MARGINAL COST BY ER. A, KULKARNI

Saturday Brain Storming Thought (192) 14/10/2023

MARGINAL COST

The marginal cost is the change in total production cost that comes from making or producing one additional unit

Key Takeaways of Marginal Cost

1) Marginal Cost is an important concept in managerial accounting

2) it can help an organisation optimize it’s production through economies of scale

3) a company can maximize its profits by producing to where marginal cost (MC) equals marginal revenue (MV)

4) fixed costs are constant regardless of production levels, so Higher production leads to a lower fixed cost per unit as the total is allocated over more units

5) variable costs change based on production levels, so producing more units will add more variable costs

6) companies must be mindful of when increasing production necessities results in step costs due to changes in relevant ranges (ie additional machinery or storage space needed)

Marginal Cost Formula

Marginal Cost = (change in total expenses) / (change in quantity of units produced)

Marginal Cost example

If firm produces X unit at a cost of Rs 300

If (X + 1) units ata cost of Rs 320

Then the cost of additional unit is Rs 20, which is marginal cost

Marginal Costing

Marginal costing is defined as the technique of presenting cost data wherein variable costs and fixed costs are shown seperately for managerial decision making

Technique of the analysis of cost information for the guidance of management which tries to find out an effect on profit due to changes in the volume of output

Absorption Costing

It is costing system which treats all manufacturing costs including both the fixed and variable costs as product costs

Principle of Marginal Costing

1) revenue will increase by the sales value of the item sold

2) costs will increase by the variable cost per unit

3) profit will increase by the amount of contribution earned from the extra item

4) if the volume of sales falls by one item, the profit will fall by the amount of contribution earned from the item

5) profit measurement should therefore be based on an analysis of total contribution

6) when the unit of product is made, the extra costs incurred in its manufacture are the variable production costs

Advantages of Marginal Cost

1) marginal cost is simple to understand

2) it helps in short-term profit planning by breakeven and profitability analysis

3) practical cost control is greatly facilitated

4) efforts can be concentrated on maintaining a uniform and consistent marginal cost, which is useful to various levels of management

Marginal cost concept is helpful in decision making

1) make or buy decision

2) capturing the foreign markets

3) change of product mix

4) sales price in normal condition

5) determination of minimum price

6) temporary/permanent closure of production

Disadvantages of marginal cost

1) normal costing systems also apply under normal operating volume and this shows that no advantage is gained by marginal costing

2) under marginal costing, stocks and work in progress are understated, the exclusion of fixed costs from inventories affect Profit

3) marginal cost data becomes unrealistic in case of highly fluctuating levels of production eg in case of seasonal factories

4) for long-term profit planning, absorption Costing is the only answer

Marginal Cost and Standard Cost

Marginal cost is a part of the standard cost

Standard cost is a broader concept than the marginal cost

Standard costing is a form of costing which comprises of two types of costing techniques that is, marginal costing and absorption costing

Level of marginal cost

A lower marginal cost of production means that the business is operating with lower fixed costs at a particular production volume

If the marginal cost of production is high, then the cost of increasing production volume is also high and increasing production may not be in the business’s best interest

Markup on marginal cost

Markup is the difference between price and marginal costs, as a percentage of marginal cost

The more elastic the demand curve faced by a firm, the smaller the markup

Marginal cost curve

It is the graphical representation of the relationship between the marginal cost and the quantity of output produced by the firm

The marginal cost curve usually has a U shape

Marginal cost decreases for low level of output and increases for larger output quantities

Marginal cost declines by increasing the number of goods produced and reaches a minimum value at some point

Then it starts to increase after its minimum value has been reached

Minimum cost output

The point where the marginal cost curve intersects the average total cost curve shoes the minimum cost output