The definition and features of a marginal costing system

The definition and features of a fringy appealing systemIntroductionThe be that vary with a last should only be included in decision analysis. For many decisions that involve relatively small variations from existing practice and/or are for relatively limited periods of time, opinionated tolls are not relevant to the decision. This is because either dictated costs tend to be impossible to alter in the little term or managers are reluctant to alter them in the short termMarginal be definitionMarginal cost distinguishes amongst stubborn costs and variable costs as conventionally classified.The fringy cost of a product -is its variable cost. This is normally taken to be, trail labor, direct material, direct expenses and the variable part of overheads.What is Marginal Costing?It is a costing technique where only variable cost or direct cost will be charged to the cost unit produced.Marginal costing also shows the effect on profit of changes in volume and type of output by differentiating between primed(p) variable costs.Salient PointsMarginal costing involves ascertain(p)ing borderline costs. Since marginal costs are direct cost, this costing technique is also cognise as direct costingIn marginal costing, fixed costs are never charged to merchandise. They are treated as period charge and is write despatch to the profit and loss account in the period incurredOnce marginal cost is ascertained contribution can be computed. Contribution is the pointless of revenue over marginal costs.The marginal cost bidding is the basic document/format to capture the marginal costs.Features of Marginal Costing SystemIt is a method acting of recording costs and reporting profitsAll operate costs are differentiated into fixed and variable costsVariable cost charged to product and treated as a product cost whilstFixed cost treated as period cost and written off to the profit and loss accountAdvantagesMarginal costing is simple to understand.By not charging fix ed overhead to cost of production, the effect of varying charges per unit is avoided.It prevents the abrupt carry forward in stock valuation of some proportion of current years fixed overhead.The effects of alternative sales or production policies can be more readily available and assessed, and decisions taken would yield the maximum return to business.It eliminates large balances left in overhead control accounts which luff the difficulty of ascertaining an accurate overhead recovery rate.Practical cost control is greatly facilitated. By avoiding arbitrary allocation of fixed overhead, efforts can be difficult on maintaining a uniform and consistent marginal cost. It is useful to confused levels of management.It helps in short-term profit planning by breakeven and profitability analysis, both in terms of quantity and graphs. Comparative profitability and performance between two or more products and divisions can easily be assessed and brought to the notice of management for dec ision making.DisadvantagesThe separation of costs into fixed and variable is difficult and sometimes gives misleading results.Normal costing systems also apply overhead under normal operating volume and this shows that no advantage is gained by marginal costing.Under marginal costing, stocks and work in progress are understated. The exclusion of fixed costs from inventories push profit and true and fair view of financial affairs of an organization whitethorn not be clearly transparent.Volume variance in measuring costing also discloses the effect of move output on fixed overhead. Marginal cost entropy becomes unrealistic in case of highly fluctuating levels of production, e.g., in case of seasonal factories.Application of fixed overhead depends on estimates and not on the actual and as such there may be under or over absorption of the same.Control affected by means of budgetary control is also accepted by many. In coiffe to know the net profit, we should not be satisfied with contribution and hence, fixed overhead is also a valuable item. A system which ignores fixed costs is less effective since a major portion of fixed cost is not taken care of under marginal costing.In practice, sales price, fixed cost and variable cost per unit may vary. Thus, the assumptions underlying the surmisal of marginal costing sometimes becomes unrealistic. For long term profit planning, absorption costing is the only answer.Marginal Costing Formulae-MARGINAL COST = VARIABLE COST DIRECT LABOUR+DIRECT MATERIAL+DIRECT EXPENSE+VARIABLE OVERHEADSpossibility of Marginal CostingThe theory of marginal costing as set out in A report on Marginal Costing.In congress to a given volume of output, additional output can normally be obtained at less than proportionate cost because within limits, the aggregate of certain items of cost will tend to remain fixed and only the aggregate of the remainder will tend to rise proportionately with an step-up in output. Conversely, a decrease in th e volume of output will normally be accompanied by less than proportionate fall in the aggregate cost.The theory of marginal costing may, wherefore, by understood in the following two stepsIf the volume of output increases, the cost per unit in normal slew reduces. Conversely, if an output reduces, the cost per unit increases. If a factory produces 1000 units at a correspond cost of Rs. 3,000 and if by increasing the output by virtuoso unit the cost goes up to Rs. 3,002, the marginal cost of additional output will be Rs.2.If an increase in output is more than one, the total increase in cost divided by the total increase in output will give the average marginal cost per unit. If, for example, the output is increase to 1020 units from 1000 units and the total cost to produce these units is Rs. 1,045, the average marginal cost per unit is Rs. 2.25. It can be described as follows special cost =Additional unitsRs. 45 = Rs. 2.2520The ascertainment of marginal cost is based on the class ification and segregation of cost into fixed and variable cost. In order to understand the marginal costing technique, it is essential to understand the meaning of marginal cost.Marginal cost means the cost of the marginal or last unit produced. It is also defined as the cost of one more or one less unit produced besides existing level of production. In this connection, a unit may mean a single commodity, a dozen, a gross or any other measure of goods.For example, if a manufacturing firm produces X unit at a cost of Rs. 300 and X+1 units at a cost of Rs. 320, the cost of an additional unit will be Rs. 20 which is marginal cost. Similarly if the production of X-1 units comes down to Rs. 280, the cost of marginal unit will be Rs. 20 (300-280).The marginal cost varies directly with the volume of production and marginal cost per unit remains the same. It consists of prime cost, i.e. cost of direct materials, direct labor and all variable overheads. It does not contain any element of fi xed cost which is kept separate under marginal cost technique.Marginal costing May be defined as the technique of presenting cost selective tuition wherein variable costs and fixed costs are shown separately for managerial decision-making. It should be clearly understood that marginal costing is not a method of costing like process costing or job costing. Rather it is simply a method or technique of the analysis of cost reading for the management of management which tries to find out an effect on profit due to changes in the volume of output.Marginal costing technique has given acquit to a very useful concept of contribution where contribution is given by Sales revenue less variable cost (marginal cost)Contribution may be defined as the profit before the recovery of fixed costs. Thus, contribution goes toward the recovery of fixed cost and profit, and is equal to fixed cost addition profit (C = F + P).In case a firm neither makes profit nor suffers loss, contribution will be jus t equal to fixed cost (C = F). this is known as breakeven point.The concept of contribution is very useful in marginal costing. It has a fixed relation with sales. The proportion of contribution to sales is known as P/V ratio which remains the same under given conditions of production and sales.The principles of marginal costingThe principles of marginal costing are as follows.For any given period of time, fixed costs will be the same, for any volume of sales and production (provided that the level of activity is within the relevant range). Therefore, by selling an unembellished item of product or service the following will happen.Revenue will increase by the sales encourage of the item sold.Costs will increase by the variable cost per unit.Profit will increase by the amount of contribution earned from the extra item.Similarly, if the volume of sales falls by one item, the profit will fall by the amount of contribution earned from the item.Profit measurement should therefore be ba sed on an analysis of total contribution. Since fixed costs relate to a period of time, and do not change with increases or decreases in sales volume, it is misleading to charge units of sale with a share of fixed costs.When a unit of product is made, the extra costs incurred in its manufacture are the variable production costs. Fixed costs are unaffected, and no extra fixed costs are incurred when output is increased.Features of Marginal CostingThe main features of marginal costing are as followsCost ClassificationThe marginal costing technique makes a sharp distinction between variable costs and fixed costs. It is the variable cost on the basis of which production and sales policies are designed by a firm following the marginal costing technique. shoot/Inventory ValuationUnder marginal costing, inventory/stock for profit measurement is valued at marginal cost. It is in sharp contrast to the total unit cost under absorption costing method.Marginal ContributionMarginal costing techn ique makes use of marginal contribution for marking various decisions. Marginal contribution is the difference between sales and marginal cost. It forms the basis for judging the profitability of different products or departments.Presentation of Cost Data under Marginal CostingMarginal costing is not a method of costing but a technique of presentation of sales and cost data with a view to guide management in decision-making.The traditional technique popularly known as total cost or absorption costing technique does not make any difference between variable and fixed cost in the calculation of profits. But marginal cost statement very clearly indicates this difference in arriving at the net operational results of a firm.Following presentation of two Performa shows the difference between the presentation of information according to absorption and marginal costing techniquesSummaryMarginal cost is the cost management technique for the analysis of cost and revenue information and for the guidance of management. The presentation of information through marginal costing statement is easily understood by all mangers, even those who do not have exploratory knowledge and implications of the subjects of cost and management accounting.