Lecture 5 –Marginal costing Differential Cost Analysis

Reference :Ravi M Kishore –cost Accounting

Differential costing is defined as a technique used in the preparation of ad-hoc information in

which only costs and income differences between alternative courses of action are taken into
consideration. (CIMA Terminology). Costs may increase or decrease due to change in
production, sale, production method, production-mix, etc. This change in total cost at a particular
level of activity compared to another one is called differential costs, which are obtained by
subtracting costs at one level from those at a higher level. Differential cost calculation includes
both variable as well as fixed costs which are affected by the alternative course of action.
Thus, the information can be presented by absorption costing of marginal costing techniques.
Difference with marginal costing.

In fact, differential costs are often confused with marginal costs,. This is because of the fact that
both marginal costing and differential cost analysis stem from the basic behaviour of cost,i.e.
fixed and variable. When fixed cost remain unaffected, both marginal costs and differential;
costs are the same. However, they are not the same. The differences are as follows :

(a) Marginal cost is an unit concept and applies to output per unit basis. Differential cost isa total
concept and applies to a fixed additional quantity of output.

(b) Marginal costing is presented by showing contribution per unit and fixed cost as a total
amount. Differential costs are presented in totals in both formats – i.e. under marginalcost as well
as absorption cost techniques.

(c) Product cost under differential cost analysis may contain fixed costs, which will not be
so under marginal costing.

Use of Differential Cost Analysis

Differential cost analysis may be a useful technique in taking appropriate policy decisions,
Such as,—
(i) Acceptance of an additional order at lower than existing price to a special customer,
(ii) Acceptance of an export order, requiring additional outlay,
(iii) Introduction of a new product,
(iv) Opening of a new sales territory or channel of distribution,
(v) Processing of a by-product or a joint product beyond the split-off point
In all such cases, the differential cost is compared with incremental revenue. As long as
incremental revenue is more than or equals to incremental or differential cost, the additional
activity is justified. However, if differential cost exceeds incremental revenue, the project should
be abandoned.