PRINCIPLES OF MARGINAL COSTING

1. Fixed costs are the same whatever volume of sales and production.

2. What happens if one extra unit is sold?

a) Revenue increases by sales value of one item.

b) Costs increase -- by the variable cost per unit.

c) Increase in profit will equal sales value minus variable costs i.e. contribution.

3. If volume of sales falls by one item -- profit will fall by amount of contribution.

4. Profit measurement should therefore be based on analysis of total contribution. Fixed costs do not change with rises or falls in sales volume, so it is misleading to charge units of sales with fixed costs -- Absorption costing is misleading. It is more appropriate to deduct fixed costs from total contribution to give profit.

5. When a unit of product is made the extra costs incurred are the variable production costs -- fixed costs do not change. Valuation of closing stocks should be at these variable production costs because they are the only costs properly attributable to the product.

A MARGINAL COST is that part of the cost of a unit of product/service that would be avoided if that unit were not produced/provided.

The marginal production cost per unit is usually therefore: a) direct materials b) direct labour c) variable production overheads

CONTRIBUTION Contribution is the difference between sales value