MARGINAL

COSTING
i. Marginal Costing
ii. Features of Marginal Costing
iii. Direct Costing
iv. Differential Cost
v. Incremental Cost
vi. Factors to be considered in Marginal costing decisions
(distinguish between marginal and absorption costing and limitations of
absorption costing)
vii. Distinction between marginal and absorption costing
viii. Use of absorption costing method for the valuation of finished
goods inventory
ix. Advantages of Marginal Costing
x. Limitations of Marginal Costing
Marginal Costing
- It is defined as the amount at any given volume of output by which aggregate costs can be changed if the volume of output is
increased or decreased by one unit.

- also known as variable costing or out of pocket costing

Marginal Costing is a technique of decision making, which involves:

a. Ascertainment of total costs
b. Classification of costs into Fixed and Variable
c. Use of such information for analysis and decision making
For example,
If a company needs to build a new factory in order to produce more
goods, the cost of building the factory is a marginal cost.
Formula :
Marginal Cost =  (Change in Costs) / (Change in
Quantity)

Example:
Johnson Tires, a public company, consistently
manufactures 10,000 units of truck tires each year, incurring
production costs of $5 million. However, one year finds the
market demand for tires significantly higher, requiring the
additional production of units, which prompts management
to purchase more raw materials and spare parts, as well as
to hire more manpower. This demand results in overall
production costs of $7.5 million to produce 15,000 units in
that year.  
As a financial analyst, you determine that the marginal cost
for each additional unit produced is $500 ($2,500,000 /
 Features of Marginal Costing

1. Cost are separated into the fixed and variable elements and
semi-variable costs are also differentiated like-wise.
2. Only the variable costs are taken into account for computing
the value of stocks of work in progress and finished products.
3. Fixed costs are charged off to revenue wholly during the
period on which they are incurred and are not taken into
account for valuing product cost/inventories.
4. Prices may be based on marginal cost and contribution, but
in normal circumstances prices would cover costs in total.
5. It combines the techniques of cost recording and cost
reporting
Cont.
6. Profitability of departments or products is determined in terms of
marginal contribution.
7. The unit cost of a product means the average variable cost of
manufacturing/ the
product.
8. Only the variable costs (marginal costs) are treated as the cost of
the product.
9. The stock of finished goods and work in progress are valued at
marginal cost only.
10. Prices are based on marginal cost plus contribution. Contribution
is the difference between selling price and variable cost.
What is Direct Costing?
■ Direct costing is the practice of charging all direct cost to
operations, processes or products, leaving all indirect
costs to be written off against profits in the period in
which they arise. Under direct costing the stocks are
valued at direct costs, i.e, whether fixed or variable which
can be directly attribute to the cost units.

■ Add together direct materials and direct labor to find total

direct costs.

Examples: Direct labor, Direct materials, Commissions, piece

 Differential Cost
■ the increase or decrease in total cost or the change in
specified elements of cost that result from any
variation in operation. It represents an increase or
decrease in total cost resulting out of:
a. Producing or distributing a few more or less
of the products;
b. A charge in the method of production or of
distribution;
c. An addition or deletion of production or a
territory; and
d. Selection of an addition sales channel.
Example:
The telecom operator currently spends $400 on newspaper
ads and $100 on maintaining the company’s website every
month. The marketing director estimates that it will spend
approximately $1,000 on television ads every month. Also, the
company will need to hire a millennial at $250 per week to
oversee its social media marketing efforts. If the telecom
operator adopts the new advertisement techniques, they will
spend $2,000 per month as advertising expenses. 

  The differential cost, in this case, is $1,500 ($2,000 – $500).

 Incremental
Cost
■ Incremental costs and revenues are the difference
between costs and revenue for the corresponding items
under each alternative being considered.

■ The total change a company experiences within its

balance sheet or income statement due to the production
and sale of an additional unit of product. It's calculated by
analyzing the additional expenses incurred based on the
addition of the unit.
Example:

Suppose the Deluxe Widget Company has a one-time order

for 500 units. Normal production is 5,000 units at a total cost of
$500,000. Analysis of the cost data shows that adding another
500 units will increase total cost to $530,000. Subtracting the
regular production cost leaves $30,000. Divide $30,000 by 500
and you have an incremental cost of $60 per unit.

 If the price offered by the customer is at least this much, management

should accept the order. If the offer is less, the company would take a loss.
 Difference between
Incremental and Differential
Cost
■ Incremental Cost means increase in the cost of
production as a result of an increase in
action/activity.

For example,
The cost of production increased from $10,000 to
$12,000. The increase resulted in the increase of
numbers of hours needed to complete the project.
The incremental cost for the increase in the number
Cont.

■ Differential Cost, on the other hand, is the

difference of cost to be incurred when there are
more than one alternative.

For example,
Option 1 will incur a total of $15,000 to meet
the production requirement. Option 2 needs a total
of $14,000 to complete the same. There is a
Differential Cost of $1,000 and Option 2 is favorable.