Marginal Costing: formula sheet

Key formulas

Marginal cost equation (contribution)

Contribution = Sales − Variable Cost

Variable cost includes variable production, administration, selling and distribution costs.

Marginal cost equation (profit)

Profit = Contribution − Fixed Cost

Equivalent form: Sales − Variable Cost = Fixed Cost + Profit.

Contribution per unit

Contribution per unit = Selling price per unit − Variable cost per unit

Total contribution = contribution per unit × units sold.

Marginal cost of production

Marginal cost = Direct material + Direct labour + Direct expenses + Variable overheads

Used to value stock and work in progress under marginal costing.

Closing stock valuation

Marginal costing: stock at variable production cost. Absorption costing: stock at variable production cost + fixed production overhead absorbed

Selling and distribution costs are not included in stock value under either method.

Marginal costing income statement

Sales − Variable cost of sales − Variable selling cost = Contribution; Contribution − Total fixed costs = Profit

Variable cost of sales = Opening stock + Variable production cost − Closing stock, all at variable cost. All fixed costs, including production, selling and administration, are charged in full.

Absorption costing income statement

Sales − Cost of goods sold ± Under/over absorption − Selling, distribution and administration costs = Profit

Cost of goods sold = Opening stock + Production cost (variable + absorbed fixed) − Closing stock, at full production cost.

Fixed overhead absorption rate

Rate per unit = Budgeted fixed production overhead ÷ Budgeted (normal) production units

Use units of production, not sales. Under/over absorption = Actual fixed overhead − Absorbed overhead (production units × rate).

Stock valuation rule

Marginal stock value per unit = Variable production cost; Absorption stock value per unit = Variable production cost + Fixed overhead rate

Non-production costs are excluded from stock under both methods.

Profit difference

Absorption profit − Marginal profit = Fixed overhead in closing stock − Fixed overhead in opening stock

If the rate is the same in both periods, this equals (Closing stock units − Opening stock units) × Fixed overhead rate per unit. If the rate differs, value each stock separately.

Direction of the difference

Stock rises: absorption profit higher. Stock falls: absorption profit lower. Stock unchanged in units at the same rate: profits equal.

Use this as a quick check on the sign of your answer.

Contribution

Contribution = Sales − Variable cost = Fixed cost + Profit

Per unit: Contribution per unit = Selling price per unit − Variable cost per unit.

P/V ratio

P/V ratio = Contribution ÷ Sales × 100 = Change in profit ÷ Change in sales × 100

The second form works when you have two periods with the same fixed cost and no other data.

Break-even point (units)

BEP (units) = Fixed cost ÷ Contribution per unit

Use when the question gives unit data.

Break-even point (sales value)

BEP (₹) = Fixed cost ÷ P/V ratio

Also equals BEP units × selling price per unit.

Margin of safety

MOS (₹) = Actual sales − BEP sales = Profit ÷ P/V ratio

MOS ratio = MOS ÷ Actual sales × 100.

Target profit

Required sales (₹) = (Fixed cost + Desired profit) ÷ P/V ratio

In units: (Fixed cost + Desired profit) ÷ Contribution per unit. For profit after tax, first convert to profit before tax.

Variable cost ratio

V/S ratio = 1 − P/V ratio

Variable cost ÷ Sales.

Contribution per unit

Contribution per unit = Selling price per unit − Variable cost per unit

Use variable cost of all kinds: material, labour, variable overheads and variable selling cost.

P/V ratio of a product

P/V ratio = Contribution ÷ Sales × 100

Use totals or per-unit values, but be consistent.

Weighted average (composite) P/V ratio

Composite P/V ratio = Total contribution of all products ÷ Total sales of all products

Equals Σ (P/V ratio of each product × its share in sales value). Weights must be sales value shares, not unit shares.

Composite break-even sales

Break-even sales (₹) = Total fixed cost ÷ Composite P/V ratio

Valid only for the sales mix assumed in the question.

Break-even sales of each product

Product break-even sales = Composite break-even sales × Product's share in sales value

This assumes the mix stays constant.

Break-even in units (bundle method)

Bundles to break even = Fixed cost ÷ Contribution per bundle; units of a product = bundles × units of it in one bundle

Use when the mix is given in units, for example 3 units of A to 2 units of B.

Margin of safety and profit

Margin of safety = Actual sales − Break-even sales; Profit = Margin of safety × Composite P/V ratio

Also, Profit = Total contribution − Fixed cost.

Indifference point

Indifference sales = Difference in fixed costs ÷ Difference in P/V ratios; in units = Difference in fixed costs ÷ Difference in contribution per unit

The alternative with higher fixed cost and higher P/V ratio is better above this point; the other is better below it.

Shutdown point

Shutdown sales = Avoidable fixed cost ÷ P/V ratio; in units = Avoidable fixed cost ÷ Contribution per unit

Only fixed costs that would be saved on shutdown count. Unavoidable fixed costs continue anyway.

Contribution

Contribution = Sales − Variable cost

Use per unit or in total. This is the base for every decision here.

Contribution per unit of limiting factor

Contribution per unit ÷ Units of scarce resource used per unit

Rank products in descending order of this figure and allocate the scarce resource in that order, subject to maximum demand.

Make or buy rule

Make if relevant cost of making < buying price; otherwise buy

Relevant cost of making = variable cost + avoidable fixed cost + opportunity cost of capacity used. Unavoidable fixed cost is excluded.

Special order rule

Accept if offer price > variable cost + any extra specific fixed cost + opportunity cost

Valid when spare capacity exists and regular sales are not affected. If capacity is full, include the contribution lost on regular sales.

Shutdown rule

Continue if Contribution > Avoidable (shutdown-saved) fixed costs

Short-run rule. Fixed costs that continue after shutdown are ignored. Consider the long term and non-financial effects too.

Total profit after the decision

Profit = Total contribution − Fixed costs

Use it to check that your chosen plan beats the alternatives.

Quick revision

• Contribution = Sales − Variable cost.
• Profit = Contribution − Fixed cost.
• P/V ratio = Contribution ÷ Sales × 100.
• Break-even sales = Fixed cost ÷ P/V ratio.
• Break-even units = Fixed cost ÷ Contribution per unit.
• Margin of safety = Actual sales − Break-even sales.
• Sales for target profit = (Fixed cost + Target profit) ÷ P/V ratio.
• Under marginal costing, stock is valued at variable cost only.
• Profit difference = Fixed overhead per unit × change in closing and opening stock units.
• If closing stock exceeds opening stock, absorption costing profit is higher.
• With a limiting factor, rank products by contribution per unit of that factor.
• Fixed costs unchanged by a decision are irrelevant to it.

Common mistakes

• Including fixed overhead in the cost per unit under marginal costing. Fix: Under marginal costing, list only variable items per unit. Show fixed cost once as a lump sum below contribution.
• Leaving out variable selling and distribution cost when calculating contribution. Fix: Contribution is sales minus all variable costs. Variable selling cost belongs in it. Only variable production cost goes into stock.
• Including fixed production overhead in stock under marginal costing Fix: Keep two stock columns. Marginal stock carries only variable production cost. Absorption stock carries variable cost plus fixed overhead.
• Including selling or administration costs in stock valuation Fix: Only production overhead goes into stock. Selling, distribution and administration costs are charged to the period under both methods.
• Using total cost instead of variable cost when finding contribution. Fix: Contribution = Sales − Variable cost only. Fixed cost is deducted after contribution, never before.
• Dividing fixed cost by P/V ratio and calling the answer units. Fix: Fixed cost ÷ P/V ratio gives rupees of sales. Fixed cost ÷ contribution per unit gives units. Label the answer.
• Averaging the P/V ratios simply, for example (40% + 25%) ÷ 2. Fix: Always weight by sales value share, or divide total contribution by total sales.
• Using the unit mix as the weights for P/V ratio. Fix: Convert units to sales value first, or use the bundle method with contribution per bundle.
• Using fully absorbed (total) cost to decide make or buy. Fix: Use only variable cost plus avoidable fixed cost. Unavoidable fixed overhead continues whether you make or buy, so leave it out.
• Ranking products by contribution per unit when a limiting factor exists. Fix: Rank by contribution per unit of the scarce resource, and then apply the demand limit for each product.

Exam tips

• In MCQs, check whether the question asks for contribution, profit or stock value. The same data gives different answers for each.
• For the marginal versus absorption difference, write points on stock valuation, treatment of fixed cost and cost classification. Add the effect on profit.
• Show the marginal cost statement in the standard order: sales, variable cost, contribution, fixed cost, profit. Step marks are given for layout.
• When writing features, advantages and limitations, give one reason per point. For example, advantage: easy decision making because contribution is visible. Limitation: separating semi-variable costs is difficult.
• State clearly that the method treats fixed cost as a period cost. Examiners look for this phrase.
• Show the unit working and the rate calculation at the top. Step marks are given for them even if a later figure is wrong.
• Use a two-column layout or two separate statements with the same line items so the examiner can see where the methods differ.
• Always end with the reconciliation and one sentence of explanation: stock rose or fell by so many units at ₹ per unit. ICMAI expects interpretation, not just numbers.