MARGINAL COST OR VARIABLE COST OR DIRECT COST · 10/13/2015 · MARGINAL COST OR VARIABLE COST OR DIRECT COST ... Marginal Cost or variable cost = Total cost ... DIFFERENCE BETWEEN

MARGINAL COST OR VARIABLE COST OR DIRECT COST

Samir K Mahajan



Marginal cost is the variable cost of one more unit of a product or service. As such, it

arises from additional increments of output. Marginal costing considers only variable

cost ( those costs of production that vary with output) in calculating the cost of the

product while fixed costs are charged against the revenue (sales) of the product.

Thus, Marginal cost or variable cost = Prime cost (Direct Materials + Direct Labour +

Direct expenses )+ Total Variable Overheads

Or

Marginal Cost or variable cost = Total cost - Fixed Cost


Thus, here variable costs are treated as product cost and fixed manufacturing

costs are not treated as product cost. Fixed manufacturing cost are part of part

of period cost.

As such marginal cost remain in inventory as an asset until such time as the

inventory is sold and inventory ( or cost of sales) under this method contain

variable costs only.

MARGINAL or VARIABLE or DIRECT COSTING

The revenue arising from the sales over variable costs is technically known as Contribution

(profit plus fixed cost) under marginal costing.

Marginal costing is considered superior to absorption costing so far as managerial decision

making is considered. It identifies only such costs with the jobs or products which directly

vary with the level of output. Consequently the cost of goods in inventory or cost of

goods sold under this method does not contain any fixed overhead cost.

Thus the uncertainty and irrationality associated with apportionment of fixed cost in

traditional costing is thus avoided.

MARGINAL COST contd.

A factory produces 500 bicycles per annum. The variable cost per by cycle is US$ 100. the fixed

expenses are US$ 10000 per annum.

The cost sheet of bicycle will appear as follows:

US $

Variable cost (500 X US$ 100) 50000

Fixed cost 10000___

60000___

If production is increased by one unit i.e. if it becomes 501 bicycles per annum, the cost sheet

will appear as follows :

US $

Variable cost (501 X US$ 100) 50100

Fixed cost 10000___

60 100___

The marginal cost is therefore US$ 100

DIFFERENCE BETWEEN ABSORPTION COSTING AND VARIABLE (MARGINAL COSTING)

Recovery of Overheads: In case of absorption costing, both fixed and variable overheads arecharged to production while in case of marginal costing only variable overheads are charged toproduction.

Valuation of stocks: Absorption costing of stocks of work-in-progress and finished goods arevalued at work cost and total cost of production respectively. Work cost and cost of production isdefined to include fixed overheads too.

While in marginal costing, only variable costs are considered while computing the value ofwork-in-progress or finished goods. Thus, closing stock is undervalued in marginal costing ascompared to absorption costing.

DIFFERENCE BETWEEN ABSORPTION COSTING AND VARIABLE (MARGINAL COSTING)

CONTRIBUTION and PROFIT

Contribution is the difference between selling price and variable cost. It is sum of fixed cost and

profit.

Contribution or Gross Margin = Selling Price (total revenue) – Variable Cost (marginal cost)

Contribution= (Variable cost + Fixed cost + Profit) – variable cost

Contribution= Fixed cost + Profit

Or, Profit = Contribution – Fixed cost

Or, Fixed cost = Contribution – profit

Let us take an example.

Variable cost Rs 5000

Fixed cost Rs. 2000

Selling Price Rs 8000

Contribution = Selling price – variable cost

= Rs 8000 – Rs 2000

= Rs 3000

Profit = Contribution – fixed cost

= Rs 3000 – Rs 2000

= Rs 1000

As contribution exceeds fixed cost, there is a

profit of Rs. 1000.

If fixed cost is assumed as Rs 4000, the

position will change as:

Contribution – fixed cost = Negative

Profit (loss)

= Rs 3000 – Rs 4000

= Rs 1000

The sum of Rs 1000 represents the extent

of loss since the fixed costs are more than

the contribution. At the level of foxed

cost of Rs 3000, there shall be no profit

and no loss. The concept of break-even

analysis arises out of this basic fact.

CONTRIBUTION or GROSS MARGIN contd.

Example 1: Tripura Ltd is manufacturing three product : A, B, C. the cost of manufacture are as follows

A B C

Direct Material per unit

Rs 3 Rs 4 Rs 5

Direct labour per unit Rs 2 Rs 3 Rs 3

Selling price per unit Rs 10 Rs 15 Rs 20

Output 1000 units 1000 units 1000 units

The total overhead costs are Rs.12000 out of which Rs. 9000 are fixed and the rests are

variable. It is decided to apportion these costs over different products in the ratio of output.

From the above data, prepare a statement of cost and profit according to Marginal Costing.

Example 1: solution

Statement showing Profit And Cost (Marginal Costing )

Product A_____ _____Product _B __ ____Product C _____

Per unit Rs

TotalRs

Per unit Rs

TotalRs

Per unit Rs

TotalRs

Direct material Direct labour

Variable OverheadsTotal Marginal CostContribution (Sales – MC)Selling price

32

1

30002000

1000

43

1

40003000

1000

54

1

50004000

1000

64

60004000

87

80007000

1010

1000010000

10 10000 15 15000 20 20000

Example 1: solution contd.

Total profit under marginal costing would be:

Total Contribution Rs.

Product A 4000Product B 7000Product C 10000 21000

Less: Fixed Cost Product A 3000Product B 3000Product C 3000 9000

Profit 12000


A B C


Rs 3 Rs 4 Rs 5




The total overhead costs are Rs.12000 out of which Rs. 9000 are fixed and the rests are variable.It is decided to apportion these costs over different products in the ratio of output. Prepare astatement showing the cost and profit of each product according to marginal costing.

Calculate amount of profit and profit and loss made by Tripura Ltd in the first two years of itsexistence, presuming thati. In the first year, it manufactures 1000 units of each product A, B, C but fails to effect any

sales.ii. In the second year, it does not produce anything but sells the entire stock carried forward

from the first year.iii. What fallacious conclusions can be drawn from the results.

Solution : Example2

Tripura Limited Profit and loss Account of 1st Year (as per marginal costing)

Rs Rs

Direct material ABC

Direct labour ABC

Overhead: variables

A 1000B 1000C 1000

Fixed -----

300040005000___ 12000

200030004000___ 9000

30009000 _12000__

___33000_

SalesClosing Stock Loss

-----240009000

___________33000_

Solution : Example 2 contd.

Tripura Limited Profit and loss Account of 2nd Year (as per marginal costing)

Rs Rs

Opening Stock Fixed overhead Profit

24000900012000

_______45000__

SalesA BC

100001500020000_ 45000

______45000_

The above Profit and Loss accounts shows that the company suffered a loss of Rs.9000 in the firstyear because of non-recovery of fixed overheads while in the second year it makes a profit of Rs.12000. It may be seen from the profit and loss account that the fixed cost of one year has beencarried forward to the next year. Thus, the profit and loss account gives the correct pictureaccording to marginal costing.


A B C


Rs 3 Rs 4 Rs 5




The total overhead costs are Rs.12000 out of which Rs. 9000 are fixed and the rests are

variable. It is decided to apportion these costs over different products in the ratio of output.

From the above data, prepare a statement of cost and profit according to Marginal Costing.

Compute the amount of profit under absorption costing and marginal costing in case units of

goods sold of products A, B, C are 900 each.

Example 3: solution

Statement showing Profit And Cost (Absorption Costing )

Product A_____ _____Product _B _____ ____Product C _____

TotalRs

TotalRs

TotalRs

Direct material Direct labour Variable OverheadsTotal Marginal (variable) CostAdd: Fixed Overheads

Total cost of production Less: Closing Stock Cost of goods sold Profit (sales – cost of goods sold)

300020001000

400030001000

500040001000

60003000

80003000

100003000

9000900

110001100

130001300

8100900

99003600

117006300

Sales 9000 13500 18000

Total profit under absorption costing is

Total Profit Rs._______

Product A 900 Product B 3600 Product C 6300 Rs 10800


Example 3: solution

Statement showing Profit And Cost (Marginal Costing )

Product A_____

_____Product _B _____

____Product C _____

TotalRs

TotalRs

TotalRs

Direct material Direct labour Variable Overheads

300020001000

400030001000

500040001000

Total Marginal CostLess: Closing Stock Cost of goods sold Contribution (Sales – MC)Sales

6000600

8000800

100001000

54003600

72006300

90009000

9000 13500 18000


Total profit under marginal costing would be:

Total Contribution Rs.

Product A 3600Product B 6300Product C 9000 18900

Less: Fixed Cost Product A 3000Product B 3000Product C 3000 9000

Profit Rs. 9900

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MARGINAL COST OR VARIABLE COST OR DIRECT COST · 10/13/2015 · MARGINAL COST OR VARIABLE COST OR DIRECT COST ... Marginal Cost or variable cost = Total cost ... DIFFERENCE BETWEEN