Marginal Costing Vs CVP Analysis

Marginal Costing

Marginal cost means the same thing as variable cost. The term is not a new one. The accountants concept of marginal cost differs from economists concept of marginal cost Economists define marginal cost as the additional cost of production one additional unit. This shall include an element of fixed cost also. Moreover, the economists marginal cost per unit cannot be uniform with the additional production since the law of diminishing or increasing returns is applicable; whereas the accountants marginal cost shall be constant per unit of output with the additional production.

The Institute of Cost and Works Accountants of India defined marginal cost as, :The amount at any given volume of output by which aggregate costs are changed, if the volume of output is increased of decreased by one unit”. Here a unit may be a single article, a batch of articles, an order, a stage of production capacity, a process or department. To ascertain the marginal cost, we need the following element of cost.

ü Direct Materials

ü Direct Labour

ü Other Direct Expensed, and

ü Total Variable overheads.

That is Marginal Cost = Prime Cost + Total Variable overheads

Or

Marginal Cost = Total Cost – Fixed Cost

Marginal Cost = Increase in total cost

Increase in total units

Fixed costs remain fixed within a frange of production. They are not directly linked to product units. Rather, they are spent on elapse of time. Some portion of the fixed costs may be discretionary, which the management spends on availability of adequate profit. Other portion of fixed costs in non-discretionary which the management cannot avoid in the short run.

So in the short run decisions only incremental to fixed costs are considered. Decisions are based on marginal cost and contribution. Cost, volume and profit (C.V.P.) relationship provides important information to aid decision – making.

Also, managerial decisions are affected by product’s life cycle. This means the various stages through which a product passes, from conception and development through introduction into the market through maturation and finally, withdrawal from market.

Marginal Costing is defined by the ICWA as, the ascertainment by differentiating between fixed costs, and variable costs, of marginal costs and of the effect on profit of change in volume of type of output”. According to Dr. Joseph, “Marginal Costing is a technique of determining the amount of change in the aggregate costs due to an increase of one unit over the existing level of production. As such, it arises from the production of additional increments of output.

Batty defines Marginal Costing as a “Technique of Cost accounting which pays special attention to the behavior of costs with changes in the volume of output”.

Example:

RS.

Variable cost 8,000 @ Rs. 5 40,000/-

Fixed cost 10,000/-

-----------

50,000/-

ii. Standard Costing Vs Variance Analysis:

Standards are set for various activities with reference to resource, time and values on the basis of normally available working facilities and capability of an average employee and machine. Similarly, sales standard is set on the basis of appropriate market survey.

Budgets may be set after deciding upon the standards. In actual circumstances, after budgets are set on the basis of past experience and given resources ignoring the standard requirements.

Standards are nothing but a control device. Deviation from the standards is called variance. Analysis of variances is an effective means of control.