Marginal Costing - FAQ

Marginal costing is one of important technique of cost accounting to control the cost. It is used every type of company who is interested to reduce cost and increase profitability. Marginal costing is also included in all professional accounting courses. That is the reason, you should watch following frequently asked questions (FAQ) of marginal costing.

Q: - 1. What is marginal costing?

Ans. Marginal costing means to control the cost by calculating all variable cost and deduct it from sale. With this, we find a special reserve that is called contribution. This contribution can be used to pay fixed cost and rest will be our profit. With this we decide whether we have to produce new product or not, whether we have to diversify of producing of our product or not. Marginal costing is one of best technique, with this, we can proper use of cost-volume- profitability analysis because PV ratio is just relationship of contribution and sales. By calculating it, we can compare two products PV ratio.  Products having high PV ratio will be prefer to produce instead of producing products having  low PV ratio.


Q:- 2. What is marginal Costing formula?

Ans. Following are the main formulae which are used in marginal costing.

Marginal Cost : Effect on total cost by producing one more or less unit of product.

Marginal Costing  Equation

Contribution = Sales - Variable Cost

or
Contribution = Fixed Cost +/- Profit

If both side will equal, then

Contribution = contribution

Sales - Variable cost = Fixed Cost +/- Profit

S - V = F + P

Profit Volume Ratio =  Contribution / Sale

PV Ratio = Fixed Cost  +/- Profit / Sale or F- P / S

or
PV Ratio = Sales - Variable Cost / Sale or S-V / S


Q:- 4. What is difference between marginal costing and absorption costing?

Ans. 1. # Absorption costing is a costing system which treats all costs of production as product costs, regardless weather they are variable or fixed. This would usually include direct materials, direct labor and variable portion of manufacturing overhead. Fixed manufacturing cost is not treated as a product costs under marginal costing.Link

2. # Main difference of marginal costing and absorption costing is of calculating profit. In marginal costing, we calculate profit by calculating contribution and then net profit by deducting fixed cost from contribution. By this, we need not to absorb fixed cost per unit. Per unit cost will be same because we give first preference to marginal cost or variable cost. It is easy to decide by how much contribution (and therefore profit) will be affected by changes in sales volume

3. # In absorption costing, we calculate profit with following formula

Absorption Cost of Production = Opening stock + Production Cost - closing stock

Absorption Cost of Sales = Absorption Cost of Production + Add Selling, Admin & Distribution Cost +/- Adjustment of Under or Over absorption of Overheads

Adjusted Profit = Sales - Absorption Cost of Sales

But, in marginal costing, we calculate first contribution and then net profit

Contribution = Sales - Variable Cost

Net Profit = Contribution - Fixed Cost

In marginal costing, however, the actual fixed overhead incurred is wholly charged against contribution.

Q: - 5. What are the main applications of marginal costing?

Ans. Please read it at here.

Q:- 6. What are the limitations of marginal costing?

1. Proper classification of fixed and variable cost is not easy. If you deem any fixed cost as variable cost, it may mislead your decision. Moreover, some cost may be semi-variable. We can not classify it either in fixed cost or variable cost.

 

2.  In marginal costing, we give less preference to fixed cost. But fixed cost can also affect net flow of cash and cash from operation. So, your decision may be affected from this point.

 

3. In the area of construction or making of building or big contract, we can not use marginal costing technique for controlling the cost because fixed cost is more important and it should be take as part of cost of production for normal showing of profit every year.

 

Q :-  7. Which product would you recommend to be manufactured in a factory under marginal costing rules, time being the key factor?

 

Given information  :

 

	Per unit of product A	Per unit of product B
	$	$
Direct Material	24	14
Direct Labor at $ 1 per hour	2	3
Variable Overheads at $ 2 per hour	4	6
Selling Price	100	110
Standard Time to Produce	2hrs.	3 hrs.

Ans. We have to calculate contribution for checking whose contribution is better as per marginal costing rules.

	Per unit of product A	Per unit of product B
	$	$
Selling Price	100	110
Less Marginal Cost :
Direct Material	( - ) 24	( - )14
Direct Labor at $ 1 per hour	( - ) 2	( - ) 3
Variable Overheads at $ 2 per hour	( - ) 4	(  - ) 6
Contribution	70	87
Standard Time to Produce	2hrs.	3 hrs.
Contribution Per Hour = contribution/ standard time	$ 35 per hour	$ 29 per hour

From the above it is clear that contribution per hour of Product A is $ 35 per hour which is more than that of product B by $ 6. There product A is more profitable and is recommend to be manufactured.