Page 50 - DCOM206_COST_ACCOUNTING_II

Unit 3: Absorption Costing and Marginal Costing

Marginal Costing has been defined as, ‘Ascertainment of cost and measuring the impact on Notes
profits of the change in the volume of output or type of output. This is subject to one assumption
and that is the fixed cost will remain unchanged irrespective of the change.’

Note The marginal costing involves firstly the ascertainment of the marginal cost and
measuring the impact on profit of alterations made in the production volume and type.

Example: Suppose company X is manufacturing three products, A, B and C at present
and the number of units produced are 45,000, 50,000 and 30,000 respectively p.a. If it decides to
change the product mix and decides that the production of B is to be reduced by 5000 units and
that of A should be increased by 5000 units, there will be impact on profits and it will be essential
to measure the same before the final decision is taken. Marginal costing helps to prepare
comparative statement and thus facilitates the decision-making. This decision is regarding the
change in the volume of output.
Now suppose if the company has to take a decision that product B should not be produced at all
and the capacity, which will be available, should be utilized for A and B this will be change in the
type of output and again the impact on profit will have to be measured. This can be done with
the help of marginal costing by preparing comparative statement showing profits before the
decision and after the decision. This is subject to one assumption and that is the fixed cost
remains constant irrespective of the changes in the production. Thus marginal costing is a very
useful technique of costing for decision-making.

3.2 Features of Marginal Costing

As mentioned above, marginal costing is not a separate method of costing but it is a technique
of costing distinct from the traditional costing which is also called as ‘Absorption Costing’. The
distinguishing features of marginal costing are as follows:

1. In marginal costing, costs are segregated into fixed and variable. Only variable costs are
charged to the production, i.e. included in the cost of production. Fixed costs are not
included in the cost of production, which means that they are not absorbed in the production.
However this does not mean that they are ignored or not taking into consideration at all.
They are taken into consideration while computing the final profit or loss by debiting
them to the Costing Profit and Loss Account. The logic behind omitting fixed costs from
cost of production is that fixed costs do not remain fixed on per unit basis. On per unit
basis, the fixed cost will increase if the production decreases while it will decrease on per
unit basis if the production increases. Thus fixed cost per unit are always variable. In view
of this, a question arises; on what basis they should be charged to the product? Similarly,
there is a problem of under and over absorption of these overheads also. Therefore it is
advocated that fixed cost should be eliminated from the cost of production but should be
taken into consideration while computing the final figure of profit by charging them to
the Costing Profit and Loss Account. The following illustration will clarify the point.

Example: Company X is producing 1,00,000 units. The variable cost per unit is ` 5 and
the fixed costs are ` 5,00,000. If we work out the total cost per unit, it will be variable cost + fixed
cost per unit [at present level of production] that means, the total cost will be ` 5 + ` 5 = ` 10. But
as per the technique of marginal costing, the variable cost only i.e. ` 5, will be charged to the
production while the fixed cost of ` 5,00,000 will not be charged to the cost of production, it will

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