Marginal Costing – Basic Concept

Marginal costing is a technique of ascertaining cost used in any method of costing. According to this technique, variable costs are charged to cost units and the fixed cost attributable to the relevant period is written off in full against the contribution for that period. Contribution is the difference between sales value and variable cost. Thus, all expenses are classified under two groups, variable and fixed. Variable expenses are those which vary in sympathy with increase or decrease of unit production or sales. Variable expenses are direct materials, direct labour, direct expenses, variable factory overheads and variable administration, selling & distribution overheads. Fixed expenses include fixed factory overheads, administration overheads and fixed selling and distribution overheads. Fixed expenses have no effect on the volume of activity and are written-off to the profit and loss account at the end of the period. It is, therefore, called period cost. Variable cost, on the other hand, relates to the product, and hence, termed as product cost.

Fixed and Variable Cost

Marginal costing technique is based on the segregation of fixed and variable costs. Fixed costs or period or time costs arise from policy decisions of the top-management to provide and to keep in readiness a given capacity to produce and sell, regardless of the current actual volume of production or sales. Most of the fixed costs are determined by the volume of business expected rather than by the volume of business actually done. Variable costs or product or output costs, on the other hand, vary directly or tends to vary directly with current volume without need for managerial decision. Time has no effect on this type of cost.  However, it is important to note that fixed costs tend to remain unchanged only within a given range of activity and within a relevant time-period. If activity level fluctuates from zero level to full capacity, naturally fixed expenses cannot remain constant. Similarly, fixed cost cannot remain unchanged over a long period of time. Even within a short period, say, one year, there may be changes in salary and wages for normal increments or change in Dearness Allowance rates or price increase due to inflation. Such changes are inevitable even within a short period, say, one year. Hence, the concept of fixed cost as envisaged in marginal costing holds good within a relevant period. Variable costs normally remain unaffected by the change in activity level or change in the period, unless there are operational changes.