UNIT 15 MARGINAL COSTING

 

UNIT 15 MARGINAL COSTING

SEGREGATION OF MIXED COSTS

The elements of cost can be divided into two categories. Fixed and variable costs.

For decision making, it becomes necessary to segregate the mixed costs

into fixed and variable costs.

 

Methods of Segregating Mixed Cost

1) Analytical Method : A careful analysis of mixed cost is done to determine how far it varies with production.

2) High Low Method : This technique was developed by J.H. William. In this method, the difference in two production levels i.e. highest and lowest, are compared out of the various levels.

3) Scatter Diagram Method

In this method, production and semi-variable cost data are plotted on a graph paper and tentative line of best fit is drawn.

4) Method of Least Square

This method is based on econometric technique, in which line of best fit is drawn with the help of linear equations.

 

CONCEPT OF MARGINAL COST ANDMARGINAL COSTING

The elements of costs are material, labour and expenses. These elements of costs are broadly put into two categories: fixed and variable costs. The cost of product or process can be ascertained by absorption costing and marginal costing. In absorption costing or full costing, cost of a product is determined after considering both fixed and variable cost. Whereas in marginal costing only variable costs are considered in calculating the cost of product and fixed costs are charged against the revenue (consideration) of the period.

 

The term ‘Marginal Cost’ is defined as the amount at any given volume of output by which the aggregate costs are changed if the volume of output is increased or decreased by one unit.

 

Marginal costing may be defined as “the ascertainment of marginal costs and of the effect on profit of changes in volume or type of output by differentiating between fixed costs and variable costs”.

 

Total sales – Variable costs = Contribution

Sales = Variable cost + Contribution

Sales – Variable cost = Fixed cost +/- profit/loss

Contribution – Fixed costs = Profit

The main features of marginal costing are:

1) All costs are classified in fixed and variable costs. Variable cost per unit remains

same and fixed costs remain same in total regardless of the changes in production.

2) Fixed costs are considered period costs and variable costs are considered as

product costs. Hence fixed costs are not included in product cost.

3) Stock of work-in progress and finished goods are valued at marginal costs or

variable costs.

4) The difference in the value of opening stock and closing stock does not affect the unit cost of production as all the product costs are variable costs.

 

PROFIT-VOLUME RATIO

Profit volume ratio or contribution to sales ratio is a relationship between contribution and sales.

P/V Ratio =(Sales – variable cost)/ Sales

P/V Ratio = Contribution/ Sales

P/V Ratio = Change in Profit/Change in sales

 

MANAGERIAL USES OF MARGINAL COSTING

1) Price Fixation

2) Accepting Special Order and Exploring Additional Markets

3) Profit Planning

4) Key Factors or Limiting Factor

5) Sales Mix Decisions

6) Make or Buy Decisions

7) Adding or Dropping Decisions

8) Suspension of Activities

 

LIMITATIONS OF MARGINAL COSTING

1) Difficulty in cost Analysis

2) Inappropriate basis of pricing

3) Under valuation of inventory

4) Same marginal cost per unit

5) Not suitable to all concerns

6) New Technology

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