What is Marginal cost?

A Management accountant takes the help of various tools and techniques to assist the management in taking an informed decision. Analysis of Financial statements, Funds Flow Analysis, Cash Flow Analysis and Ratio Analysis are some of the popular tools. Apart from the above, he takes the help of various costing techniques such as Marginal Cost Analysis, Break Even Analysis, Cost Volume Profit Analysis, Analysis of Variances etc.

Definition: According to ICMA London, “Marginal Cost” is the amount for any given volume of output by which aggregate costs are changed, if the volume of output is increased or decreased by one unit”

Concept of Cost:

The British Institute of Cost and Management Accountants defines ‘Cost’ as the amount of expenditure incurred on given thing.

Cost can also be classified based on their relationship with the volume of production. On the basis, cost can be classified in to fixed costs, Variable Costs, Semi Variable Costs and Step Costs.

Fixed Costs: Fixed costs, as the name suggests, remain fixed in amount. The amount spent towards such an expense remains same irrespective of the volume of production. They may have to be incurred even if there is no production. For Ex. Rent of factory building has to be paid irrespective of whether or not production is taking place.

Variable Cost: Variable costs in vary in direct proportion to the volume of production.No variable costs are incurred if production is stopped. As production increases, Variable costs increases. However, variable cost per unit will not change.

For Example: If it is estimated that 3 units of a material are required to produce 2 unit of finished product, then material cost will continue to increase as the no. of units of finished stock desired increases. Similarly, cost of material will be nil, if production is stopped.

All direct costs are variable costs. Example: Commission to sales persons etc…

Marginal Costing Equation:

Total cost = Fixed costs + Variable costs

Profit = Sales- (Fixed Cost – Variable cost)

Profit = Sales-Fixed Cost-Variable cost

Fixed Cost + Profit = Sales- Variable Cost

The above equation is termed as Marginal cost Equation.

Contribution = Sales – Variable cost

P/v Ratio=

1. Contribution/ Sales   (or)   Sales – Variable cost/Sales  (or)

2. Fixed cost + Profit/Sales  (or) 

3. (Change in profit / Contribution)/Change in Sales