Marginal Costing

Question 1

What is marginal costing

Answer 1

Marginal costing uses variable production costs only. This includes variable production overheads. These costs are charged to cost units and the fixed costs attributable to the relevant period are written off in full against the contribution for the period.

Inventory is valued at the variable cost of production only. This is not allowed in IAS2.

Question 2

What are the marginal costing formula

Answer 2

Contribution per unit = selling price – all variable costs per unit

Question 3

What are the advantages of marginal costing

Answer 3

1. Most appropriate for short term decision making as it highlights the contribution. The actual cost of production is very clear.
2. Fixed costs are treated in accordance with their nature, that is as period costs. I.E fixed costs should not increase or decrease with production volume.
3. Profit depends on sales and efficiency, not production levels. I.E. Profit could be increased by increasing production of unsold inventory as the fixed cost would be carried over into the next period.
4. Slightly simpler variance analysis

Question 4

What are the disadvantages of marginal costing

Answer 4

1. Products sold on an ongoing basis at a marginal contribution, which fails to cover fixed costs.
2. Does not comply with IAS2.
3. Categorising fixed & variable costs can be arbitrary.
4. Inadequate when fixed costs are a large portion of total costs

Question 5

What are the differences between marginal and ABC costing

Answer 5

Marginal analysis can only be used in short term decision making.
ABC is a longer term view that overhead and fixed overhead can variable but not in relation to output, they may relate to another cost driver

Where fixed costs are a large proportion of the total production cost, ABC can help reveal which products are profitable. Marginal costing does not provide this insight