sales and Marginal cost.

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Marginal Costing is concerned basically with the determination of ‘Product Cost’ which consist of ‘Total Cost’, excluding ‘Fixed Cost’. Marginal costing is the ascertainment of Variable cost & the effect of changes in Volume of Sales/Output on Profit. MARGINAL COST = VARIABLE COST= DIRECT LABOUR+DIRECT MATERIAL+DIRECT EXPENSE+VARIABLE OVERHEADS. Marginal costing technique has given birth to a very useful concept of contribution where contribution is given by: Sales revenue less variable cost (marginal cost) CONTRIBUTION= SALES - MARGINAL / VARIBALE COST.

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Contribution may be defined as the profit before the recovery of fixed costs. Thus, contribution goes toward the recovery of fixed cost and profit, and is equal to fixed cost plus profit (C = F + P). In case a firm neither makes profit nor suffers loss, contribution will be just equal to fixed cost (C = F). this is known as break even point. Marginal costing is a technique in which all costs are classified into two parts as Fixed & Variable costs. In Marginal Costing, only VC is charged (allocated) to the Product where as on the other hand FC which has incurred can’t be waived but it has to be adjusted/absorbed through Total profit of the Company. FC are not charged / allocated to the Product i.e. it is not considered while calculating the Total Cost of Product.

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The concept of contribution is very useful in marginal costing. It has a fixed relation with sales. The proportion of contribution to sales is known as P/V ratio which remains the same under given conditions of production and sales.

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