Marginal Costing

ACCA F5 - Performance Management 

Marginal Costing principles are used for internal decision-making purposes (short-term). As fixed costs are incurred regardless of the level of activity the purpose of marginal costing is to determine what contribution is been generated (sales less variable costs).

Given a firm has spare capacity, increasing an extra unit of product output only consumes the variable costs for that extra product. This is marginal cost. (in case no spare capacity in the production process, it may need input of fixed cost which will results very high marginal cost for the extra unit) Sum of the marginal cost over all units produced gives total variable costs for production.

Contribution margin is dollar contribution per unit divided by the selling price per unit. Contribution represents the portion of sales revenue that is not consumed by variable costs and so contributes to the coverage of fixed costs.

Absorption/Variable costing

The table provides the relation between variable and absorption income in relation to production and sale for a particular period and its effect on inventory.

Year	Relation between production and sales	Effect on inventory	Relation between variable and absorption income
1st	Production = 25,000 Sales = 20,000	increase by 5,000 units	Absorption > Variable (Total marginal)
2nd	Production = 25,000 Sales = 30,000	decrease to zero	Absorption < Variable (Total marginal)
3rd	Production = 50,000 Sales = 50,000	No change	Absorption = Variable (Total marginal)

Management Accounting - Decision Management

Marginal costing ignores cash flows that won't be affected by a proposal, since they are deemed irrelevant, but this can take a naïve view of prepaid sunk costs or future committed costs when applied to short-term decisions, since firms must cover all their costs in the medium to long term to make a profit. Prepaid or committed costs can't be ignored when preparing quotations just because a company has decided for good business reasons to buy an asset outright rather than leasing it, for example. The application of marginal costing in these circumstances could result in the setting of lower prices, which could trigger a price war and drive down profitability in an entire sector.

Absorption Costing V's Marginal Costing CPA IRELAND

Marginal Costing principles are used for internal decision making purposes (short-term). As fixed costs are incurred regardless of the level of activity the purpose of marginal costing is to determine what contribution is been generated (sales less variable costs).

CIMA: Management Accounting - Decision Management

 CPA Ireland:Absorption Costing V's Marginal Costing CPA IRELAND