ICAI Notes: Marginal Costing | Cost and Management Accounting for CA Intermediate PDF Download

 Page 1


CHAPTER 
14 
LEARNING OUTCOMES 
 
 
MARGINAL COSTING 
? Explain the meaning and characteristics of Marginal Costing. 
? Describe the meaning of CVP Analysis and apply the same in 
making short-term managerial decisions.  
? Describe the meaning and application of Break-even point, 
Margin of safety, Angle of incidence etc. and apply the same 
in making computations. 
? Calculate and explain the various formulae used in CVP 
analysis. 
? Apply the concepts of marginal costing and CVP analysis in 
short-term decision making. 
? Differentiate between Marginal Costing and Absorption 
Costing. 
 
CHAPTER 
14
© The Institute of Chartered Accountants of India
Page 2


CHAPTER 
14 
LEARNING OUTCOMES 
 
 
MARGINAL COSTING 
? Explain the meaning and characteristics of Marginal Costing. 
? Describe the meaning of CVP Analysis and apply the same in 
making short-term managerial decisions.  
? Describe the meaning and application of Break-even point, 
Margin of safety, Angle of incidence etc. and apply the same 
in making computations. 
? Calculate and explain the various formulae used in CVP 
analysis. 
? Apply the concepts of marginal costing and CVP analysis in 
short-term decision making. 
? Differentiate between Marginal Costing and Absorption 
Costing. 
 
CHAPTER 
14
© The Institute of Chartered Accountants of India
COST AND MANAGEMENT ACCOUNTING 
14.2 
 
1. INTRODUCTION 
As discussed in the first chapter ‘Introduction to Cost and Management 
Accounting’, the cost and management accounting system by provision of 
information, enables management to take various decisions. Marginal Costing is a 
technique of cost and management accounting which is used to analyse 
relationship between cost, volume and profit.  
In order to appreciate the concept of marginal costing, it is necessary to study the 
definition of marginal costing and certain other terms associated with this 
technique. The important terms have been defined as follows:  
1. Marginal Cost: Marginal cost as understood in economics is the 
incremental cost of production for producing one additional unit of product. 
As we understood, variable costs have direct relationship with volume of output 
and fixed costs remains constant irrespective of volume of production. Hence, 
marginal cost is measured by the total variable cost attributable to one 
Marginal Costing
Meaning of Marginal Cost 
and Marginal Costing
Characteristics of Marginal 
Costing
Cost-Volume-Profit (CVP) 
Analysis
Break-even Analysis
Marginal of Safety
Angle of Incidence
Contribution Ratio
Short-term Decision 
making
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
Page 3


CHAPTER 
14 
LEARNING OUTCOMES 
 
 
MARGINAL COSTING 
? Explain the meaning and characteristics of Marginal Costing. 
? Describe the meaning of CVP Analysis and apply the same in 
making short-term managerial decisions.  
? Describe the meaning and application of Break-even point, 
Margin of safety, Angle of incidence etc. and apply the same 
in making computations. 
? Calculate and explain the various formulae used in CVP 
analysis. 
? Apply the concepts of marginal costing and CVP analysis in 
short-term decision making. 
? Differentiate between Marginal Costing and Absorption 
Costing. 
 
CHAPTER 
14
© The Institute of Chartered Accountants of India
COST AND MANAGEMENT ACCOUNTING 
14.2 
 
1. INTRODUCTION 
As discussed in the first chapter ‘Introduction to Cost and Management 
Accounting’, the cost and management accounting system by provision of 
information, enables management to take various decisions. Marginal Costing is a 
technique of cost and management accounting which is used to analyse 
relationship between cost, volume and profit.  
In order to appreciate the concept of marginal costing, it is necessary to study the 
definition of marginal costing and certain other terms associated with this 
technique. The important terms have been defined as follows:  
1. Marginal Cost: Marginal cost as understood in economics is the 
incremental cost of production for producing one additional unit of product. 
As we understood, variable costs have direct relationship with volume of output 
and fixed costs remains constant irrespective of volume of production. Hence, 
marginal cost is measured by the total variable cost attributable to one 
Marginal Costing
Meaning of Marginal Cost 
and Marginal Costing
Characteristics of Marginal 
Costing
Cost-Volume-Profit (CVP) 
Analysis
Break-even Analysis
Marginal of Safety
Angle of Incidence
Contribution Ratio
Short-term Decision 
making
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
MARGINAL COSTING 
14.3 
additional unit. For example, the total cost of producing 10 units and 11 units 
of a product is `10,000 and `10,500 respectively. The marginal cost for 11
th
 unit 
i.e. 1 unit extra from 10
 
units is `500. 
Marginal cost can precisely be the sum of prime cost and variable overhead. 
Example 1: Arnav Ltd. produces 10,000 units of product Z by incurring a total 
cost of ` 3,50,000. Break-up of costs are as follows: 
(i)  Direct Material @ ` 10 per unit, ` 1,00,000, 
(ii)  Direct employee (labour) cost @ ` 8 per unit, ` 80,000 
(iii)  Variable overheads @ `2 per unit, ` 20,000 
(iv)  Fixed overheads ` 1,50,000 (upto a volume of 50,000 units) 
In this example, if Arnav Ltd. wants to know marginal cost of producing one 
extra unit from the current production i.e. 10,001
st
 unit. The marginal cost would 
be the change in the total cost due production of this 10,001
st
 extra unit. The 
extra cost would be `20, as calculated below: 
 10,000 
units
10,001 
units
Change in 
Cost
(A) (B) (c) = (B) - (A) 
(i) Direct Material @ `10 per unit 1,00,000 1,00,010 10 
(ii)  Direct employee (labour) cost @ `8 
per unit 
80,000 80,008 8 
(iii) Variable overheads @ `2 per unit 20,000 20,002 2 
(iv)  Fixed overheads 1,50,000 1,50,000 0 
Total Cost 3,50,000 3,50,020 20 
2.  Marginal Costing: It is a costing system where products or services 
and inventories are valued at variable costs only. It does not take 
consideration of fixed costs. This system of costing is also known as direct 
costing as only direct costs forms the part of product and inventory cost. Costs 
are classified on the basis of behavior of cost (i.e. fixed and variable) rather 
functions as done in absorption costing method. 
3.  Direct Costing: Direct costing and Marginal Costing is used synonymously 
at various places. But the relation of costs with respect to activity level must be 
© The Institute of Chartered Accountants of India
Page 4


CHAPTER 
14 
LEARNING OUTCOMES 
 
 
MARGINAL COSTING 
? Explain the meaning and characteristics of Marginal Costing. 
? Describe the meaning of CVP Analysis and apply the same in 
making short-term managerial decisions.  
? Describe the meaning and application of Break-even point, 
Margin of safety, Angle of incidence etc. and apply the same 
in making computations. 
? Calculate and explain the various formulae used in CVP 
analysis. 
? Apply the concepts of marginal costing and CVP analysis in 
short-term decision making. 
? Differentiate between Marginal Costing and Absorption 
Costing. 
 
CHAPTER 
14
© The Institute of Chartered Accountants of India
COST AND MANAGEMENT ACCOUNTING 
14.2 
 
1. INTRODUCTION 
As discussed in the first chapter ‘Introduction to Cost and Management 
Accounting’, the cost and management accounting system by provision of 
information, enables management to take various decisions. Marginal Costing is a 
technique of cost and management accounting which is used to analyse 
relationship between cost, volume and profit.  
In order to appreciate the concept of marginal costing, it is necessary to study the 
definition of marginal costing and certain other terms associated with this 
technique. The important terms have been defined as follows:  
1. Marginal Cost: Marginal cost as understood in economics is the 
incremental cost of production for producing one additional unit of product. 
As we understood, variable costs have direct relationship with volume of output 
and fixed costs remains constant irrespective of volume of production. Hence, 
marginal cost is measured by the total variable cost attributable to one 
Marginal Costing
Meaning of Marginal Cost 
and Marginal Costing
Characteristics of Marginal 
Costing
Cost-Volume-Profit (CVP) 
Analysis
Break-even Analysis
Marginal of Safety
Angle of Incidence
Contribution Ratio
Short-term Decision 
making
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
MARGINAL COSTING 
14.3 
additional unit. For example, the total cost of producing 10 units and 11 units 
of a product is `10,000 and `10,500 respectively. The marginal cost for 11
th
 unit 
i.e. 1 unit extra from 10
 
units is `500. 
Marginal cost can precisely be the sum of prime cost and variable overhead. 
Example 1: Arnav Ltd. produces 10,000 units of product Z by incurring a total 
cost of ` 3,50,000. Break-up of costs are as follows: 
(i)  Direct Material @ ` 10 per unit, ` 1,00,000, 
(ii)  Direct employee (labour) cost @ ` 8 per unit, ` 80,000 
(iii)  Variable overheads @ `2 per unit, ` 20,000 
(iv)  Fixed overheads ` 1,50,000 (upto a volume of 50,000 units) 
In this example, if Arnav Ltd. wants to know marginal cost of producing one 
extra unit from the current production i.e. 10,001
st
 unit. The marginal cost would 
be the change in the total cost due production of this 10,001
st
 extra unit. The 
extra cost would be `20, as calculated below: 
 10,000 
units
10,001 
units
Change in 
Cost
(A) (B) (c) = (B) - (A) 
(i) Direct Material @ `10 per unit 1,00,000 1,00,010 10 
(ii)  Direct employee (labour) cost @ `8 
per unit 
80,000 80,008 8 
(iii) Variable overheads @ `2 per unit 20,000 20,002 2 
(iv)  Fixed overheads 1,50,000 1,50,000 0 
Total Cost 3,50,000 3,50,020 20 
2.  Marginal Costing: It is a costing system where products or services 
and inventories are valued at variable costs only. It does not take 
consideration of fixed costs. This system of costing is also known as direct 
costing as only direct costs forms the part of product and inventory cost. Costs 
are classified on the basis of behavior of cost (i.e. fixed and variable) rather 
functions as done in absorption costing method. 
3.  Direct Costing: Direct costing and Marginal Costing is used synonymously 
at various places. But the relation of costs with respect to activity level must be 
© The Institute of Chartered Accountants of India
COST AND MANAGEMENT ACCOUNTING 
14.4 
understood. Some costs are variable at batch level but fixed for unit level 
whereas others are variable at production line level but fixed for batches and 
units.  
Example 2: Arnav Ltd. produces 10,000 units of product Z by incurring a total 
cost of `4,80,000. Break-up of costs are as follows: 
(i)  Direct Material @ `10 per unit, `1,00,000, 
(ii)  Direct employee (labour) cost @ `8 per unit, `80,000 
(iii)  Variable overheads @ ` 2 per unit, `20,000 
(iv)  Machine set up cost @ `1,200 for a production run (100 units can be 
manufactured in a run) 
(v)  Depreciation of a machine specifically used for production of Z `10,000 
(iv)  Apportioned fixed overheads ` 1,50,000. 
Analysis of the costs: 
 10,000 
units 
10,001 
units 
Change in 
Cost 
Direct Cost 
(A) (B) (c) = (B) - (A) 
(i)  Direct Material 
@ ` 10 per unit 
1,00,000 1,00,010 10 Unit level Direct 
Cost.  
(ii) Direct employee 
(labour) cost @ 
` 8 per unit 
80,000 80,008 8 Unit level Direct 
Cost. 
(iii)  Variable 
overheads @ `2 
per unit 
20,000 20,002 2 Unit level Direct 
Cost. 
(iv)  Machine set up 
cost 
1,20,000 1,21,200 1,200 Batch level Direct 
Cost 
(v)  Depreciation of 
a machine 
10,000 10,000 0 Product level Direct 
Cost. 
(vi) Apportioned 
fixed overheads 
1,50,000 1,50,000 0 Department level 
Direct Cost 
Total Cost 4,80,000 4,81,220 1,220 
© The Institute of Chartered Accountants of India
Page 5


CHAPTER 
14 
LEARNING OUTCOMES 
 
 
MARGINAL COSTING 
? Explain the meaning and characteristics of Marginal Costing. 
? Describe the meaning of CVP Analysis and apply the same in 
making short-term managerial decisions.  
? Describe the meaning and application of Break-even point, 
Margin of safety, Angle of incidence etc. and apply the same 
in making computations. 
? Calculate and explain the various formulae used in CVP 
analysis. 
? Apply the concepts of marginal costing and CVP analysis in 
short-term decision making. 
? Differentiate between Marginal Costing and Absorption 
Costing. 
 
CHAPTER 
14
© The Institute of Chartered Accountants of India
COST AND MANAGEMENT ACCOUNTING 
14.2 
 
1. INTRODUCTION 
As discussed in the first chapter ‘Introduction to Cost and Management 
Accounting’, the cost and management accounting system by provision of 
information, enables management to take various decisions. Marginal Costing is a 
technique of cost and management accounting which is used to analyse 
relationship between cost, volume and profit.  
In order to appreciate the concept of marginal costing, it is necessary to study the 
definition of marginal costing and certain other terms associated with this 
technique. The important terms have been defined as follows:  
1. Marginal Cost: Marginal cost as understood in economics is the 
incremental cost of production for producing one additional unit of product. 
As we understood, variable costs have direct relationship with volume of output 
and fixed costs remains constant irrespective of volume of production. Hence, 
marginal cost is measured by the total variable cost attributable to one 
Marginal Costing
Meaning of Marginal Cost 
and Marginal Costing
Characteristics of Marginal 
Costing
Cost-Volume-Profit (CVP) 
Analysis
Break-even Analysis
Marginal of Safety
Angle of Incidence
Contribution Ratio
Short-term Decision 
making
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
MARGINAL COSTING 
14.3 
additional unit. For example, the total cost of producing 10 units and 11 units 
of a product is `10,000 and `10,500 respectively. The marginal cost for 11
th
 unit 
i.e. 1 unit extra from 10
 
units is `500. 
Marginal cost can precisely be the sum of prime cost and variable overhead. 
Example 1: Arnav Ltd. produces 10,000 units of product Z by incurring a total 
cost of ` 3,50,000. Break-up of costs are as follows: 
(i)  Direct Material @ ` 10 per unit, ` 1,00,000, 
(ii)  Direct employee (labour) cost @ ` 8 per unit, ` 80,000 
(iii)  Variable overheads @ `2 per unit, ` 20,000 
(iv)  Fixed overheads ` 1,50,000 (upto a volume of 50,000 units) 
In this example, if Arnav Ltd. wants to know marginal cost of producing one 
extra unit from the current production i.e. 10,001
st
 unit. The marginal cost would 
be the change in the total cost due production of this 10,001
st
 extra unit. The 
extra cost would be `20, as calculated below: 
 10,000 
units
10,001 
units
Change in 
Cost
(A) (B) (c) = (B) - (A) 
(i) Direct Material @ `10 per unit 1,00,000 1,00,010 10 
(ii)  Direct employee (labour) cost @ `8 
per unit 
80,000 80,008 8 
(iii) Variable overheads @ `2 per unit 20,000 20,002 2 
(iv)  Fixed overheads 1,50,000 1,50,000 0 
Total Cost 3,50,000 3,50,020 20 
2.  Marginal Costing: It is a costing system where products or services 
and inventories are valued at variable costs only. It does not take 
consideration of fixed costs. This system of costing is also known as direct 
costing as only direct costs forms the part of product and inventory cost. Costs 
are classified on the basis of behavior of cost (i.e. fixed and variable) rather 
functions as done in absorption costing method. 
3.  Direct Costing: Direct costing and Marginal Costing is used synonymously 
at various places. But the relation of costs with respect to activity level must be 
© The Institute of Chartered Accountants of India
COST AND MANAGEMENT ACCOUNTING 
14.4 
understood. Some costs are variable at batch level but fixed for unit level 
whereas others are variable at production line level but fixed for batches and 
units.  
Example 2: Arnav Ltd. produces 10,000 units of product Z by incurring a total 
cost of `4,80,000. Break-up of costs are as follows: 
(i)  Direct Material @ `10 per unit, `1,00,000, 
(ii)  Direct employee (labour) cost @ `8 per unit, `80,000 
(iii)  Variable overheads @ ` 2 per unit, `20,000 
(iv)  Machine set up cost @ `1,200 for a production run (100 units can be 
manufactured in a run) 
(v)  Depreciation of a machine specifically used for production of Z `10,000 
(iv)  Apportioned fixed overheads ` 1,50,000. 
Analysis of the costs: 
 10,000 
units 
10,001 
units 
Change in 
Cost 
Direct Cost 
(A) (B) (c) = (B) - (A) 
(i)  Direct Material 
@ ` 10 per unit 
1,00,000 1,00,010 10 Unit level Direct 
Cost.  
(ii) Direct employee 
(labour) cost @ 
` 8 per unit 
80,000 80,008 8 Unit level Direct 
Cost. 
(iii)  Variable 
overheads @ `2 
per unit 
20,000 20,002 2 Unit level Direct 
Cost. 
(iv)  Machine set up 
cost 
1,20,000 1,21,200 1,200 Batch level Direct 
Cost 
(v)  Depreciation of 
a machine 
10,000 10,000 0 Product level Direct 
Cost. 
(vi) Apportioned 
fixed overheads 
1,50,000 1,50,000 0 Department level 
Direct Cost 
Total Cost 4,80,000 4,81,220 1,220 
© The Institute of Chartered Accountants of India
MARGINAL COSTING 
14.5 
In the example, the direct cost of producing 10,001
st
 unit is 1,220 but it is not 
the marginal cost of producing one extra unit rather marginal cost of running 
one extra production run (batch). 
4. Differential and Incremental Cost: Differential cost is difference 
between the costs of two different production levels. It is a relative 
representation of costs for two different levels that results in the increase or 
decrease in cost. Incremental cost, on the other hand, is the increase in the costs 
due to change in the volume or process of production activities. Incremental 
costs are sometime compared with marginal cost but in reality, there is a thin 
line difference between the two. Marginal cost is the change in the total cost 
due to production of one extra unit while incremental cost can be both for 
increase in one unit or in total volume. In the Example 2 above, ` 1,220 is the 
incremental cost of producing one extra unit but not marginal cost for 
producing one extra unit.  
2. CHARACTERISTICS OF MARGINAL COSTING 
The technique of marginal costing is based on the distinction between product 
costs and period costs. Only the variables costs are treated as the costs of the 
products while the fixed costs are treated as period costs which will be incurred 
during the period regardless of the volume of output. The main characteristics 
of marginal costing are as follows:  
1. All elements of cost are classified into fixed and variable components. 
Semi-variable costs are also analyzed into fixed and variable elements. 
2. The marginal or variable costs (as direct material, direct labour and variable 
factory overheads) are treated as the cost of product. 
3. Under marginal costing, the value of finished goods and work–in–progress 
is also comprised only of marginal costs. Variable selling and distribution 
are excluded for valuing these inventories. Fixed costs are not considered for 
valuation of closing stock of finished goods and closing WIP. 
4. Fixed costs are treated as period costs and are charged to profit and loss 
account for the period for which they are incurred. 
5. Prices are determined with reference to marginal costs and contribution margin. 
© The Institute of Chartered Accountants of India