How to solve marginal costing step by step

Marginal costing, also known as variable costing or direct costing, is a cost accounting technique where only variable costs are charged to cost units, and fixed costs are treated as period costs. This method is particularly useful for decision-making processes such as pricing, output level determination, and financial analysis. Here’s a step-by-step guide on how to solve problems using marginal costing:

### Step-by-Step Guide to Marginal Costing

**Understand the Concepts:**

**Variable Costs**: Costs that vary directly with the level of production (e.g., raw materials, direct labor).**Fixed Costs**: Costs that remain constant regardless of the level of production (e.g., rent, salaries).**Contribution Margin**: Sales revenue minus variable costs. It contributes towards covering fixed costs and generating profit.**Break-even Point**: The level of sales at which total revenue equals total costs (both variable and fixed), resulting in no profit or loss.

**Calculate Variable Costs:**

- Identify all variable costs associated with the production of each unit.
- Sum these costs to determine the total variable cost per unit.

**Determine Fixed Costs:**

- List all fixed costs that are incurred during the period.
- Ensure that these costs are not included in the unit cost calculation.

**Compute Contribution Margin:**

**Contribution Margin per Unit**:

Contribution Margin per Unit=Selling Price per Unit−Variable Cost per UnitContribution Margin per Unit=Selling Price per Unit−Variable Cost per Unit

**Total Contribution Margin**:

Total Contribution Margin=Contribution Margin per Unit×Number of Units SoldTotal Contribution Margin=Contribution Margin per Unit×Number of Units Sold

5. **Break-even Analysis:**

**Break-even Point in Units**:

Break-even Point (units)=Total Fixed CostsContribution Margin per UnitBreak-even Point (units)=Contribution Margin per UnitTotal Fixed Costs

**Break-even Point in Sales Revenue**:

Break-even Point (sales revenue)=Total Fixed CostsContribution Margin RatioBreak-even Point (sales revenue)=Contribution Margin RatioTotal Fixed Costs

Where Contribution Margin Ratio is:

Contribution Margin Ratio=Contribution Margin per UnitSelling Price per UnitContribution Margin Ratio=Selling Price per UnitContribution Margin per Unit

6. **Target Profit Analysis:**

- To determine the sales volume required to achieve a target profit, use the formula:

Required Sales Volume (units)=Total Fixed Costs+Target ProfitContribution Margin per UnitRequired Sales Volume (units)=Contribution Margin per UnitTotal Fixed Costs+Target Profit

7. **Decision Making:**

**Make or Buy Decision**: Compare the contribution margin from producing internally to the cost of buying externally.**Special Orders**: Assess if accepting a special order (at a different price) would cover its variable costs and contribute to fixed costs/profit.**Product Mix Decisions**: Allocate resources to products with the highest contribution margin per unit of the constraint (e.g., labor hours, machine hours).

### Example Problem

**Problem:** A company produces a single product. The following information is available:

- Selling price per unit: $50
- Variable cost per unit: $30
- Total fixed costs: $20,000

**Steps to Solve:**

**Contribution Margin per Unit:**

Contribution Margin per Unit=Selling Price per Unit−Variable Cost per Unit=50−30=20Contribution Margin per Unit=Selling Price per Unit−Variable Cost per Unit=50−30=20

**Break-even Point (units):**

Break-even Point (units)=Total Fixed CostsContribution Margin per Unit=20,00020=1,000 unitsBreak-even Point (units)=Contribution Margin per UnitTotal Fixed Costs=2020,000=1,000 units

**Break-even Point (sales revenue):**

Break-even Point (sales revenue)=1,000 units×50 (selling price per unit)=$50,000Break-even Point (sales revenue)=1,000 units×50 (selling price per unit)=$50,000

**Target Profit Analysis:**Suppose the company wants to achieve a target profit of $10,000.

Required Sales Volume (units)=Total Fixed Costs+Target ProfitContribution Margin per Unit=20,000+10,00020=1,500 unitsRequired Sales Volume (units)=Contribution Margin per UnitTotal Fixed Costs+Target Profit=2020,000+10,000=1,500 units