For any company, managing its costs is of utmost importance, since it is based on the costs incurred are profits of that company determined and further prices fixed. When batches of products are produced at a singular instance, cost is taken to be uniform. However, in case of production of additional units, costs need to be taken into account.
When a certain additional cost is added for production of an extra amount, it is this incremental cost that brings forth the concept of marginal cost.
Understanding Marginal Cost:
There are multiple techniques of costing as process costing and job costing, and marginal costing is also one of them. It is these techniques that provide details of interrelation between different facets as volume of sales that have been made, profit and costs.
Cost can be classified into two categories: Fixed and Variable.
Whereas variable costs are extremely useful in finding out those costs that are associated with production, such is not the case with fixed costs that once being invested is taken as a constant element. Thus, to find out these details, another format of costing known as marginal costing has been introduced.
Specifically known as differential/direct/comparative or incremental costing, this method is used to find out the cost that is associated with a per unit level up to a particular level of output.
Differentiating Marginal Cost and Marginal Costing:
As per The Institute of Cost and Works Accountants of India, Marginal Cost is defined as, ‘’That amount which at any given volume of output by which there comes a change in the aggregate costs, if there is a change in the volume amount by a singular number.’’
There are certain details that are required for finding the marginal cost:
Thus, Marginal Cost can be stated as a summation of Total Variable Overheads and Prime Costs.
For Marginal Costing, there are double definitions associated. Defined by The Institute of Cost and Works Accountants of India, Marginal Costing is found by, ‘’finding the difference between fixed costs and variable costs of marginal costs and its effect on changes in profit in regards to volume and type of output.’’
Apart from the ICWA, Batty has also defined Marginal Costing as that technique of cost accounting that specifically pays attention to behaviour of costs with changes in output volume.
Specific features of Marginal Costing:
There are certain specific features associated with this format of costing.
It is as per these features that certain positives and negatives associated with marginal costing can be classified.
Positives associated with Marginal Costing:
It is with the help of flexible budget that fixed and variable costs are determined at various levels of production activity.
With the help of a break-even chart, profit levels at various stages can be determined. With the help of this, unproductive products are removed from the list while productive goods are added on to the set.
With the help of differentiation between fixed and variable costs of a production process, the price of a particular product can be set, and it is based on that price, profit and loss of an organisation are determined.
In every production process there are issues as over absorption and under absorption. With help of this technique, the problem is negated completely as fixed overheads are subtracted from production costs.
In case of any mode of external transaction of a company, the price that is to be covered needs to be understood and accordingly other prices are to be set, so that total expenses are covered.
Since marginal costing is associated with both standard costs and budgetary controls, it is imperative that when costs are to be controlled, a singular decision can be taken that would be beneficial for the company.
Marginal costs in comparison to variable costs do not fluctuate and therefore in case of computation; it is easier to understand.
Problems associated with Marginal Costing:
Since, selling price is fixed in regards to contribution (income/profit), so fixing the price and settling between two jobs cannot be done in an accurate manner.
There arises a major technical glitch in differentiating between fixed and variable costs.
In case of a short-run period of production, both fixed and variable costs are kept at a standard point, whereas in long run period, there is a change between these costs hence a standard format cannot be reached.
In case of fixed overheads, over and under absorption are completely managed by marginal costing. However such is not the case with variable overheads.
While following this technique of marginal costing, if any untoward incident occurs in the industry, there arises a problem in computation.
In case of those industries that have high work in progress in comparison to actual turnover, this method of costing is just not suitable. Since fixed cost is negated in case of this procedure, so a manipulation is done in terms of profit making.
Certain industries which adopt marginal costing for estimating profits do not show accurate profits, hence income tax department does not accept it.
So, once you check out a specimen of this marginal cost statement, your problems will be clarified.
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