This document defines and explains marginal costing. It states that marginal cost is the same as variable cost, which is the increase in costs from producing one additional unit within existing capacity. Marginal cost is calculated as direct materials, labor, expenses and variable overheads. It also explains the differences between absorption costing and marginal costing and how marginal costing is useful for decision making.

2.  Marginal cost means same thing as variable cost.
 Marginal cost is also termed as variable cost
because within the capacity of the industry or
organisation, an increase of one unit in production
will cause an increase in variable costs only.
 According to Certified Institute of Management
Accountants, London, ”Marginal cost means 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”.

3.  Thus, marginal cost is the amount by which total
cost changes when there is a change in output by
one unit. To ascertain the marginal cost, we need
the following elements of cost:
 Direct materials;
 Direct labour or wages;
 Direct expenses, and
 Total variable overheads.
 That is marginal cost = prime cost + total variable
overheads.
 Or, marginal cost = total cost – fixed cost

4.  In marginal costing, a differentiation is made between the
fixed costs elements and the variable costs elements. No
other category of costs is taken into consideration.
 In marginal costing, only variable costs are taken into
account for computing cost of production.
 The finished socks and work – in- progress are valued at
marginal cost.
 In marginal costing, prices are determined on the basis of
marginal costs plus contribution.
 Marginal income or marginal contribution is known as the
income or the profit.
 Fixed costs remain constant irrespective of level of
activity.
 The difference between the contribution and fixed costs is
the net profit or loss.

5. Basis of differences Absorption costing Marginal costing
Classification of overheads
and costs
The overheads may be
classified as factory,
administrative, selling and
distribution.
But in marginal costing,
costs are classified as fixed
and variable.
Calculation of
manufacturing overhead
rates
Absorption rate include
both fixed and variable
manufacturing overhead.
Rates includes only variable
manufacturing overheads.
Element of cost Fixed overheads are added
to the cost of production.
Fixed overheads are not
included in the cost of
production.
Valuation of inventory Valuation is on product cost
i.e. prime cost + applied
fixed and variable
manufacturing overheads.
It will be at prime cost+
applied variable
manufacturing overheads.
Suitability of decision
making
It is not suitable for decision
making.
It is suitable for decision
making.

6. Gross profit or operating
profit
Gross profit = net sales –
manufacturing cost of
goods sold. Manufacturing
costs = prime cost + fixed
and variable
manufacturing overheads.
Marginal income or
contribution = net sales –
variable manufacturing
cost of goods sold –
variable administrative,
selling and distribution
overheads.
Net operating profit Net operating profit = gross
profit – administrative
selling and distribution
overheads.
Net operating profit =
marginal income or
contribution – fixed
manufacturing,
administrative, selling and
distribution overheads.

7.  Fixation of selling price.
 Helpful to management.
 Effective cost control.
 Helps in production planning.
 Helpful in Budgetary control.
 Helpful in make or buy decisions.
 Better presentation.
 Preparing tenders.

8.  Difficulty in the fixation of price.
 Difficult to analyse overhead
 Unrealistic assumptions.
 Problem of variable overheads.
 Unreliable stock valuation.
 Complete or full information not given.
 Sales oriented.
 Automation.

9.  Cost – volume profit analysis is a part of marginal
costing. The cost volume profit analysis is the
analysis of three variables, viz., cost, volume and
profit.
 Profit of a business organization depends upon a
number of factors such as selling price, sales volume,
per unit of variable cost, fixed cost and sales mix.
 The cost volume profit analysis explains the
interrelationships of these variables for decision
making.
 The management is always interested to know
which product or product mix is more profitable;
what effect a change in the volume of output will
have on the cost of the production and profit etc.

10.  To achieve the minimum level of sales for avoiding
losses.
 To arrive at the desirable product mix so as to maximise
profit.
 The required level of sales that will fetch the planned rate
of profit.
 To ascertain the most viable product and the least profits
required to gain ground in the market.
 to determine the resultant impact on cost volume profit
relationships an account of the planned expansion of
activities.
 To ascertain the effect of changes in the volume of
output, costs and prices on the planned profit, and
 To determine the sale of a product of a plant to be
discounted or the operation of the business firm should
be temporarily stopped.

11.  Marginal Cost Equation,
 Profit – Volume Ratio,
 Break – Even Analysis,
 Margin of Safety,
 Break – Even Chart, and
 Angle of Incidence.

12.  The element of cost can be written in the form
of equation. This equation is known as
‘marginal cost equation’.
 Sales = variable cost + fixed cost + profit.
 Or, Sales – variable cost = fixed cost + profit.
 Or, Sales – variable cost = contribution.

13.  The important element of the marginal cost
equation is the ‘ contribution’ factor which is
resulted from the sales value after deduction of
variable costs.
 Contribution = sales – marginal cost.
 Or, Contribution = sales – variable cost.
 Or, Contribution = fixed cost + profit.
 Or, Sales – variable cost = fixed cost + profit.

14.  It is popularly known as P/V Ratio, expresses the
relation of contribution to sales.
 This ratio is also known as contribution to sales or the
marginal income ratio.
 It is expressed in percentage.
 It is important in decision making.
 P/V Ratio = contribution / sales *100.
 Or, P/V Ratio = contribution per unit/ selling price
per unit * 100.
 Or, P/V Ratio = fixed cost + profit / sales * 100
 Or, P/V Ratio = sales – variable cost / sales *100
 Or, P/V Ratio = change in profits (in 2 periods)/
change in sales(in 2 periods) * 100

15.  To determine the variable cost for any volume of sales,
 To determine the volume of sales required to earn a
given profit,
 To fix the selling prices,
 To locate the break – even point and margin of safety,
 To determine the volume of sales required for
maintaining the present level of profit, if selling price is
reduced, and
 To compute the profit when margin of safety is given.

16.  It is a technique of studying cost volume profit
relationship.
 It determines break even point.