The technique of marginal costing involves the following steps:
a)Differentiation between the fixed costs and variable costs; b)Ascertainment of marginal costs and c)Ascertaining the effect on profit due to changes in volume or type of output; i.e. the determination of cost-volume-profit relationship.
The steps involved in marginal costing are explained as below: a)Difference between fixed costs and variable costs: Marginal costing technique involves the segregation of all costs into fixed costs and variable costs. The costs may be divided into fixed costs, variable costs and semi fixed or semi variable costs. Fixed cost may be defined as a cost which tends to remain unaffected in aggregate by changes in the volume of output. Fixed costs are generally referred to as period costs as they are incurred on the basis of time and do not vary directly with volume or rate of output such as rent, rates, insurance premium etc.
The variable cost may be defined as a cost which tends to change in aggregate in direct proportion to changes in output. The variable costs mainly depend on output and are sometimes referred to as direct costs. The examples of variables costs are direct material cost, direct wages, direct expenses etc. Semi variable cost or semi fixed cost is a cost which is partly fixed and partly variable. It tends to change in aggregate with changes in volume of output but not directly in proportion to such changes. The examples of semi variable costs are repairs and maintenance, cost of supervision etc.
b)Ascertainment of marginal cost: Under the marginal costing technique only variable costs are applied to products. The cost of production is the marginal cost of production and the cost of sales is the marginal cost of sales. The marginal cost refers to the aggregate of prime cost and all variable overheads. The prime cost is the aggregate of direct material cost, direct wages and direct or chargeable expenses. All variable overheads means variable overheads plus the variable portion of semi variable overheads. Semi variable overheads are partly fixed and partly variable and require segregation into fixed and variable elements.
The variable portion is added to fixed overheads thus forming part of marginal cost whereas the fixed portion is added to fixed overheads and the total fixed overheads are treated as separate costs. These separate costs are related to time and hence are known as period costs. The main problem to a cost accountant is to segregate the semi variable overhead into fixed and variable elements. The segregation or separation of semi variable overhead into fixed and variable elements can be done by adopting various methods such as comparison method. The high and low points method, equation method, averages method, graphical method or least square method.
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