Marginal Cost Notes

1. Theory of Marginal Costing:

Marginal costing is a method of costing where costs are classified into two categories:

• Fixed Costs: These do not change with the level of production.
• Variable Costs: These change with the level of production.

Key Concepts:

• Marginal Cost: The cost of producing one additional unit of output, considering only variable costs.
• Fixed Costs: Do not contribute to the marginal cost of each unit and are written off in the period incurred.
• Contribution: The difference between sales and variable costs. It contributes towards covering fixed costs and generating profit.
• Break-even Point (BEP): The point where total revenue equals total costs, resulting in no profit or loss.

Features of Marginal Costing:

1. Marginal costing differentiates between fixed and variable costs.
2. Only variable costs are assigned to products, while fixed costs are period costs.
3. Profit is calculated by subtracting fixed costs from contribution.
4. Inventory is valued based on marginal cost.
5. It helps in decision-making, cost control, and evaluating the profitability of products or departments.
6. Break-even analysis and cost-volume-profit (CVP) analysis are integral parts of this method.

2. Formulas and Their Applications:

Key Formulas:

1. Contribution:

   $$\text{Contribution}=\text{Sales}-\text{Variable Costs}$$

2. Profit Calculation:

   $$\text{Net Profit}=\text{Contribution}-\text{Fixed Costs}$$

3. Profit-Volume (PV) Ratio:

   $$\text{PV Ratio}=\left(\frac{\text{Contribution}}{\text{Sales}}\right)\times 100$$

4. Break-even Point (BEP) in Units:

   $$\text{BEP (Units)}=\frac{\text{Fixed Costs}}{\text{Contribution per Unit}}$$

5. Break-even Point (BEP) in Value:

   $$\text{BEP (Value)}=\frac{\text{Fixed Costs}}{\text{PV Ratio}}$$

6. Margin of Safety (MOS):

   $$\text{MOS}=\text{Total Sales}-\text{BEP Sales}$$

   Or

   $$\text{MOS}=\frac{\text{Profit}}{\text{PV Ratio}}$$

7. Sales for Desired Profit:

   $$\text{Sales (Value)}=\frac{\text{Fixed Costs}+\text{Net Profit}}{\text{PV Ratio}}$$

8. Sales (Units) for Desired Profit:

   $$\text{Sales (Units)}=\frac{\text{Fixed Costs}+\text{Net Profit}}{\text{Contribution per Unit}}$$

9. Change in Profit due to Change in Sales:

   $$\text{PV Ratio}=\frac{\text{Change in Profit}\times 100}{\text{Change in Sales}}$$

10. Variable Cost per Unit:

    $$\text{Variable Cost per Unit}=\frac{\text{Change in Total Cost}}{\text{Change in Volume}}$$

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These are the primary theoretical concepts and formulas used in Marginal Costing to assist with various business decisions, such as pricing, cost control, and profitability analysis.