MARGINAL COST OR VARIABLE COST OR DIRECT COST Marginal cost is the variable cost of one more unit of a product or service. As such, it arises from additional increments of output. Marginal costing considers only variable cost ( those costs of production that vary with output) in calculating the cost of the product while fixed costs are charged against the revenue (sales) of the product. Thus, Marginal cost or variable cost = Prime cost (Direct Materials + Direct Labour + Direct expenses )+ Total Variable Overheads Or Marginal Cost or variable cost = Total cost - Fixed Cost
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MARGINAL COST OR VARIABLE COST OR DIRECT COST
Marginal cost is the variable cost of one more unit of a product or service. As such, it
arises from additional increments of output. Marginal costing considers only variable
cost ( those costs of production that vary with output) in calculating the cost of the
product while fixed costs are charged against the revenue (sales) of the product.
Thus, Marginal cost or variable cost = Prime cost (Direct Materials + Direct Labour +
Direct expenses )+ Total Variable Overheads
Or
Marginal Cost or variable cost = Total cost - Fixed Cost
MARGINAL COST OR VARIABLE COST OR DIRECT COST
Thus, here variable costs are treated as product cost and fixed costs are not treated as
product cost. Fixed manufacturing cost are part of part of period cost.
MARGINAL or VARIABLE or DIRECT COSTING
The revenue arising from the sales over variable costs is technically known as Contribution
under marginal costing.
Marginal costing is considered superior to absorption costing so far as managerial decision
making is considered. It identifies only such costs with the jobs or products which directly
vary with the level of output. Consequently the cost of goods in inventory or cost of
goods sold under this method does not contain any fixed overhead cost.
Thus the uncertainty and irrationality associated with apportionment of fixed cost in
traditional costing is thus avoided.
MARGINAL COST contd.
A factory produces 500 bicycles per annum. The variable cost per by cycle is US$ 100. the fixed
expenses are US$ 10000 per annum.
The cost sheet of bicycle will appear as follows:
US $
Variable cost (500 X US$ 100) 50000
Fixed cost 10000___
60000___
If production is increased by one unit i.e. if it becomes 501 bicycles per annum, the cost sheet
will appear as follows :
US $
Variable cost (501 X US$ 100) 50100
Fixed cost 10000___
60 100___
The marginal cost is therefore US$ 100
DIFFERENCE BETWEEN ABSORPTION COSTING AND VARIABLE (MARGINAL COSTING)
Recovery of Overheads: In case of absorption costing, both fixed and variable overheads arecharged to production while in case of marginal costing only variable overheads are charged toproduction.
Valuation of stocks: Absorption costing of stocks of work-in-progress and finished goods arevalued at work cost and total cost of production respectively. Work cost and cost of production isdefined to include fixed overheads too.
While in marginal costing, only variable costs are considered while computing the value ofwork-in-progress or finished goods. Thus, closing stock is undervalued in marginal costing ascompared to absorption costing.
DIFFERENCE BETWEEN ABSORPTION COSTING AND VARIABLE (MARGINAL COSTING)
CONTRIBUTION and PROFIT
Contribution is the difference between selling price and variable cost. It is sum
of fixed cost and profit.
Contribution or Gross Margin = Selling Price (total revenue) – Variable Cost
(marginal cost)
Contribution= (Variable cost + Fixed cost + Profit) – variable cost
Contribution= Fixed cost + Profit
Or, Profit = Contribution – Fixed cost
Or, Fixed cost = Contribution – profit
Let us take an example.
Variable cost Rs 5000
Fixed cost Rs. 2000
Selling Price Rs 8000
Contribution = Selling price – variable cost
= Rs 8000 – Rs 2000
= Rs 3000
Profit = Contribution – fixed cost
= Rs 3000 – Rs 2000
= Rs 1000
As contribution exceeds fixed cost, there is a
profit of Rs. 1000.
If fixed cost is assumed as Rs 4000, the
position will change as:
Contribution – fixed cost = Negative
Profit (loss)
= Rs 3000 – Rs 4000
= Rs 1000
The sum of Rs 1000 represents the extent
of loss since the fixed costs are more than
the contribution. At the level of foxed
cost of Rs 3000, there shall be no profit
and no loss. The concept of break-even
analysis arises out of this basic fact.
CONTRIBUTION or GROSS MARGIN contd.
Example 1: Tripura Ltd is manufacturing three product : A, B, C. the cost of manufacture are as follows
A B C
Direct Material per unit
Rs 3 Rs 4 Rs 5
Direct labour per unit Rs 2 Rs 3 Rs 3
Selling price per unit Rs 10 Rs 15 Rs 20
Output 1000 units 1000 units 1000 units
The total overhead costs are Rs.12000 out of which Rs. 9000 are fixed and the rests are
variable. It is decided to apportion these costs over different products in the ratio of output.
From the above data, prepare a statement of cost and profit according to Marginal Costing.
Example 1: solution
Statement showing Profit And Cost (Marginal Costing )
Product A_____ _____Product _B __ ____Product C _____
Per unit Rs
TotalRs
Per unit Rs
TotalRs
Per unit Rs
TotalRs
Direct material Direct labour
Variable OverheadsTotal Marginal CostContribution (Sales – MC)Selling price
32
1
30002000
1000
43
1
40003000
1000
54
1
50004000
1000
64
60004000
87
80001000
1010
1000010000
10 10000 15 15000 20 20000
Example 1: solution contd.
Total profit under marginal costing would be:
Total Contribution Rs.
Product A 4000Product B 7000Product C 10000 21000
Less: Fixed Cost Product A 3000Product B 3000Product C 3000 9000
Profit 12000
Example 2: Tripura Ltd is manufacturing three product : A, B, C. the cost of manufacture are as follows
A B C
Direct Material per unit
Rs 3 Rs 4 Rs 5
Direct labour per unit Rs 2 Rs 3 Rs 3
Selling price per unit Rs 10 Rs 15 Rs 20
Output 1000 units 1000 units 1000 units
The total overhead costs are Rs.12000 out of which Rs. 9000 are fixed and the rests are variable.It is decided to apportion these costs over different products in the ratio of output. Prepare astatement showing the cost and profit of each product according to marginal costing.
Calculate amount of profit and profit and loss made by Tripura Ltd in the first two years of itsexistence, presuming thati. In the first year, it manufactures 1000 units of each product A, B, C but fails to effect any
sales.ii. In the second year, it does not produce anything but sells the entire stock carried forward
from the first year.iii. What fallacious conclusions can be drawn from the results.
Solution : Example2
Tripura Limited Profit and loss Account of 1st Year (as per marginal costing)
Rs Rs
Direct material ABC
Direct labour ABC
Overhead: variables
A 1000B 1000C 1000
Fixed -----
300040005000___ 12000
200030004000___ 9000
30009000 _12000__
___33000_
SalesClosing Stock Loss
-----240009000
___________33000_
Solution : Example 2 contd.
Tripura Limited Profit and loss Account of 2nd Year (as per marginal costing)
Rs Rs
Opening Stock Fixed overhead Profit
24000900012000
_______45000__
SalesA BC
100001500020000_ 45000
______45000_
The above Profit and Loss accounts shows that the company suffered a loss of Rs.9000 in the firstyear because of non-recovery of fixed overheads while in the second year it makes a profit of Rs.12000. It may be seen from the profit and loss account that the fixed cost of one year has beencarried forward to the next year. Thus, the profit and loss account gives the correct pictureaccording to marginal costing.
Example 3: Tripura Ltd is manufacturing three product : A, B, C. the cost of manufacture are as follows
A B C
Direct Material per unit
Rs 3 Rs 4 Rs 5
Direct labour per unit Rs 2 Rs 3 Rs 3
Selling price per unit Rs 10 Rs 15 Rs 20
Output 1000 units 1000 units 1000 units
The total overhead costs are Rs.12000 out of which Rs. 9000 are fixed and the rests are
variable. It is decided to apportion these costs over different products in the ratio of output.
From the above data, prepare a statement of cost and profit according to Marginal Costing.
Compute the amount of profit under absorption costing and marginal costing in case units of
goods sold of products A, B, C are 900 each.
Example 3: solution
Statement showing Profit And Cost (Absorption Costing )
Product A_____ _____Product _B _____ ____Product C _____
TotalRs
TotalRs
TotalRs
Direct material Direct labour Variable OverheadsTotal Marginal (variable) CostAdd: Fixed Overheads
Total cost of production Less: Closing Stock Cost of goods sold Profit (sales – cost of goods sold)
300020001000
400030001000
500040001000
60003000
80003000
100003000
9000900
110001100
130001300
8100900
99003600
117006300
Sales 9000 13500 18000
Total profit under absorption costing is
Total Profit Rs._______
Product A 900 Product B 3600 Product C 6300 Rs 10800
Example 3: solution contd.
Example 3: solution
Statement showing Profit And Cost (Marginal Costing )
Product A_____
_____Product _B _____
____Product C _____
TotalRs
TotalRs
TotalRs
Direct material Direct labour Variable Overheads
300020001000
400030001000
500040001000
Total Marginal CostLess: Closing Stock Cost of goods sold Contribution (Sales – MC)Sales
6000600
8000800
100001000
54003600
72006300
90009000
9000 13500 18000
Example 3: solution contd.
Total profit under marginal costing would be:
Total Contribution Rs.
Product A 3600Product B 6300Product C 9000 18900
Less: Fixed Cost Product A 3000Product B 3000Product C 3000 9000
Profit Rs. 9900
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