Course Name: Cost and Management

Accounting
Module 4: Marginal Costing

1. Define the term ‘marginal costing’.

Answer: Marginal Costing is a costing technique wherein the marginal cost, i.e. variable
cost is charged to units of cost, while the fixed cost for the period is completely written
off against the contribution. The term marginal cost implies the additional cost involved
in producing an extra unit of output, which can be reckoned by total variable cost
assigned to one unit.

2. How would you calculate marginal cost?

Answer: The term marginal cost implies the additional cost involved in producing an
extra unit of output, which can be reckoned by total variable cost assigned to one unit.

It can be calculated as:

Marginal Cost = Direct Material + Direct Labor + Direct Expenses + Variable

Overheads

Marginal cost is the change in the total cost when the quantity produced is incremented
by one. That is, it is the cost of producing one more unit of a good.

3. Mention all the features of marginal costing.

Answer: The features of marginal costing are as follows:
 Classification into Fixed and Variable Cost: Costs are bifurcated, on the basis of
variability into fixed cost and variable costs. In the same way, semi variable cost
is separated.
 Valuation of Stock: While valuing the finished goods and work in progress, only
variable cost are taken into account. However, the variable selling and distribution
overheads are not included in the valuation of inventory.
 Determination of Price: The prices are determined on the basis of marginal cost
and marginal contribution.
  Profitability: The ascertainment of departmental and product’s profitability is
based on the contribution margin.
In addition to the above characteristics, marginal costing system brings together the
techniques of cost recording and reporting.

4. Why is marginal costing needed?

Answer: Marginal Costing is needed for the following reasons:
• Variable cost per unit remains constant; any increase or decrease in production
changes the total cost of output.
• Total fixed cost remains unchanged up to a certain level of production and does
not vary with increase or decrease in production. It means the fixed cost remains constant
in terms of total cost.
• Fixed expenses exclude from the total cost in marginal costing technique and
provide us the same cost per unit up to a certain level of production.

5. Explain the advantages of marginal costing.

Answer: The advantages of marginal costing are as follows:
 Easy to operate and simple to understand.
 Marginal costing is useful in profit planning; it is helpful to determine
profitability at different level of production and sale.
 It is useful in decision making about fixation of selling price, export decision and
make or buy decision.
 Break even analysis and P/V ratio are useful techniques of marginal costing.
 Evaluation of different departments is possible through marginal costing.
 By avoiding arbitrary allocation of fixed cost, it provides control over variable
cost.
 Fixed overhead recovery rate is easy.
 Under marginal costing, valuation of inventory done at marginal cost. Therefore,
it is not possible to carry forward illogical fixed overheads from one accounting
period to the next period.
 Since fixed cost is not controllable in short period, it helps to concentrate in
control over variable cost.

6. What are the limitations of marginal costing?

Answer: The limitations of marginal costing are as follows:
  Classifying costs: It is very difficult to separate all costs into fixed and variable
costs clearly, since all costs are variable in the long run. Hence such classification
sometimes may give misleading results. Furthermore, in a firm with many
different kinds of products, marginal costing can prove less useful.
 Accurately representing profits: Since the closing stock consists only of variable
costs and ignores fixed costs (which could be considerable), this gives a distorted
picture of profits to shareholders.
 Semi-variable costs: Semi-variable costs are either excluded or incorrectly
analyzed, leading to distortions.
 Recovery of overheads: With marginal costing, there is often the problem of
under or over-recovery of overheads, since variable costs are apportioned on an
estimated basis and not on actual value.
 External reporting: Marginal costing cannot be used in external reports, which
must have a complete view of all indirect and overhead costs.
 Increasing costs: Since it is based on historical data, marginal costing can give an
inaccurate picture in the presence of increasing costs or increasing production.

7. Mention all the equations for elements of cost.

Answer: The equations for elements of cost are as follows:

8. Define contribution margin.

Answer: The contribution margin is the excess between the selling price of the product
and total variable costs.
The contribution margin is the amount of money a business has to cover its fixed costs
and contribute to net profit or loss after paying variable costs.
9. Describe the calculations for P/V Ratio.
Answer: Profit / Volume (P/V) ratio is calculated while studying the profitability of
operations of a business and to establish a relation between Sales and Contribution. It is
one of the most important ratios, calculated as under:

The P/V Ratio shares a direct relation with profits. Higher the P/V ratio, more the profit
and vice-a-versa.

10. Mention the formula for calculating Break-Even Analysis.

Answer: The break‐even point represents the level of sales where net income equals
zero. In other words, the point where sales revenue equals total variable costs plus total
fixed costs, and contribution margin equals fixed costs.

When the total cost of executing business equals to the total sales, it is called break-even
point. Contribution equals to the fixed cost at this point. Here is a formula to calculate
break-even point:
11. How can you calculate margin of safety?
Answer: Margin of safety is also expressed in the form of ratio or percentage that is
calculated by using the following formulas/equations:
MOS ratio = MOS/Actual or budgeted sales
MOS percentage = (MOS/Actual or budgeted sales) × 100

12. What is the use of a break-even chart?

Answer: Break-Even Chart is the most useful graphical representation of marginal
costing. It converts accounting data to a useful readable report. Estimated profits, losses,
and costs can be determined at different levels of production.

13. What do you mean by the margin of safety?

Answer: In break-even analysis, from the discipline of accounting, margin of safety is
how much output or sales level can fall before a business reaches its break-even point.
 Margin of safety (MOS) is the difference between actual sales and break even sales. In
other words, all sales revenue that a company collects over and above its break-even
point represents the margin of safety.
Excess of sale at BEP is known as margin of safety.
Therefore,
Margin of safety = Actual sales – Sales at BEP

14. Write a short note on Composite Break-Even Point.

Answer: A company may have different production units, where they may produce the
same product. In this case, the combined fixed cost of each productions unit and the
combined total sales are taken into consideration to find out BEP.
• Constant Product - Mix Approach In this approach, the ratio is constant for the
products of all production units.
• Variable Product - Mix Approach In this approach, the preference of products is
based on bigger ratio.

15. Write a short note on Cost-Volume-Profit (CVP) Analysis.

Answer: Cost-Volume-Profit (CVP) Analysis is also known as Break–Even Analysis.
Every business organization works to maximize its profits. With the help of CVP
analysis, the management studies the co-relation of profit and the level of production.
CVP analysis is concerned with the level of activity where total sales equal the total cost
and it is called as the break-even point. In other words, we study the sales value, cost and
profit at different levels of production. CVP analysis highlights the relationship between
the cost, the sales value, and the profit.

Let us go through the assumptions for CVP analysis:

• Variable costs remain variable and fixed costs remain static at every level of
production.
• Sales volume does not affect the selling price of the product. We can assume the
selling price as constant.
• At all level of sales, the volume, material, and labor costs remain constant.
• Efficiency and productivity remains unchanged at all the levels of sales volume.
• The sales-mix at all level of sales remains constant in a multi-product situation.
• The relevant factor which affects the cost and revenue is volume only.
• The volume of sales is equal to the volume of production.
Cost-volume-profit (CVP) analysis is used to determine how changes in costs and volume
affect a company's operating income and net income. CVP analysis requires that all the
company's costs, including manufacturing, selling, and administrative costs, be identified
as variable or fixed.

CVP analysis is also used when a company is trying to determine what level of sales is
necessary to reach a specific level of income, also called targeted income.