A PROJECT REPORT ON

“ ANALYTICAL STUDY OF MARGINAL COSTING

CONCEPT OF EVALUATION”

A project submitted to

University of Mumbai for partial completion of the degree of

Master of Commerce (Advance Accountancy) under the

faculty of Commerce

By

TEJAL MISHRA
ROLL NO: 05

Under the Guidance of

MR. RAJIV MISHRA

N.E.S RATNAM COLLEGE OF ARTS, SCIENCE & COMMERCE

NES COMPLEX, NES MARG, BHANDUP (W), MUMBAI-400078

ACADEMIC YEAR 2023-24

 A PROJECT REPORT ON

“ ANALYTICAL STUDY OF MARGINAL COSTING

CONCEPT OF EVALUATION”

A project submitted to

University of Mumbai for partial completion of the degree of

Master of Commerce (Advance Accountancy) under the

faculty of Commerce

By

TEJAL MISHRA
ROLL NO: 05

Under the Guidance of

MR. RAJIV MISHRA

N.E.S RATNAM COLLEGE OF ARTS, SCIENCE & COMMERCE

NES COMPLEX, NES MARG, BHANDUP (W), MUMBAI-400078

ACADEMIC YEAR 2023-24

 Declaration by learner

I the undersigned Mr./Mrs. TEJAL MISHRA here by, declare that the
work embodied in this project work titled “ ANALYTICAL STUDY OF
MARGINAL COSTING CONCEPECT AND EVALUATION " ,
forms my own contribution to the research work carried out under the
guidance of MR. RAJIV MISHRA is a result of my own research work
and has not been previously submitted to any other University for any
other Degree/ Diploma to this or any other University.

Wherever reference has been made to previous works of others, it has been
clearly indicated as such and included in the bibliography.

I, here by further declare that all information of this document has been
obtained and presented in accordance with academic rules and ethical
conduct.

TEJAL MISHRA

Certified by

MR. RAJIV MISHRA

NES RATNAM COLLEGE OF ARTS, SCIENCE
& COMMERCE
BHANDUP (W) , MUMBAI – 400078

CERTIFICATE

This is to certify that MRS. TEJAL MISHRA Of

M.COM ( Advance accountancy) Semester III (2023-24)
has successfully completed the Project on
ANALYTICAL STUDY OF MARGINAL COSTING

CONCEPECT AND EVALUATION Under the

guidance of Mr. Rajiv Mishra

COURSE COORDINATOR PRINCIPAL

Mr. Rajiv Mishra Mrs. Vinita Dhulia

PROJECT GUIDE / INTERNAL EXAMINER

Mr. Rajiv Mishra
 Acknowledgment

To list who all have helped me is difficult because they are so numerous
and the depth is so enormous.

I would like to acknowledge the following as being idealistic channels and

fresh dimensions in the completion of this project.

I take this opportunity to thank the University of Mumbai for giving me

chance to do this project.

I would like to thank my Principal, DR. MRS. VINITA DHULIA for

providing the necessary facilities required for completion of this project.

I take this opportunity to thank our Coordinator MR. RAJIV MISHRA for
his moral support and guidance.

I would also like to express my sincere gratitude towards my project guide

MR. RAJIV MISHRA whose guidance and care made the project
successful.

I would like to thank my College Library. For having provided various

reference books and magazines related to my project.

Lastly, I would like to thank each and every person who directly or
indirectly helped me in the completion of the project especially my
Parents and Peers who supported me throughout my project.
 INDEX

SR. NO TOPIC NAME PAGE NO.

1 INTRODUCTION 07-26

2 REVIEW OF LITREATURE 27- 50

3 HYPOTHESIS OF STUDY 51-52

4 OBJECTIVES OF SYUDY 53-55

5 DATA ANALYSIS & INTERPRETATION 56-73

6 CONCLUSION 74-75

7 SUGGESTION OF STUDY 76-77

8 REFERENCES 78-79
 ABSTRACT AND FIGURES
Purpose – Management requires adequate, systematic and useful cost data
and reports to manage a business enterprise and to achieve its business
objectives. The useful information provided by cost records and reports in cost
accounting assist management in making their decisions. Therefore,
Management
Accounting may be defined as the application of accounting techniques for
providing information designed to aid all levels of management in planning and
controlling the activities of the business enterprise in decision making.
Marginal costing is a costing technique in which only variable manufacturing
cost are considered and used while valuing inventories and determining the
cost of goods sold.
That is, only variable manufacturing costs are considered product cost and are
allocated to products manufactured. Absorption cost also known as full costing
is a costing technique in which all manufacturing costs, variable and fixed are
considered as cost of production and are used in determining the cost of goods
manufactured and inventories. All manufacturing costs are fully absorbed in to
finished goods. Traditional absorption costing systems have long been subject
to criticism.
Two long-standing issues have been the choice of appropriate overhead
recovery rates and secondly the controversy about the need to allocate
overheads at all.
During the last two decades the problems of traditional absorption costing and
marginal costing were again brought under the spotlight. The paper extends
the previous research and literature review that investigate marginal and
absorption costing methods whose obviously each have their supporters and
arguments both in favor of and against each method.
 CHAPTER 1: INTRODUCTION

Marginal Cost performance analysis is a term used to describe the change in

total cost of production resulting from the addition of one item. It can also be
seen as the avoidable cost of not producing an additional item. It is usual to
look at short term marginal cost, which is an additional cost when only some of
the cost of production can be varied in long term or more commonly known as
long run marginal cost is the change in cost when all input cost can varied. It is
closely related to marginal cost pricing, in which prices are set at an amount
equal to the Marginal Cost. the raw material is easy access,although not
always, determining Marginal cost is much easier in a manufacturing setting
that.
The marginal cost is the cost to produce one additional unit. This cost would
include the raw materials used to make the item, the average labour cost of the
item, the average machine or hardware cost associated with creating the item.
Marginal costs are sometimes very difficult to assess. First, we must determine
the useful life of our machinery, that can be a very subjective determination.
Typically, the raw material is easy access,although not always, determining
Marginal cost is much easier in a manufacturing setting that it is in a service
oriented area. Marginal Costing is the ascertainment of marginal cost and of
the effect on profit due to changes in volume or type of output by different
between fixed cost and variable cost.
The marginal cost refers to the increase in production costs generated by the
production of additional product units. It is also known as the marginal cost of
production. Calculating the marginal cost allows companies to see how volume
output influences cost and hence, ultimately, profits.

1
In economics, marginal concepts are associated with a specific change in the
quantity used of a good or service, as opposed to some notion of the over-all
significance of that class of good or service, or of some total quantity thereof.
The marginal use of a good or service is the specific use to which an agent
would put a given increase, or the specific use of the good or service that
would be abandoned in response to a given decrease.
The marginal utility of a good or service is the utility of the specific use to
which an agent would put a given increase in that good or service, or of the
specific use that would be abandoned in response to a given decrease. In other
words, marginal utility is the utility of the marginal use.

2
The marginal rate of substitution is the rate of substitution that is the least
favorable rate, at the margin, at which an agent is willing to exchange units of
one good or service for units of another.
A marginal benefit is a benefit (howsoever ranked or measured) associated
with a marginal change.
The term “marginal cost” may refer to an opportunity cost at the margin, or
more narrowly to marginal pecuniary cost — that is to say marginal cost
measured by forgone cash flow.
Constraints are conceptualized as a border or margin.[1] The location of the
margin for any individual corresponds to his or her endowment, broadly
conceived to include opportunities. This endowment is determined by many
things including physical laws (which constrain how forms of energy and matter
may be transformed), accidents of nature (which determine the presence of
natural resources), and the outcomes of past decisions made both by others
and by the individual himself or herself.
A value that holds true given particular constraints is a marginal value. A
change that would be affected as or by a specific loosening or tightening of
those constraints is a marginal change, as large as the smallest relevant division
of that good or service.[2] For reasons of tractability, it is often assumed
in neoclassical analysis that goods and services are continuously divisible. In
such context, a marginal change may be an infinitesimal change or a limit.
However, strictly speaking, the smallest relevant division may be quite large.
Marginal Costing Is Very Important Technique In Solving Managerial Problems
And Contributing In Various Areas Of Decisions. In This Context Profitability Of
Two Or More Alternative Options Is Compared And Such Options Is Selected
Which Offers Maximum Profitability Along With Fulfillment Of Objectives Of
The Enterprise.
Like process costing or job costing, marginal costing is not a distinct method of
ascertainment of cost but is a technique which applies existing methods in a
particular manner so that the relationship between profit & the volume of
output can be clearly brought out. Marginal costing ascertains marginal or
variable costs & the effect on profit, of the changes in volume or type of
output, by differentiating between variable costs & fixed costs. To any type of
costing such as historical, standard, process or job; the marginal costing
technique may be applied.

3
Under the process of marginal costing, from the cost components, fixed costs
are excluded. The difference which arises between the variable costs incurred
for activities & the revenue earned from those activities is defined as the gross
margin or contribution. It may relate to total sales or may relate to one unit.

What Is Marginal Costing?

Marginal costing in economics and managerial accounting refers to an increase

or decrease in the total cost of production due to a change in the quantity of
the desired output. It is variable, depending on the inclusion of resources
required to produce or deliver additional unit(s) of a product or service.
Calculating marginal cost enables managers to make decisions on resource
allocation, optimize the production and operation, control manufacturing
costs, plan budget and profits, etc. It considers expenses incurred at each
production stage, except for overhead pricing. The practice is common in
manufacturing industries, allowing companies to achieve economies of scale.

4
Marginal costing is the increase or decrease in the overall cost of production
due to changes in the quantity of desired output.
Managers can use it to make resource allocation decisions, optimize
production, streamline operations, control manufacturing costs, plan budgets
and profits, and so on.
In most cases, variable costs influence marginal costs. It can, however,
consider fixed expenses in circumstances of increased output.
When a company’s marginal cost equals its marginal income, it maximizes
profits while setting the selling price of a product or service.
The marginal costing technique is crucial for any business aiming to optimize
the production of goods or delivery of services. The concept technically means
extra costs added to the production cost due to additional unit(s). It helps
companies determine the selling price of a product or service. Furthermore,
they can estimate the desired output by understanding marginal and sales
costs. It simply works like this:
Sale or Unit price > Marginal cost = More production = Profit
Marginal cost > Sale or Unit price = Less production = Loss
Moreover, entities can calculate the price associated with resources needed to
scale up the production of additionally ordered items. Also, it enables
managers to estimate production expenses and budget, avoiding last-minute
resource shortages.
Marginal costing varies with the production level and volume. Based on this, it
can be either short-run (i.e., fixed costs for additional production in a short
time) or long-run (i.e., variable inputs for extra output in more time).
In accounting, marginal costing is a variable expense applied to the unit cost.
The quantity produced by removing marginal cost from the product’s selling
price is referred to as a contribution. In this situation, the contribution
completely offsets the fixed cost.
DEFINATION :
Marginal Costing is a costing technique wherein the marginal cost, i.e. Variable
cost is charged to units of cost, while the fixed cost for the period is completely
written off against the contribution.

5
Types of Marginal Costs :
However, costs may not vary directly on a per unit basis. It is possible that
increasing production by a unit may not cause a proportional increase in costs.
It is because different business activities face different forms of cost behaviors.
Unit Costs

6
Unit costs would be the traditional idea of variable costs where an increase in a
single unit of production leads to a proportional increase in costs. For example,
the cost of materials required to produce another coffee mug.
Batch Costs
Batch costs would vary not by the individual unit of production but by the
number of batches for a given number of units produced. Taking the coffee
mug example further, a ceramic shaping machine may need to be brought up
to an optimal temperature before production may begin. Beyond this point,
there are no additional costs to operate this machine until production is
stopped. Beginning the next batch would then incur this startup cost once
more.
Product Costs
Product costs occur regardless of the number of batches or units produced.
This is a cost that is attributed directly to a particular item on a product
portfolio. For instance, the cost to design and market a holiday variant of a
coffee mug would not be affected by the number of mugs produced.
Customer Costs
Customer costs are incurred by the number of customers serviced instead of
any particular level of production or expansion of a product line. This could be
in the form of after-sales service or legal costs resulting from a contractual
agreement.
Organization Sustaining Costs
Organizational sustaining costs are costs that are incurred as a result of general
business operations. These are costs that are incurred regardless of any
quantity of production. These might include such things as the fixed salaries of
employees at a company or auditing fees for preparing financial statements to
shareholders
The marginal cost refers to the increase in production costs generated by the
production of additional product units. It is also known as the marginal cost of
production. Calculating the marginal cost allows companies to see how volume
output influences cost and hence, ultimately, profits.
Understanding Marginal Analysis

7
In microeconomics, most decisions usually evaluate whether the benefit of a
particular activity or action is greater than the cost. Marginal analysis comes in
handy when making a decision with a causal relationship involving two
variables. It explains the potential effect of some conditional changes on a
company as a whole.
Economies of scale apply to the long run, a span of time in which all inputs can
be varied by the firm so that there are no fixed inputs or fixed costs.
Production may be subject to economies of scale (or diseconomies of scale).
Economies of scale are said to exist if an additional unit of output can be
produced for less than the average of all previous units – that is, if long-run
marginal cost is below long-run average cost, so the latter is falling. Conversely,
there may be levels of production where marginal cost is higher than average
cost, and the average cost is an increasing function of output. Where there are
economies of scale, prices set at marginal cost will fail to cover total costs, thus
requiring a subsidy.[9] For this generic case, minimum average cost occurs at
the point where average cost and marginal cost are equal (when plotted, the
marginal cost curve intersects the average cost curve from below).

By examining the associated costs and potential benefits, marginal analysis

provides useful information that is likely to prompt price or production change
decisions.
Marginal analysis also looks at the conditions under which the company may
continue with the same cost of producing an individual unit or output in the
face of expected or actual changes. Here, the dominating principle is the
adjustment to change. The idea is that it is worthwhile for a company to
continue investing until the marginal revenue from each extra unit is equal to
the marginal cost of producing it.
Marginal analysis may also be applied in a situation where an investor is faced
with two potential investments but with the resources to only invest in one.
The investor can use marginal analysis to compare the costs and the benefits of
both investments to determine the option with the highest income potential.
Uses of Marginal Analysis :
The following are the two prevalent uses of marginal analysis:
1. Observed changes
Marginal analysis can be used by managers to create controlled experiments
based on the observed changes of particular variables. For example, the tool
8
can be used to evaluate the impact of increasing production at a given
percentage on cost and revenues.
A benefit is accrued when the marginal cost is reduced or the increased
revenues cover and spill over total production costs. If the experiment yields a
positive result, incremental steps are taken until the result yields a negative
outcome. This may be the scenario when the market cannot take the additional
production units, leading to excessive overheads. At that stage, a company with
the capacity to expand will opt to increase its market reach.
2. The opportunity cost of an action
Managers regularly find themselves in situations where they are required to
make a choice among available options. For example, suppose a company has a
single job opening, and they have the choice of hiring a junior administrator or
a marketing manager.
Marginal analysis may indicate that the company has resources to grow and
that the market is saturated. As a result, hiring a marketing manager will yield
higher returns than an administrator.
Rules of Marginal Analysis in Decision-Making
There are two rules for profit maximization that make marginal analysis a key
component in the microeconomic analysis of decisions. They are:
1. Equilibrium Rule
The first rule posits that the activity must be carried out until its marginal cost
is equal to its marginal revenue. The marginal profit at such a point is zero.
Typically, profit can be increased by expanding the activity if the marginal
revenue exceeds marginal cost.
Marginal benefit is a measure of how the value of cost changes from the
consumer side of the equation, while the marginal cost is a measure of how
the value of cost changes from the producer side of the equation. The
equilibrium rule implies that units will be purchased up to the point of
equilibrium, where the marginal revenue of a unit is equal to the marginal cost
of that unit.
2. Efficient Allocation Rule
The second rule of profit maximization using marginal analysis states that an
activity should be performed until it yields the same marginal return for every
9
unit of effort. The rule is premised on the idea that a company producing
multiple products should allocate a factor between two production activities
such that each provides an equal marginal profit per unit.
If it is not achieved, profit could be realized by allocating more input to the
activity with the highest marginal profit and less to the other activity.
Limitations of Marginal Analysis
One of the criticisms against marginal analysis is that marginal data, by its
nature, is usually hypothetical and cannot provide the true picture of marginal
cost and output when making a decision and substituting goods. It therefore
sometimes falls short of making the best decision, given that most decisions
are made based on average data.
Another limitation of marginal analysis is that economic actors make decisions
based on projected results rather than actual results. If the projected income is
not realized as predicted, the marginal analysis will prove to be worthless.
For example, a company may decide to start a new production line based on a
marginal analysis projection that the revenue will exceed costs to establish the
production line. If the new production line does not meet the expected
marginal costs and operates at a loss, it means that the marginal analysis used
the wrong assumptions.
Special Considerations
Marginal analysis may also apply to the effects of small changes and
the opportunity cost concept. In the former, marginal analysis relates to
observed changes with total outputs. Evaluating such changes can help
determine the standard production rate.
It is common in employment scenarios, where the Human Resource (HR)
manager makes a hiring decision. Suppose a company’s budget allows the
recruitment of one employee. With marginal analysis, the HR can know
whether an additional employee in the production department provides net
marginal benefit.
Additional Resources
CFI is the official provider of the global Capital Markets & Securities Analyst
(CMSA)® certification program, designed to help anyone become a world-class

10
financial analyst. To keep advancing your career, the additional CFI resources
below will be useful:
Marginal Profit
Marginal Cost Formula
Profit Margin
Incremental Analysis
See all economics resources

Marginal Cost Formula

Marginal cost is calculated as the total expenses required to manufacture one
additional good. Therefore, it can be measured by changes to what expenses
are incurred for any given additional unit.
Marginal Cost = Change in Total Expenses / Change in Quantity of Units
Produced

The change in total expenses is the difference between the cost of

manufacturing at one level and the cost of manufacturing at another. For
example, management may be incurring $1,000,000 in its current process.
Should management increase production and costs increase to $1,050,000,
the change in total expenses is $50,000 ($1,050,000 - $1,000,000).
The change in quantity of units is the difference between the number of units
produced at two varying levels of production. Marginal cost strives to be based

11
on a per-unit assumption, so the formula should be used when it is possible to
a single unit as possible.
The formula above can be used when more than one additional unit is being
manufactured. However, management must be mindful that groups of
production units may have materially varying levels of marginal cost
Production costs consist of both fixed costs and variable costs. Fixed costs do
not change with an increase or decrease in production levels, so the same
value can be spread out over more units of output with increased production.
Variable costs refer to costs that change with varying levels of output.
Therefore, variable costs will increase when more units are produced.

For example, consider a company that makes hats. Each hat produced
requires $0.75 of plastic and fabric. Plastic and fabric are variable costs. The
hat factory also incurs $1,000 dollars of fixed costs per month.

If you make 500 hats per month, then each hat incurs $2 of fixed costs ($1,000
total fixed costs / 500 hats). In this simple example, the total cost per hat
would be $2.75 ($2 fixed cost per unit + $0.75 variable costs).

If the company boosted production volume and produced 1,000 hats per
month, then each hat would incur $1 dollar of fixed costs ($1,000 total fixed
costs / 1,000 hats), because fixed costs are spread out over an increased
number of units of output. The total cost per hat would then drop to $1.75 ($1
fixed cost per unit + $0.75 variable costs). In this situation, increasing
production volume causes marginal costs to go down.

If the hat factory was unable to handle any more units of production on the
current machinery, the cost of adding an additional machine would need to be
included in marginal cost. Assume the machinery could only handle 1,499
units. The 1,500th unit would require purchasing an additional $500 machine.
In this case, the cost of the new machine would need to be considered in the
marginal cost of production calculation as well.

Production costs consist of both fixed costs and variable costs. Fixed costs do
not change with an increase or decrease in production levels, so the same
value can be spread out over more units of output with increased production.
Variable costs refer to costs that change with varying levels of output.
Therefore, variable costs will increase when more units are produced.

12
For example, consider a company that makes hats. Each hat produced
requires $0.75 of plastic and fabric. Plastic and fabric are variable costs. The
hat factory also incurs $1,000 dollars of fixed costs per month.

If you make 500 hats per month, then each hat incurs $2 of fixed costs ($1,000
total fixed costs / 500 hats). In this simple example, the total cost per hat
would be $2.75 ($2 fixed cost per unit + $0.75 variable costs).

If the company boosted production volume and produced 1,000 hats per
month, then each hat would incur $1 dollar of fixed costs ($1,000 total fixed
costs / 1,000 hats), because fixed costs are spread out over an increased
number of units of output. The total cost per hat would then drop to $1.75 ($1
fixed cost per unit + $0.75 variable costs). In this situation, increasing
production volume causes marginal costs to go down.

If the hat factory was unable to handle any more units of production on the
current machinery, the cost of adding an additional machine would need to be
included in marginal cost. Assume the machinery could only handle 1,499
units. The 1,500th unit would require purchasing an additional $500 machine.
In this case, the cost of the new machine would need to be considered in the
marginal cost of production calculation as well.

Determine the parameters (maximum and minimum activity/revenue) for the

chart. Draw an L-shaped chart with the X axis (horizontal line) representing
activity in units / covers / hours, and the Y axis (vertical line) representing €
sales / costs. Map out the € sales on the Y axis and unit sales on the X axis,
starting with 0 (the point where the X and Y axis meet). Draw the fixed cost
line. The fixed cost line and should run parallel to the X axis. Draw the sales
revenue line. The sales revenue line is a diagonal line from the origin to the
maximum revenue point. Draw the total cost line. The break-even point is
where the total cost line intersects the revenue line.
The marginal costing method is based on the following fundamental
principles:  Cost of production only includes all variable costs i.e. all costs
that can be traced directly to the production units, because without those
costs production is not possible and hence, those costs are very important to
the goods produced.  Fixed overhead costs (also known as production
overhead costs) are costs that must be incurred with or without production
activities, and are excluded when calculating the cost of production because
the overhead cost do not affect the production decision on goods to be

13
produced, especially in the short run.  Under marginal costing, the fixed
production overhead costs are written off in full as an overhead period
expense, when preparing the profit or loss statement to derive the profit or
loss at the end of the period. See preparation of profit or loss statement later
  The key element in marginal costing is the assertive treatment and clear
distinction between variable and fixed production overhead costs
Absorption costing is a costing system that calculates the cost of production by
adding allocated production overhead costs to the total direct costs i.e. fixed
production overhead costs are absorbed or added to the total direct costs in
order to derive the total unit cost of production.  Absorption production
total cost = total direct costs + fixed production overhead cost   It is also
called total or full cost of production The total direct cost element is the
same prime cost as it is in the marginal costing method but the fixed
production overhead cost is an absorbed or allocated cost based on an
absorption rate which is calculated as follows: Overhead = Budgeted
production total overhead cost = £xx absorption rate = £xx Budgeted total
level of activities xx  The overhead absorption rate is also known as
factory-wide absorption rate or blanket rate   The above overhead
absorption rate can be calculated based on any “budgeted level of activities”
but a time-based level of activities such as labour or machine hours, is often
used whenever possible, because many overhead costs tend to fluctuate with
time, e.g. the overhead cost incurred for 100 units produced using 24 labour
hours will not be the same when the 100 units is produced at 36 labour
hours.   The absorption rate is calculated based on one single level of
activities, either based on the labour hours or machine hours, depending on
the type of production operation in place   Below are the types of
production operation:

Understanding Marginal Cost

Marginal cost is an economics and managerial accounting concept most often
used among manufacturers as a means of isolating an optimum production
level. Manufacturers often examine the cost of adding one more unit to their
production schedules.
At a certain level of production, the benefit of producing one additional unit
and generating revenue from that item will bring the overall cost of producing

14
the product line down. The key to optimizing manufacturing costs is to find
that point or level as quickly as possible.
Marginal cost includes all of the costs that vary with that level of production.
For example, if a company needs to build an entirely new factory in order to
produce more goods, the cost of building the factory is a marginal cost. The
amount of marginal cost varies according to the volume of the good being
produced.
Marginal cost is an important factor in economic theory because a company
that is looking to maximize its profits will produce up to the point where
marginal cost (MC) equals marginal revenue (MR). Beyond that point, the cost
of producing an additional unit will exceed the revenue generated.
Economic factors that may impact marginal cost include information
asymmetries, positive and negative externalities, transaction costs, and price
discrimination.
Special Considerations
Marginal cost is often graphically depicted as a relationship between marginal
revenue and average cost. The marginal cost slope will vary across company
and product, but it is often a "U" shaped curve that initially decreases as
efficiency is realized only to later potentially exponentially increase.
Marginal costs are not affected by the level of fixed cost. Marginal costs can be
expressed as ∆C/∆Q. Since fixed costs do not vary with (depend on) changes in
quantity, MC is ∆VC/∆Q. Thus if fixed cost were to double, the marginal cost
MC would not be affected, and consequently, the profit-maximizing quantity
and price would not change. This can be illustrated by graphing the short run
total cost curve and the short-run variable cost curve. The shapes of the curves
are identical. Each curve initially increases at a decreasing rate, reaches an
inflection point, then increases at an increasing rate. The only difference
between the curves is that the SRVC curve begins from the origin while the
SRTC curve originates on the positive part of the vertical axis. The distance of
the beginning point of the SRTC above the origin represents the fixed cost –
the vertical distance between the curves. This distance remains constant as the
quantity produced, Q, increases. MC is the slope of the SRVC curve. A change
in fixed cost would be reflected by a change in the vertical distance between
the SRTC and SRVC curve. Any such change would have no effect on the shape
of the SRVC curve and therefore its slope MC at any point. The changing law of
marginal cost is similar to the changing law of average cost. They are both

15
decrease at first with the increase of output, then start to increase after
reaching a certain scale. While the output when marginal cost reaches its
minimum is smaller than the average total cost and average variable cost.
When the average total cost and the average variable cost reach their lowest
point, the marginal cost is equal to the average cost.

Of great importance in the theory of marginal cost is the distinction between

the marginal private and social costs. The marginal private cost shows the cost
borne by the firm in question. It is the marginal private cost that is used by
business decision makers in their profit maximization behavior. Marginal social
cost is similar to private cost in that it includes the cost of private enterprise
but also any other cost (or offsetting benefit) to parties having no direct
association with purchase or sale of the product. It incorporates all negative
and positive externalities, of both production and consumption. Examples
include a social cost from air pollution affecting third parties and a social
benefit from flu shots protecting others from infection.

Externalities are costs (or benefits) that are not borne by the parties to the
economic transaction. A producer may, for example, pollute the environment,
and others may bear those costs. A consumer may consume a good which
produces benefits for society, such as education; because the individual does
not receive all of the benefits, he may consume less than efficiency would
suggest. Alternatively, an individual may be a smoker or alcoholic and impose
costs on others. In these cases, production or consumption of the good in
question may differ from the optimum level.

Internal vs. External Reporting

Marginal cost is strictly an internal reporting calculation that is not required for
external financial reporting. Publicly-facing financial statements are not
required to disclose marginal cost figures, and the calculations are simply used
by internal management to devise strategies.In many ways, a company may be
at a disadvantage by disclosing their marginal cost. Competitors would gain the
advantage of knowing the company's cost structure, and the market could
attempt to apply pressure to a company knowing the specific manufacturing
levels where operations become unprofitable for other companies.
Relevant Range

16
Marginal cost highlights the premise that one incremental unit will be much
less expensive if it remains within the current relevant range. However,
additional step costs or burdens to the existing relevant range will result in
materially higher marginal costs that management must be aware of.
Consider the warehouse for a manufacturer of landscaping equipment. The
warehouse has capacity to store 100 extra-large riding lawnmowers. The
margin cost to manufacture the 98th, 99th, or 100th riding lawnmower may
not vary too widely. However, manufacturing the 101st lawnmower means the
company has exceeded the relevant range of its existing storage capabilities.
That 101st lawnmower will require an investment in new storage space, a
marginal cost not incurred by any of the other recently manufactured goods.
Pricing Strategy
Marginal cost figures significantly into the marginal cost pricing doctrine, aka
marginal cost theory, an economic principle that dictates that prices for
products or rates for service should be predicated upon marginal costs for the
purpose of economic efficiency.
The doctrine stems from political economist and professor Alfred E. Kahn's
seminal work, The Economics of Regulation (1970 and 1971)
Under pure competition, price will be set at marginal cost” (the marginal price
will equal the marginal cost)," Kahn wrote, and this results in “the use of
society's limited resources in such a way as to maximize consumer satisfaction.

17
 The term marginal cost implies the additional cost involved in producing an
extra unit of output, which can be reckoned by total variable cost assigned to
one unit. It can be calculated as:
Marginal Cost = Direct Material + Direct Labor + Direct Expenses + Variable
Overheads .

Characteristics of Marginal Costing

 Classification into Fixed and Variable Cost: Costs are bifurcated, on the basis
of variability into fixed cost and variable costs. In the same way, semi variable
cost is separated.

 Valuation of Stock: While valuing the finished goods and work in progress,
only variable cost are taken into account. However, the variable selling and
distributionoverheads are not Included in the valuation of inventory.

18
between product costs and period costs forms a basis for marginal costing
technique, wherein only variable cost is considered as the product cost while
the fixed cost is deemed as a period cost, which

Features of Marginal Costing:

Features of marginal costing are as follows:

Marginal costing is used to know the impact of variable cost on the volume of
production or output.
Break-even analysis is an integral and important part of marginal costing.
Contribution of each product or department is a foundation to know the
profitability of the product or department.
Addition of variable cost and profit to contribution is equal to selling price.
Marginal costing is the base of valuation of stock of finished product and work
in progress.

19
Fixed cost is recovered from contribution and variable cost is charged to
production.
Costs are classified on the basis of fixed and variable costs only. Semi-fixed
prices are also converted either as fixed cost or as variable cost.

FACTS ABOUT MARGINAL COSTING

Some of the facts about marginal costing are depicted below:

Not a distinct method:

Marginal costing is not a distinct method of costing like job costing, process
costing, operating costing, etc., but a special technique used for managerial
decision making. Marginal costing is used to provide a basis for the
interpretation of cost data to measure the profitability of different products,
processes and cost centres in the course of decision making. It can, therefore,
be used in conjunction with the different methods of costing such as job
costing, process costing, etc., or even with other techniques such as standard
costing or budgetary control.

Cost Ascertainment:
In marginal costing, cost ascertainment is made on the basis of the nature of
cost. It gives consideration to behaviour of costs. In other words, the
technique has developed from a particular conception and expression of the
nature and behaviour of costs and their effect upon the profitability of an
undertaking.

Decision Making:
In the orthodox or total cost method, as opposed to marginal costing, the
classification of costs is based on functional basis. Under this method the
total cost is the sum total of the cost of direct material, direct labour, direct
expenses, manufacturing overheads, administration overheads, selling and
distribution overheads.

20
In this system, other things being equal, the total cost per unit will remain
constant only when the level of output or mixture is the same from period to
period. Since these factors are continually fluctuating, the actual total cost
will vary from one period to another. Thus, it is possible for the costing
department to say one day that an item costs `20 and the next day it costs
.
This situation arises because of changes in volume of output and the peculiar
6ehavior of fixed expenses included in the total cost. Such fluctuating
manufacturing activity, and consequently the variations in the total cost from
period to period or even from day to day, poses a serious problem to the
management in taking sound decisions. Hence, the application of marginal
costing has been given wide recognition in the field of decision making.

21
 Chapter 2 : REVIEW OF LITERATURE

The CIMA Official Terminology defines marginal costing as ‘The accounting

system in which variable costs are charged to cost units and fixed costs of the
period are written off in full against the aggregate contribution. Its special value
is in recognizing cost behavior and hence assisting in decision-making’.
Marginal Costing is the technique of costing fully oriented towards managerial
decision making and control. This technique can be used in conjunction with
any method of cost ascertainment. It can also be used in combination with
technique such as budgeting and standard costing. Marginal costing is helpful
in determining the profitability of products, departments, process and cost
centers. While analyzing the profitability, marginal costing interprets the cost
on the basis of nature of cost. Marginal cost in other words is variable cost.
For a typical manufacturing company the following elements of costs are
variable or marginal costs: Direct material, direct wages, direct expenses,
Variable overheads. Thus, Marginal Cost = Prime cost + Total variable
overheads Or Marginal Cost = Total cost - fixed cost. Marginal costing is a
different approach compared to the absorption costing methodologies.
Marginal costing methodology is used to calculate the cost of one additional
unit of service. Economists argue that variable costs can be equal to marginal
costs in the relevant range. In a given ranges of volume of services the fixed
costs are constant, therefore the marginal costs are equal to the variable costs.
Therefore, marginal costing requires the total costs to be split into fixed and
variable components (Lucey 2002). Marginal costing is useful for the short term
(tactical decisions) such as accepting a special order (special order or marginal
cost pricing), dropping a product or service, and/or making “make or buy”
decisions, because the fixed costs remain unchanged. On the other hand, in the
long term and/or when fixed costs are expected to change, the differential
costing method should be used (Lucey 2002, Millchamp 1997). Absorption
Costing: Costs which are fixed within the short term plan e.g. transport
manager's salary, warehouse rent and rates, and which do not vary with the
level of activity, can be charged to a cost Centre and apportioned hopefully on
some rational basis to the output concerned.
To avoid absorbing different unit costs with different rates of throughput, an 5
overhead absorption rate can be applied based on estimated volume and past

22
Marginal costing is useful for the short term (tactical decisions) such as
accepting a special order (special order or marginal cost pricing), dropping a
product or service, and/or making “make or buy” decisions, because the fixed
costs remain unchanged. On the other hand, in the long term and/or when
fixed costs are expected to change, the differential costing method should be
used (Lucey 2002, Millchamp 1997). Absorption Costing:
Costs which are fixed within the short term plan e.g. transport manager's
salary, warehouse rent and rates, and which do not vary with the level of
activity, can be charged to a cost Centre and apportioned hopefully on some
rational basis to the output concerned. To avoid absorbing different unit costs
with different rates of throughput, an 5overhead absorption rate can be
applied based on estimated volume and past experience. Individual unit rates
can be applied to the various stored products on, say, a volume basis or
whatever feature of the situation is most appropriate.
However, in certain areas of distribution an appropriate feature may not always
be obvious, or the task may not be of a similar enough or repetitive nature.
Additionally, any significant change in the volume of throughput will lead to an
over or under recovery of overheads. In absorption costing the cost objects are
usually the final products (services or jobs), the absorption cost system is
widely used to value the costs of products manufactured, or services and jobs
delivered in manufacturing firms, as well as in service sectors.
Although there is no substantial difference in the absorption costing used in
service and non-service industry, defining a product (service or job) could be
difficult in the service industry (Zimmerman 2003). There are two major (basic)
types of absorption costing: (a) job order costing and (b) process costing. Job
order costing estimates the average unit costs for each job delivered. Process
costing assesses the average unit cost for each service provided in a given time
period.
It is important to keep in mind that absorption costing allocates historical
costs, and therefore the unit costs estimated by this system may or may not be
reasonably good estimates of opportunity costs (Zimmerman 2003).
The absorption costing system can produce inaccurate unit cost estimates
partly due to the biases embodied in the overhead allocation methods applied.
If the overhead allocation method does not represent the cause-and-effect
relationship between the final product (service or job) and the overheads, the

23
unit cost estimates could be more or less inaccurate especially in multi-product
plants such as a hospital.
Activity based costing was introduced to improve the accuracy of unit cost
estimates, but it has its limitations (Zimmerman 2003). Activity based costing
(ABC) is a relatively new approach in full absorption costing. ABC is getting
more widely used for costing public services, such as diagnostic imaging,
laboratory services or intensive care. This latest approach allocates overhead
costs more fairly. Using activity based costing could improve costing in health
care, and shed light on services that were under-costed or over-costed in the
past using traditional costing methodologies (Pyke 1998
experience. Individual unit rates can be applied to the various stored products
on, say, a volume basis or whatever feature of the situation is most
appropriate. However, in certain areas of distribution an appropriate feature
may not always be obvious, or the task may not be of a similar enough or
repetitive nature.
Finance is regard as the lifeblood as business enterprise. No enterprise can
exist without finance. The owners all always eager to know the financial
position of the business, which can be know with the help of financial
statements. i.e. Profit and Loss account and Balance Sheet. Profit and Loss
account shows the profitability of the business during the accounting period.
It indicates the earning capacity and potential of the firm. It presents summary,
revenues, expenses and Net Income or Net Loss of a firm for a period of time.
The Balance Sheet indicates the financial position of the last day of the
accounting period. It contains information about resources and obligations
entity and about its owner’s interests in the business of particular period of
time.
According to American Institute of Certified Public Accounts, Financial
Statements reflects a combination of recorded facts, accounting principles and
personal judgements. FINANCIAL STATEMENT ANALYSIS Financial statement
contains a wealth of information which, it properly analyzed and interpreted,
can provide valuable insight into a firm’s performance and position. financial
statements analysis is largely is a study of the relationship among the various
financial factors in a business as disclosed by a single set of statements and a
study of the trend of these factors as shown in a serious of statements.

24
Marginal costing technique has the following limitations:
 In marginal costing, costs are classified into fixed and variable.
Segregation of costs into fixed and variable is rather difficult and cannot
be done with precision.
 Marginal costing assumes that the behavior of costs can be represented
in straight line. This means that fixed costs remains completely fixed
over a period at different levels and variable costs change in linear
pattern i.e. the change is proportion to the change in volume. In real life,
fixed costs are liable to change at varying levels of production especially
when extra plant and equipments are introduced and hence variable
costs may not vary in the same proportion as the volume.
 Under marginal costing technique fixed costs are not included in the
value of stock of finished goods and work-in-progress. As fixed costs are
incurred, these should also form part of the costs of the product. Due to
this elimination of fixed costs from finished stock and work-in-progress,
the stocks are understated. This affects the results of profit and loss
account and the balance sheet. Thus, profit may be unnecessarily
deflated.
 In the marginal costing system monthly operating statements will not be
as realistic or useful as under the absorption costing system. This is
because under this system, marginal contribution and profits vary with
change in sales value. Where sales are occasional, profits fluctuate from
period to period.
 Marginal costing fails to give complete information, for example rise in
production and sales may be due to extensive use of existing machinery
or by expansion of the resources or by replacement of the labour force
by machines. The marginal contribution of P/V ratio fails to bring out
reasons for this.
 Under marginal costing system the difficulties involved in the
apportionment and computation of under and over absorption of fixed
overheads are done away with but problem still remains as far as the
under absorption or over absorption of variable overheads is concerned.
 Although for short term assessment of profitability marginal costs may
be useful, long-term profit is correctly determined on full costs basis
only.
 Marginal costing does not provide any standard for the evaluation of the
performance. Marginal contribution data do not reveal many effects
which are furnished by variance analysis. For example, efficiency

25
 variance reflects the efficient and inefficient use of plant, machinery and
labour and this sort of valuation is lacking in the marginal cost analysis.
 Marginal costing analysis assumes that sales price per unit will remain
the same on different levels of production but these may change in real
life and give unrealistic results.
 In the age of increased automation and technology advancement,
impact of fixed costs on product is much more than that of variable
costs. As a result a system that does not account the fixed costs is less
effective because a substantial portion of the cost is not taken into
account.
 Selling price under the marginal costing technique is fixed on the basis of
contribution. This may not be possible in the case of ‘cost plus
contracts’.

Thus the above limitations indicate that fixed costs are equally important in
certain cases.
In marginal costing closing inventory has no element of fixed costs, as all fixed
costs are charged to income of the period. Hence profit under variable a
Additionally, any significant change in the volume of throughput will lead to an
over or under recovery of overheads. In absorption costing the cost objects are
usually the final products (services or jobs), the absorption cost system is
widely used to value the costs of products manufactured, or services and jobs
delivered in manufacturing firms, as well as in service sectors. Although there is
no substantial difference in the absorption costing used in service and non-
service industry, defining a product (service or job) could be difficult in the
service industry (Zimmerman 2003). There are two major (basic) types of
absorption costing: (a) job order costing and (b) process costing. Job order
costing estimates the average unit costs for each job delivered. Process costing
assesses the average unit cost for each service provided in a given time period.
It is important to keep in mind that absorption costing allocates historical costs,
and therefore the unit costs estimated by this system may or may not be
reasonably good estimates of opportunity costs (Zimmerman 2003).
The absorption costing system can produce inaccurate unit cost estimates
partly due to the biases embodied in the overhead allocation methods applied.
If the overhead allocation method does not represent the cause-and-effect
relationship between the final product (service or job) and the overheads, the
unit cost estimates could be more or less inaccurate especially in multi-product
plants such as a hospital.

26
 Activity based costing was introduced to improve the accuracy of unit cost
estimates, but it has its limitations (Zimmerman 2003). Activity based costing
(ABC) is a relatively new approach in full absorption costing. ABC is getting
more widely used for costing public services, such as diagnostic imaging,
laboratory services or intensive care. This latest approach allocates overhead
costs more fairly. Using activity based costing could improve costing in health
care, and shed light on services that were under-costed or over-costed in the
past using traditional costing methodologies (Pyke 1998).
Costing contributes to an understanding of how profits and value are created,
and how efficiently and effectively operational processes transform input into
output. It can be applied to resource, process, product/service, customer, and
channel-related information covering the organization and its value chain.
Costing information can be used to provide feedback on past performance, and
to motivate and change future performance. Costing is thus an essential tool in
creating shareholder and stakeholder value.

Given its importance and breadth of scope, it is unsurprising that many

different costing methods exist, both in the literature and in practice. This can
create confusion and uncertainty for managers, and need a sufficient
understanding of sound costing principles to be able to select and apply useful
approaches. The history of Absorption Costing is as old as Cost accounting
(Cunagin and Stancil, 1992). Metcalfe, Garcke and Fells, Norton, Lewis, and
later with Church, Nicholson and Clark introduced the concepts of various
costing techniques including Absorption and Marginal Costing (Cited by
Chandra and Paperman, 1976).

Cost Accounting is usually used for internal decision making which does not
require following GAAP standards, so organizations develop their own secret
standards that help them to enhance knowledge in decision making process.
(Cunagin and Stancil, 1992). External Financial accounting requires
manufacturing costs to be divided into Product Cost and Period Cost for stock
valuation.

27
Product costs are those costs that are identified with goods purchased or
produced for resale. Product cost is used for stock valuation and it becomes the
part of per unit cost. Product cost is incurred in the period in which it is
produced and taken to profit and loss account and charged when product is
sold. (Drury, 2008). Period cost is that cost that expires with the passage of
time, regardless of production activity (Fremgen, 1964), and are not included in
the inventory valuation and as a result are treated as expenses in the period in
which they are incurred. Period cost is incurred and charged in the same period
to profit and loss accounts as an expense.

Selling and administrative expenses in a manufacturing concern are an example

of period cost. Absorption costing is a method for appraising or valuing a firm's
total inventory by including all manufacturing costs as product costs, regardless
of whether they are variable or fixed and therefore it is frequently referred as
the full cost method. (Seiler, 1959; Chandra and Paperman, 1976; Lal and
Srivastava, 2008).

Under variable costing, only those manufacturing costs that vary with output
are treated as product costs. This would usually include direct material, direct
labor, and the variable portion of manufacturing overhead. Variable costing is
sometimes referred as direct costing or marginal costing.

Fixed manufacturing overhead is treated as period cost just as selling and

administrative expenses. Thus in inventory valuation or in cost of goods sold
fixed manufacturing overhead is not treated as product cost in marginal costing
technique. (Seiler, 1959; Chandra and Paperman, 1976; Lal and Srivastava,
2008; Swamidass, 2000).

Classification into Fixed and Variable Cost : Costs are bifurcated, on the basis
of variability into fixed cost and variable costs. In the same way, semi variable
cost is separated.

28
Valuation of Stock: While valuing the finished goods and work in progress,
only variable cost are taken into account. However, the variable selling and
distribution overheads are not included in the valuation of inventory.

Make or Buy Decision

Make or Buy Decision‘ is a problem in respect of which management has to

take decision continuously, In this context, the management has to decide
whether a certain product or component should be made in the factory itself
or bought from outside suppliers.

The nature of decision regarding make or buy may be of the following types:

(a) Stopping the production of the part and buying it from the maket: A
business co is already making a part or component which is used in the
business. Now due to some decision has to be taken whether this part or
component should be bought from the market additional requirement
due to increase in production of main factory should be made in factory or
should be bought from the market. In the case of a decision like stopping the
production of the part or component and buying it from market, it is to be
remembered that there would not be additional fixed cost in case and only
marginal cost is the relevant factor to be considered. If the marginal cost is less
than buying price, additional requirement of the component should be met by
making rather than buying. Similarly, if buying price is less than marginal cost,
it will be advantageous to purchase it from the market.
(b) Stopping the purchase of a component and to produce it in own factory:
The second aspect of the problem of make or buy may be that a c0mponent or
part thus far being purchased from the market should be produced or made in
factory or not. In this case, normally some extra arrangement regarding space,
labour, machine etc. will be required. This may involve capital investment too.
Some special overheads may also be necessary. If the decision for making
requires the setting up of a new and separate factory, separate supervisory
staff may also be needed.

29
 All these arrangements will require additional costs. As such, the price being
paid to
outsiders should be compared with additional costs which will have to be
incurred in the form of raw materials, wages, salaries of additional supervisors,
interest on capital investment, depreciation on new machine, rent of premises
etc. If such additional cost are less than the buying price, the component
should be manufactured and vice-versa.

Change in Product Mix

(a). Introducing a new line or department: The problem of introducing a new

product or line involves decision in two respects- whether a new product or
line should be added to the existing production or not, and if it should be
introduced, then what should be the model or design or shape of the new
product. In other words, if new product can be produced in more than one
model, which model should be introduced? The marginal cost of new product
in all its possible models should be considered. It also possible that a portion of
the cost of facilities relating to the original production may be used for the
purpose of producing new product.
(b). Selecting optimum product mix: When a company is engaged in a number
of lines or produts, there may arise a problem of selecting most optimum
product mix which would maximize the earnings. This problem becomes
complicated, when one of the factors happens to be limiting or key factors.
Under such a situation, profitability will be improved only by economizing the
scarce resources. As pointed out earlier, contribution per unit of key factor is
the real index of profitability under such case. Thus, while deciding a profitable
mix of products, contribution per unit of key factor should be considered.

Shut-Down Decisions

Shut-down decisions may be of two types- closure of entire business and

dropping a line or product or department. Closure of entire business:
Sometimes, a business concern may not be in a position to carry out its trading

30
activities in an adequate volume due to trade recession or cut throat
competition. As such, the management of such business concern may be faced
with a problem of suspending the trading activities.

Shut-down point = Net escapable fixed cost / contribution per unit Or Shut-
down point = Avoidable expenses / contribution per unit of raw materials.

Example
Sales Rs. 1,00,000; Profit Rs. 10,000; Variable cost 70%. Find out (i) P/V ratio, (ii)
Fixed Cost (iii) Sales volume to earn a Profit of Rs. 40,000.
Sales Rs.1,00,000
Variable Cost = 70%
(70/100) X 1,00,000 = Rs.70,000
(i)P/V Ratio = (Sales — Variable Cost) / Sales x 100 = [(1,00,000 - 70,000)/
1,00,000] x 100 = 30%
(ii) Contribution = Fixed Cost + Profit or, 30,000 = Fixed Cost + 10,000 or, Fixed
Cost = 30,000 -10,000 = Rs, 20,000
(iii) Sales = (Fixed Cost + Profit) / P/V Ratio = (20,000 + 40,000) / 30%
(60,000 x 100)/ 30 = Rs, 2,00,000
Proof: Sales = Rs, 2,00,000
Variable Cost (70%) = Rs. 1,40,000
----------------
Contribution = Rs. 60,000
Fixed Cost = Rs. 20,000
------------------
Profit = Rs. 40,000
----------------

31
Advantages of Marginal Costing

The following are the important advantages of marginal costing :

1 Constant in nature
While variable costs occasionally change, marginal costs are stable over the
long term. Regardless of the level of production, margin costs are constant.
2. Effective cost control
It divides cost into fixed and variable. Fixed cost is excluded from product. As
such, management can control marginal cost effectively.
3. Simplified treatment of overheads
By separating fixed overheads from production costs, it lessens the degree to
which overheads are over- or under-recovered.
4. Uniform and realistic valuation
As the fixed overhead costs are excluded from product costs, the valuation of
work-in-progress and finished goods becomes more realistic.
5. Helpful to management
Management finds it helpful because it makes it possible to launch a profitable
new production line. Finding out whether to buy or manufacture a product
helps determine the more profitable one. Regarding pricing and tendering,
management has the final say.
6. Helps in production planning
It shows the amount of profit at every output level with the help of the cost-
volume-profit relationship. Here the break-even chart is made use of.
7. Decision-making
Marginal costing helps management with adequate information appropriate
enough for making vital business decisions such as making or buying
discontinuance of a particular product or a particular line of activity, pricing
during the depression, export pricing, appropriate product mix, replacement of
machines, sub-contracting, etc.
8. Better results

32
When used with standard costing, it gives better results.
9. Fixation of selling price
The differentiation between fixed costs and variable costs is very helpful in
determining the selling price of the products or services. Sometimes, different
prices are charged for the same article in different markets to meet varying
degrees of competition.
10. Helpful in budgetary control
The classification of expenses is very helpful in budgeting and flexible budget
for various levels of activities.
11. Responsibility accounting
Since under marginal costing, fixed expenses are treated as period costs, there
is no arbitrary allocation of such expenses to the various departments. As such,
responsibility accounting becomes more effective when it is based on marginal
costing.
12. Preparing tenders
Many business enterprises have to compete in the market in quoting the
lowest price. Total variable cost, when separately calculated, becomes the
'floor price.' Any price above this floor price may be quoted to increase the
total contribution.
13. "Make or Buy" decision
Sometimes a decision has to be made whether to manufacture a component or
a product or to buy it ready-made from the market. The decision to purchase it
would be taken if the price paid recovers some of the fixed expenses.
14. Better presentation
Management executives better understand the statements and graphs
prepared under marginal costing. The break-even analysis presents the
behavior of cost, sales, contribution, etc. in terms of charts and graphs. And,
thus the results can easily be grasped.
1, The technique of marginal costing is very simple to operate and easy to
understand. Since, fixed costs are kept outside the unit cost, the cost
statements prepared on the basis of marginal cost are much less complicated.

33
 2. It does away with the need for allocation, apportionment and absorption of
fixed overheads and hence removes the complexities of under absorption of
overheads
. 3. Marginal cost remains the same per unit of output irrespective of the level
of activity. It is constant in nature and helps the management in production
planning
. 4. It prevents the carry forward of current year’s fixed overheads through
valuation of closing stocks. Since fixed costs are not considered in valuation of
closing stocks, there is no possibility of fictitious profits by over-valuing stocks.
5. It facilitates the calculation of various important factors, viz., break-even
point, expectations of profits at different levels of production, sales necessary
to earn a predetermined target of profit, effect on profit due to changes of raw
materials prices, increased wages, change in sales mixture, etc.
6.It is a valuable aid to management for decision-making and control. It helps
management in taking many crucial decisions, such as fixation of selling prices,
selection of a profitable product/sales mix, make or buy decision, problem of
key or limiting factor, determination of the optimum level of activity, close or
shut down decisions, evaluation of performance and capital investment
decisions, etc.
7. It facilitates the study of relative profitability of different product lines,
departments, production facilities, sales divisions, etc.
8. It is complementary to standard costing and budgetary control and can be
used along with them to yield better results.
9. Since fixed costs are not controllable and it is only variable or marginal cost
that is controllable, marginal costing, by dividing costs into controllable and
noncontrollable, helps in cost control.
10. It helps the management in profit planning by making a study of
relationship between cost, volume and profits. Further, break-even arts and
profit graphs make the whole problem easily understandable even to a layman.
11. It is very useful in management reporting. Marginal costing facilitates
‘management by exception’ by focussing attention of the management towards
more important areas than to waste time on problems which do not require
urgent attention of the higher managements.

34
2.1 Limitation Of The Study
Limitations or Disadvantages of Marginal Costing In spite of so
many advantages, the technique of marginal costing suffers from
the following
limitations :
1. Difficulty of Segregation
Since marginal costing is the ascertainment of marginal cost and the effect on
profit of changes in the volume or type of output by differentiating between
fixed costs and variable costs, it is necessary to segregate the expenses into
fixed and variable items.
However, it is not that easy to segregate the expenses. Most of the expenses
are neither totally variable nor wholly fixed. As such, the expenses are to be
separated with reasonable accuracy. Otherwise, the technique ceases to be
accurate.
2. Time element ignored
Fixed costs and variable costs are different in the short run, but in the long run,
all costs are variable. In the long run all costs change at varying levels of
operation. When new plants and equipment are introduced, fixed costs and
variable costs will vary.
3. Unrealistic assumption
Assumption that the sale price will remain the same at different levels of
operation. In real life, they may change and give unrealistic results.
4. Difficulty in the fixation of price
Under marginal costing, the selling price is fixed based on contribution. In case
of cost plus contract, it is very difficult to fix price.
5. Complete information not given
It does not explain the reason for the increase in production or sales.

35
6. Stock Valuation
Apart from work-in-progress in the case of large contracts, even stocks of
manufacturing concerns cannot be shown in the balance sheet by excluding
fixed costs. If they are excluded, stocks of work-in-progress and finished goods
would be undervalued, and to that extent, the balance sheet fails to reflect a
true and fair view of the affairs of the business.
7. Significance lost
In capital-intensive industries, fixed costs occupy major portions of the total
cost. But marginal costs cover only variable costs. As such, it loses its
significance in capital industries.
8. The problem of variable overheads
Marginal costing overcomes the problem of over and under-absorbing fixed
overheads. Yet there is the problem in the case of variable overheads.
9. Sales-oriented
Successful business has to go in a balanced way regarding selling production
functions. But marginal costing is criticized because of its over-importance to
the selling function. Thus it is said to be sales-oriented. Production function is
given less importance.
10. Unreliable stock valuation
Under marginal costing, stock of work-in-progress and finished stock is valued
at variable cost only. No portion of fixed cost is added to the value of stocks.
Profit determined, under this method, is depressed.
11. Claim for loss of stock
Insurance claim for loss or damage of stock based on such a valuation will be
unfavorable to the business.
12. Automation
Nowadays, increasing automation is leading to an increase in fixed costs. If such
increasing fixed costs are ignored, the costing system cannot be effective and
dependable. Marginal costing, if applied alone, will not be of much use unless
it is combined with other techniques like standard costing and budgetary
control.
13. Difficulty in Application

36
The technique of marginal costing is difficult to apply in industries like
shipbuilding, contracts, etc., where the value of work-in-progress is large in
proportion to turnover. Thus, if fixed overheads are not included in the closing
value of work-in-progress, losses on contracts may result in every year, while on
completion of the contract, there may be large profits.
1. The technique of marginal costing is based upon a number of assumptions
which may not hold good under all circumstances.
2. All costs are not divisible into fixed and variable. There are certain costs
which are semi-variable in nature. It is very difficult and arbitrary to classify
these costs into fixed and variable elements. 3.Variable costs do not always
remain constant and do not always vary in direct proportion to volume of
output because of the laws of diminishing and increasing returns.
4. Selling prices do not remain constant for ever and for all levels of Output
due to competition, discounts for bulk orders, changes in the general price
level. Further, marginal costing ignores the fact that fixed costs are also
controllable.
6. The exclusion of fixed costs from the stocks of finished goods and work-
inprogress is illogical since fixed costs are also incurred on the “manufacture of
products, Stocks valued on marginal costing are undervalued and the profit and
loss account cannot reveal true profits. Similarly, as the stocks are undervalued,
the balance sheet does not give a true picture.
7. Although the technique of marginal costing overcomes the problem of
under or overabsorption of fixed overheads, the problem still exists in fegard to
under or overabsorption of variable overheads.
8. Marginal costing completely ignores the ‘time factor’, Thus, if two jobs give
equal contribution but one takes longer time to complete, the one which takes
longer time should be regarded as costlier than the other. But this fact is
ignored altogether under marginal costing.
9. The technique of marginal costing cannot be applied in contract or ship-
building industry because in such cases, normally the value of work in-progress
is very high and the exclusion of fixed overheads may results into losses every
year and a huge profit in the year of completion of the job.
10. Cost control can better be achieved with the help of other techniques, viz.,
standard costing and budgetary control than by marginal costing technique.

37
DISTINCTION BETWEEN MARGINAL AND ABSORPTION COSTING

The distinctions in these two techniques are illustrated by the following :

COST-VOLUME-PROFIT (CVP) ANALYSIS

Meaning: It is a managerial tool showing the relationship between various
ingredients of profit planning viz., cost, selling price and volume of activity. As
the name suggests, cost volume profit (CVP) analysis is the analysis of three
variables cost, volume and profit. Such an analysis explores the relationship
between costs, revenue, activity levels and the resulting profit. It aims at
measuring variations in cost and volume.
Assumptions:

Changes in the levels of revenues and costs arise only because of changes in
the number of product (or service) units produced and sold –
For example, the number of television sets produced and sold by Sony
Corporation or the number of packages delivered by Overnight Express. The
number of output units is the only revenue driver and the only cost driver.
Just as a cost driver is any factor that affects costs, a revenue driver is a
variable, such as volume, that causally affects revenues.

38
Total costs can be separated into two components; a fixed component that
does not vary with output level and a variable component that changes with
respect to output level. Furthermore, variable costs include both direct
variable costs and indirect variable costs of a product. Similarly, fixed costs
include both direct fixed costs and indirect fixed costs of a product
When represented graphically, the behaviours of total revenues and total
costs are linear (meaning they can be represented as a straight line) in
relation to output level within a relevant range (and time period).
Selling price, variable cost per unit, and total fixed costs (within a relevant
range and time period) are known and constant.

The analysis either covers a single product or assumes that the proportion of
different products when multiple products are sold will remain constant as
the level of total units sold changes.
All revenues and costs can be added, subtracted, and compared without taking
into account the time value of money. (Refer to the FM study material for a
clear understanding of time value of money).
Importance

It provides the information about the following matters:

The behavior of cost in relation to volume.
Volume of production or sales, where the business will break-even.
Sensitivity of profits due to variation in output.
Amount of profit for a projected sales volume.
Quantity of production and sales for a target profit level.

Impact of various changes on profit:

39
An understanding of CVP analysis is extremely useful to management in
budgeting and profit planning. It elucidates the impact of the following on the
net profit:

Changes in selling prices,

Changes in volume of sales,
Changes in variable cost,
Changes in fixed cost.

APPLICATION OF CVP ANALYSIS IN DECISION MAKING

As discussed earlier CVP analysis is used as an evaluation tool for managerial

decisions. In this chapter we will discuss the use of CVP Analysis for short term
decision making. Before going into illustration, let us discuss the decision
making framework.
Framework for Decision Making

Step 1: Identification of Problem

Step 2: Indentification of Options

Step 3: Evaluation of the Options

Step 4: Selection of the Option

Step-1: Identification of Problem

Every organisation has its own objectives, and goals are set to achieve these
objectives. To reach at the goal, actions are to be taken. For example, if an
organisation wants to be a cost leader in the industry it operates in, it has to
achieve 3Es in its all activities. 3Es means economy in inputs, efficiency in
process and operations and effectiveness in output. An entity that exists for
profit may identify few areas (problem areas) which if worked on can add to

40
the profit or wealth maximisation. For example, Arnav Ltd. a manufacturer of
Steel products, has identified that it can be leader in the industry if it can
produce steel products at lower cost than its rival. Here the goal should be
(problem area) low cost production.
Step- 2: Identification of Options

After identification of problem(s), the next step is identification of options to

achieve the goal (to answer the problem). Every possible options need to be
explored. In the above example, the Arnav Ltd. may have the following options
for low cost production:
Purchase of inputs from specialised market- Local vs Import
Make the input in its own factory- Make or Buy
Bulk purchase to avail discount offer- How much to purchase
Make in-house- Make vs Outsource
Bulk processing- How much to produce
Using efficient machine for manufacturing- Old machine vs New machine
Optimisation of key resources- Product mix decisions etc.

Step- 3: Evaluation of the Options

After identification of options, each option is to be evaluated against the
objective criteria. An entity with objective of making profit may evaluate
options on the basis of financial measures like impact of profit or loss, market
share, overall impact on profitability, return on investment etc. Non-financial
factors like customer satisfaction, impact on existing market/ customer, ethics
of decision are also evaluated.

This step is a very important and may be grouped into two tasks

Identification of Cost and Benefits of each options

Estimation of amount of each options
41
Step-4: Selection of option:
After evaluation of the options, the best option is selected and implemented.
Principles for Identification of Cost and Benefits for measurement
The cost and benefit of an options is identified for measurement if it passes the
principles of Controllability and Relevance.

Controllability:
Those cost and benefits which arise due to choice of an option. In other
words, benefits received and cost incurred are directly related with the choice
of the option. Thus, the costs and benefits which are controllable are
considered for measurement for making decision.

Relevance:
The costs which are controllable need to be relevant for decision making. This
means all controllable costs are not relevant for decision making unless it
differs under the two options. Thus, a cost is treated is relevant only if

(a) it is a future cost and (b) it differs under two options under consideration.

42
Cost Relevance Reason
(i) Historical Irrelevant The cost has already been incurred and
Cost do not affect the decision. Example:
Book value of machinery etc.
(ii) Sunk Cost Irrelevant The cost which are already paid either
for goods or services availed or to be
availed. Example: Raw material
purchased and held in store without
having replacement cost, Cost of
drawing, blueprint etc.
(iii) Committed Irrelevant The committed costs are the pre-
Cost agreed cost which cannot be revoked
under the normal circumstances. This is
also a sunk cost. Examples: Cost of
materials as per rate agreement, Salary
cost to employees etc.
(iv) Opportunity Relevant The opportunity cost is represented by
Cost the forgone potential benefit from the
best rejected course of action. Had the
option under consideration not chosen,
the benefit would come to the
organisation.
(v) Notional Relevant Notional costs are relevant for the
or Imputed decision making only if company is
Cost actually forgoing benefits by employing
its resources to alternative course of
action. For example, notional interest on
internally generated fund is treated as
relevant notional cost only if company
could earn interest from it.
(vi) Shut-down Relevant When an organization suspends its
Cost manufacturing operations, certain fixed
expenses can be avoided and certain
extra43
fixed expenses may be incurred
depending
For Example, Arnav Ltd. wants to manufacture 1,000 additional units of
Product X. It is considering either to manufacture in its own factory or to
outsource to job workers. In this example cost of raw materials to
manufacture additional 1,000 units is controllable as it arises due to
management’s decision to make additional units.
cost and benefits are identified for measurement which are both Controllable
and Relevant.

But it is not relevant for making choice between manufacture in-house and
outsource to job workers, as under the both options, the raw materials cost
would be same.
Hence, for decision making purpose only those.

After identification of the costs and benefits, it is now required to be quantified

i.e. the cost and benefit should be measured and estimated. The estimation is
done by following the two principles as discusses below:

Variability: Variability means by how much a cost or benefit increased or

decreased due to the choice of the option. Variable costs are the cost which
differs under the different volume or activities. On the other hand, fixed costs
remain same irrespective of volume and activities.

Traceability: Traceability of cost means degree of relationship between the

cost and the choice of the option. Direct costs are directly assigned to the
option on the other hand indirect costs needs to be apportioned to the option
on some reasonable basis.

For Example, Arnav Ltd. wants to manufacture 1,000 units of Product X. It is

considering to manufacture the same in its own factory. To manufacture in its
own factory it requires 1,000 hours of employees and a specialised machine. In
this example, employee cost for labour of 1,000 hours is variable cost for in-
house manufacturing and it is directly traceable. Cost of machinery is also

44
direct cost but so far as traceability of the machinery cost is concerned it is
direct cost for 1,000 units as a whole but indirect cost for a unit.

Hence, the cost and benefits of an option is measured at directly traceable and
variable costs.
The principles of marginal costing The principles of marginal costing are as
follows. a. For any given period of time, fixed costs will be the same, for any
volume of sales and production (provided that the level of activity is within the
‘relevant range’).

Therefore, by selling an extra item of product or service the following will

happen.

 Revenue will increase by the sales value of the item sold.

 Costs will increase by the variable cost per unit.
 Profit will increase by the amount of contribution earned from the extra
item.
b. Similarly, if the volume of sales falls by one item, the profit will fall by the
amount of contribution earned from the item.
c. Profit measurement should therefore be based on an analysis of total
contribution. Since fixed costs relate to a period of time, and do not change
with increases or decreases in sales volume, it is misleading to charge units of
sale with a share of fixed costs. d. When a unit of product is made, the extra
costs incurred in its manufacture are the variable production costs. Fixed costs
are unaffected, and no extra fixed costs are incurred when output is increased.
cost and benefits are identified for measurement which are both Controllable
and Relevant.

45
 Chapater no: 3 Hypothesis of study
The following hypotheses are considered as the basis for the questions set for
this study.
Marginal costing technique is not the best technique for decision making
compared to Absorption costing techniques.
Marginal costing technique is the best technique for decision making compared
to Absorption costing techniques
Strict adherence to marginal costing technique does not enhance profitability
level and growth of an organization compared to strict adherence to
Absorption costing technique
Strict adherence to marginal costing technique enhance profitability level and
growth of an organization compared to strict adherence to Absorption costing
techniques
Marginal costing techniques does not serve as a tool for planning and short
term decisions compared to absorption costing techniques.
Marginal costing techniques serves as a tool for planning and short term
decisions compared to absorption costing technique
In relation to a given volume of output, additional output can normally be
obtained at less than proportionate cost.
This is because of the reason that within certain limits the aggregate of certain
items of cost will tend to remain fixed.
Increase in the volume of output will normally be accompanied by less than
proportionate increase in total cost (fixed + variable).
Similarly, decrease in the volume of output will normally be accompanied by
less than proportionate decrease in total cost.

46
 This is because fixed cost remains constant irrespective of the level of output
(upto a certain level), and it is only the variable cost which changes according
to the change in the output level.
The amount at any volume of output by which aggregate costs are changed it
the volume of output is increased by one unit.

In general it is measured as to total variable cost attributable to one unit.

Marginal Cost = Variable Cost = Direct Labour + Direct Material + Direct
Expenses + Variable Overheads. • Marginal Cost = Prime Cost + Variable
Overheads. • It is a relevant cost useful for decision making.
Marginal costing is not a distinct method of costing like job costing, process
costing etc. It uses a special technique for managerial making. It is used to
provide a basis for interpretation of cost data to measure the profitability.
Here, cost is classified on the basis of behaviour or nature (ie Fixed cost,
Variable cost and Semi-variable cost).

47
 Chapater No : 4 Objectives of study

1) Since the overall constant value is the same in any respect ranges of output
and income, the exchange in general fee isn’t always proportional to the
alternative inside the quantity of output.
2) Inclusion of a fixed price for valuing a product leads to outstanding results in
extraordinary intervals as it tends to vary with the exchange in the production
stage.
3) Fixed costs are incurred irrespective of manufacturing or utilization level.
4) Fixed costs are related to a selected accounting period and, consequently,
need to be no longer carried ahead to the subsequent accounting duration in
the form of inventory valuation.
5) Fixed expenses are unimportant for choice-making as these charges stay the
same with output and income quantity. It is one of the objectives of marginal
costing.
Marginal costing allows for determining the level of output which is most
worthwhile for the jogging problem.
The marginal costing method enables determining the most profitable
manufacturing line by comparing the profitability of different merchandise.
Marginal costing is used to know the impact of variable cost on the volume of
production or output.
 Break-even analysis is an integral and important part of marginal costing.
 Contribution of each product or department is a foundation to know the
profitability of the product or department.
 Addition of variable cost and profit to contribution is equal to selling price.
 Marginal costing is the base of valuation of stock of finished product and
work in progress.
 Fixed cost is recovered from contribution and variable cost is charged to
production.
 Costs are classified on the basis of fixed and variable costs only. Semi-fixed
prices are also converted either as fixed cost or as variable cost.
48
It helps to implement budgetary control system in operation
(b) It helps to ascertain performance evaluation.
(c) It supplies the ways to utilise properly material, labour and also overhead
which will be economic in character.
(d) It also helps to motivate the employees of a firm to improve their
performance by setting up a ‗standard‘.
(e) It also helps the management to supply necessary data relating to cost
element to submit quotations or to fix up the selling price of a firm.
(f) It also helps the management to make proper valuations of inventory (viz.,
Work-inprogress, and finished products).
(g) It acts as a control device to the management.
(h) It also helps the management to take various corrective decisions viz.,
fixation of price, make-or-buy decisions etc. which will be more beneficial to
the firm.
 Fixed cost is recovered from contribution and variable cost is charged to
production.
 Costs are classified on the basis of fixed and variable costs only. Semi-fixed
prices are also converted either as fixed cost or as variable cost.
It helps to implement budgetary control system in operation
(b) It helps to ascertain performance evaluation.
(c) It supplies the ways to utilise properly material, labour and also overhead
which will be economic in character.
(d) It also helps to motivate the employees of a firm to improve their
performance by setting up a ‗standard‘.
(e) It also helps the management to supply necessary data relating to cost
element to submit quotations or to fix up the selling price of a firm.
(f) It also helps the management to make proper valuations of inventory (viz.,
Work-inprogress, and finished products).
(g) It acts as a control device to the management

49
(h) It also helps the management to take various corrective decisions viz.,
fixation of price, make-or-buy decisions etc. which will be more beneficial to
the firm
Marginal cost includes all of the costs that vary with that level of production.
For example, if a company needs to build an entirely new factory in order to
produce more goods, the cost of building the factory is a marginal cost. The
amount of marginal cost varies according to the volume of the good being
produced.
Since the overall constant value is the same in any respect ranges of output
and income, the exchange in general fee isn’t always proportional to the
alternative inside the quantity of output.

Inclusion of a fixed price for valuing a product leads to outstanding results in

extraordinary intervals as it tends to vary with the exchange in the production
stage. Fixed costs are incurred irrespective of manufacturing or utilization
level.

Fixed costs are related to a selected accounting period and, consequently,

need to be no longer carried ahead to the subsequent accounting duration in
the form of inventory valuation. Fixed expenses are unimportant for choice-
making as these charges stay the same with output and income quantity. It is
one of the objectives of marginal costing.

50
 Chapater No: 5 Data Analysis & Interpretation

1. what is your gender ?

 Male
 Female

2. what is your age ?

 20-30
 31-40
 41-50
 51-60

3. what is your education ?

 Hsc
 Graduation
 Post graduation
 Other

4. what is you occupation ?

 Businessman
 Employee
 Professional
 Other

5. Do you know the purpose of marginal costing ?

 To help them maximize their potential profits.

 The change in the total cost due to production of one extra

unit

 Controlling
51
  Others

6. What is another name for variable cost in marginal costing?

 Period cost
 Product cost
 Toatal cost
 All the above

7.Do you know about the marginal costing ?

 Yes
 No
 May be

7. Which of the terms given below will help an organisation in

decision-making?
 Total cost
 Fixed cost
 Marginal cost
 Opportunity cost

8.What is another name for fixed cost in the marginal costing?

 Period cost
 Total cost
 Product cost
 All of the above

9. The variable cost is made of ?

 The salary of all employees
 The electricity bills
 Cost of all the raw materials
52
  All of the above
10. Another term for marginal costing is ?
 The production costing
 Direct costing
 Variable costing
 Both b and c
11.The marginal cost will be equal to ?
 All the sales profit minus all the production cost
 The sum of the fixed cost and the variable cost
 Prime cost plus all variables overhead
 Prime cost minus all the variables overhead
12. The kind of cost which will not differ due to the volume of the
production is called ?
 cost
 Variable Fixed cost
 Marginal cost
 None of above
13. The marginal costing technique is useful in making the
following decisions for the management?
 The decision to make or buy
 To determine the price of the product
 To accept fresh orders at a low price
 All of the above
14.The profit-to-volume ratio in marginal costing can be improved
due to the following factors?

 If the fixed cost is decreased

 If the variable cost is increased
 If the selling price is increased
 If the fixed cost is increased

15.The P/V ratio will be equal to ?

53
  The profits by sales ratio
 The profits by the contribution ratio
 The contribution by the sales ratio
 The profits by the sale ratio

16.What is BEP in marginal costing?

 Bank entry Pass
 Break entity point
 Break-even point
 Break entity profit

17. The marginal costing is calculated for which of the following?

 Manufacturing of one additional unit
 Manufacturing of one less unit
 Manufacturing of many additional units
 Manufacturing of many fewer units

18.The costing method where fixed factory overheads are added to

inventory is called ?
 Activity-based costing
 Absorption costing
 Marginal costing
 All of the above

19. Contribution margin in marginal costing is also known as ?

 Net income
 Gross profit
 Marginal income
 None of the above

54
20. Which of the following techniques of costing differentiates
between fixed and variable ?
 Marginal costing
 Standard costing
 Absorption costing
 None of the above

21. Do you know about the marginal costing ?

 Yes
 No
 Maybe

55
56
57
58
59
60
61
62
63
64
65
66
s

67
68
 Chapater no : 6 conclusion

Absorption costing is the basis of all financial accounting systems. It means that
all costs are absorbed (allocated or shared out) into production and operation
statements do not distinguish between fixed and variable costs.
In other words, both fixed and variable costs are included into the cost
calculation. Conversely, fixed costs are not absorbed into production when
marginal costing is used. Marginal and absorption costing could yield different
profit (surplus) figures because they differ in stock valuation. The process by
which overheads are absorbed into product or service costs is known as
absorption costing. If only production overheads are absorbed to products or
services, the process is called absorption costing. If all the overheads, including
non-production overheads, are absorbed into product or service costs, the
process is called full or total absorption costing (Dyson 2001). The process by
which total overheads are absorbed into production or service delivery is
known as (full) absorption costing.
Full absorption costing or the absorption costing method is used to cost
products or services for inventory valuation, and to cost goods and services. It
is called full absorption costing because it fully “absorbs” all manufacturing
overheads (including fixed and variable overheads). Conversely, variable costing
or marginal costing addresses only the incremental or marginal cost of the next
unit of services provided or goods produced. In marginal costing the same
absorption principles and techniques are used, but costing excludes fixed costs
from the absorption.

Variable costing is used in break-even analysis and production volume

optimization. Activity based costing is a “new” approach to costing services
and/or products compared to the traditional approaches. Traditional
approaches frequently use flat rate (broad average) or output as a basis for
overhead allocation and uniformly assign (spread out) the overhead costs to
services and products. In practice, overheads are allocated to the service
(hospital or outpatient) departments using a single allocation base. No attempt
has been made to find specific cost drivers to refine overhead allocation. As a
result, high volume services absorb most of the overheads, but in reality, they
may or may not use most of the overheads.
69
The consequence of this can be under-costing or over costing. In other words,
traditional approaches could over-cost or under-cost services, because
overhead costs could vary with complexity of service delivery (or production)
and not with volume of services or products.

The risk of over or under-absorption is higher for organization where the non-
production overheads are an increasing proportion of the total costs.

ABC tries to overcome this shortfall of traditional approaches by using 7 more

homogenous indirect cost pools, and cost drivers instead of volume or budget
as cost-allocation bases to allocate overheads to products or services. ABC
recognizes that in the allocation of overhead costs there is a closer cause-and-
effect relationship between activities and costs than product or service volume
and costs. The basic assumption of ABC is that the delivery of services requires
a particular set of activities, but activities consume resources.
Therefore, it puts more emphasis on the identification of cost generating
activities. It helps not just in refining costing but also in reducing costs and
identifying non-value-added activities (Lucey 2002, Ridderstolpe 2002).

Although SSAP 9 required that absorption costing should be the basis of

financial accounting, planning and decision-making are usually based on
marginal costing. Both techniques (marginal and absorption costing) have their
advantages, and accountants should select those, which are best suited to the
organization.

70
 Chapater no : 7 Suggestion of the study

Nature of Incremental Analysis Decision-making is essentially a process of

selecting the best alternative given the available information for comparison of
strengths and weaknesses of each alternative. If there exists no alternative to
the current course of action, then there is no decision to be made.
However, it is rare regarding any course of action for there not be alternatives.
In personal decision-making, factors other than income and expenses such as
qualitative factors may be more important than cost in deciding.
However, in business decisions are generally made by identifying the
alternative with the most revenue or the least cost. Incremental analysis is a
decision-making tool in which the relevant costs and revenues of one
alternative are compared to the relevant costs and revenues of another
alternative.
Relevant costs may be defined as those future costs that are different between
alternatives. Costs that are the same are considered irrelevant. Incremental
analysis is sometimes called differential costing, marginal costing, or relevant
costing. Incremental analysis is basically a worksheet technique in which the
relevant costs of one alternative are listed in one column and the relevant costs
of another alternative are listed in an adjacent column. Frequently, an optional
third column is used to show the difference in the costs.
The differences in relevant costs are called incremental costs. Technically,
incremental cost may be defined as the difference between the sum of the
relevant costs of two alternatives. In short, it is a tool for choosing between
two alternatives. The best decision is the one with the least amount of relevant
costs or the greatest relevant revenue.
Incremental analysis is not an optimization technique. Rather it is a tool for
using appropriate cost concepts to measure and evaluate the relevant cost
inputs. It is basic tool for measuring the difference in revenues or costs
between two alternatives.
Incremental analysis is a tool which first requires that the appropriate costs be
identified and then measured. Under appropriate circumstances, incremental
analysis is a tool for evaluating decision alternatives such as:

71
Keep or replace • Make or buy • Sell now or process further • Lease space or
continue operations • Continue or discontinue product line • Accept or reject
special offer • Change credit terms • Open new territory Buy or lease As a tool,
incremental analysis can be used in all areas of a business.
The tool is just as useful in the area of marketing as it is in the area of
production. The objective in using incremental analysis is to identify the
alternative with the least relevant cost or the most relevant revenue.
The difference in the sum of relevant costs is either called incremental cost or
net benefit. Consequently, the alternative with a favorable incremental cost
(sometimes called net benefit) is the desirable alternative. Since this tool relies
strictly on estimated costs/revenues and because the margin of error can be
significant, different computations of incremental cost should be made based
on different cost assumptions. Both optimistic and pessimistic arrays of cost
data should be used. Incremental analysis is an ideal tool for what-if analysis.

72
 Chapater :8 References

Kelly, J.M. (2014) How to find a research topic. Available

at: https://www.jasonmkelly.com/jason-m-kelly/2014/01/08/flowchart-how-
to-find-a-research-topic (Accessed: 28 April 2020).
Kibin (2017) How to make a thesis statement the easy way. Available
at: https://www.kibin.com/essay-writing-blog/how-to-make-a-thesis-
statement-the-easy-way-infographic/ (Accessed: 8 May 2020).
N. N., & Rahman, M. F. A.2 (2015). Access to Government Information in Public
Policy Making Process: A Case Study of Kurdistan. International Information
Institute (Tokyo). Information 18, no. 8 (2015):
 Dr. Vinod K. Singhania (2017), Students Guide to Income Tax, Taxman
Publications, New Delhi

 evaluation and concept Ready Reckoner – A.Y. 2007-08, Tax Mann

Publications,
New Delhi

 Ainapure & Ainapure – marginal costing A.Y. 2014-15, Manan

Prakashan

 Nabi’s marginal Guidelines & Mini Ready Reckoner A.Y. 2013-14 &
2014-15, A Nabhi Publication

 T. N. Manoharan (2007), costing account (7th edition), Snow white

Publications Pvt. Ltd.

 marginal costing evaluation

 Finance Act, 2018.

 Report of Comptroller and Auditor General of India, 2017.

 0- http://in.marginal costing .yahoo.com/taxcentre/ninstax.html

 http://in.biz.yahoo.com/costing .html

73
 http://www.bajajcapital.com/financial-planning.
 http://www.incometaxindia.gov.in

 http://www.marginal.in

 http://www.moneycontrol.com

 http://www.google.com

74