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Theory of Marginal Costing

Marginal Costing

Q. What is marginal costing ?
Ans. The term marginal costing is Defined by ICMA London as follows:
Marginal Costing is the ascertainment of marginal cost and of the effect on profit due to changes in volume or type of output by differentiating between fixed cost and variable cost.

 Q. What is fixed cost ? 
Ans. Cost which remains fixed with change in production.

 Q. What is Variable cost ? 
Ans. Variable cost means cost which change with output it is also known as marginal cost.

 Q. What is contribution ?
Ans. Contribution is the difference between selling price and variable cost or marginal cost of sales.

 Q. What is PV Ratio?
Ans. Relationship between contribution and sale is called PV Ratio.

               PV Ratio = Contribution (CPU) / Sale X 100

 Q. What is break even point ?
Ans. Break even point represent that volume of sale or production where no profit and loss is incurred. At break even point contribution is equal to fixed cost.

 Q. What is break even chart ? 
Ans.Graphical representation of cost and revenue shown their inter-relation at different volume of output is called break even chart.

 Q. What is margin of safety ? 
Ans. Difference between sales and break even sales is called margin of safety.
        This is the area of earning profit. A reasonable margin of safety should be there otherwise a small reduced level of production may prove dangerous.

Q. What is angle of Incidence ?
Ans. This is the angle at which sale line cuts total cost line. The size of this angle decides the extent of profit. Larger the angle higher the profit.

 Q. What is break even analysis ?
Ans. It is popularly known as cost volume profit relationship.
       It shows the level of operation where cost and revenue are in equilibrium.

 Q. What are the Assumption of Break even Analysis or Cost per contribution (CPU) analysis ?
Ans. Assumption of Break even Analysis or Cost per contribution (CPU) analysis are as follows :

  1. All cost can be separated in fixed and variable.
  2. Variable cost varies in proportion to output and fixed costs remain constant.
  3. Cost and revenue are linear over the range of activity under consideration.
  4. Cost and revenue are influenced only by revenue.
  5. There will be no change in general price level.
  6. The state of Technology, method production and efficiency remain unchanged.



Main limitations of Marginal Costing:

  1. Classification of cost into fixed and variance is not very easy.
  2. Assumption that fixed cost remain fixed and variable cost varies with volume of production is less realistic.
  3. It ignores fixed cost in valuating stock and work in progress.
  4. The information supplied by marginal costing is not complete.
  5. Profit and contribution concept fully ignore the market agreement.
  6. It cannot be applied in case of industrial value of work in progress is very high.
  7. State are valued at marginal cost.
  8. There will be no significant change in the level of inventory.
  9. The company manufacture a single product.
  10. In case of multi product sales receipt will remain unchanged.
Q. Distinguish between absorption costing and marginal costing ?

Absorption costing:-
  1. All cost fixed and variable are included for ascertaining the cost.
  2. Difference between sales and total cost is profit.
  3. Stock of finished good and work in progress are valued at total cost. 
  4. Cost are classified according to function basis. Such as production cost, office cost, administration cost, selling and distribution cost, etc.
  5. Managerial decision are guided by profit.


Marginal costing:-
  1. Only variable cost are included.
  2. Difference between contribution and fixed cast is profit.
  3. Stock of finished good and work in progress are valued at marginal cost.
  4. Cost are classified according to their behavior basic. Such as fixed cost and variable cost.
  5. Managerial decision are guided by contribution.

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