THEORY OF MARGINAL COSTING

The theory of marginal costing is that in relation to a given volume of output, additional
output can normally be obtained at less than proportionate cost because within limits the
aggregate of certain items of cost will tend to remain fixed and only the aggregate of the
remainder will tend to rise proportionately with increase in output. Conversely, a
decrease in the volume of output will normally be accompanied by a less than
proportionate fall in the aggregate cost.
The theory of marginal costing may therefore be explained in three steps:
(i) If the volume of output increases, the average cost per unit will, in the normal
circumstances, be reduced. Conversely, if the output is reduced, the average cost per
unit will go up. If the factory produces 1,000 units at a total cost of Rs. 3,000 and if by
increasing the output by one unit, the cost goes up to Rs. 3,002, the marginal cost of the
additional output is Rs. 2.