Even a school-going student knows that profit is a balancing figure of sales over costs, i.e. Sales - Cost = Profit.
This knowledge is not sufficient for management for discharging the functions of planning and control, etc. The cost is further
divided according to its behavior, i.e., fixed cost and variable cost. The age-old equation can be written as:
Sales - Cost = Profit or
Sales - (Fixed cost + Variable Cost) = Profit.
The relevance of segregating costs according to variability can be understood by a very simple example of a shoe-maker, whose
Cost data for a particular period is given below:
1. Rent of shop is Rs. 1200 for period under consideration,
2. Selling price per pair is Rs. 55.
3. Input material required for making one pair is Rs. 50.
4. He is producing 1000 pairs during period under consideration. In this data, only two types of costs are mentioned-rent of shop and cost of input materials. The rent of shop will not change, if he produces more than 1,000 pairs or less than 1,000 pairs. This cost is, therefore, referred to as fixed cost. The cost of input material will change according to the number of pairs produced. This is variable cost.
Thus, both the costs do not have the same behavior. This knowledge about the changes in behavior of costs can yield wonderful results for the shoemaker in decision-making. Based on these changes in behavior of costs, a very effective cost accounting technique emerges. It is known as marginal costing. Marginal Costing is a management technique of dealing with cost data. It is based primarily on the behavioral study of cost.
Absorption costing i.e., the costing technique, which does not recognize the difference between fIxed costs and variable costs does not adequately cater to the needs of management. The statements prepared under absorption costing do elaborately explain past profit, past losses and the costs incurred in past, but these statements do not help when It comes to predict about tomorrow’s result. A conventional income statement cannot tell what the profit or loss will be, if the volume is increased or decreased. These days there is a cutthroat competition in market and management has got to know its cost structure thoroughly.
Marginal costing provides this vital information to management and it helps in the discharge of its functions like cost control, profit planning, performance evaluation and decision making. Marginal costing plays its key role in decision making. Marginal Cost
Defines the marginal costing as “the cost of one unit of product or service which would be avoided if that unit were not produced or provided.” Simple Calculation of Marginal Cost
Suppose following cost data is given:
Variable cost = Rs. 5 per unit,
Fixed Cost for a specific period = Rs. 2,000 and
Present activity level = 200 units.
In this case total cost of producing 200 units will be found out as follows:
Fixed cost + (Variable cost per unit X Present production) = Total cost.
= Rs2,000 + (Rs. 5 X 200) = Rs. 3,000
If activity level becomes 201 units aggregate cost will be
= Rs.2000 + (5 x 201)
= Rs. 2,000 + 1,005 = Rs. 3,005
It means marginal cost is Rs. 5 because change in activity level by one unit leads to a
Change in aggregate cost by Rs. 5.
Marginal Costing. Defines marginal costing as “the accounting system in which variable cost are charged to the cost units and fixed costs of the period are written-off in full ,against the aggregate contribution. Its special value is in decision-making”. Process of marginal Costing
Under marginal costing, the difference between sales and marginal cost of sales is found out. This difference is technically called contribution. Contribution provides for fixed cost and profit. Excess of contribution over fixed cost is profit emphasis remains here on increasing total contribution.
Variable Cost. Variable cost is that part of total cost, which changes directly in proportion with...