CHAPTER 1INTRODUCTION

DefinitionThe increase or decrease in the total cost of a production run for making one additionalunit of an item. It is computed in situations where the breakeven point has been reached: the fixed costs have already been absorbed by the already produced items and only the direct (variable) costs have to be accounted for.Marginal costs are variable costs consisting of labor and material costs, plus an estimated portion of fixed costs (such as administrationoverheads and selling expenses). In companies where average costs are fairly constant, marginal cost is usually equal to average cost. However, in industries that requireheavycapital investment (automobileplants, airlines, mines) and have highaverage costs, it is comparatively very low. The concept of marginal cost is critically important in resource allocation because, for optimumresults, management must concentrate itsresources where the excess of marginal revenue over the marginal cost is maximum. Also called choice cost, differential cost, or incremental cost.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/type of output by differentiating between fixed and variable costs.

Salient Points: Marginal costing involves ascertaining marginal costs. Since marginal costs are direct cost, this costing technique is also known as direct costing; In marginal costing, fixed costs are never charged to production. They are treated as period charge and is written off to the profit and loss account in the period incurred; Once marginal cost is ascertained contribution can be computed. Contribution is the excess of revenue over marginal costs. The marginal cost statement is the basic document/format to capture the marginal costs.

Marginal Costing is ascertainment of the marginal cost which varies directly with the volume of production by differentiating between fixed costs and variable costs and finally ascertaining its effect on profit.

Marginal costis the cost associated with producing one more unit of output. Mathematically speaking, marginal cost is equal to the change in total cost divided by the change in quantity.Marginal costcan either be thought of as the cost of producing the last unit of output or the cost of producing the next unit of output. Because of this, it's sometimes helpful to think of marginal cost as the cost associated with going from one quantity of output to another, as shown by q1 and q2 in the equation above. To get a true reading on marginal cost, q2 should be just one unit larger than q1.For example, if the total cost of producing 3 units of output is $15 and the total cost of producing 4 units of output is $17, the marginal cost of the 4th unit (or the marginal cost associated with going from 3 to 4 units) is just ($17-$15)/(4-3) = $2.Marginal fixed cost and marginal variable cost can be defined in a way similar to that of overall marginal cost. Notice that marginal fixed cost is always going to equal zero since the change in fixed cost as quantity changes is always going to be zero.Marginal cost is equal to the sum of marginal fixed cost and marginal variable cost. However, because of the principle stated above, it turns out that marginal cost only consists of the marginal variable cost component.Technically, as we consider smaller and smaller changes in quantity (as opposed to discrete changes of while number units), marginal cost converges to the derivative of total cost with respect to quantity. Some courses expect students to be familiar with and able to use this definiton (and the calculus that comes with it), but a lot of courses stick to the simpler definition given earlier.

The basic assumptions made by marginal costing are following:

-Total variable cost is directly proportion to the level of activity. However, variable cost per unit remains constant at all the levelsof activities.

-Per unit selling price remains constant at all levels of activities.

-All the items produced by the organization are sold off.

Features of Marginal costing:- It is a method of recoding costs and reporting profits.- It involves ascertaining marginal costs which is the difference of fixed cost and variable costs.- The operating costs are differentiated into fixed costs and variable costs. Semi variable costs are also divided in the individual components of fixed cost and variable cost

- Fixed costs which remain constant regardless of the volume of production do not find place in the product cost determination and inventory valuation.

- Fixed costs are treated as period charge and are written off to the profit and loss account in the period incurred- Only variable costs are taken into consideration while computing the product cost.- Prices of products are based on variable cost only.- Marginal contribution decides the profitability of the products.Assumption of Marginal CostingThe Marginal Costing technique is based on the following assumptions.:-1. All elements of costs can be divided in to two parts viz.variable and fixed2. Variable cost remain constant per unit and fluctuates directly in proportion to change in the volume of out put.3. Fixed Cost remain constant at all levels of production. the share of fixed cost per unit output vary according to the volume of production.4. The selling price per unit remains unchanged at all levels of activity5. The volume o f output is the only factor which influences the cost.

Advantages of Marginal Costing: It is simple to understand re: variable versus fixed cost concept; A useful short term survival costing technique particularly in very competitive environment or recessions where orders are accepted as long as it covers the marginal cost of the business and the excess over the marginal cost contributes toward fixed costs so that losses are kept to a minimum; Its shows the relationship between cost, price and volume; Under or over absorption do not arise in marginal costing; Stock valuations are not distorted with present years fixed costs; Its provide better information hence is a useful managerial decision making tool; It concentrates on the controllable aspects of business by separating fixed and variable costsThe effect of production and sales policies is more clearly seen and understood.

Disadvantages Of Marginal Costing:

Marginal cost has its limitation since it makes use of historical data while decisions by management relates to future events; It ignores fixed costs to products as if they are not important to production; Stock valuation under this type of costing is not accepted by the Inland Revenue as its ignore the fixed cost element; It fails to recognize that in the long run, fixed costs may become variable; Its oversimplified costs into fixed and variable as if it is so simply to demarcate them; Its not a good costing technique in the long run for pricing decision as it ignores fixed cost. In the long run, management must consider the total costs not only the variable portion;

Difficulty to classify properly variable and fixed cost perfectly, hence stock valuation can be distorted if fixed cost is classify asvariableIneconomicsandfinance,marginal costis the change intotal costthat arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good.In general terms, marginal cost at each level of production includes any additional costs required to produce the next unit. For example, if producing additional vehicles requires building a new factory, the marginal cost of theextra vehicles includes the cost of the new factory. In practice, this analysis is segregated into short and long-run cases, so that over the longest run, all costs become marginal. At each level of production and time period being considered, marginal costs include all costs that vary with the level of production, whereas other costs that do not vary with production are considered fixed.

If the good being produced is infinitely divisible, so the size of a marginal cost will change with volume, as a non-linear and non-proportional cost function includes the following: variable terms dependent to volume, constant terms independent to volume and occurring with the respective lot size, jump fix cost increase or decrease dependent to steps of volume increase.

In practice the above definition of marginal cost as the change in total cost as a result of an increase in output of one unit is inconsistent with the differential definition of marginal cost for virtually all non-linear functions. This is as the definition finds the tangent to the total cost curve at the point q which assumes that costs increase at the same rate as they were at q. A new definition may be useful for marginal unit cost (MUC) using the current definition of the change in total cost as a result of an increase of one unit of output defined as: TC(q+1)-TC(q) and re-defining marginal cost to be the change in total as a result of an infinitesimally small increase in q which is consistent with its use in economic literature and can be calculated differentially.

The concept of marginal costing is practically applied in the following situations:

-Evaluation of Performance: The evaluation of the performance of various departments or products can be evaluated with the help of marginal costing which is based on contribution generating capacity.

-Profit Planning: This technique through the calculation of P/V Ratio helps the management to plan the activities in such a way that the profit can be maximised.

-Fixation of Selling Price: The technique of marginal costing assists the management to fix the price in such a way so that prices fixed can cover at least the variable cost.

-Make or Buy decision: Marginal cost analysis helps the management in making or buying decision.

-Optimizing Product Mix: To maximise profits and increase sales volume it is necessary to decide an optimized mix or proportion in which various products of a company can be sold.generating-Cost Control: Marginal Costing is a technique of cost classification and cost presentation which enable the management to concentrate on the controllable costs.

-Flexible Budget preparation: As the marginal costing particularly classifies costs as fixed and variable costs which facilitates the preparation of flexible budgets.

Elements of Marginal CostingProcess of marginal costing:Under marginal costing, calculation of the difference between sales & marginal cost of sales is done. This difference is known as contribution, which provides for fixed cost & profit. Excess of contribution over the fixed cost is known as net margin or profit. Here on the increasing total contribution emphasis remains. Variable Cost:Variable is that part of total cost which in proportion with volume changes directly. With change in volume of output, total variable cost changes. Increase in total variable cost results from increase in output & reduction in total variable cost results from decrease in output. However, irrespective of increase or decrease in volume of production, there will be no change in variable cost per unit of output. Cost of direct material, direct labour, direct expenses etc. are included in variable cost. By dividing total variable cost by units produced, variable cost per unit is arrived at. Variable cost per unit is also referred as variable cost ratio. By dividing change in cost by change in activity, variable cost can be arrived at.Variable costs are very sensitive in nature & variety of factors can influence the same. Helping management in controlling variable cost is the main aim of marginal costing because this is the area of cost which itself needs control by management.

Fixed Cost:Cost which is incurred for a period & which tends to remain unaffected by fluctuations in the level of activity, output or turnover, within certain output & turnover limits. Examples are rent, rates, salaries of executive & insurance etc.Break-Even Point (B/E Point):The break-even point is the level of activity or sales at which a company makes neither profit nor loss. Sales revenue exactly equals total costs at this level. Thus, the sales volume at which operations break-even is indicated by the break-even point. In terms of number of units sold or in terms of sales value, it can be expressed.Sales Variable cost = Fixed cost + ProfitSince at break-even point, profit is nil, it follows that:Sales at break-even point Variable cost = Fixed cost Thus, at break-even point, contribution is just enough to provide for fixed cost. Thus, enough contribution is necessary to be earned to cover fixed costs before any profit can be earned. If level of actual sales is above break-even point, profit will be earned by the company. On the other hand, if actual sales are below break-even point, loss will be incurred by the company.

By any of the following formula, the by the break-even point (B/E) can be calculated:(a) B/E (in terms of units) =Fixed Cost Contribution per unit(b) B/E (in terms of sales value) =Fixed Cost * Sales Contribution Or,Fixed Cost P/V ratio When graphical presentation of cost-volume-profit relationship is made, the break-even point will be the point at which total cost line & total sales line intersect each other.

The break-even point is important to the management because the lowest level to which activity can be dropped without putting the continued life of the firm in jeopardy is indicated by the break-even point. Occasionally, operating below the break-even point may not be necessarily being fatal for a concern, but it must operate above this level in the long run.Contribution:On the idea of contribution, analysis of marginal costing depends a lot. In this technique, for increasing total contribution only, efforts are directed. Contribution is a term which defines the surplus that remains after variable cost of sales is deducted from sales revenue as indicated below:Contribution = Sales revenue Variable cost of sales

A product whose selling price exceeds its variable cost is said to have:(a) Covering its variable cost &

(b) Making a contribution,

(i) towards the firms fixed cost & after these have been covered;

(ii) towards the firms profit.Alternatively, contribution is equivalent to fixed costplusprofit. Thus, this relationship may be expressed as under:Sales Variable cost = ContributionFixed cost + Profit = ContributionThereby,Sales Variable cost = Fixed cost + ProfitIt becomes easy to determine the missing one if any three of these four items is known to us. In break-even analysis, some of the specific uses of contribution are:a. Break-even point determination;b. Profitability of products assessment;c. Different departments selling price determination;d. The optimum sales mix determination.Key factor or Limiting factor:There are always factors which, for the purpose of managerial control, do not lend themselves. For example, if at a particular point of time, on the import of a material, which is the principal element of companys product, there is a restriction of Government, then the production cannot be undertaken by the company, as it wishes. Production has to be planned after taking into consideration this limiting factor. However, towards the maximum utilization of available sources, its efforts will be directed. Thus, limiting factor is a factor, by which, at a given point of time, the volume of output of an organization gets influenced.Key factor is the factor whose influence, for the purpose of ensuring the maximum utilization of resources, must be ascertained first. Profit can be maximized by gearing the process of production in the light of influences of key factors. Managerial action is constrained & output of company is limited by key factor. Any of the following factors can be a limiting factor, although usually sale is the limiting factor but:

(a) Material (b) Labour (c) Power d) Capacity of plant (e) Action of government.When, in operation, there is a key factor & regarding relative profitability of different products, a decision has to be taken, then for selecting the most profitable alternative, contribution for each product is divided by key factor. With the products or projects, the choice of management rests with, thereby showing more contribution per unit of key factor. Thus, if the key factor is sales, then consideration should be given to contribution to sales ratio. If labour shortage is faced by the management, then consideration should be given to contribution per labour hour. Suppose sales of product X & Y are $ 200 & $ 220 & variable cost of sales are $ 60 & $ 46. The labour hours (key factor) required for these products are 4 hours & 6 hours respectively. The contribution will be: Product X, $200 - $60 = $ 140 per unit or $ 35 per hour; Product Y, $220 - $46 = $174 per unit or $29 per hour. In this case, P/V ratio of product Y (79%) is better than P/V ratio of product X (70%) & producing product Y will be the normal conclusion. Here, the key factor is time. Contribution per hour is better in product X than in product Y. Thereby, product X is more profitable than product Y, during labour shortage.Online Live Tutor Key factor or Limiting factor:We have the best tutors in Economics in the industry. Our tutors can break down a complex Key factor or Limiting factor problem into its sub parts and explain to you in detail how each step is performed. This approach of breaking down a problem has been appreciated by majority of our students for learning Key factor or Limiting factor concepts. You will get one-to-one personalized attention through our online tutoring which will make learning fun and easy. Our tutors are highly qualified and hold advanced degrees. Please do send us a request for Key factor or Limiting factor tutoring and experience the quality yourself.Online Elements of Marginal Costing Help:If you are stuck with an Elements of Marginal Costing Homework problem and need help, we have excellent tutors who can provide you with Homework Help. Our tutors who provide Elements of Marginal Costing help are highly qualified. Our tutors have many years of industry experience and have had years of experience providing Elements of Marginal Costing Homework Help. Please do send us the Elements of Marginal Costing problems on which you need help and we will forward then to our tutors for review.Other topics under Marginal Costing: Marginal Costing - Introduction Budgeted BES to earn the target profit Criticism of Marginal Costing Marginal Costing Vs. Absorption Costing Profit/Volume Ratio, Improvement of P/V Ratio