The principles of marginal costing are often used to determine how changes in the volume of output effects the overall profit by separating fixed and variable costs and considering them as two separate elements of the overall product cost.
An important point to know about marginal costing process is that fixed costs are never charged to in determining the final product cost. Fixed costs are in such a case are considered to be a period specific cost. They are not added while determining the price of the product and consequently expensed in the profit and loss account in the period of use.
Contribution is a term that is very widely every time marginal costing is used. Contribution can be defined as the excess of sales price or revenue above the marginal costs. Another way of explaining contribution is the amount of profit made be any fixed costs have been accounted for.
In very competitive market environments firms often make sales on marginal costs in the short term. As long as marginal costs are recovered, firms continue production as marginal costs cover all variable costs of production. Any excess of marginal cost to the sales price in such a situation contributes to the fixed costs and ultimately the firms break even.
Monopolists often price their products on marginal costing basis whenever they see a market threat. Making sales at marginal cost in the short term would allow them to lower their prices temporarily until their competitors are driven out of the market. Consequently they can price their products at marginal cost plus profit formula and continue to exploit customers from their position as the sole supplier.
There are some criticisms of the marginal costing process which must be discussed. Decisions taken on marginal costing are based on data derived from historical information. However, decisions made by management accountants relate to the future events and it is not clear whether the past