MARGINAL COSTING

MODULE IV

🔰MARGINAL COSTING & ABSORPTION COSTING🔰

🔰Meaning of marginal cost

The marginal cost is the change in the total cost that arises when the quantity produced is increased, i.e. the cost of producing additional quantity.

🔰Marginal costing

Marginal costing is a cost accounting method that calculates the cost of producing one more unit of a product or service. It's also known as variable costing. 

🔰Definition of Marginal Costing

According to ICMA, London “Marginal Costing is the ascertainment of marginal cost and of the effect of profit of changes in the volume or type of output, by differentiating between fixed costs and variable costs.” It separates the product costs i.e. variable costs from the period costs i.e. the fixed costs

🔰FEATURES OF MARGINAL COSTING

Marginal costing is a cost accounting method that focuses on variable costs to help businesses make decisions. It has several key features, including: 

👉Focus on variable costs

Marginal costing focuses on costs that change with production volume, like materials, labor, and variable overhead. 

👉Fixed costs are not included in product costs

Fixed costs, like rent and salaries, are considered period costs and are not included in product costs. 

👉Valuing inventory

Finished goods and work-in-progress are valued at marginal cost of production. 

👉Break-even analysis

Break-even analysis is an important part of marginal costing. 

👉Determining profitability

Marginal costing helps businesses understand the profitability of products and departments. 

👉Pricing

Marginal costing helps businesses determine prices based on marginal cost and contribution margin. 

👉Decision-making

Marginal costing helps businesses make decisions about pricing, product mix, and budgets. 

🔰Advantages of Marginal Costing🔰

Marginal costing offers several advantages to businesses. Here are some of the key advantages of this costing technique

👉Clear Cost-Volume-Profit Analysis

Marginal costing clearly explains the relationship between costs, volume, and profit. By distinguishing between fixed and variable costs, it becomes easier to calculate the contribution margin—the difference between sales revenue and variable costs. This information is crucial for determining the breakeven point and assessing the profitability of different product lines or services.

👉Effective Decision Making

Marginal costing aids decision-making by providing insights into various options’ incremental costs and revenues. It helps assess the impact on overall profitability. It can evaluate the profitability of a new project, pricing decisions, or make-or-buy choices. It enables managers to make informed decisions by considering the incremental contribution of each option.

👉Simplified Costing

Unlike absorption costing, which allocates fixed overheads to products, marginal costing only considers variable costs directly attributable to production. This simplifies the costing process, making it easier to understand and apply. It also eliminates the complexities of apportioning fixed overheads, sometimes leading to misleading cost information.

👉Efficient Cost Control

It facilitates effective cost control by identifying and isolating variable costs. Managers can focus on managing and controlling these costs more directly, as they tend to be more controllable in the short term. By monitoring and analyzing variable costs, businesses can identify areas of cost overruns, implement cost-saving measures, and improve overall cost efficiency.

👉Flexibility in Pricing Decisions

It offers flexibility by separating fixed costs from variable costs. Businesses can set prices based on incremental production costs. It ensures that each unit sold contributes towards covering the variable costs and generating a positive contribution margin. This approach helps optimize pricing strategies and achieve profitability objectives.

👉Performance Evaluation

Marginal costing facilitates performance evaluation at various levels, such as products, departments, or business segments. Focusing on contribution margins provides a more accurate assessment of profitability. It also analyzes the performance of different units within the organization. Managers can identify underperforming products or divisions and take necessary corrective actions.

🔰CVP ANALYSIS🔰

Cost-volume-profit (CVP) analysis is a financial tool that helps businesses understand how changes in costs, sales volume, and selling prices affect profits

Cost-volume-profit (CVP) analysis is a vital tool for businesses to understand how costs, volume, and profit interact. It helps businesses make better decisions about pricing, production, and growth. 

CVP analysis importance

• Helps determine break-even point

CVP analysis helps businesses identify the sales level at which they break even, meaning they cover all costs but don't make a profit. 

• Helps plan growth

CVP analysis helps businesses plan how much they need to sell to reach their target goals. 

• Helps set prices

CVP analysis helps businesses set realistic sales targets and pricing strategies to ensure profitability. 

• Helps evaluate new products

CVP analysis helps businesses evaluate the feasibility of new products or markets by estimating sales volume needed to cover costs. 

• Helps improve decision-making

CVP analysis helps businesses understand how changes in costs, sales volume, and pricing affect profitability. 

While often used interchangeably,

"CVP analysis" (Cost-Volume-Profit Analysis) is a broader concept that examines the relationship between sales volume, costs, and profit, while "break-even analysis" is a specific part of CVP analysis that focuses solely on determining the sales volume needed to cover all costs and generate zero profit, essentially representing the point where revenue equals expenses