Marginal cost can define as “the cost added by producing one new unit of a product. “This process allowed us to increase expenditures without tolerating the total price during production.
Meaning of Marginal cost
Marginal cost is the change in the total cost that arises when the production quantity increases by one new unit. It is the cost of one more unit of a good during production. Marginal cost is the cost of additional inputs required to produce the goods at each production level. It includes all costs of production and considered periods that vary with the level of output.
Importance of marginal cost
Marginal costing is critical for cost and benefits analysis. Marginal costing is a cost-benefit study of business activity to see if the additional benefits gained by taking action that value the cost earned. The marginal analysis uses the profit maximization tool that performs a cost-benefit analysis to determine how an incremental change in production volume can affect the business and its profitability.
Features of Marginal Costing
- Marginal costing is used to regulate the minimal cost and the effect of variable costs on output production.
- All costs can be categorized based on the fluctuation in the fixed price and variable value.
- Marginal costs are treated as the cost of the product during production, while fixed costs are used to establish a Profit and Loss Account for the sustained period.
- Production and Stock of goods are calculated based on marginal costs.
- Selling price can maintain based on marginal cost.
- Cost-volume profit analysis and Break-even analysis are essential for marginal costing.
Marginal cost and its benefits
- Marginal costing is a simple technique to understand and easy to operate because it reduces the distribution of fixed costs.
- Cost comparisons become meaningful in this technique.
- Marginal costing provides useful data for decision-making.
- The impact of profit on sales variations can be clearly shown under marginal costing.
- The Marginal costing technique goes best with other methods like budgeting control and standard costing.
- It launches a relationship between cost, sales, and output volume and break-even analysis.
Application of Marginal Costing
Following are some of the uses of marginal costing:
- Maintain the desired profit.
- Make or buy decision.
- Fixation of selling prices and contract bidding.
Limitations of Marginal Costing
Marginal costing has some of the following restrictions:
- The exclusion of costs into fixed and variable elements is very technical and challenging.
- The linear relationship between costs and output is not valid at some activities because the prices do not remain constant at a different level of operations.
- The stock value cannot be accepted by taxation if it collapses profit.
- Decision-making for pricing cannot be based on just contribution.
- The elimination of fixed costs forces cost comparison of production very difficult.
- The distinction between fixed and variable costs holds good only in a short time. In the long run, yet, all prices are unstable.
The Marginal costing technique helps in the decision-making of production and manufacturing goods. It allows organizations to accumulate the trend and market for their production at a manageable cost and generate good profit while less capital.