Cost is the price of tangible or intangible inputs, which are involved in the
transformation process of raw materials into finished goods and such inputs
may or may not form part of the final product. The cost can be classified
into many types depending on the relevancy of the cost to the analytical or
decision-making situation. It has been a very apparent practice of classifying cost as fixed or
variable. Decision-making by taking total cost into consideration is sometimes ambiguous
and misleading. In order to reach a more comprehensive analysis, marginal costing
provides a better picture.
Marginal cost has been identified as the incremental cost of increasing the level of
activity by one unit, at any level of activity, assuming fixed cost to be constant irrespective of
the level of activity. For example: XYZ Ltd., is producing `n' units with fixed cost of Rs.
`a' and variable cost of Rs. `b' per unit, the total cost of activity and variable cost can
be calculated as shown in Exhibit: 1. At any level of activity, the cost of increasing
output by 1 unit is Rs. `b' which is also the variable cost per unit. As only the variable cost
will contribute in increasing total cost, variable cost is treated as marginal cost. This
marginal or variable cost element helps in decision-making in various situations. Marginal
costing is a superior concept in comparison to other cost concepts.
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