This lesson explores marginal costing, a technique that differentiates between fixed and variable costs. It is a powerful tool for internal decision-making, as it focuses on the concept of ‘contribution’ and the behaviour of costs. This approach is central to the CIMA syllabus under ‘marginal costing’ .

• Definition of Marginal Cost: The marginal cost is the total variable cost attributable to producing one additional unit of a product or service. It includes direct materials, direct labour, and variable overheads.

• The Principles of Marginal Costing: Under marginal costing, only variable costs are charged to products. Fixed costs are treated as period costs and are expensed in full against the profit of the period, regardless of production levels. This is a key difference from absorption costing, where fixed costs are included in product costs.

• The Concept of Contribution: The central metric in marginal costing is contribution. Contribution = Sales Revenue – Total Variable Costs. It represents the amount of revenue available to first cover the firm’s fixed costs and then to generate profit .

• Reconciling Marginal and Absorption Profits: Because marginal and absorption costing treat fixed overheads differently, they will report different profit figures for a period when inventory levels change. If production exceeds sales (inventory increases), absorption costing will report a higher profit because some fixed overhead is deferred in inventory. If sales exceed production (inventory decreases), marginal costing will report a higher profit .

• Advantages of Marginal Costing: Marginal costing provides a clearer picture of the relationship between costs, volume, and profit. It is simpler and avoids the complexities of overhead allocation. It also avoids the need to make arbitrary assumptions about fixed cost absorption, making it more useful for operational decisions .