Marginal costing is the amount that the variable cost of producing an item goes up for each unit manufactured. For instance, if 20 cars are built at a cost of $10,000 US Dollars (USD), and another is built raising the cost by $4,000 USD for a total of $14,000 USD, the marginal costing for one car would be $4,000 USD. Mathematical formulas are used to figure the exact amount, and various cost considerations, such as payroll, are excluded since it is not normally increased by simply increasing the production amount. This is the reason that simply dividing the total cost by the number of units made will not give an accurate marginal costing rate. Each variable must be accounted for, or eliminated, in order to produce the actual amount of the increase for the unit made.
The basic formula for figuring marginal costing can vary depending upon the industry and the specific context, but basically it is marginal costing equals the cost of labor plus the cost of materials to make the one unit plus any extra expenses and overhead costs incurred by building the one unit. To show an example of this concept in working contexts the previous example can be used. In this case, an extra hour of labor is needed to produce the one car, which will have a cost to the company of $200 USD. Therefore, in this example, the marginal costing for the one extra car being built would be $4,500 USD.
The marginal costing of a company helps to determine the total amount of profits made for the given period of time. To put this idea into basic terms, the income earned from one unit minus the variable costs of the product will equal the contribution amount for the unit. After this is factored for each unit, the amount of units is then multiplied by the amount giving the total contribution amount. This number is then placed into another formula: total contribution minus the total fixed costs equals the profit earned.
Many different numbers are used in the accounting equation to formulate exactly how much a company makes within a set period of time. Marginal costing is one such number that indicates the increase in cost, including all variables, incurred for making that one unit. Companies not only use this number to figure their ending profits or losses, but to also analyze the cost of each unit in an attempt to lower total debits and increase profits for the business.