MARGINAL COST Meaning of marginal costCIMA defines Amount

MARGINAL COST

Meaning of marginal cost-CIMA defines; Amount at any given volume of output by which aggregate costs are changed if volume of output is increased or decreased by one unit. It relates to change in output in particular circumstances under consideration.

Meaning of marginal costing –A/C to CIMA, Marginal costing is the ascertainment of marginal cost and of the effect on profit of changes in volume or type of output by differentiating fixed cost &variable cost. In this technique of costing only variable cost are charged to operation , processes or products leaving all indirect cost to be written off against profits in period in which they arise.

Difference Between Absorption costing & Marginal costing l l l l All costs fixed &variable are included for ascertaining the cost. Different unit costs are obtained at different levels of output because of fixed expenses remaining same. Difference between sales &total cost is profit. A portion of fixed costs is carried forward to the next period because closing stock of work -in progress & finished goods is valued at cost of production which is inclusive of fixed cost. In this way costs of a particular period are vitiated because fixed cost being period cost should be charged to the period concerned & should not be carried over to next period. The apportionment of fixed expenses on an arbitrary basis given rise to over or under absorption which ultimately makes the product cost inaccurate and unreliable. Absorption costing is not very helpful in taking managerial decision such as whether to accept the export order or not , whether to buy or manufacture , the minimum price to be charged during depression etc. Costs are classified according to functional basis such as production cost , office and administrative cost and selling and distribution cost. Absorption costing fails to establish relationship of cost volume and profit as costs are seldom classified into fixed &variable. l l l l Only variable cost are included. fixed cost are recovered from contribution. Marginal cost per unit will remain same at different levels of output because variable expenses vary in the same proportion in which output varies. Difference between sales and marginal cost is contribution and difference between contribution and fixed cost is profit or loss. Stock of work- in-progress and finished goods are valued at marginal cost which does not include fixed cost. Fixed cost of a particular period is charged to that very period and is not carried forward to next period by including in closing stock. Being so , cost of a particular period are not vitiated. Only variable cost are charged to products. marginal cost technique does not lead to over or under absorption of fixed overheads. The technique of marginal costing is very helpful in taking managerial decisions because it takes into consideration the additional cost involved only assuming fixed expenses remaining constant. Cost are classified according to the behaviour of cost i. e. fixed cost and variable cost. Cost , volume and profit relationship is an integral part of marginal cost studies as costs are classified into fixed and variable costs.

IMPORTANCE; Fixed expenses are not allocated to cost units but are charged against ‘fund’ which arises out of excess of sales price over total variable costs.

LIMITATIONS; l l l l Technical difficulties. Time taken for completion of jobs is not given due attention. Less effective. Balance sheet will not exhibit true and fair view. Problem of apportionment of variable cost still arises. Difficulty to apply in contract or ship building industry. Does not provide any standard. General reduction in selling price and thus losses.

COST–VOLUME –PROFIT ANALYSIS

Assumptions; l l l Fixed cost remain static & marginal costs are completely variable at all levels of output. Selling prices are constant at all sales volume. Factor prices are constant at all sales volume. Efficiency and productivity remain unchanged. In a multi product situation , there is constant sales mix at all level of sales. Turnover level is only relevant factor affecting cost & revenue. Value of production is equal to volume of sales.

ELEMENTSl MARGINAL COST EQUATION l CONTRIBUTION MARGIN. l PROFIT /VOLUME RATIO. l BREAK EVEN POINT. l MARGIN OF SAFETY.

MARGINAL COST EQUATION SALES=VARIABLE COSTS +FIXED EXPENSES+P/L OR S-V=F+P/L

CONTRIBUTION MARGINCONTRIBUTION =SELLING PRICE –MARGINAL COST OR C=F+P/L OR C-F=P/L

PROFIT /VOLUME RATIO; P/V=CONTRIBUTION /SALES OR F+P/L/V. C+F. C+P/L=[F+P/S] OR S-V/S=CHANGE IN PROFITS OR CONTRIBUTION/CHANGE IN SALES

BREAK EVEN POINT; B. E. P=FC/P/V OR TOTAL FIXED EXPENSES/S. P PER UNIT-MC PER UNIT OR TOTAL FIXED EXPENSES/CONTRIBUTION PER UNIT

VALUE OF SALES TO EARN DESIRED AMOUNT OF PROFIT ; SALES=F. C+D. P/P/V RATIO

MARGIN OF SAFETY ; l MOS=PROFIT/P/V RATIO

DIFFERENCE BETWEEN CONTRIBUTION &PROFIT l l Includes fixed cost & profit. Based on marginal cost concept. Contribution above break even contributes to profit. Contribution analysis requires a knowledge of break even concept. Does not include fixed cost. l Based on common man concept. l Profit is expected only after covering variable and fixed cost. l Profit does not require any such concept. l

APPLICATION OF MARGINAL COST & COST, VOLUME & PROFIT ANALYSISl COST CONTROL. l PROFIT PLANNING. l EVALUTION OF PERFORMANCE. l DECISION MAKING. l FIXATION OF SELLING PRICE. l KEY LIMITING FACTOR. l SUITABLE PRODUCT MIX.