Cost Concepts — Fixed, Variable, Marginal

Topic

Cost Concepts — Fixed, Variable, Marginal

Area

Cost Accounting

Explanation

Types of Costs

• Fixed Costs: Do not change with the level of production (e.g., rent, salaries, insurance).
• Variable Costs: Change directly in proportion to the level of output (e.g., raw materials, direct labour).
• Semi-Variable / Mixed Costs: Contain both a fixed and a variable component (e.g., electricity with a base charge plus usage).

Marginal Cost

• Marginal Cost: The additional cost incurred to produce one more unit.
• Formula: $\frac{\Delta \text{Total Cost}}{\Delta \text{Quantity}}$
• In the short run, marginal cost is primarily driven by changes in variable costs.

Average Costs

• AFC (Average Fixed Cost) $= \frac{Total \text{ Fixed Cost}}{Quantity}$
• AVC (Average Variable Cost) $= \frac{Total \text{ Variable Cost}}{Quantity}$
• ATC (Average Total Cost / AC) $= \frac{Total \text{ Cost}}{Quantity} = AFC + AVC$

Contribution Margin

• Contribution $= Sales \text{ Revenue} - Total \text{ Variable Costs}$
• Contribution per unit $= Selling \text{ Price per Unit} - Variable \text{ Cost per Unit}$
• Used in break-even point (BEP) analysis and profit planning.

Absorption vs. Marginal Costing

• Absorption Costing: All manufacturing costs (fixed and variable) are included in the product cost.
• Marginal Costing: Only variable manufacturing costs are included in the product cost; fixed manufacturing costs are treated as period expenses.

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