Marginal Costing as a Tool for Decision Making

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MARGINAL COSTING AS A COSTING SYSTEM

Marginal Costing is a type of flexible standard costing that separates fixed costs from proportional costs in relation to the output quantity of the objects. In particular, Marginal Costing is a comprehensive and sophisticated method of planning and monitoring costs based on resource drivers. Selecting the resource drivers and separating the costs into fixed and proportional components ensures that cost fluctuations caused by changes in operating levels, as defined by marginal analysis, are accurately predicted as changes in authorized costs and incorporated into variance analysis. This form of internal management accounting has become widely accepted in business practice over the last 50 years. During this time, however, the demands placed on costing systems by cost management requirements have changed radically. MARGINAL COST

In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. It is the cost of producing one more unit of a good. Mathematically, the marginal cost (MC) function is expressed as the first derivative of the total cost (TC) function with respect to quantity (Q). Note that the marginal cost may change with volume, and so at each level of production, the marginal cost is the cost of the next unit produced. A typical Marginal Cost Curve

In general terms, marginal cost at each level of production includes any additional costs required to produce the next unit. If producing additional vehicles requires, for example, building a new factory, the marginal cost of those extra vehicles includes the cost of the new factory. In practice, the analysis is segregated into short and long run cases, and over the longest run, all costs are marginal. At each level of production and time period being considered, marginal costs include all costs which vary with the level of production, and other costs are considered fixed costs. A number of other factors can affect marginal cost and its applicability to real world problems. Some of these may be considered market failures. These may include information asymmetries, the presence of negative or positive externalities, transaction costs, price discrimination and others. RELATION BETWEEN MARGINAL COST AND ECONOMIES OF

SCALE

• Production may be subject to economies of scale (or diseconomies of scale). Increasing returns to scale are said to exist if additional units can be produced for less than the previous unit, that is, average cost is falling. • This can only occur if average cost at any given level of production is higher than the marginal cost. • Conversely, there may be levels of production where marginal cost is higher than average cost, and average cost will rise for each unit of production after that point. This type of production function is generally known as diminishing marginal productivity: at low levels of production, productivity gains are easy and marginal costs falling, but productivity gains become smaller as production increases; eventually, marginal costs rise because increasing output (with existing capital, labour or organization) becomes more expensive. For this generic case, minimum average cost occurs at the point where average cost and marginal cost are equal (when plotted, the two curves intersect); this point will not be at the minimum for marginal cost if fixed costs are greater than zero.

Short and long run marginal costs and economies of scale
The former takes as unchanged, for example, the capital equipment and overhead of the producer, any change in its production involving only changes in the inputs of labour, materials and energy. The latter allows all inputs, including capital items (plant, equipment, buildings) to vary. A long-run cost function describes the cost of production as a function of output assuming that all inputs are obtained at current prices, that current technology is employed, and everything is being built...
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