BSN622

MANAGEMENT ACCOUNTING

Unit – 4 :
Marginal Costing and Decision Making
Dr. ASHOK KUMAR
dr.ashok@shobhituniversity.ac.in

Dr. Ashok Kumar, 1

Shobhit Deemed University
 Marginal Costing
 Marginal costing, as one of the tools of management
accounting helps management in making certain
decisions.
 It provides management with information regarding
the behavior of costs and the incidence of such costs
on the profitability of an undertaking.
 Marginal costing is defined as “the ascertainment of
marginal costs and of the effect on profit of changes
in volume or type of output by differentiating
between fixed costs and variable costs”.

Dr. Ashok Kumar, 2

Shobhit Deemed University
Marginal Costing
 Marginal costing is one of the special
techniques of costing used for analyzing and
interpreting cost data for the purpose of
assessing the profitability or otherwise of
product, process, department or cost center.

Dr. Ashok Kumar, 3

Shobhit Deemed University
Marginal Cost
 The technique of marginal costing is related to
the concept of marginal cost. According to CIMA
London, “Marginal cost means the amount at any
given volume of output by which aggregate cost
are changed if the volume of output is increased
or decreased by one unit.”
 Thus, marginal cost is the amount by which total
cost changes when there is a change in output by
one unit. Marginal cost per unit remains
unchanged irrespective of level of output.

Dr. Ashok Kumar, 4

Shobhit Deemed University
Marginal Cost
 Marginal cost is also termed as variable cost
because within the capacity of organization, an
increase of one unit of production will cause an
increase in variable cost only.
 The marginal cost is the sum total of direct
material cost, direct labour cost, variable direct
expenses, and all variable overheads. Marginal
cost is the same as the variable cost.

Dr. Ashok Kumar, 5

Shobhit Deemed University
Marginal Costing
 According to CIMA London, “Marginal costing is
a technique where only the variable costs are
charged to the cost units, the fixed cost
attributable being written off in full against the
contribution for that period.”
 It implies that Marginal costing is a technique
of costing which distinguishes between fixed
cost and variable cost. In marginal costing only
the variable costs are charged to the cost units.
Therefore marginal costing is also termed as
‘variable costing’.
Dr. Ashok Kumar, 6
Shobhit Deemed University
Features of Marginal Costing
1. Marginal costing is not a method of costing just
as job costing, process costing, etc. it is a
special technique for managerial decision
making.
2. Marginal costing necessitates the segregation of
costs into fixed costs and variable costs. Semi
variable costs are also segregated into fixed
costs and variable costs.
3. In marginal costing only the variable costs are
taken into account for computing cost of
production and value of stock.
Dr. Ashok Kumar, 7
Shobhit Deemed University
Features of Marginal
Costing…
4. Fixed costs are charged to profit and loss
account of the period for which costs are
incurred.
5. The profitability of the product or department is
ascertained in terms of marginal contribution,
i.e. sales value – variable costs.

Dr. Ashok Kumar, 8

Shobhit Deemed University
 Difference between Marginal
Costing and Absorption Costing
1. Segregation of costs into fixed and variable
costs: Marginal costing considered variable costs
as cost of production and therefore, requires
segregation of costs into fixed and variable. On the
other hand, under absorption costing , all costs are
allocated to precuts. Hence there is no need of
segregation of costs into fixed and variable costs.
2. Cost element in product cost : Under absorption
costing, fixed overheads are added to the cost of
production whereas under marginal costing, fixed
costs are not included in the cost of production.

Dr. Ashok Kumar, 9

Shobhit Deemed University
 Difference between Marginal
Costing and Absorption Costing …
3. Inventory Values : Under marginal costing, the value
of inventories is comparatively lower as inventories are
the valued in the term of variable costs only. Under
absorptions costing , the value inventories is
comparatively higher because inventories are valued
at total cost, i.e variable as well as fixed costs.
4. Profit : The term profit, under the absorptions costing
is the difference between sales and cost of goods sold.
Under marginal costing, the term profit, in a broader
perspective, is known as contributions margin which is
excess of sales over variable cost of goods sold.

Dr. Ashok Kumar, 10

Shobhit Deemed University
 Difference between Marginal
Costing and Absorption Costing
5. Effect of increase or decrease in inventories
: In inventories increase during the period,
absorption costing will reveal more profit than
marginal costing. When inventories decrease,
absorption costing will reported lesser profits
than marginal costing.
6. Suitability : Absorption costing is not suitable
for decision-making whereas marginal costing is
suitable for decision-making.

Dr. Ashok Kumar, 11

Shobhit Deemed University
Advantages of Marginal
Costing
1. Easy and simple: marginal costing technique is
very easy and simple to understand and to
operate. Marginal cost remains the same per unit
of production irrespective of the volume of
production and fixed costs are totally ignored./
2. Simplification of Overhead treatment :
Marginal costing technique does away with the
need for all allocation, apportionment and
absorption of fixed overheads, thereby, eliminating
th problem of over or under absorption of
overheads. Thus , marginal costing simplifies the
overhead recovery system.
Dr. Ashok Kumar, 12
Shobhit Deemed University
Advantages of Marginal
Costing…
3. Cost Control: Marginal costing facilitates the
control over cost. By avoiding arbitrary
allocation of fixed overhead, the management
can concentrate on controlling marginal cost.
4. Helpful in Profit Planning : Marginal costing
enables the management to plan for future
profits by providing data in a manner showing
cost-volume-profit relationship. Marginal
costing helps in break-even-analysis which is
related to profit planning.

Dr. Ashok Kumar, 13

Shobhit Deemed University
Advantages of Marginal
Costing…
5. Aid to Management : Marginal costing is an aid to
management in taking many important decisions
such as pricing, make or buy, selecting the most
profitable product mix, accepting orders at low
price, reduction of price in times of competition of
depression, itc. It helps the management in
evaluating the profitability of alternative operations.
6. Compatibility with Standard Costing and
Budgeting : Marginal costing can conveniently be
combined with budgetary control and standard
costing technique, thereby, making it all the more
useful.

Dr. Ashok Kumar, 14

Shobhit Deemed University
Uses and Applications of
Marginal Costing
1. Maintaining a desired level of profit : The
industries may have to reduce the price of its products
on of government regulations, competition, etc. The
volume of sales needed to have a desired level of
profits can be ascertained by the marginal costing
technique.
2. Level of Activity planning : When the management
is considering different levels of production are selling
activities to decide optimum level of activity,. The
technique of marginal costing is helpful to the
management. The optimum level of activity will be
activity whereas contribution per unit is the maximum.

Dr. Ashok Kumar, 15

Shobhit Deemed University
Uses and Applications of
Marginal Costing
3. Selection of Optimum Sales Mix : When a firm
produces more than one product, it has to decide
the product mix which will give maximum profits.
The best product mix is that which yield give
maximum contribution which can easily be
ascertained with the help of marginal costing
4. Alternative Methods of Production : Where
there are alternative method of production, say,
hand work or machine work, the management has
to ascertain the method which gives the greater
contribution. Marginal costing is helpful in such
decision making.

Dr. Ashok Kumar, 16

Shobhit Deemed University
Uses and Applications of
Marginal Costing
5. Make or Buy Decision: The technique of marginal
costing is also applied when management has too decide
whether to make a product/component or buy it from
outside. The management will compare the marginal cost
of manufacturing the precut which compare the marginal
cost of manufacturing the product with is purchase price.
6. Operate of Shut-down Decision: If the sales of the
product is not adequate enough to cover fixed costs, the
management may decide whether to shut down the
production of the product temporarily or continue.
Marginal costing helps the management in such decision-
making.

Dr. Ashok Kumar, 17

Shobhit Deemed University
7. Introduction of a New Product: When a firm
intends to introduce a new product in the market
to make use of the available facilities or to capture
a new market, it takes the helps of marginal
costing technique . The decision to do so centers
round the profitability of the new products, i.e.
whether it could contribute something towards the
fixed costs and profits.
8. Accepting price less than total cost: During
normal circumstances, price is fixed on the basis of
the total cost. But under abnormal conditions, the
prices may be fixed below the total cost. Marginal
costing technique helps the management in taking
such a decision . If selling price is equal to or more
than marginal cost, the firm may accepts a price
than the total cost.
Dr. Ashok Kumar, 18
Shobhit Deemed University
CVP Analysis
 Breakeven analysis is the study of the
relationship between selling prices, sales
volumes, fixed costs, variable costs and
profits at various levels of activity.

 Cost–volume–profit (CVP) analysis is defined

in CIMA’s Official Terminology as ‘the study
of the effects on future profit of changes in
fixed cost, variable cost, sales price,
quantity and mix’.
CVP Analysis
 A fixed cost is one that is independent of the level of
sales; rather, it is related to the passage of time. Examples
of fixed costs include rent, salaries and insurance.
 A variable cost is one that is directly related to the level of
sales, such as cost of goods sold and commissions.
 This categorisation of costs into “variable” and “fixed”
elements and their relationship with sales and profits has
been developed as “break-even analysis”. This break even
analysis is also known as Cost–volume– profit (CVP)
analysis.
 USES OF COST-VOLUME-PROFIT ANALYSIS

1. C.V.P. analysis helps in forecasting costs and profits as a result of

change in volume.
2. It helps fixing a sales volume level to earn or cover a given revenue,
return on capital employed, or rate of dividend.
3. It assists determination of effect of change in volume due to plant
expansion or acceptance of an order, with or without increase in costs
or in other words a quantum of profit to be obtained can be determined
with change in volume of sales.
4. C.V.P. analysis helps in determining relative profitability of each
product, line, project or profit plan.
5. Through cost volume-profit analysis inter-firm comparison of
profitability can be done intelligently.
 USES OF COST-VOLUME-PROFIT ANALYSIS

6. It helps in determining cash requirements at a desired

volume of output, with the help of cash break- even charts.
7. Break-even analysis emphasises the importance of capacity
utilisation for achieving economy.
8. From break-even analysis during severe recession, the
comparative effects of a shut down or continued operation
at a loss is indicated.
9. The effect on total cost of a change in the fixed over-head is
more clearly demonstrated through break-even analysis and
cost- volume-profit charts.
Contribution
Contribution is the difference between sales and variable
cost. Or Contribution is the difference between selling price
and variable cost of sales.
(i) Selling price containing profit:
Contribution = Fixed cost + Profit
(ii) Selling price at cost:
Contribution = Fixed cost
(iii)Selling price at loss:
Contribution = Fixed cost - Loss
Contribution = Sales - Variable Cost
Contribution = Profit + Fixed Cost
MARGINAL COST EQUATION
As we know: Sales-Cost= Profit
or Sales- (Fixed cost + Variable cost)= Profit
or Sales- Variable cost= Fixed cost + Profit
It is known as marginal cost equation. We can convey it
as under:
S-V=F+P

Where S = Sales V= Variable cost F= Fixed cost

P= Profit
 PROFIT-VOLUME RATIO
(P/V Ratio)
 The ratio or percentage of contribution margin to
sales is known as P/V ratio. This ratio is also
known as marginal income ratio, contribution to
sales ratio, or variable profit ratio.
 P/V ratio, usually expressed as a percentage, is
the rate at which profit increases with the
increase in volume.
The formulae for P/V ratio are:
P / V ratio = Marginal Contribution
Sales