What is Marginal Cost?

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What is Marginal Cost?

Marginal cost is an important factor to analyze and to know the concept in detail then you need to understand its basics.

So, let us get familiar with the term and its use in the financial world.

This article you will going to learn the concept of “What is Marginal Cost?”

Without any further delaying, let’s start with the article.

What is Marginal Cost?

The marginal Costing is a costing technique wherein the marginal cost, i.e. variable cost is charged to units of cost, while the fixed cost for the period is completely written off against the contribution.

The term marginal cost applies in the additional cost that is involved in producing an extra unit of output, which can be calculated by total variable cost assigned to one unit. It can be calculated as:

Marginal Cost = Direct Material + Direct Labor + Direct Expenses + Variable Overheads

Characteristics of Marginal Costing

  • Classification into Fixed and Variable Cost: Costs are bifurcated, on the basis of variability into fixed cost and variable costs. In the same way, semi variable cost is also separated.
  • Valuation of Stock: While valuing the finished goods and work in progress, only variable cost are taken into account. However, the variable selling and the distribution overheads are not included for the valuation of inventory.
  • Determination of Price: The prices are determined on the basis of marginal cost and marginal contribution.
  • Profitability: The ascertainment of departmental and product’s profitability is based on the contribution margin.

With addition to the above characteristics, the marginal costing system also bring together with the techniques of cost recording and reporting.

Marginal Costing Approach

The difference between the product costs and the period costs forms a basis for marginal costing technique, wherein only the variable cost is considered as the product cost while the fixed cost is considered as a period cost, which incurs during the period, irrespective of the level of activity.

Facts Concerning Marginal Cost

  • Cost Ascertainment: The basis for ascertaining cost in marginal costing is the nature of cost, which gives an idea of the cost behavior that has a great impact on the profitability of the firm.
  • Special technique: It is not a unique method of costing, like contract costing, process costing batch costing. But, marginal costing is a different type of technique that is used by the managers for the purpose of decision making. It provides a basis for understanding the cost data so as to watch the profitability of various products, processes and cost centers.
  • Decision Making: It has a great role to play, in the field of decision making, as the changes in the level of activity pose a serious problem to the management of the undertaking.

Marginal Costing also help in assisting the managers in taking an end number of business decisions, such as replacement of machines, discontinuing a product or service, etc.

This also helps the management in discovering the appropriate level of activity, through break even analysis, that reflect the impact of increasing or decreasing production level, on the company’s overall profit.

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