Marginal costing is formally defined as the accounting system in which variable costs are charged to cost units and the fixed costs are treated as period costs and are written off in fully against the aggregate contribution for that period.
In other words marginal costing is the costing method in which only variable costs are accumulated and cost per unit is ascertained only the basis of variable costs.
The main features of marginal costing are as follows:
- Cost classification: The marginal costing technique makes a sharp distinction between variable cost and fixed cost. It is variable cost on the basis of which production and sales policies are designed by a firm following the marginal costing techniques;
- Stock/inventory valuation: Under the marginal costing, inventory stock for profit measurement is valued at marginal cost. It is sharp contrast to the total unit cost in absorption costing method.
- Selling price determination: Selling price of the product in the marginal costing method is determined based on the cost plus the contribution always. Here, the contribution, of course means the difference between the sales and the variable cost.
- Profitability; the profitability of the product/department is based on the contribution made available by each product/department.
- Fixed cost vs period cost: Fixed cost are treated as period cost and are charged to the costing profit and loss account of the period in which they incurred.
- Marginal contribution: marginal costing techniques makes use of marginal contribution for making various decisions. Marginal contribution is the difference between sales and marginal cost. It forms the basis for judging the profitability of different product or department.