(Unit-II)

Marginal Costing and Absorption Costing

 Introduction
Marginal cost is nothing but a change occurred in the
total cost due to changes taken place on the level of
production i.e., either an increase/decrease by one unit
of product.
Fixed manufacturing costs are not allotted to products
but are considered as period costs and thus charged
directly to Profit and Loss account of the year.
Fixed cost also do not enter inventory valuation.
Example
 Definition of Marginal Cost

According to ICMA, London “Marginal cost is the

amount at any given volume of output, by which
aggregate costs are charged, if the volume of output
is increased or decreased by one unit.”

Basically, it is the additional cost of producing an

additional unit of product. It is the total of all direct
and variable costs.
 MCQ
• Which of the following statements are true?

A) Marginal costing is not an independent system of costing.

B) In marginal costing all elements of cost are divided into fixed and variable components.

C) In marginal costing fixed costs are treated as product cost.

D) Marginal costing is not a technique of cost analysis.

a) A and B

b) B and C

c) A and D

d) B and D
 Features of Marginal Costing
Segregation of cost into fixed and variable elements

Fixed cost as period costs. Charged to statement of P and L

Marginal cost as product cost

Pricing : Price is equal to marginal cost plus contribution

Valuation of inventory - stock of WIP and finished goods valued at this

MC.

Marginal costing and profit

 MCQ
• The technique of marginal costing is based on
classification of cost into ------
• A. Period and Product Cost

• B. Fixed and Variable Cost

• C. Variable and Semi-variable Cost

• D. None of these
 Practical Example
The firm XYZ Ltd. incurs ` 1000 for the production
of 100 units at one level of operation. By increasing
only one unit of product i.e. 101 units, the firm’s
total cost of production amounted ` 1010.
Total cost of production at first instance (C’) = `
1000 Total cost of production at second instance
(C”) = ` 1010 Total number of units during the first
instance (U’) = 100 Total number of units during
the second instance (U”) = 101
 Marginal Cost Calculation
Change in the level of units = U’’-U’= 101-100= 1
Change in the cost = C”-C’ = 1010-1000= 10
Therefore, Marginal Cost = Change in total cost/
Change in units = 10/1= Rs.10
Marginal cost is nothing but a cost which
incorporates the incremental changes in the cost of
production due to either an increase or decrease in
the level of production by one unit, meant as
incremental cost.
 MCQ
• ABC Ltd. is incurring 5500 on producing100 chocolates
in company. The total cost rose to 6700 after increasing
production of chocolate by one unit, then marginal cost
will be
A. 1000

B. 1200

C. 1300

D. 1500
 Importance
useful in decision
Easy to operate and
useful in profit making about fixation
simple to
planning of selling price, make
understand.
or buy decision

Evaluation of
Break even analysis
provides control over different
and P/V ratio are
variable cost. departments is
useful techniques
possible

Fixed overhead
recovery rate is easy.
 Contribution
It is the difference between sales value and marginal (variable) cost of sales

also known as contribution or gross margin. Thus, it is calculated as:

Contribution = Sales – Variable cost

The costs are classified into two categories viz. fixed and variable cost.

Variable cost per unit is considered as marginal cost of the product. Fixed

costs are charged against contribution of the transaction.

Therefore, Selling price of the product = marginal cost + contribution.

Contribution

Method of Difference= Sales - Variable Cost , Method of Meeting = Fixed

cost + Profit
 Marginal costing profitability
statement
Sales xxxx
(Variable Cost) xxxx
Contribution xxxx
(Fixed Cost) xxxx
Profit xxxx
 Practical Example
• Example: Sales ` 100,000, variable cost `
25,000/- and fixed cost ` 20,000 find out the
contribution and profit.
Sales 1,00,000
Variable Cost (-) 50,000
Contribution 50,000
Fixed Cost (-)20,000
Profit 30,000
 Contribution and Marginal Cost Equation
C = S-V…(i)
C = F+P…(ii)
C = F-L…..(iii)
From this, S-V= F+P
If any of the three out of four are known, the fourth
can be known:
P=S-V-F
P=C-F
F=C-P
V=S-F-P
 Sales =12000, variable cost=7000, fixed
cost=4000
• Thus, C=S-V (12000-7000) =5000
• P= C-F (5000-4000) =1000
Thus, profit= 1000
i. If sales not given, but contribution is given
S= 5000 +7000= 12000
ii. If fixed cost is not given, but profit is given
F= 5000-1000= 4000
iii. If variable cost is not given, but sales is given
V= S-C (12000-5000) = 7000
 MCQ
• Period cost is associated with
• A. Fixed Cost
• B. Variable Cost
• C. Prime Cost
• D. None of these