what is marginal cost example?

Give managerial application of marginal costing. Support your answer with practical illustrations.(2021)

Managerial Applications of Marginal Costing

Marginal costing is a costing technique where only variable costs (costs that change with the level of production) are considered when determining the cost of a product, while fixed costs (Which costs do not change with production level) are considered as period costs. This method provides valuable insights for decision-making in various managerial applications. what is marginal cost example?

Here are some key managerial applications of marginal costing, supported by practical illustrations:

1. Decision-Making for Pricing

Application:
Marginal costing helps managers determine the minimum price at which a product should be sold to cover variable costs and make a contribution toward covering fixed costs.

Practical Illustration:

A company manufactures a units with the following costs:

• Variable cost per unit: ₹100
• Fixed costs: ₹20,000 per month
• Monthly production: 500 units

The company would like to know the minimum price at which the product should be sold to break even for the purpose of market capture.

Calculation:

• Total variable cost = ₹100 × 500 = ₹50,000
• To break even, the company needs to cover the fixed costs of ₹20,000. Therefore, the price should be set higher than ₹100 to contribute to the fixed costs. what is marginal cost example?

Breakeven price per unit:

Price=Variable cost per unit +(Fixed costs÷ Units produced) =100+(20,000÷500) =100+40=₹140

Thus, the company must sell the product for at least ₹140 to cover both variable as well as fixed costs. what is marginal cost example?

2. Product Mix Decisions

Application:
Marginal costing helps in deciding the most profitable product mix when there are constraints on resources, such as labor or machine time. Managers can choose the combination of products that maximizes contribution margin per unit of the scarce resource. what is marginal cost example?

Practical Illustration:

A company manufactures two products, A and B, with the following data:

The company has 200 hours of machine time available each month.

Decision:

• The contribution margin per hour of product A = ₹50 / 2 = ₹25
• The contribution margin per hour of product B = ₹30 / 1 = ₹30

Thus product B earns a higher contribution margin per hour, thus company must produce product B for the purpose of maximising profits. what is marginal cost example?

3. Profitability Analysis and Break-even Analysis

Application:
Managers use marginal costing to conduct break-even analysis to determine the sales volume needed to cover total costs. This analysis helps in setting sales targets and understanding the financial viability of the business. what is marginal cost example?

Practical Illustration:

A company produces and sells a product with the following data:

• Selling price per unit: ₹200
• Variable cost per unit: ₹120
• Fixed costs: ₹60,000

Break-even Point (BEP): The BEP is the point at which total revenue equals the total costs which includes (fixed + variable), meaning where there is no profit or loss for the organisation.

BEP (in units)=Fixed CostsSelling Price per unit−Variable Cost per

BEP=60,000200−120=60,00080=750 units

So, the company needs to sell 750 units to break even. If Sales occurs beyond this point will contribute to profit.

4. Make or Buy Decisions

Application:
Marginal costing is very helpful in business. Which helps managers in deciding whether to manufacture a product in-house or buy it from an external supplier, which one will be beneficial to the organization. So based on the comparison of the cost of manufacturing versus the cost of purchasing, Thus the decision will be taken by the manager.

Practical Illustration:

A company produces a component in-house with the following costs:

• Variable cost per unit: ₹50
• Fixed costs: ₹30,000 per month
• Number of units produced: 2,000

An external supplier offers to sell the component for ₹70 per unit.

Cost of Manufacturing (in-house):

• Total variable cost = ₹50 × 2,000 = ₹1,00,000
• Fixed costs = ₹30,000
• Total cost = ₹1,00,000 + ₹30,000 = ₹1,30,000

Cost of Purchasing (external):

• Cost of buying = ₹70 × 2,000 = ₹1,40,000

Since the total cost of manufacturing (₹1,30,000) is less than the total cost of buying (₹1,40,000), it is more cost-effective to produce the component in-house. what is marginal cost example?

5. Contribution Margin Analysis for Decision-Making

Application:
Managers use marginal costing to analyze the contribution margin of different products or services to understand how much each product contributes to covering fixed costs and generating profit.

Practical Illustration:

A company manufactures three products with the following data:

The company needs to decide which product to focus on.

Decision: All products have the same contribution margin (₹200), but managers should also consider factors like sales volume, production capacity, and customer demand when making the final decision. Marginal costing allows for easy comparison and helps prioritize high-margin products if there is limited capacity. what is marginal cost example?

6. Cost Control and Reducing Wastage

Application:
Marginal costing can be used to identify inefficiencies and control costs by focusing only on variable costs. Managers can monitor these costs closely and take corrective actions to minimize waste and inefficiencies.

Practical Illustration:

A company observes that its variable costs for raw materials have increased by 10% over the last month. Using marginal costing, the company identifies the exact areas where waste is occurring, such as excessive spoilage during production. As a result, the company takes corrective action to reduce waste and improve efficiency, lowering variable costs in the future. What is marginal cost example?

Conclusion:

Marginal costing is a powerful tool that helps managers make key decisions such as setting prices, evaluating product mix, conducting break-even analysis, deciding whether to make or buy, and controlling costs. By focusing on variable costs and the contribution margin, marginal costing provides actionable insights that can significantly improve profitability and operational efficiency. You can find the syllabus of Cost Accounting on the official website under Gndu.

Essential questions of Cost Accounting

1. Budget and Budgetary control notes
2. Ascertainment of Profit on Contracts nearing completion.

what is marginal cost example?