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:
- Direct labour
- Direct material
- Total variable overheads
- Other direct expenditure
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.
- There are two types of costs: Fixed and Variable.
- In case of finished goods or those goods that are still in progress are taken into consideration, it is only variable costs that are included in calculation.
- The selling price and variable cost per unit remain
- In case of getting the net profit or loss, fixed cost is to be deducted.
- Since Fixed costs are specifically charged on that particular year when it was incurred, there is no adjustment made in subsequent years.
- Total fixed costs remain constant but fixed costs per unit can be changed.
- To find out the relation of cost volume and profit relation, it is important to determine profits at every stage.
- It is important that fixed and variable costs are separated from each other and along with that semi-variable costs are also divided accordingly.
It is as per these features that certain positives and negatives associated with marginal costing can be classified.
Positives associated with Marginal Costing:
- Controlling the budget:
It is with the help of flexible budget that fixed and variable costs are determined at various levels of production activity.
- Help in planning of production:
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.
- Help in setting up a selling price:
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.
- Advantages of overhead simplification:
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.
- Controlling of cost:
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.
- Simple and consistent:
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:
- Problematic price fixation:
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.
- Difficulty in analysing overheads:
There arises a major technical glitch in differentiating between fixed and variable costs.
- Time factor negated:
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.
- Variable overheads:
In case of fixed overheads, over and under absorption are completely managed by marginal costing. However such is not the case with variable overheads.
- Claiming for loss of stock:
While following this technique of marginal costing, if any untoward incident occurs in the industry, there arises a problem in computation.
- Not suitable for certain factories:
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.
- Problems with taxation department:
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.
Links of Previous Main Topic:-
- Introduction to accounting and branches of accounting
- Preparation of final accounts
- Introduction of fund flow statement
- Introduction cash flow statement
- Ratio analysis significance of ratio analysis
- Fixed assets and depreciation meaning causes objectives methods and basic factor
- Cost accounting concept objectives advantages limitations general principles and cost sheet
- Job costing
- Introduction process costing
- Activity based costing introduction concept and classification
- Introduction inventory pricing and valuation
- Standard costing introduction
- Management accounting
Links of Next Finance Topics:-