Marginal Costing | PAPER III – ACCOUNTING & FINANCIAL MANAGEMENT FOR BANKERS | MODULE D: TAXATION AND FUNDAMENTALS OF COSTING

Marginal Costing and Absorption Costing

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Meaning

Marginal Costing is a costing technique where only variable costs are considered for product costing and decision-making. Fixed costs are treated as period costs and charged against the revenue of the period.

Advantages

• Helps in decision making (e.g., pricing, product mix)
• Simplifies cost control
• Facilitates breakeven and CVP analysis

Limitations

• Ignores fixed costs in product valuation
• Not suitable for external reporting
• Assumes linear cost behavior

Applications

• Decision making in pricing, product discontinuation
• Make or buy decisions
• Profit planning

Breakeven Analysis & Cost-Volume-Profit (CVP) Analysis

Breakeven Point = Fixed Costs / Contribution per Unit

CVP analysis studies the relationship between cost, volume, and profit.

P/V Ratio and its Significance

P/V Ratio = (Contribution / Sales) × 100

Higher P/V ratio indicates higher profitability.

Margin of Safety

Margin of Safety = Actual Sales - Breakeven Sales

It indicates the risk buffer against losses.

Absorption Costing

It includes all fixed and variable costs in product costing. Fixed costs are allocated to units produced.

Difference: Marginal vs Absorption Costing

• Marginal Costing: Only variable costs are included in product cost.
• Absorption Costing: Both variable and fixed costs are included.

Income Measurement

Under marginal costing, income is affected only by sales volume, while under absorption costing, it is affected by both sales and production volume.

Mathematical Examples

Example 1: Fixed Cost = ₹60,000; Selling Price = ₹50; Variable Cost = ₹30;
Break-even Units = 60,000 / (50-30) = 3,000 units

Example 2: Contribution = ₹40,000; Sales = ₹1,00,000;
P/V Ratio = (40,000/1,00,000) × 100 = 40%

Example 3: Actual Sales = ₹1,50,000; Breakeven Sales = ₹1,00,000;
Margin of Safety = ₹50,000

Example 4: Fixed Costs = ₹25,000; Contribution per Unit = ₹10;
BEP (units) = 2,500

Example 5: Sales = ₹3,00,000; Variable Costs = ₹1,80,000;
Contribution = ₹1,20,000; P/V Ratio = 40%

Example 6: Under Absorption Costing: Fixed Cost = ₹40,000; Produced Units = 4,000;
Fixed cost/unit = ₹10

Example 7: Units Produced = 10,000; Units Sold = 8,000; Fixed Cost = ₹50,000;
Closing Stock Valuation under Absorption = 2,000 × ₹5 = ₹10,000

Example 8: Selling Price = ₹60, Variable Cost = ₹45; Units = 2,000;
Contribution = ₹30,000

Example 9: Profit under Absorption = ₹70,000; Under Marginal = ₹60,000;
Difference = ₹10,000 due to fixed cost in closing stock

Example 10: Contribution = ₹2,000, Fixed Cost = ₹1,200;
Profit = ₹800

MCQs

1. In marginal costing, fixed costs are treated as:
a) Product cost
b) Period cost
c) Sunk cost
d) Capital cost
Answer: b) Period cost

2. The breakeven point is the level at which:
a) Sales = Profit
b) Sales = Costs
c) Variable cost = Fixed cost
d) Contribution = Variable cost
Answer: b) Sales = Costs

3. Which of the following affects profit under absorption costing but not under marginal costing?
a) Production volume
b) Selling price
c) Sales volume
d) Variable cost
Answer: a) Production volume

4. P/V Ratio improves if:
a) Fixed cost increases
b) Variable cost increases
c) Selling price increases
d) Sales volume decreases
Answer: c) Selling price increases

5. Margin of safety is the difference between:
a) Actual sales and fixed cost
b) Actual sales and breakeven sales
c) Actual sales and variable cost
d) Actual profit and fixed cost
Answer: b) Actual sales and breakeven sales

6. Fixed cost per unit changes with:
a) Sales volume
b) Production volume
c) Contribution
d) P/V ratio
Answer: b) Production volume

7. Under marginal costing, inventory is valued at:
a) Prime cost
b) Full cost
c) Fixed cost
d) Variable cost
Answer: d) Variable cost

8. Absorption costing is suitable for:
a) Management decisions only
b) Tax purposes only
c) Financial reporting
d) None of these
Answer: c) Financial reporting

9. Contribution is calculated as:
a) Sales - Profit
b) Sales - Fixed Cost
c) Sales - Variable Cost
d) Sales - Total Cost
Answer: c) Sales - Variable Cost

10. The difference in profit under marginal and absorption costing is due to:
a) Variable cost changes
b) Opening stock value
c) Closing stock value
d) Both b and c
Answer: c) Closing stock value