This document provides an overview of variable costing (also known as marginal costing). Some key points: 1. Variable costing only includes variable costs in product costs and inventory valuations. Fixed costs are expensed entirely in the period they are incurred. 2. Contribution is defined as the difference between sales and variable costs. It represents the funds available to cover fixed costs and profits. 3. Marginal costing can show different profits than absorption costing depending on whether production matches sales in a period, as absorption costing includes fixed costs in inventory valuation. 4. Marginal costing is useful for profit planning and evaluating performance of different products/departments based on their contribution ratios

1. 1. CONCEPTUAL FRAMEWORKVariable costingisacostingmethodinwhichonlyvariable costsare
accumulatedandcost perunitis ascertainedonlyonthe basisof variable costs.Prime costsand
variable factoryoverheadsare usedtovalue inventories.Fixed coststendtovary withtime,suchas
salariesandrent,ratherthan level of outputandvariable coststendtochange in total withincrease
or decrease inthe level of activity,e.g.,materials,poweretc.Fixedcostswhichare byandlarge
uncontrollable,are nottakenintoaccountundermarginal costingwhile ascertainingperunitcost
but are not ignored.Itshouldbe borne inmindthat variable costperunitare fixedandfixedcosts
perunitare variable withchangesinlevelof output.Variablecostingisgenerallyknownasmarginal
costing.The CIMA has definedmarginal costas"the cost of one unitof product or service which
wouldbe avoidedif thatunitwere notproducedorprovided."Marginal costingisdefinedas"the
accountingsysteminwhichvariable costsare chargedto cost unitand fixedcostsof the periodare
written-offinfull againstthe aggregate contribution.Itsspecial valueisindecision-making."Itisa
technique of applyingthe existingmethodinaparticularmannerinorderto bringout the
relationshipbetweenprofitandvolume of output.Marginal CostingandDirectCostingare often
treatedas interchangeable terms.Profitismeasuredbydeductingfixedcostsfromthe total
contribution.Contributionorgrossmarginis the difference betweensalesandthe marginal costof
sales.Marginal costingassumesthatthe contributionprovidesapool outof whichfixedcost ismet;
any surplusbeingthe profitornet margincontributionorcontributiontofixedcosts.The main
featuresof marginal costingare the following:
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a)Costsare separatedintothe fixedandvariable elementsandsemivariablecostsare also
differentiatedlikewise.b)Onlythe variable costsare takenintoaccountfor computingthe value of
stocksof work-in-progressandfinishedproducts.c) Fixedcostsare chargedoff torevenue wholly
duringthe periodinwhichtheyare incurredandare not takenintoaccount forvaluingproduct
costs/inventories.d)Pricesmaybe basedonmarginal costsand contributionbutinnormal
circumstancespriceswouldcovercostsintotal.e)Itcombinesthe techniquesof costrecordingand
cost reporting.f) Profitabilityof departmentsorproductsisdeterminedintermsof marginal
contribution.g)The unitcostof a productmeansthe average variable costof manufacturingthe
product.
2. CONTRIBUTION If a systemof managerial costingisoperatedinanorganisationwithmore than
one product,it will notbe possible toascertainthe netprofitperproductbecause fixedoverheads
are chargedintotal to the profit andlossaccount rather thanrecoveredinproductcosting.The
contributionof eachproductischarged to the firms total fixedoverheadsandprofitisascertained.
As statedearlier,contributionisthe difference betweensellingprice andvariable costof sales.Itis
visualisedassome sortof a fundor pool,outof whichall fixedcosts,irrespective of theirnature are
to be met,and to each producthas to contribute itsshare.The excessof contributionoverfixed
costs isthe profit. If the total contributiondoesnotmeetthe entirefixedcost,there will be loss.In
normal circumstances,sellingpricescontainanelementof profitbutthere maybe circumstances,
whenproductsmayhave to be soldat cost or evenatloss.Therefore the characterof contributions
will have the followingcompositionunderdifferentcircumstances:
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2. i." Sellingprice containingprofit: "Contribution=Fixedcost+ Profitii." Sellingprice atcost: "
Contribution=Fixedcostiii."Sellingprice atloss: "Contribution=Fixedcost - Loss
3. INCOME DETERMINATION UNDER VARIABLEANDABSORPTION COSTINGUndervariable costing,
onlyfactoryoverheadscoststhattendto vary withvolume are chargedto productcosts inaddition
to prime cost.While evaluatinginventoryonlydirectmaterials,directlabourandvariable factory
overheadare includedandare consideredasproductcosts.Fixedfactoryoverheadunderdirector
marginal costingisnot includedininventory.Itistreatedas a periodcostand chargedagainst
revenue whenincurred.Underabsorptioncosting,sometimescalledfull orconventional costing,all
manufacturingcosts,bothfixedandvariable are chargedto productcosts; ThusAbsorptioncosting
is"a principle wherebyfixedaswell asvariable costsare allottedtocostunits."Itmeansa system
underwhichcost perunitincludesfixedexpenses,especiallyfixedproductionoverheadsinaddition
to the variable cost.Profitemergesonlyafterchargingall costs - fixedandvariable.Inmarginal
costingalsothisis true;onlyprofitis ascertainedbychargingthe fixedexpensescoststo
contribution.Contributionisthe difference betweensellingprice andmarginal costs.Fixedcosts
writtenoff againstthe profit(calledcontribution) duringthe period.Thus;""Sellingprice - Variable
cost = Contribution ""Contribution - Fixedcosts= Profit""If profit and fixedcostsare ""Known,
Fixedcosts+ Profit = Contribution
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Thisgivesus a basicmarginal equation;"Sales - Marginal costs = Contribution=Fixedcosts+ Profit
""""""""(if there isaprofit) " or sales= Marginal costs + Fixedcosts+ Profit Since the closingstocks
do nothave any elementof fixedcosts,profitshownbymarginal costingtechnique maybe different
fromthat shownby absorptioncosting.Whenthe entire stockissold,there isnoinventoryi.e.,
neitherthere isopeningnorclosingstock,the profitrevealedbyboththe methodswillbe same.But
whensalesandproductionare outof balance,difference innetprofitisreported.Whenabsorption
costingisapplied,the fixedmanufacturingcostsare shiftedfromone yeartoanotheryearas a part
of the inventorycosti.e.stock.If a companyproducesmore thanit sells inagivenperiod,notall of
the current manufacturingoverheadswill be deductedfromsalesi.e.,closingstockwill include a
portionof fixedoverheads.Inotherwords,inabsorptioncostinginventorywillbe valuedasahigher
figure;therefore,profitwillbe more asrevealedbyabsorptioncostingthanmarginal costing.Hence,
profitswill notnecessarilyincrease withanincrease insale value.The positionwill be reverse,in
case a companyproduceslessthanitsellsina givenperiod.Thus,marginal costingcanproduce a
netprofit figure whichissmallerthanor greaterthan or equal tothe net profitas shownunder
absorptioncosting.
4. APPLICATION OFVARIABLECOSTINGProfitplanningThere are fourwaysinwhichprofit
performance of a businesscanbe improved:a) byincreasingvolume;b) byincreasingsellingprice;c)
by decreasingvariablecosts;andd) by decreasingfixedcosts.
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Profitplanningisthe planningof future operationstoattainmaximumprofitorto maintaina
specifiedlevel of profit.The contributionratio(whichisthe ratioof marginal contributiontosales)
indicatesthe relativeprofitabilityof the differentsectorsof the businesswheneverthere isachange
insellingprice,variable costsorproductmix.Due to the mergingtogetherof fixedandvariable

3. costs,absorptioncostsfail to bringoutcorrectlythe effectof anysuchchange onthe profitof the
concern.Illustration - 1 A toy manufacturermakesanaverage netprofit of Rs. 2.50 per piece ona
sellingprice of Rs.14.30 byproducingand selling60,000 piecesor60% of the potential capacity.His
cost of salesis:" Direct material""" " Re. 3050 " Direct wages""""Rs."1.25 " Works overhead"""
" Rs. 6.25 (50% fixed) "Salesoverhead"""" Re.0.80 (25% variable) Duringthe currentyear,he
anticipatesthathis fixedchargeswill goupby 10% while ratesof directmaterial anddirectlabour
will increase by6%and 8% respectively.Buthe hasnooptionof increasingthe sellingprice.Under
thissituationhe obtainsanofferforan orderequal to 20% of hiscapacity.The concernedcustomer
isa special customer.Whatminimumprice will yourecommendforacceptance toensure the
manufacture anoverall of Rs.1,67,300 ?
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Solution:
PreviousYear
PerPiece Rs.
Amount Rs.
PerPiece Rs.
BudgetforCurrentyear priorto acceptance of 20% excessorders Amount Rs.
Sales Variablecost: Directmaterial Directlabour Variableworks Overhead Variable sales
Overhead
Contribution Fixedcost: Worksoverhead Salesoverhead Profit
14.30
3.500 1.250
3.125
0.200 8.075 6.225
1,87,500 36,000
8,58,000

4.
4,84,500 3,73,500
2,23,500 1,50,000
14.30
3.710 1.350
3.125
0.200 8.385
2,06,250 39,600
8,58,000
5,03,100 3,54,900

5.
2,45,850 1,09,050
Marginal cost of additional 20,000 units:" " " Rs.1,67,700 ""(Rs.20,000 x Rs. 8.385) Increased
contributionrequired=Rs. 1,67,300 - Rs.1,09,050 = Rs. 58,250 Total Salesprice expectedfor20,000
units:" = Rs.1,67,700 + Rs. 58,250 Salesprice perunit= Rs. 2,25,950 = Rs.11.297 """"""20,000
Note:Suchconcessional price isacceptable onlyforspecial markets(e.g.,exportmarket) orspecial
customerslike governmentandonlyif idle capacityexists.
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Illustration - 2 The followingdatarelate toa manufacturingcompany:Plantcapacity:""4,00,000
unitsperannum Presentutilization:"40% Actualsfor the year 1991 were: SellingPrice """"""Rs.
50 per unit Materialscost" " " " " " Rs. 20 perunit Variable ManufacturingCosts""Rs.15 perunit
FixedCosts""" " " " " Rs. 27 lakhsIn orderto improve capacityutilizationthe followingproposalsare
beingconsidered:Reduce sellingprice by10% Spendadditional Rs.3 lakhsonsalespromotionHow
manyunitsshouldbe made and soldinorderto earn a profit of Rs. 5 lakhsperyear?Solution:
Revisedsellingprice (Rs.50less10%)"""""""""Rs.45 per unit Variable Costs Material Cost"""""Rs.
20 Variable ManufacturingCost (perunit)""""""Rs.15 Total Variable Cost""" " " " " " " Rs. 35 per
unit Contribution"""" " " " " " " " Rs. 10 perunit Total Contributionrequired: FixedCosts"""" " "
" " " " " Rs. 27,00,000 AdditionalPromotionExpenses""" " " " Rs. 3,00,000 Profit"" " " " " " " " " "
" Rs. 5,00,000 """""""""""""Rs.35,00,000
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Total numberof unitstobe made and soldtoearc Rs. 35,00,000 " = " Total Contribution
""Contributionperunit"= " Rs. 35,00,000 = 3,50,000 units. """Rs.10 Evaluationof Performance:
The varioussectionof a concern suchas a department,aproductline,ora particularmarketor sales
division,have differentrevenue earningpotentialities.A companyalwaysconcentratesonthe
departmentsorproductlineswhichyieldmore contributionthanothers.The performance of each
such sectorcan be broughtoutby meansof cost volume -profitanalysisorthe contribution
approach.The analysiswill helpthe companytotake decisionthatwill maximize the profits.
Illustration - 3 A businessproducesthree productsA,Band C forwhichthe standard variable costs
and budgetedsellingpricesare asfollows:""""""""A"""B" " " C """"""""Rs.""" Rs."" " Rs. Direct
Material"" " " " 3" " " 6" " " 8 DirectWages"""""4"" " 4" " " 10 Variable overhead""" " 3" " " 5" " "
7 Sellingprice""""" " 18" " " 25" " " 48 In twosuccessive periods,salesare asfollows:""""""""A""
" B" " " C """"""""Units""Units"" Units PeriodI"" " " " " " 10,000"" 10,000"" 10,000 PeriodII""" "
" " " 20,000"" 13,000"" 5,000 The budgetfixedoverheadsamountedtoRs.1,35,000 foreach period.
In spite of increasedsalesthe profitforthe secondperiodhasfallenbelow thatof the 1st period.
Presentfigurestomanagementtoshowwhythisfall inprofitsshould,orshouldnothave occurred.
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Solution:"""""""""""""""""" """"ProductA""" ProductB"" " Product C""" Total"" Sales(units)"
10,000 20,000 10,000 13,000 10,000 5,000 30,000 38,000 (Rs.000) Sales(value)" "

6. 180" 360" 250" 325" 480" 240" 910" 625 Variable Cost""100" 200" 150" 195"
250" 125" 500" 520 Contribution"" 80" 160" 100" 130" 230" 115" 410" 405
Fixedoverheads""" " " " " " " " " 135" 135 NetProfit""" " " " " " " " " " " 275" 270
Marginal Contribution Ration(%)""A:44.4"" " " B: 40.0" " " C: 47.9
Comments:Saleshave increasedby8,000 unitsbutthe salesvalue hasincreasedbyRs.15,000.
Marginal costs have increasedbyRs.20,000 to meetcost of increasedunitsof production,resulting
inthe fall of profitsby Rs.5,000. ProductC whichyieldsthe highestpercentage of contributionto
salesisthe most profitable line.ProductA comesnextandproductB isthe leastprofitable of the
three.The unsatisfactorypositioninPeriodIIisbecause of unfavourablesalesmix asthe production
of mostprofitable line Chasbeencutdownand the lessprofitable productsA and B have been
pushedup.Illustration - 4A factoryproduces300 unitsof a product permonth.The sellingprice is
Rs. 120 and variable costRs. 80 perunit.The fixedexpensesof the factoryamountto Rs.8,000 per
month.Calculate:(i) the estimatedprofitinamonthwhere in240 unitsare produced,(ii) the sales
to be made to earn a profit of Rs. 7,000 permonth.
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Solution:
Make or Buy Decisions:Whenthe managementisconformedwiththe problemwhetheritwouldbe
economical topurchase a componentora product fromoutside sources,orto manufacture it
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internally,marginal costanalysisrendersuseful assistance inthe matter.Undersuchcircumstances,
a misleadingdecisionwouldbe takenonthe basisof the total cost analysis.Incase the proposal isto
buyfrom outside then,whatisalreadybeingmade,andthe price quotedbythe outsidershouldbe
lowerthanthe marginal cost.If the proposal isto make something whatisbeingpurchasedoutside,
the cost makingshouldinclude all additional costslike depreciationonnew plant,interestoncapital
involvedandthatcostshouldbe comparedwiththe purchase price.Illustration - 5 A.T.V.
manufacturingcompanyfinds thatwhile itcoststo make componentX,the same isavailable inthe
marketat Rs. 5.75 each, will all assurance of continuedsupply.The breakdownof costsis:
Material""" " " " " " Rs. 2.75 each Labour" " " " " " " " Rs. 1.75 each Variable overheads"""" " Rs.
0.50 each Depreciationandotherfixedcost""Rs.1.25 each """""""""Rs.6.25 each a) Shouldthe
companymake or buy the component?b) What shouldbe yourdecisionif the supplieroffered
componentatRs.4.85 each ? Solution:Marginal costperunitof componentX""Rs.2.75
Materials""""""""Rs.1.75 Labour" " " " " " " " " Re.0.50 Variable overheads""" " " " Rs. 5.00 a) The
purchase cost of the above componentisRs.5.75 each.If the companyishavingspare capacity
whichcannotbe filledwithmore remunerative jobs,itisrecommendationthatthe above
componentbe manufacturedinthe companysince the marginal costat Rs.5.00 eachis lessthanthe
purchase cost of Rs. 5.75. b) Inthe eventof purchase cost of Rs.5.00 each,it isrecommendedthat
the componentbe boughtfromthe supplierasthisresultsina savingof Re.0.15
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7. each.The spare capacitythus available canbe utilizedforotherpurposes,asfaras possible.Closure
of a DepartmentorDiscontinuance of aProduct:As discussedearlier,marginalcostingtechnique
helpsindecidingthe profitabilityof aproduct.It providesthe informationinamannerthat tellsus
howmuch eachproduct contributestowardsfixedcostandprofit;the productor departmentthat
givesleastcontributionshouldbe discardedexceptforashort period. If the managementisto
choose some productout of the givenones,thenthe productsgivingthe highestcontributionshould
be chosenand givingthe leastshouldbe discontinued.MaintainingaDesiredLevel of profitA
companyhas to cut pricesof its productsfromtime to time because of competition,Government
regulationandothercompellingreasons.The contributionperunitonaccountof such cuttingis
reducedwhile the industryisinterestedinmaintainingaminimumlevelof itsprofits.Incase the
demandforthe company'sproduct iselastic,the maximumlevel of profitscanbe maintainedby
pushingupthe sales.The volume of suchsalescan be foundoutby marginal costingtechniques.
Illustration - 6 S.Ltd. manufacturesandmarketsa single product.The followinginformationis
available:There isacute competition.Extraeffortsare necessarytosell.Suggestionshave been
made for increasingsales:""""""""""""Rs.Perunit Materials"""""""""""8.00 Conversioncosts
(variable)""" " " " " 6.00 Dealersmargin""" " " " " " " " 2.00 Sellingprice""""" " " " " " 20.00
FixedcostRs.2,50,000 PresentSales80,000 units Capacityutilization:60 perunit
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MARGINALCOSTING
i.By reducingsalesprice by5% ii.By increasingdealersmarginby 25% overthe existingrate.Which
of the twosuggestionyouwouldrecommendif the companydesirestomaintainthe presentprofit?
Give reasons.Solution:Presentmarginalcostperunit:""""""""""""Rs. Materials""""""""""8.00
Conversioncosts""""""""6.00 Dealerscosts""" " " " " " 2.00 Total"""""""""" 16.00
Contributionperunit=Sellingprice - Marginal cost ""= Rs. 20.00 - 16.00 = Rs. 4.00 Total
Contribution=Rs.4. x 90,000 = 3,60,000 Profit= Contribution - Fixedcost " = Rs. 3,60,000 - Rs.
2,50,000 = Rs. 1,10,000 Since inbothsuggestions, fixedcostsremainunchanged,the presentprofit
can be maintainedbykeepingthe total contributionatthe presentlevel i.e.Rs.3,60,000.i.Reducing
salesprice by5% " NewSalesprice""="(Rs.2000 - Rs. 1.00) = Rs. 19.00 " New dealersmargin"="
10% of Rs. 19.00 """"""=" Rs. 1.90 " Variable Costs """"""="Rs.8 + Rs. 6 + Rs. 1.90 = Rs. 15.90 "
Contributionperunit"="Rs. 19.00 - Rs. 15.90 = Rs. 3.10 "
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MARGINALCOSTING
Sales(units) requiredtomaintainthe presentlevel of profit."""=" Total contribution"""=" Rs.
3,60,000 """"Contributionperunit"""" Rs. 3.10 """=" 1,16,111 unitsii.Increasingdealersmarginby
25% " Newdealersmargin"=Rs. 2 + 25%" " " " =" Rs. 2.50 " New variable cost"= Rs. 8 + Rs. 6+
Rs. 2.50"" =" Rs. 16.50 " Contribution"""= Rs. 20 - Rs. 16.50"" " =" Rs. 3.50 " Sales(units)"""=
Rs. 3,60,000" """=" 1,02,857 units " " " " " " " Rs. 3.50 The secondproposal isrecommended
because the contributionperunitishigherandthe sales(inunits) are lower.Lowersaleseffortsand
lessfinance wouldbe requiredinimplementingthe proposal.Offeringquotation:One of the best
waysfor salespromotionistoofferquotationatlow rates.A companyisproducing80,00 units
(80%) of capacity andmakinga profit of Rs. 2,40,000. Suppose the PunjabGovernmenthasgivena
tendernotice for20,000 units.Itis expectedthatthe unitstakenbythe Governmentwill notaffect
the sale of 80,000 unitswhichthe companyisalreadysellingandthe companyalsowishestosubmit
the companyis alreadysellingandthe companyalsowishestosubmitthe lowestquotation.The

8. companymay quote anyamountabove marginal cost,because itwill give anadditional marginal
contributionandhence profit.AcceptinganOfferorExportingbelow Normal Price:Sometimesthe
volume of outputandsale may be increasedbyreducingthe normal pricesof additionalsale.Inthis
case the concernshouldbe cautiousenoughtosee thatthe sale below normal price inadditional
marketsshouldnotaffectthe normal market.To be on the safe side the productmay be soldunder
the label of a differentbrand.If there isadditional sale because of exportorders,goodsmaybe sold
at a price belowthe normal.
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Illustration - 7 The cost of a manufacturingcompanyforthe products:"""""""""Rs.
Materials"""""""12.00 Labour"" " " " " " " 9.00 Variable expenses""" " " 6.00 Fixedexpenses"""
" " " 18.00 Total""""""""45.00 The unitof productis sectorRs. 51.00 The company'snormal
capacityis 1,00,000 units.The figuresgivenabove are for80,000 units.The companyhas receivedan
offerforadditional 20,000 units@ Rs.36 per unitfroma foreigncustomer.Advisethe manufacture
on whetherthe ordershouldbe accepted.Alsogiveyouradvice if the orderisfroma local merchant.
Solution:Marginal Costforadditional 20,000 unitsPerunitFor 20,000 unitsRs.Rs. Material Labour
Variable expenses Marginal cost12.00 9.00 6.00 27.00 2,40,000 1,80,000 1,20,000
5,40,000 Additional revenuetobe realized"""= S.P. - Marginal cost (Rs.36 x 20000) """""""""=
7,20,000 - 5,40,000 Additional revenuetobe realized"""= S.P. - Marginal cost (Rs.36 x 20000)
"""""""""= 7,20,000 - 5,40,000 Additional revenue tobe realized""" = S.P. - Marginal cost (Rs.36 x
20000) """""""""= 7,20,000 - 5,40,000 As the fixedcostof Rs. 18 is fixeduptothe normal capacity of
1,00,000 unitsthese additional 20,000 unitswill generatearevenue of (Rs.7,20,000 - 5,40,000),
hence the ordershouldbe accepted.