- Marginal costing is a method of costing that considers only the variable costs involved in producing a unit of output. In this method, fixed costs are treated as period costs and are not included in the cost of production.
- This approach provides valuable information for decision-making such as pricing, product mix, and volume decisions.
Suppose a company produces 10,000 units of a product with a selling price of $20 per unit. The total variable costs per unit are $12, and the total fixed costs are $50,000.
Features of Marginal Costing:
- Only variable costs are considered in product costing.
- Fixed costs are treated as period costs and are not included in the cost of production.
- It helps in making decisions related to pricing, product mix, and volume.
Process: To calculate the marginal cost of a product, we only consider the variable costs involved in producing a unit of output. The formula for calculating marginal cost is:
Marginal Cost = Variable Cost per Unit
Using the numerical example above, the marginal cost per unit would be $12.
Advantages of Marginal Costing:
- Easy to understand and implement: Marginal costing is a simple costing method that is easy to understand and implement.
- Useful for short-term decision making: It is useful for short-term decision-making as it considers only the variable cost of production and helps to determine the contribution margin.
- Helps to determine the breakeven point: It helps in determining the breakeven point, which is the point where total revenue equals total costs.
- Helps in pricing decisions: Marginal costing helps in pricing decisions as it calculates the contribution margin per unit and helps to set the selling price.
- Useful for cost control: Marginal costing is useful for cost control as it helps in identifying the areas where costs can be reduced.
Disadvantages of Marginal Costing:
- Does not consider fixed costs: Marginal costing does not consider fixed costs, which can lead to an underestimation of the total cost of production.
- Difficulty in separating costs: It may be difficult to separate fixed and variable costs, especially when there are several cost centers involved.
- Ignores long-term effects: Marginal costing ignores long-term effects and may lead to sub-optimal decisions in the long run.
- May lead to under-pricing: If the selling price is based solely on the variable cost, it may lead to under-pricing, which can affect the profitability of the company.
- Limited scope: Marginal costing has a limited scope and cannot be used for financial reporting purposes, as it does not consider fixed costs.