Marginal Costing

Topics: Costs, Variable cost, Marginal cost Pages: 10 (2815 words) Published: July 6, 2013
MARGINAL COSTING

Introduction
This paper explores the use of cost accounting information for decision-making purposes.

DEFINITION OF KEY TERMS

Marginal cost: This is the cost of a unit of a product or service, which would be avoided if that unit or service was not produced or provided
Break-even point: This is the volume of sales where there is neither profit nor loss. 1 9 6 COST ACCOUNTING
S T U D Y T E X T
Margin of safety: This is the excess of sales over the break-even volume in sales. It states the extent to which sales can drop before losses begin to be incurred in a firm Contribution: This is the difference between sales value and the marginal cost of sales. To understand this topic, you need to understand the topic on cost behavior first. Marginal costing is built on cost behavior and terms. Of key importance are product costs, period costs, variable costs and fixed cost. Product costs are costs identified with goods produced or purchased for resale. Such costs are initially identified as part of the value of stock and only become expenses when the stock is sold. In contrast, period costs are costs that are deducted as expenses during the current period without ever being included in the value of stock held. We saw how product costs are absorbed into the cost of units of output. Now we describe marginal costing and compare it with absorption costing. Whereas absorption costing recognizes fixed costs (usually fixed production costs) as part of the cost of a unit of output and hence as product costs, marginal costing treats all fixed costs as period costs. Two such different costing methods obviously each have their supporters and we will be looking at the arguments both in favor of and against each method. Each costing method, because of the different stock valuation used, produces a different profit figure and we will be looking at this particular point in detail.

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Note that in marginal costing, all costs need to be classified as variable costs or fixed costs. Semi-variable costs are separated into their fixed and variable components. For instance, if total overhead cost figure given is Shs.50,000, which comprises of, say, Shs.20,000 fixed costs, the difference, Shs.30,000 is taken to be variable and is taken into account when computing contribution. The fixed cost (Shs.20,000) is deducted from the contribution to get the profit figure.

MARGINAL COST AND MARGINAL COSTING
Marginal Costing is an alternative method of costing to absorption costing. In marginal costing, only variable costs are charged as a cost of sale and a contribution is calculated which is sales revenue minus the variable cost of sales. Closing stocks of work in progress or finished goods are valued at marginal (variable) production cost. Fixed costs are treated as a period cost, and are charged in full to the profit and loss account of the accounting period in which they are incurred. Marginal costing as a form of management accounting is based on the distinction between the marginal costs of making selling goods or services, and fixed costs, which should be the same for a given period of time, regardless of the level of activity in the period. Marginal Cost

This is the cost of a unit of a product or service which would be avoided if that unit or service was not produced or provided. A marginal cost refers to a variable cost just that the term ‘marginal cost’ is usually applied to the variable cost of a unit of product or service, whereas the term ‘variable cost’ is more commonly applied to resource costs, such as the cost of materials and labour hours. The marginal production cost per unit of an item usually consists of the following items, which have been well elaborated in the previous chapters:

Ø Direct materials,
Ø Direct labour,
Ø Variable production overheads.

Contribution is the difference between sales value and the marginal cost of sales. Contribution is fundamental in marginal costing, and the term...
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