Effective Marginal Costing:
Know Your Resource Needs
Larry R. White, CGFM, CMA, CFM, CPA
Executive Director, Resource Consumption
Accounting Institute
CAPT, USCG (Retired)
Agenda
What exactly is Marginal Costing?
• Why is Marginal Costing important?
• How is Marginal Costing done?
Quiz
• What is Marginal Costing?
• Does it have any other names?
• Where or When do you use it?
• What do you remember about it from Cost
Accounting or Microeconomics?
What is Marginal Costing?
• Wikipedia:
– Marginal Cost is the change in total cost that arises
when the quantity produced changes by one unit.
– Marginal Costing (under Cost Accounting): This
method is used particularly for short-term decisionmaking. Its principal tenets are:
– Revenue (per product) - variable costs (per product) = contribution
(per product)
– Total contribution - total fixed costs = total profit or total loss)
• Thus, it does not attempt to allocate fixed costs in an arbitrary
manner to different products.
A Closer Look
• What resource use (and costs) will change if
output changes?
• What you need to know:
– Relationships within a process: What resources in the
value chain contribute to creating the output?
– Characteristics of the resources used:
• Which resources will need beefed up or reduced?
• What resource quantities have fixed and proportional
relationships with the change in output?
– Costs associated with the resource changes.
What we need to know:
Resource Pool A
Resource Pool E
Resource Pool B
Final Output 1
Final Output 2
Resource Pool F
Final Output 3
Resource Pool C
Resource Pool G
Final Output 4
Resource Pool D
Resource Pool H
Cost-Volume-Profit Analysis
Product A
Service 1
Product B
Service 2
Service 3
Variable
Cost
$’s
Change in
Total $’s Due to
a Change in
Total Volume
Fixed
Cost
Total Volume
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RCA Institute All Rights Reserved
7
Responsiveness
Proportional
Inputs
Inputs
&
their
$’s
Fixed
Inputs
Proportional
Inputs
Inputs
&
their
$’s
Product A
Product B
An Output
An Output
Service 2
Service 1
Proportional
Inputs
Inputs
&
their
$’s
Fixed
Inputs
An Output
3/16/2016
Fixed
Inputs
Inputs
&
their
$’s
Proportional
Inputs
Fixed
Inputs
An Output
Service 3
Inputs
&
their
$’s
RCA Institute All Rights Reserved
Proportional
Inputs
Fixed
Inputs
An Output
8
Marginal Costing vs. Unit Costing
• More Accounting Transactions – 12,000/yr
• Finance Center:
– Personnel Cost $30,000,000
– Operating Cost $15,000,000
– Transactions/year: 3,000,000
– Unit Full Cost Cost: $15/transaction X 12,000
= $180,000
– Judgmental Marginal Cost: 1 GS-7 = $65,000
Agenda
What exactly is Marginal Costing?
Why is Marginal Costing important?
• How is Marginal Costing done?
Importance of Marginal Costing
• Budgets are incremental or decremental.
• Full Cost is nearly always a gross
overstatement.
• Only way to achieve transparency and
internal management alignment around
financial impacts.
Full Cost
• Full Cost is the correct figure for very few
actions
• Worse you can calculate full cost easily
• And……know next to nothing about your
processes or resources.
– Finance Center Transaction Example.
Example
• Fact set: City Council is requiring fire
inspections every 18 mths rather than every
3 years.
• Current Fire Inspection Staff: 1
Supervisor, 3 Inspectors, 1 Clerk, .75 FTE
Hearing Officer/Judge, 1 FTE Billing and
Collection at City Treasurer
• What else do you need to know?
– Space, Current Capacity (including non fire
inspection work), equipment (computers,
vehicles), training, hearing workload………
Agenda
What exactly is Marginal Costing?
Why is Marginal Costing important?
How is Marginal Costing done?
Calculating Marginal Costs
• How are marginal costs calculated?
• Ad hoc Analysis
– Advantages/Disadvantages
• Policy Based Formulas
– Advantages/Disadvantages
• Directly fm Management Accounting
Information
– Advantages/Disadvantages
Calculating Marginal Costs
• What you need to know:
– Process Flow
– Resources in the process
– How resources interact/support each other
Characteristics of the resource
• Fixed and proportional relationship to outputs
(intermediate and/or final)
– Costs to overlay the resource flows.
Information Elements for Marginal Costing
•
•
•
•
•
Organizational components
Resource Pools in the Process
RP output & ouput consumers
Output Capacity
Resource Relationships to Output
– Fixed & Proportional
• Cost of Resource Pools
– Primary (inherent) & Secondary (support)
Based on Cause and Effect Relationships
Creating Accurate Marginal Costs
• Requirement 1: Accurately render the
enterprise’s flow of economic goods and
services with causal relationships
Bldg Space
IT Support
Motor Pool
Output:
Inspector
Labor Hrs
SQFT
# WS
# Cars
# Miles
Fire Inspection
Resource Pool
HR Events
HR & Pay
Procurement
# PO’s
# Man hrs
FD Internal Affairs
Inspections Clean
Inspections –
Fines & Penalty
Re-Inspections Clean
Re-Inspections –
Fines & Penalty
Hearings/Court
Appearances
Causal Relationships
• Strong Form - Consumption relationship
can be quantified
• Weak Form – Consumption relationship
exists, but cannot be quantified
– Examples: Excess Capacity, Fire Chief &
personal staff
• Attributable Cost – Costs of an output that
could be eliminated if that output were
discontinued and resources were reduced
accordingly.
Attributable Cost Example
Product/Services
Bldg Space
Fire Inspectors
Inspections
IT Support
Fire Investigators
Investigations
Motor Pool
Fire Stations
Readiness
HR & Pay
Training Center
Procurement
Internal Affairs
Fire Chief/Staff
Weak
Causal
Relation
Fire Safety
Mission
Man-Hrs
Results
Segment
Creating Accurate Marginal Costs
• Requirement 2: Link the quantitative flow
of goods and services to their monetary
implications.
Example
Primary Costs:
Fixed $
Prop $
Supervisor
2,000 hrs
75,000
Inspectors
6,000hrs
180,000
Clerk
2,000 hrs
30,000
Operating Budget
Secondary Costs:
100,000
Output
Fixed
Qty
Prop
Qty
Fixed $
Bldg Space
SQFT
1,200
IT Support
Wk St
8
0
24,000
Motor Pool
F:Cars
P:Miles
3
30,000
9,000
HR& Pay
HR Events
130
15
2,050
Procurement
PO’s
60
24
3,000
FD Internal Aff
Man Hrs
120
25,000
Prop $
120,000
6,000
18,000
2,400
Example (Continued)
• Output Capacity: 6,000 Inspection Hours
• Planned Output: 4,500 Inspection Hours
• Restricted/Idle Capacity: 1,500 Hours
•
•
•
•
Fixed Cost: $339,050
Rate: $56.50
Proportional Cost: $255,400
Rate: $42.60 – 6,000 hrs
Rate: $56.80 – 4,500 hrs
Creating Accurate Marginal Costs
• Requirement 3: Provide Insight into inputoutput behaviors and their respective costs
– Changing Nature of Costs – Become more
Fixed
Electricity
Janitorial
HVAC Maint
Bldg Security
Building 6
Space
Resource Pool
Proportional
Fixed
Creating Accurate Marginal Costs
• Requirement 4: Segment the cost model for
only that portion of economic goods and
services relevant to the decision at hand.
– Ex: Levels of decisions
• Resource Level: Fire Inspection Dept Costs &
Resources
• Value Chain/Process Level: Improve Fire Inspection
Violation Enforcement. Inspection to Hearing to
Collection.
• Product/Service Line Level: Fire Prevention Activities
• Organizational Profitability/Performance: Reduce
Number of Fires in City – Incidents, Property/Lives Lost
Creating Accurate Marginal Costs
• Requirement 5: Reflect all causal
relationships and their characteristics relevant
to the decision at hand
– What costs are relevent?
• Hire 3 new inspectors
• Contract for 4500 hrs of Inspector Expertise.
• Buy new Inspection Documentation software and
equipment.
• Revise inspection schedule to permit geographic
sequencing.
• Increase fines for Fire Inspection violations.
Creating Accurate Marginal Costs
• Requirement 6: Provide accurate
monetary information for all relevant cost
categories appropriate to the decision.
• Relevance =
– For Strong Causal Relationship
• A clear Cause and Effect Relationship
• Proportional or Fixed
– For Weak Causal Relationship
• Cost Assignment to the responsibility level that can
eliminate the resource and its cost.
Cost of Fire Code Enforcement
Marginal
Attributable
FID Primary Proportional Cost
xxx
xxx
FID Secondary Proportional Cost
xxx
xxx
FID Primary Fixed Cost
xxx
FID Secondary Fixed Cost
xxx
FID Excess Capacity
xxx
Hearing Officer Primary Proportional Cost
xxx
xxx
Hearing Officer Secondary Proportional Cost
xxx
xxx
Hearing Officer Primary Fixed Cost
xxx
Hearing Officer Secondary Fixed Cost
xxx
Billing/Collection Primary Proportional Cost
xxx
xxx
Billing/Collection Secondary Proportional Cost
xxx
xxx
Billing/Collection Primary Fixed Cost
xxx
Billing/Collection Secondary Fixed Cost
xxx
Marginal Costing Requirements
•
Incorporate Foundational
Economic Principles
1. Provide an accurate
rendering of an enterprise’s
flow of economic goods
and services.
•
•
Accommodate the strong
form of causality.
Accommodate the weak
form of causality
2. Link the quantitative flow of
goods and services to their
monetary implications.
3. Provide insight into inputoutput behaviors - and their
respective costs
•
Segment Information to
Enhance Its Relevance
to Decision Makers
4. Segment the cost model
for only that portion of
economic goods and
services relevant to the
decision at hand.
5. Reflect all causal
relationships and their
characteristics relevant to
the decision
6. Provide accurate monetary
information for all relevant
cost categories appropriate
to the decision.
RCAStructure
Structure
RCA
for Marginal Costing
Quantitative
Definition of
Material Causal
Relationships
Support/Secondary
Resource Pools
Support/Secondary
Activities
Primary Resource
Pools
Primary Activities
Product/Service
Objects
Result Segments
Common
Fixed
Costs
RCA Recognition
Costing Continuum/Levels of Maturity
Predictive: Demand Planning Driven with
Capacity Sensitivity
Descriptive: Expense Tracking, Cost Reporting and Consumption Rates
Bookkeeping
1
Blind
No
marginal
insights
No
Marginal
Insight
Process/
lean
accounting
2
Process
Visibility
Limited
process
marginal
insights
Direct
cost to
outputs
3
Add
indirect
costs
4
Output
Visibility
Output
Visibility
Direct cost
marginal
insights
All output
cost
marginal
insights
Individual
std costs,
project &
job
costing
5
Explicit
Outputs
Output
specific
marginal
insights
Push
activitybased
costing
(ABC),
Product
costs
6
Explicit
Indirect
Costs
Explicit
output
marginal
insights
Level 6
with
customer
& channel
profitability
reporting;
Cost-toserve
7
Customer
Demand
Sensitive
Add
customer
& channel
marginal
insights
Marginal Insight Awareness
Unused
capacity
costs
(estimated)
8
(ABRP);
forecast
driver
quantities
X std unit
rates,
driverbased
budgeting
9
Unused Pull ABC
Capacity Resource
Aware
Planning
Common
fixed costs
begin to be
isolated
Increased
ability to
isolate
common
fixed costs
(TDABC);
forecast
driver
quantities
X std unit
rates;
direct cost
focus;
repetitive
work
conditions
10
Timedriven
ABC
Increased
ability to
isolate
common
fixed costs
Attributable
costs on all
objects,
blends
activity and
direct
resource
charges,
consumes
activities
back to
resources
11
R
C
A
Explicit
resource
cost object,
supplybased
denominator, strong
& weak
forms of
causality
catered for
Finite
systems
modeling
12
Simulation
No change
Detailed
Marginal Insights
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www.RCAInstitute.org
lwhite@rcainstitute.org
757 288 6082