Concept of Marginal Cost and Marginal Costing

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The concept of ‘marginal cost’ has been borrowed from economic theory. To the economist, marginal cost is an incremental cost: he considers it as the addition to total cost which results from the production of one more unit of output. That is, it does not arise if the additional unit is not produced.

 

The Institute of Costs and Management Accountants, London, defines marginal cost as:

 

“The amount at any given volume of output by which aggregate cost are changed if the volume of output is increased or decreased by one unit.” As referred to here, a unit may indicate a single article, a batch of articles, an order a stage of production capacity, a processor a department, i.e., it relates to the change in output in the particular circumstances under consideration.

 

Under marginal costing, costs are mainly classified into fixed costs and variable costs. the essential feature of marginal costing is that the product or marginal costs (i.e., those costs which are dependent on the volume of activity, are separated from the period or fixed costs, i.e., costs which remain unchanged with a change in the volume of activity. Variability with the volume of output is the main criterion for the classification of costs into product and period categories. Even the semi-variable costs have to be bifurcated into their fixed and variable components based on the variability criterion. In this regard, the absorption or conventional costing system differs from marginal costing. Under absorption costing system all manufacturing costs, whether of fixed or variable nature are treated as product costs. all companies which use marginal costing as an aid to managerial decision-making mainly use the absorption costing system.

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