SBCS Campus: Champ Fleur

CAT T4: Lecture 9

Date: 5th Sept 2009
Lecturer: Kelly Ann Traboulay

Topic: Marginal Costing

Objective: By the end of this session, each student should be able to:

- Produce a Profit Statement using the Marginal costing method

- Reconcile the profits obtained under Absorption costing with that under
Marginal costing
- Make comparisons between the 2 methods

Lecture 9 Sequence:
- Define Marginal Costing
- Elements used in Marginal Costing
- Profit statement using Marginal Costing
- Profit Reconciliation
- Arguments for Absorption Costing
- Arguments for Marginal Costing
- Worked Questions showing comparisons under both methods
Marginal Costing

Marginal costing is an alternative to the absorption costing method.

Marginal Cost: is the cost of producing an additional product unit = variable cost

Contribution: Sales revenue – Variable (marginal) cost of sales

It is the contribution towards covering fixed overheads and making a profit, and it is of fundamental
importance in marginal costing.

 Under this method variable cost of production is identified i.e. prime cost and variable production
overheads.

 Costs will increase by the variable cost per unit

 Revenues will increase by the sales value of the item sold

 Closing stocks are valued at marginal costs

 Fixed Costs are treated as period costs and charged in full to the profit and loss account in the period
incurred

 If sales increase by one item, the profit will increase by the contribution for the one item

 Contribution per unit is constant at all levels of output and sales.

Under marginal costing, it is necessary to find:-

- Variable costs
- Contribution
- Fixed costs

Profit Statement using Marginal costing:

£ £

Sales X
Variable Cost of Production X
Add Opening stock (at variable cost) X
Less closing stock (at variable cost) X
Variable production cost of sales X
Contribution X
Fixed Costs X
Profit
Profit Reconciliation

The difference in reported profits is calculated as:

The difference between the fixed production overhead included in the opening and closing stock valuations
using absorption costing.

Marginal costing X
Adjust for Fixed O/H in stock:
Increase/decrease X/(X)
Absorption costing X

Increase in Stock Level:

 Absorption costing reports a higher profit
 Fixed overheads included in closing stock
 Cost of sales decreased
 Profit higher

Decrease in Stock Level:

 Absorption costing reports a lower profit
 Fixed overheads included in opening stock
 Cost of sales increased
 Profit lower

Arguments for Absorption Costing:

 Fixed production costs are incurred in order to produce output; therefore all output must be charged
with a share of thee costs.
 Closing stock values must be consistent with the SSAP 9
 Where various products are produced, calculation of their individual contributions may not make it
clear as to what is contributing to the fixed costs of the company and if it is sufficient.

SSAP 9 – states that costs of all stocks should comprise those costs which have been incurred in the
normal course of business in bringing the product to its ‘present location and condition’. These costs
incurred will include all related production overheads, even though these overheads may accrue on a
time basis. In other words, in financial accounting, closing stock should be valued at full factory costs
and it may therefore be convenient and appropriate to value stocks by the same method in the cost
accounting system.
Arguments for Marginal Costing:

 There are no apportionments of fixed costs

 It is simple to operate
 Fixed costs will be the same regardless of the volume of output….therefore they are not to be charged
in full as cost to a period
 The cost to produce an extra item is the variable production cost.
 The size of contribution varies directly with sales volume at a constant rate per unit
 Under or over absorption of fixed overheads is avoided.