Meaning of Marginal cost
Chartered Institute of Management Accounting (CIMA) defines the term marginal cost that it excludes fixed overhead cost entirely from cost of production but charged against ‘fund’ which arises out of excess of selling price over total variable cost.
So it is the amount at any given volume of output by which total cost is changed if the volume of output is increased or decreased by one unit.
For example variable cost is Rs. 20 per unit. Fixed expenses =100000 output= 20000 units
Total cost = 100000+ 400000 =500000
If the output increases by 1 unit
Total cost will be= 100000+ 400010=500010
In this case the marginal cost will be = 10
Thus the above example shows that only variable cost form part of product cost because only variable cost is changed if the output is increased or decreased and the fixed cost remains the same.
Features of marginal cost
1) In this all costs are divided into two parts i.e. marginal cost and variable cost.
2) Only variable cost forms the part of product cost fixed cost remains constant.
3) Profit is calculated by deducting marginal cost and fixed cost from sales.
4) Breakeven point is a part of marginal cost.
5) The profitability of product is based on the contribution
6) Contribution= selling price- marginal cost
Or contribution = fixed expenses+ profit
Advantages of marginal cost
1) It is easy to understand, simple.
2) It is a useful tool in decision making.
3) It is helpful in profit planning.
4) It helps in finding out break even ratio.
5) It helps in knowing the performance of different departments.
6) It is also helpful in standard costing and budgetary control.
Disadvantages of marginal cost
1) To make fixed and variable cost separate is difficult.
2) Cost control can be done in a better way in standard costing or budgetary control.
3) It is not applicable in ship building industry where value of work in progress is high.
4) Due to development of technology fixed cost increased and its impact on production is more than variable cost.