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  Marginal Costing and Break Even Analysis

Introduction to Marginal Costing and Break Even Analysis

Marginal Costing is not a technique of costing such as job, batch or contract costing. It is actually a method of costing where only variable manufacturing costs are taking into account when determining the cost of goods that are sold and also for valuation of inventories. In fact this method is based on the basic principle that the total costs can be separated into fixed and variable. When the total fixed costs stay constant at all levels of production, the variable costs continue changing along with the production level. It will rise if the production increases and will reduce if the production decreases. The method of marginal costing assists in supplying the relevant information to the management to allow them to take decisions in various areas. In this chapter, the method of marginal costing is described in detail.

Definition

Marginal Cost is described as, 'the change in aggregate costs because of change in the volume of production through one unit'. For instance, if the total number of units generated are 800 and the total cost of production is Rs.12, 000, if one unit is in addition produced the total cost of production may become Rs.12, 010 and if the production quantity is reduced by one unit, the total cost might come down to Rs.11, 990. So the change in the total cost is by Rs.10 and though the marginal cost is Rs.10. The get increase or get decrease in the total cost is by similar amount since the variable cost all the time remains constant on per unit basis.

Marginal Costing has been described as, 'Ascertainment of cost and measuring the impact on gains of the change in the volume of output or type of output. This is matter to one supposition and that is the fixed cost will stay unchanged irrespective of the change.' So the marginal costing includes firstly the ascertainment of the marginal cost and measuring the impact on profit of changes made in the production type and volume. To make clear the point, let us get a simple instance, suppose company X is manufacturing three products, A, B and C at present and the number of units generated are 45 000, 50 000 and 30 000 correspondingly p.a. If it decides to alter the product mix and fixed that the production of B is to be decreased by 5000 units and that of A should be increased by 5000 units, there will be result on profits and it will be necessary to measure similar before the final decision is taken. Marginal costing assists to arrange comparative statement and so facilitates the decision-making. This decision is considering the change in the volume of output. Now assume if the company have to take a decision that product B should not be generated at all and the capacity, that will be presented, should be utilized for A and B this will be modify in the type of output and again the result on profit will have to be computed. This can be completed with the help of marginal costing through preparing comparative statement depicting profits before the decision and after the decision. This is matter to one assumption and that is the fixed cost stay constant irrespective of the alteration in the production. So marginal costing is a very helpful method of costing for decision-making.

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