Marginal costing is one of the important concepts of cost accounting. In the case of the camera when we want to take picture of an object which is far we zoom the camera so that we can get a clear picture of the object, in case of marginal costing it is a costing method that helps companies zoom in on the most critical costs of production which is the variable costs. Marginal costing in simple words is a way for companies to figure out how much it costs to make one thing. They only look at the things that change when they make more or less of that thing, like the materials and the workers needed to make it. When a company knows how much it costs to make one thing, it can decide how much to sell it for to make some money. And if it knows how much money it will make from each thing it sells, it can decide if it’s worth making that thing or if it should make something else instead. In order to understand this concept better one should look at some of the important features of marginal costing –
Features of Marginal Costing
Variable Costing
The first and foremost feature of marginal costing is that marginal costing considers the variable costs of production, such as direct materials, direct labor, and direct expenses when determining the cost of a product. Hence for example if the fixed cost of a product is $200 and the cost of direct labor in making one additional product is $10 then marginal costing will consider the $10 while calculating the marginal cost of the additional product.
Use of Contribution Margin
The contribution margin is the highlight of marginal costing in the sense that the contribution margin is calculated by subtracting the total variable costs from the selling price of a product and hence this contribution margin helps the company in determining what is the profit potential of producing the extra product and hence in a way is guiding principle as far as marginal costing is concerned.
Simplicity
Another important characteristic of marginal costing is the simplicity of this costing method as anyone having basic knowledge of accountancy can easily understand this concept of accountancy as compared to other methods of costing which involve complex terms as well as calculations.
Short Term Focus
Marginal costing has a short-term focus in the sense that marginal costing is primarily used for short-term decision-making, as it only considers the impact of changes in production volume on profits without analyzing the long-term impact of any decision based on marginal costing.
Helps in Better Pricing
Marginal costing can be used to determine the optimal selling price for a product, based on the contribution margin and the fixed costs. Hence for example if the variable cost per unit is $10 and the fixed cost per unit is $10 then the breakeven price of the product is $20 and the company will do well to price the product anything above $20.
Marginal Costing helps in Decision Making
Marginal costing also helps the company when the company is facing the dilemma of choosing between the production of two products as marginal costing can be used to determine which product is giving the company the highest contribution margin. Hence for example if product A is giving a contribution of $20 and product B is giving a contribution of $30 than the company should choose product B over product A.
As one can see from the above that marginal costing has some unique characteristics and that is the reason why any company thinking of doing marginal costing should carefully read the above points and then only should take any decision whether it wants to go for marginal costing or for some other costing method.