MARGINAL COST OR VARIABLE COST OR DIRECT COST 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

MARGINAL COST OR VARIABLE COST OR DIRECT COST Thus, here variable costs are treated as product cost and fixed costs are not treated as product cost. Fixed manufacturing cost are part of part of period cost.

MARGINAL or VARIABLE or DIRECT COSTING The revenue arising from the sales over variable costs is technically known as Contribution 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.

The cost sheet of bicycle will appear as follows: 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 : 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 are charged to production while in case of marginal costing only variable overheads are charged to production. Valuation of stocks: Absorption costing of stocks of work-in-progress and finished goods are valued at work cost and total cost of production respectively. Work cost and cost of production is defined to include fixed overheads too. While in marginal costing, only variable costs are considered while computing the value of work-in-progress or finished goods. Thus, closing stock is undervalued in marginal costing as compared 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

CONTRIBUTION or GROSS MARGIN contd. 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.

Direct Material per unit 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 Selling price per unit Rs 10 Rs 15 Rs 20 Output 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.

Statement showing Profit And Cost Example 1: solution Statement showing Profit And Cost (Marginal Costing ) Product A_____ _____Product _B __ ____Product C _____ Per unit Rs Total Direct material Direct labour Variable Overheads Total Marginal Cost Contribution (Sales – MC) Selling price 3 2 1 3000 2000 1000 4 4000 5 5000 6 6000 8 7 8000 10 10000 15 15000 20 20000 s

Total profit under marginal costing would be: Total Contribution Rs. Example 1: solution contd. Total profit under marginal costing would be: Total Contribution Rs. Product A 4000 Product B 7000 Product C 10000 21000 Less: Fixed Cost Product A 3000 Product B 3000 Product C 3000 9000 Profit 12000

Direct Material per unit Example 2: 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 Selling price per unit Rs 10 Rs 15 Rs 20 Output 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. Prepare a statement 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 its existence, presuming that In the first year, it manufactures 1000 units of each product A, B, C but fails to effect any sales. In the second year, it does not produce anything but sells the entire stock carried forward from the first year. What fallacious conclusions can be drawn from the results.

Profit and loss Account of 1st Year (as per marginal costing) Solution : Example2 Tripura Limited Profit and loss Account of 1st Year (as per marginal costing) Rs Direct material A B C Direct labour Overhead: variables A 1000 B 1000 C 1000 Fixed ----- 3000 4000 5000___ 12000 2000 4000___ 9000 9000 _12000__ ___33000_ Sales Closing Stock Loss ----- 24000 9000 ________

Profit and loss Account of 2nd Year (as per marginal costing) Solution : Example 2 contd. Tripura Limited Profit and loss Account of 2nd Year (as per marginal costing) Rs Opening Stock Fixed overhead Profit 24000 9000 12000 _______ 45000__ Sales A B C 10000 15000 20000_ 45000 ______ 45000_ The above Profit and Loss accounts shows that the company suffered a loss of Rs.9000 in the first year 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 been carried forward to the next year. Thus, the profit and loss account gives the correct picture according to marginal costing.

Direct Material per unit Example 3: 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 Selling price per unit Rs 10 Rs 15 Rs 20 Output 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. 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.

Statement showing Profit And Cost Example 3: solution Statement showing Profit And Cost (Absorption Costing ) Product A_____ _____Product _B _____ ____Product C _____ Total Rs Direct material Direct labour Variable Overheads Total Marginal (variable) Cost Add: Fixed Overheads Total cost of production Less: Closing Stock Cost of goods sold Profit (sales – cost of goods sold) 3000 2000 1000 4000 5000 6000 8000 10000 9000 900 11000 1100 13000 1300 8100 9900 3600 11700 6300 Sales 13500 18000

Total profit under absorption costing is Total Profit Rs._______ Example 3: solution contd. Total profit under absorption costing is Total Profit Rs._______ Product A 900 Product B 3600 Product C 6300 Rs 10800

Statement showing Profit And Cost Example 3: solution Statement showing Profit And Cost (Marginal Costing ) Product A_____ _____Product _B _____ ____Product C _____ Total Rs Direct material Direct labour Variable Overheads 3000 2000 1000 4000 5000 Total Marginal Cost Less: Closing Stock Cost of goods sold Contribution (Sales – MC) Sales 6000 600 8000 800 10000 5400 3600 7200 6300 9000 13500 18000

Total profit under marginal costing would be: Total Contribution Rs. Example 3: solution contd. Total profit under marginal costing would be: Total Contribution Rs. Product A 3600 Product B 6300 Product C 9000 18900 Less: Fixed Cost Product A 3000 Product B 3000 Product C 3000 9000 Profit Rs. 9900